A Public Private Partnership for National Air Traffic Services Ltd (response)

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Introduction

1. This memorandum provides the Government's response to the Third Report of the Environment, Transport and Regional Affairs Committee (HC-35).

2. The Government is deeply disappointed by the report. The Department submitted two memoranda to the Committee and oral evidence was taken from Ministers and officials on 8 December 1999. The Committee's conclusions and recommendations do not properly reflect the Government's case for the Public-Private Partnership (PPP), as expounded to the Committee both during this inquiry and during the Committee's earlier inquiries on the subject. The Government does not accept the Committee's view that its reasons for dismissing the alternative models were "paltry, and at times disingenuous."

3. Nor, because of the timing of the latest inquiry, do the conclusions reflect the further development and explanation of its policies provided by the Government to the Standing Committee on the Transport Bill whose proceedings on the PPP took place after the writing of the Committee's report. In particular, the Committee does not take account of the Standing Committee's discussions on the draft licence, the Partnership Agreement and the Articles of Association for the new company. Furthermore, where the Committee did receive evidence (from the Civil Aviation Authority (CAA)) in support of the PPP proposals it dismissed this as inappropriate.

4. In short the Government rejects the Committee's conclusion that the PPP is the worst possible option given its unwillingness to consider evidence to the contrary In particular, the Committee fails to take account of the unique set of safeguards for safety and public accountability.

5. The reality is that change is essential if our air traffic control arrangements are to continue to meet the increasing demands on our airspace without prejudicing safety. The Government believes that transferring a controlling interest in NATS to the private sector will give NATS the commitment capacity and skills to manage the large and complex investment projects to time and to budget. It will also take air traffic services outside public sector borrowing controls and transfer the responsibility and risks for funding these projects to the private sector. The Government believes that the form of PPP proposed for National Air Traffic Services Limited (NATS) is coherent, robust and will meet both NATS' needs and the Government's wider policy objectives. The Government therefore does not accept the Committee's views on the proposed Public-Private Partnership and will continue to seek the legislation necessary for its introduction.

Background

6. In October 1998 the Government issued a consultation document seeking views on its preferred option for a PPP for NATS. On 27 July 1999 the Government published its report on the response to that public consultation and amplified its proposal for a PPP by confirming its intent to introduce a strategic partner into NATS who would acquire a controlling interest in the company. On 1 December 1999 the Transport Bill was introduced into Parliament containing the Government's detailed proposals for the legal and regulatory framework for the future provision of air traffic services in the United Kingdom. Proceedings of Standing Committee E on the relevant provisions of the Bill took place from 18 January 2000 to 10 February 2000. The Report of the Environment, Transport and Regional Affairs Committee was prepared in January 2000 and was published on 17 February 2000.

7. The Government's policy towards PPPs is described in "Public Private Partnerships: the Government's Approach", published on 15 March 2000. The PPP document outlined the need to devise solutions which are tailored to the particular circumstances of the public enterprise or public service concerned. In the case of NATS, the Government has devised a unique solution to address the particular circumstances. The aim is to establish a partnership between the public and private sectors to provide the UK with the world's best air traffic services in terms of safety, efficiency and capacity to meet increasing demand. It has the following objectives:

  • to enhance aviation safety in the UK by separating regulation from service provision;
  • to maintain NATS' contribution to national security through effective civil/military joint working;
  • to ensure that NATS has access both to the necessary project and management expertise and adequate funding for investment, so as to provide for the long-term development of a safe and efficient national ATC system;
  • to provide NATS with the commercial freedom to develop the business, within the necessary framework of incentives, regulations and other disciplines;
  • to introduce incentive based regulation which will replace the existing "cost-plus" regulation which fails to encourage either timely and productive investment or value for money for airlines and their customers;
  • to ensure value for money for the taxpayer and generate proceeds, which will help fund other transport programmes;
  • to provide capital investment without adding to pressure on public sector borrowing;
  • to ensure the private sector bears the risk of and responsibility for funding the NATS capital programme and new business opportunities; and
  • to maintain effective accountability to Government through the Partnership Agreement, to the Regulator through the Licence and to the wider public interest through the special share.

8. In this response to the Committee, the Government:

  • sets out the case for the PPP;
  • addresses the principal conclusions and recommendations contained in the Committee's report, including in particular why neither the Post Office model nor the trust options meet the Government's objectives.

The Case for the Public-Private Partnership

9. NATS' operational capability is widely considered as world class. It manages some of the world's most congested airspace. There is widespread agreement that the number of flights that it handles will continue to increase each year. As the density in terms of the number of flights added in a given airspace increases, the complexity of managing them increases substantially faster. At the same time developments in technology are making available systems that will allow NATS to cope with these increased volumes and densities safely and also introduce safeguards to improve safety still further.

10. While new technology can therefore manage increasingly dense airspace safely, it presents unprecedented challenges to the management of air traffic services. Judgements need to be made on which technologies offer the best way forward. Expertise is required in defining new projects and then delivering them. These are highly complex and demanding investment projects, requiring management, communication and co-ordination skills to ensure the full involvement of all air traffic personnel. Precise specification of requirements, then first class contracting, project management and implementation are required to ensure the timely introduction of new systems without disruption to the ongoing services.

11. Like other state owned air traffic services companies, and as the committee has noted in the past, NATS has a poor record in terms of the timely delivery of large scale projects and its ability to control project costs. The New En-Route Centre (NERC) at Swanwick was originally scheduled to be operational in 1996. The current operational date is the winter of 2001/2. The original estimated cost was £475 million. An independent audit report commissioned by the DETR from Arthur D Little Limited estimates that the likely cost might be nearer £620 million. This 30% increase is a direct result of poor project management within NATS. In order to avoid this situation arising again NATS and the Government have had to appoint external project managers to oversee the New Scottish Centre project. The contract to build this centre has had to be fundamentally reworked, following a review by the Government of the PFI proposals initiated by the previous administration. The new contract will save around £100 million.)

12. The primary objective of the PPP is to develop the potential of our air traffic control services to the full, so as to provide the UK with the world's best air traffic services in terms of safety, efficiency and capacity to meet increasing demand. The PPP effectively separates both economic and safety regulation from service provision - a move which the aviation industry and the Committee have been seeking for some time. This separation will remove any perceived or actual conflict of interest between the regulator and the regulated. It will also put NATS on the same footing, in respect of safety regulation, as all other UK air traffic services providers including the airport ATC providers, many of whom are already either in the private sector or managed by local airport operators.

13. The Government is also ensuring that the joint and integrated working arrangements between NATS and the Ministry of Defence (MOD) in respect of civil air traffic control will be put on a formal basis via a number of regulatory and contractual arrangements. The Heads of Terms of the principal proposed contract between NATS and the MOD were presented to Standing Committee E. Furthermore, arrangements are being put in place through the Transport Bill to protect the public interest at all times, including in situations of crisis and national emergency. The Transport Bill also includes wide-ranging powers of direction to protect national security. The Government therefore cannot accept the Committee's conclusion that the NATS PPP will undermine national security or reduce the level of service to customers which the current joint civil and military operation delivers.

14. The Government aims to develop new air traffic control operations to the highest standards. It therefore intends to attract a world class strategic partner. This partner will have the capability and commitment to provide complementary skills to NATS' existing world class operational capability. In particular, the Government regards this as an opportunity to introduce and strengthen management skills in areas such as project management, commercial development and marketing expertise.

15. The Strategic Partnership Agreement to be entered into by the Government and the strategic partner will ensure that the Government's interests are at all times fully protected, while day to day control of the business will be conferred on the strategic partner. For instance, significant actions will require the consent of the Government as shareholder before they can be taken. The Government will also have the right to appoint a number of non-executive directors to the board of NATS. The PPP will consequently ensure an alignment of objectives between the strategic partner and Government in their capacities as co-investors in NATS. It will incentivise the partner to transfer its knowledge, resources and expertise to NATS and to develop NATS into a world class company. The Government finds it hard to understand how the Committee could ignore the potential for this unique company.

16. It is the Government's view that the PPP will provide a secure vehicle for the major investment programme (estimated to be of the scale of about £1 billion over the next ten years), which the Committee acknowledges is needed, by removal of the inherent conflicts of total Government ownership. It will also allow NATS to expand, perhaps selling its safety control expertise abroad to the benefit of UK businesses and passengers using airlines of all countries. This sort of commercial venture would be more difficult if NATS were to remain classified to the public sector. In particular, there is potential for gradual revenue growth through NATS playing a leading role in the expected (and desirable) consolidation of European en-route services from the current large number of providers to a handful of major, commercially focused providers and from opportunities that are expected to emerge globally as other countries look for help in modernising and developing their air traffic services capabilities. For most countries, this will be beyond the human and financial resources they are able, or willing, to commit by themselves.

17. NATS' United Kingdom operations will in future be conducted within a new framework of economic regulation which will provide incentives for good business management whilst preserving the integrity of the safety regime. In particular, NATS will be incentivised to develop and implement a new capital investment programme on a timely and efficient basis. This will have a material positive impact on NATS' cost base. It will be achieved through a combination of obligations under the Licence and the Strategic Partnership Agreement in relation, amongst other things, to the development, maintenance and operation of the New En-Route Centre (NERC) and the New Scottish Centre (NSC). The Licence will also contain conditions relating to the development by NATS of long term capacity and investment plans built on a process of public and user consultation and subject to regulatory approval. Further conditions will ensure the maintenance of the asset base required for the continued effective operation of the business whilst protecting against monopoly abuse. In addition, the prices that NATS will be permitted to charge for its en-route services will be regulated by the Civil Aviation Authority. The RPI-x mechanism will also contain an incentive to achieve specified service quality levels. It is worth noting that this regime for economic regulation follows that already applying to the BAA's London airports and to Manchester Airport. It is proven to deliver reduced real prices to customers, and to provide an incentive both to efficiency and to the development of new revenue streams from commercial activity, consultancy work and overseas acquisitions.

18. The Committee notes that the UK is the only country considering a PPP. In fact this initiative is generating much interest from several governments that are beginning to evaluate options for their own air traffic service providers. For example, the Dutch Government is very interested in the principles of the PPP in the UK. During a recent visit to the UK the Dutch Transport Minister made a public statement to the effect that the first step towards the creation of a European 'Single Sky' will be the separation of regulation from air traffic service provision (LVNL in the Netherlands). This has already taken place in the Netherlands. The Dutch Minister commented that the NATS PPP could provide an interesting model for the future of air traffic services in that country.

19. The Committee also did not take account of the European Commission's recent initiative of a single sky for Europe. In particular it fails to note the benefits that could accrue for the UK in creating a business better positioned than any other to make the most of opportunities globally as they emerge.

20. The PPP will deliver value for money because it will improve further the management capability of NATS, secure the market price for the sale of a 46% stake to a strategic partner and retain for the public sector a 49% interest in a successful business enterprise. Importantly, the PPP will bring advantages for employees. NATS ' employees will continue to belong to the Civil Aviation Authority Pension Scheme and will be entitled to receive the benefits that scheme offers and will also be able to share in the success of the PPP via the 5% interest in the shares of the company which it is proposed to make available to them.

21. The Government remains firmly of the view that the PPP is the right solution for NATS - it will maintain safety standards, secure the investment NATS needs and quickly broaden NATS' management skills, which will enable the company to implement effectively the major investment programme. The PPP will also provide NATS with the ability to expand overseas and become a world class company through which the UK benefits.

Government response to the principal conclusions and recommendations of the third report

(a) Whatever else is decided about the future status of NATS, to effect proper safety regulation of the company the status quo cannot continue (paragraph 5).

22. The Government welcomes the Committee's conclusion that the status quo cannot continue. As part of the PPP restructuring, NATS ownership will be transferred from the Civil Aviation Authority (CAA) to the Government. 46% of the company will then be sold to a strategic partner and 5% made available to the employees. The remaining 49% will be held directly by Government. This structure will separate service provision from regulation. We believe that this restructuring meets the Committee's legitimate concerns in this area.

(b) The Government has failed, in its evidence to us, and more generally, to make a positive case for the public-private partnership for NATS. It has also failed to give adequate reasons for rejecting the options of establishing the company as an independent publicly-owned corporation, or as a trust or non-share-capital corporation, similar to NavCanada (paragraph 75).

(g) The trust model, as adopted by NavCanada, would meet the main objectives of the public-private partnership, freeing NATS to borrow on the private market, and separating the company more clearly from its regulator, the CAA. Despite the Government's contrary view, we believe that NATS would face strong demands to become more efficient, because its customers, the airlines, would be involved in its management. However, there would be no over-riding commercial pressure to maximise profits, thus jeopardising safety standards. Moreover the Government would receive significant revenue from the sale of the whole of the company. In short, since customers, staff, and the Government would all be involved in the provision of air traffic services, the trust model answers concerns about rising charges, lower safety standards, national security considerations, and the future international development of air navigation services. We therefore strongly recommend that the Government should establish a trust, or non-share-capital corporation, as the owner of National Air Traffic Services Limited (paragraph 82).

23. The Government is adopting different solutions for the future structures of public sector organisations because the needs of the organisations vary. It believes that the structure proposed for the NATS PPP is the most effective method of meeting its stated objectives. The Government studied carefully various other models, including the Post Office Model and the NavCanada model before coming to this conclusion.

Post Office Model

24. There are two key areas where the Post Office is different from NATS. The Committee referred to them in its report but did not consider fully their implications.

25. Firstly, the nature and scale of the investment required by NATS is very different. The Post Office's investment is straightforward and small compared to its huge turnover (about £7 billion in 1998/99). By contrast NATS' core business is dependent on delivering costly, complex, high technology infrastructure, such as the New En-Route Centre and the New Scottish Centre. The Committee, in its Fourth Report of the 1997/98 session, recommended that the costs and the history of the Swanwick Centre project should be studied in order to learn lessons from it. Reports commissioned by the Department to follow up the recommendations of the Committee found shortcomings in the management of the project- these included strategic, organisational and cultural problems. The Government is therefore committed to pursuing an approach for NATS which will involve a private sector partner with appropriate expertise to secure delivery of large projects to budget and to time and without adding to pressure on public sector borrowing. The Post Office model would not do this.

26. Secondly, the Post Office is operating in an increasingly competitive market, and a new postal regulator will regulate prices and encourage competition. NATS' core business (the en-route and oceanic business) is a monopoly and is therefore not exposed to competition.

27. The Post Office model therefore would not bring the benefits listed below to NATS, which the Government considers essential to the future of NATS and the UK:

  • transfer of operational control to a private sector strategic partner with the necessary expertise, commitment and skills to help NATS deliver its investment programme on time and to budget; and
  • A framework which balances private shareholder scrutiny with commercial freedom from Government, with the private sector bearing the risk of, and providing the funding for, NATS' capital programme and new business opportunities;
  • introduction of commercial dynamism and innovation into what is a natural monopoly.

28. Adopting a Post Office type approach would compromise the Government's objectives for the PPP and would not therefore be in the interests of NATS, its customers or the taxpayer.

The NavCanada Model

29. The other model advocated by the Committee was an approach similar to that used for NavCanada. NavCanada is a private sector, non-share capital corporation with voting and non-voting members rather than shareholders. It sets its charges to recover costs. It does not distribute profits; any excess earnings are reinvested in the company, kept as operating reserve, or used to reduce debt or user charges. The airlines bear the full financial risk of the organisation without being in a position to be able to manage that risk. This is something which the UK airlines, in their response to the Government consultation, warned against. The UK organisation whose corporate structure bears most resemblance to NavCanada is the BBC.

30. The Government does not believe that the NavCanada model is appropriate for NATS. Firstly, the board, comprising representatives of government, airlines, unions and 'independents' is not itself accountable to anyone. The Government considers this to be undesirable, especially in a service as strategic and sensitive as air traffic control.

31. Secondly the Government does not believe that the NavCanada model would provide the platform to bring in a committed world class strategic partner to inject complementary expertise to NATS' operational skills.

32. Thirdly the Government does not believe that the NavCanada model would provide sufficiently strong incentives to improve its performance. It would not bring shareholder scrutiny to bear on NATS' operational efficiency or business development because NavCanada has no equity, only debt. Without shareholders - who have put their own money at risk - the incentive would be lacking and all costs, irrespective of the level of inefficiency or even incompetence that cause them to be incurred, would be passed on to users in the form of higher charges than would otherwise be the case.

(c) We do not believe that it is appropriate for the CAA, as an economic and safety regulator, to give the impression that it is an advocate of the public-private partnership. It would be more sensible for it to take a disinterested view (paragraph 78).

33. The Government believes not only that the CAA is entitled to take a view on the PPP arrangements, but that its acquisition of new responsibilities mean it would be irresponsible for it not to do so. In addition to its continuing role as the safety regulator, the CAA will become the economic regulator - responsible for controlling charges and encouraging competition where appropriate - and the airspace regulator. The Government would expect the CAA to satisfy itself that the PPP is consistent with its continuing ability to discharge all of its responsibilities. The Government welcomes the continuing support of the CAA for the proposed PPP. This reflects not only the soundness of the PPP model but also the robustness, detail, efficiency and transparency of the proposed new regulatory framework. This recommendation reinforces the belief that the Committee gives undue weight to the views of those who either oppose the PPP, or want to maintain the status quo, whilst paying little regard to the legitimate views of those in favour of it.

(d) The current proposal for a public-private partnership for NATS is, in our view, the worst of all the possible options for the future structure of the company. It would lead to operational control of NATS, other than in extreme situations, being ceded to a private investor which is very likely to seek either to cut costs, jeopardising safety, or to increase revenues, by raising charges to its customers, putting airlines and airports in the United Kingdom at a competitive disadvantage. It would also give rise to other concerns about NATS continued commitment to Eurocontrol, about matters of national security, and about the future provision of non-commercial services which are vital to safety. There are questions about the validity of the special share the Government intends to hold in the company. Moreover, the Government's revenue from the sale of control of NATS would be extremely small. Even a full privatisation would at least generate a reasonable revenue for the sale of the company (paragraph 79).

34. The Government does not accept that its PPP solution for NATS is the worst possible option and feel that the Committee have not considered properly the benefits of this solution. This is clear from the evidence they have cited in their report. The Government has taken a practical approach in developing a solution that best meets its stated objectives. When looking at this country's publicly owned industries and assets we seek to develop solutions that meet the Government's, industry's and broader policy objectives while doing what is right for the business in question. This is why there are differences between the options for the Post Office, the London Underground, the Docklands Light Railway, NATS and many of the other businesses for which we are seeking to produce innovative solutions for the 21st century.

35. The Government does not accept the Committee's view that safety will be jeopardised by the PPP. The evidence does not support the conclusion. The separation of regulation and service provision inherent in the PPP will strengthen the existing robust safety regulatory framework. There is no basis for the insinuation that NATS will be permitted to cut corners on safety in order to make more money. The Government has taken every opportunity to emphasise that under the PPP safety will be of paramount importance, and has been conducting constructive discussions with the trade unions most closely concerned about the preservation of the safeguards which exist under the current arrangements. These include a strong and robust role for the Safety Regulator; the preservation of the NATS Safety Management System; and the continuation of key schemes already used by NATS to ensure that any safety threat is identified swiftly (i.e. the Mandatory Occurrence Reporting Scheme, Airprox reports, the UK Confidential Human Incident Reporting Programme and overload report schemes).

36. NATS will address the question of costs in other ways. The Government is establishing a comprehensive and strong framework of incentive-based regulation which will encourage greater efficiency- for example through more effective capital investment, while improving services and standards and ensuring the application of the world's best practice safety regulation. The Government does not agree with the Committee that there is no scope for efficiency improvements. Improvements were not likely to emerge from the cost-plus regime under which NATS is currently operating. But once there is a more suitable charge control regime in place, NATS will have an incentive to be as efficient as possible subject to other relevant regulatory constraints, including service standards and most importantly the safety regime. At the same time, the charge controls - which will themselves be set taking full account of NATS' prospective costs, capital expenditure and growth requirements - will cap NATS' allowable revenue and unit charges, so addressing the airlines' concerns about increased charges.

37. The Committee's conclusion also registers concern about the implications for national security and the future provision of non-commercial services, which are vital to safety. As regards national security, the Committee will have observed the comprehensive powers proposed in the Bill and the CAA Board will also be strengthened by a non-executive director from MOD. The draft Licence made available to the Standing Committee provides for the Licence to be revoked if there is a change of control or acquisition of material influence in NATS' licensed business which would in the opinion of the Secretary of State be against the interests of national security or relations with the Government of a territory outside the UK.

38. The Committee's concern about the future of a number of non-commercial safety services is not justified. These services are not currently provided exclusively by NATS as the Committee believes. The Civil Air Notification Procedure was set up by the MOD and NATS has no role in providing it. The Lower Airspace Radar Service is provided by 17 military air traffic units and 12 civil units, of which only two are NATS. The Distress and Diversion services are entirely provided by military air traffic controllers at both West Drayton and Prestwick with NATS providing only the VHF communications. The MOD intend to sustain these services to civil aviation and the PPP does not pose any threat to their continuation. Furthermore, the Committee will now have observed that the draft Licence placed before Standing Committee E envisages future provision of certain such services to be the subject of Licence obligations. Although, some currently attract little or no charge in their own right, many of these services are provided in support of the core services for which charges are made. There is certainly no question of the provision of any service which is material to safety not being assured.

39. The Government is unsure why the Committee has drawn the conclusion that the NATS PPP will no longer be committed to EUROCONTROL. The facts here are quite clear. The UK will continue to play a full and active role in European Programmes to enhance air traffic safety and capacity. NATS and other service providers will also be involved in this work and, like all service providers would be bound by joint decisions. There is provision in the Transport Bill to enable the Government to direct NATS in relation to the meeting of international obligations. The vast majority of revenue from NATS' regulated business will be generated through the EUROCONTROL charging arrangements. Therefore, it makes perfect commercial sense for NATS to continue to play a full role in that part of the organisation's work.

40. The Committee also questions the sustainability of the Government's proposal for a special share in NATS. We have received legal advice that the proposed special share is compatible with our EU Treaty obligations, as was made clear in Standing Committee E. If the EC Commission were to challenge our proposal for the special share, the Government would defend its position vigorously.

41. The Committee, in paragraph 73, refers to the "£20 million it (the Government) seems likely to receive under the public-private partnership." It does not take account of the explanation given to the House by Ministers both in the debate on the Committee's report on aviation safety on 16 December 1999 and again during the Second Reading of the Transport Bill on 20 December. As has been made clear yet again to Standing Committee E, the Government expects to receive several hundred million pounds. Two distinct transactions will take place under the proposed PPP. The first is that NATS' existing debt (likely to be between £300 million and £350 million at the time of the PPP) will be repaid to the Government and refinanced. The second is that a stake of 5 per cent will be made available to employees and 46 percent to a strategic partner. This second transaction will realise proceeds, initially estimated at £350 million, but potentially substantially more. This figure is net of (i.e. in addition to) any debt re-financing.

(e) Although we do not support the public-private partnership, we recommend that, if it is to be established, the Government should only sell the remaining stake to a bidder committed to making no commercial return on NATS operations (paragraph 80).

42.The Government is fully prepared to consider all proposals from bidders which meet its evaluation criteria whether or not they plan to make a commercial return from NATS' operations. All bidders will be required to satisfy the Government about their suitability as partners as well as capability and commitment to the Government's stated objectives. Bidders must be above reproach on grounds both of national security and general probity in order to be considered. Shortlisted bidders will be required to develop and then commit to business and long term development plans. They will also need to satisfy the Government on conflict of interest issues. The Government will also assess all bids on value for money.

(f) If the Airline Group or a management team, or even another bidder, were to succeed in acquiring the 46 per cent stake in NATS, and to operate the company on a not-for-profit basis, it would be possible, subject to a number of conditions, to structure the company in a way similar to a trust model such as NavCanada. The conditions would include guaranteeing the staff, as owners of 5 per cent of the company, at lease one place on its board. another condition would be that the 'stakeholder' council would require greater power to put forward its advice. Conditions would have to be placed on the company, to ensure that it did not unduly favour members of the airline Group: similar conditions already bind NavCanada. If these conditions were met, the proposed public-private partnership might be at least partially redeemed. Nevertheless, the Government would not have maximised the revenue it might be able to generate in exchange for ceding operational control of the company (paragraph 81).

43. The Government agrees with the Committee that any bid would need to be looked at closely to ensure that individual shareholders are not unduly favoured in any respect. All prospective partners will need to demonstrate conclusively that their approach to running NATS would be wholly consistent with the Government's objectives for the PPP. However it should be stressed that the Government has not yet invited any bids from parties wishing to be the strategic partner, so it would be inappropriate to form any firm views on the suitability of any potential partner. When the bidding process commences, the Government will act with transparency and impartiality to ensure that all bidders are treated fairly and equally.

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