In 1991, following the apparently successful Swedish example and wishing to create an environment where new rail operators could enter the market, the European Union issued EU Directive 91/440. This required of all EU member states to separate 'the management of railway operation and infrastructure from the provision of railway transport services, separation of accounts being compulsory and organisational or institutional separation being optional', the idea being that the track operator would charge the train operator a transparent fee to run its trains over the network, and anyone else could also run trains under the same conditions (open access). Directive 91/440 requires the 'liberalisation' of railways within the EU and for them to operate in a 'competitive market'(see http://www.dft.gov.uk/consultations/closed/eurailpassengers/). The Directive provided the British government with a blueprint for the wholesale privatisation of the railway industry. As of 2004, Ireland and Greece have yet to comply with Directive 91/440 and its successor. Ironically, the United Kingdom has not fully complied with the directive, as no moves towards compliance were made to the state-owned Northern Ireland Railways, which has always been separate from British Rail.

In Britain, Margaret Thatcher was replaced by John Major as leader of the Conservative Party at the end of 1990. The Thatcher administration had already sold off nearly all the former state-owned industries, apart from the national rail network. Although the previous Transport Secretary and arch-Thatcherite Cecil Parkinson had advocated some form of privately or semi-privately operated rail network, this was deemed 'a privatisation too far' by Thatcher herself. In its manifesto for the 1992 General Election the Conservatives included a commitment to privatise the railways, but were not specific about how this objective was to be achieved.They unexpectedly won the election on 9 April 1992 and consequently had to develop a plan to carry out the privatisation before the Railways Bill was published the next year. The management of British Rail strongly advocated privatisation as one entity, a British Rail plc in effect; Prime Minister John Major favoured the resurrection of something like the old "Big Four" geographical railway companies that had existed before 1948; however, the Treasury, under the influence of the Adam Smith Institute think tank advocated the creation of seven, later 25, passenger railway franchises as a way of maximising revenue. In this instance it was the Treasury view that prevailed.

The Railways Bill, published in 1993, established a complex structure for the rail industry. British Rail was to be broken up into over 100 separate companies, with most relationships between the successor companies established by contracts, some through regulatory mechanisms (such as the industry-wide network code and the multi-bilateral star model performance regime). Contracts for the use of railway facilities - track, stations and light maintenance depots - must be approved or directed by the Office of Rail Regulation, although some facilities are exempt from this requirement. Contracts between the principal passenger train operators and the state are called franchise agreements, and were first established with the Office of Passenger Rail Franchising (OPRAF), then its successor the Strategic Rail Authority and now with the Secretary of State for Transport.

The passage of the Railways Bill was controversial. The public was unconvinced of the virtues of rail privatisation and there was much lobbying against the Bill. The Labour Party was implacably opposed to it and promised to renationalise the railways when they got back into office as and when resources allowed. The Conservative chairman of the House of Commons Transport Committee, Robert Adley famously described the Bill as "a poll tax on wheels"; however Adley was known to be a rail enthusiast and his advice was discounted. Adley died suddenly before the Bill completed its passage through Parliament.

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The New Labour government (elected in 1997 once almost all of the privatisation process had been completed) did not fulfil its earlier commitment to keep the railways in the public sector. Instead, it left the new structure in place, even completing the privatisation process with the last remaining sales. Its one innovation in the early years was the creation of the Strategic Rail Authority (SRA), initially in shadow form until the Transport Act 2000 was brought into force on 1 February 2001 and the SRA assumed its full legal powers.

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In 2004, the Labour Party Conference voted by 2 to 1 in favour of a TSSA motion calling on the government to take the TOCs back into public ownership as franchises expired. The policy was however immediately ruled out by the then Transport Secretary Alastair Darling.