Proximo Weekly: What next for UK water?
If the UK decides that a radical change in direction is needed in the ownership structures used in UK water, can it make sure that the debt structuring baby is not thrown out with the equity bathwater?
For both good reasons and bad, the UK water sector does not get the credit it deserves as a cradle of financial engineering in infrastructure finance.
As the UK’s standing in global infrastructure procurement declines, so does the relevance of its experience to other jurisdictions. But just as the UK’s track record with the Private Finance Initiative once inspired PPP programmes across the world, the UK’s record in raising long-dated bond debt against water assets was once tipped to be very influential in broadening the debt and equity investor base for essential infrastructure.
The wholesale privatisation of water assets never really took off. As long ago as the late 1990s, water privatisation sparked riots, most notoriously in the form of Bolivia’s Cochabamba Water War. Argentina’s 2001 economic crisis threw that country’s water privatisation into reverse. After a few hesitant early moves, UK utilities’ efforts to crack the American market came to nothing.
But the English water sector eventually gave Canadian pension funds, GCC sovereign wealth funds and foreign utilities some of their earliest experiences of cross-border infrastructure ownership. The acquisitions have invited parallels with the foreign, usually state-owned, operators that now dominate the UK rail sector.
Until recently that comparison was a little unfair. The private operators generally have run their assets better than their London listed predecessors. But more recently, confronted with consistent reports of water companies discharging sewage into rivers and onto beaches, a broad chorus of opposition to the private operators has started to coalesce.
Two major UK newspapers – the Financial Times and Guardian – have recently run a series of articles looking into the regulatory regime and finances. The former suggests that the framework for English water regulation is not up to scratch, while the latter points to foreign ownership and debt levels as evidence that something is amiss in the sector.
The English regulatory system – with Ofwat at its head – has created a stable framework for financing the water sector, generally keeping bills low and avoiding nasty surprises for asset owners. It has required companies to inject equity when their leverage ratios were not strong enough, though critics of the industry tend to point to both dividends and equity injections as evidence of the essential dysfunction inherent in English water.
But this regime generally has not been up to the job of encouraging big investments in outdated water systems. The £4.2 billion Thames Tideway Tunnel was financed in 2015 at a weighted average cost of capital of 2.497%, but only by being carved out of the balance sheet of London’s water utility, Thames Water. The UK government also had to accept some residual risks to get the SPV’s investors comfortable with the project’s risk profile.
The sharper-eyed reader will notice that this article switched from talking about the UK system to the English system quite early on. Why? Because the Scottish system, in which state-owned utilities contract with private infrastructure operators for specified services, has become much more influential, except in areas with very powerful public sector unions. It’s how most major investments in treatment and desalination in the GCC region have been financed. Were Thames Water ever to be nationalised, the Tideway Tunnel would look a lot like that structure as well.
The English water financing model was briefly very influential. In the early noughties a vogue for whole business securitisations took in obvious candidates like water companies and airports, where a regulated asset base regime allowed for some revenue stability, as well as less obvious, but more fun assets, like pubs, record companies and VCR rental companies (remember those?).
These structures essentially used the UK’s highly creditor-friendly bankruptcy regime to win attractive debt costs for businesses with stable revenue regimes. Critics of the UK water industry complain that shareholders have used access to low-cost debt to extract too much in dividends and invested too little in infrastructure upgrades, though these critics can rarely point to what the right, wrong, or actual mix of these two purposes might be.
The Proximo perspective
There is unlikely to be any immediate move to renationalise England’s water companies. The Labour Party, which has a good chance of winning the UK’s next general election, has retreated from an earlier promise to take the sector back into public ownership, promising only a tougher line on leaks and sewage discharge. Still, the UK’s rail sector, which is sliding fairly rapidly back from private ownership, offers something of a model for how a set of private water operators might be coaxed back into public hands.
There’s even a precedent for this process, a precedent that kickstarted the entire water securitisation boom. In 2001 Glas Cymru, a non-profit company limited by guarantee, bought Welsh Water from Western Power Distribution, then a subsidiary of US utility PPL, but now a part of National Grid. Glas Cymru financed the acquisition with a £1.9 billion bond issue. Its private peers in England took note.
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PPP route for new Aloha Stadium
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Philippine PPP Act passes on third reading
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Globeleq seals debt funding for Menengai geothermal project in Kenya
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SOUTH AMERICA
STM's Enel Chile acquisition debt closed
The acquisition financing backing the $1.399 billion purchase of Enel's Chilean electricity transmission assets by Sociedad Transmisora Metropolitana (STM) – which is controlled by Grupo Saesa – reached financial close on 1 December, five days before the sale was completed.
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