Select Committee on Treasury Written Evidence

Memorandum submitted by T. Martin Blaiklock, Consultant, Infrastructure & Energy Project Finance


  The Treasury Committee has requested comments with respect to Private Equity.

  I have been a consultant, banker and practitioner in infrastructure and energy project finance,—PFI, PPP and the like,—for the last 30 years or more, with both UK and wide overseas experience. I also regularly give seminars on these topics internationally.

  My concern with respect to Private Equity, therefore, is with its impact on the performance and sustainability of UK private sector, public service utilities, a topic which, surprisingly, has seemingly been overlooked by the Financial Regulator (FSA), sector regulators and the media in recent discussion on Private Equity.


1.   Is the current regulatory regime for private equity funds suitable?

  In short, the answer is "no". This response requires some qualification:

    (a)  The FSA controls the nature and governance framework of investment flows by Private Equity managers in the UK. In this context, whether the investment is in a public service utility or commercial enterprise and where the funds originate from are not the concern of the FSA.

    (b)  Each privatised public service sector has its own sector regulator, eg OFWAT, Ofgem, CAA, etc.. When these regulatory bodies were created, usually by Act of Parliament in the late 1980s / early 1990's, it was not foreseen in the relevant Acts that ownership and control of utilities in the sector(s) would slip into anonymity, beyond public scrutiny and governance. It was assumed, erroneously, that these private public service utilities would fall under the normal governance criteria and financial regulation as imposed by the London Stock Exchange and the FSA.

    (c)  Time has shown that to have been short-sighted, and the City et al. have used their ingenuity and incentive-for-profit to exploit the investment opportunities that such utilities with their strong cash-flow characteristics represent. To date, the sector Acts have not been adjusted or repealed to claw-back the regulatory levers necessary to protect consumers and the public interest.

    (d)  Additionally, over the last 15 years there has been significant growth in the number of PFI/PPP transactions, representing private concessions for the provision of public services and assets—now totalling 6-700 in the UK—where the ownership and control of the Special Purpose Vehicle ("SPV"), which carries concession responsibility, often lies with Private Equity.

    (e)  Finally, in the same context many UK public service utilities are now owned and/or controlled by private family groups or individuals, whose domicile may well be offshore in some tax-haven. These too are, generically, Private Equity operations.

    (f)  Some examples of a few Private Equity-owned and/or controlled utilities may help to put some perspective on the services involved:

    —  BAA (Heathrow, Gatwick & Stansted, etc.)

    —  Thames Water

    —  South East Water

    —  Jubilee, Northern & Piccadilly Lines of London Underground

    —  M6 Toll Road

    —  90% of the UK's Ports

    —  GCHQ (40%)

    —  Inland Revenue & Customs & Excise Estate

    —  Isle of Man & Isle of Wight Ferries

    —  NHS Hospitals (eg Darent Valley; Norfolk & Norwich)

    —  Arquiva (mobile phone mast & broadcast monopoly)

    —  Seafield Water Treatment Plant, Edinburgh

    (g)  At a recent Public Accounts Committee session (Dec 11, 2006) a senior Treasury official admitted that they (HM Treasury) had no control over who bought or sold PFI/PPP-type of public service utilities, and they are seemingly content with that position.

    (h)  No other Government I know is prepared to accept such a scenario with respect to its public services. All other Governments impose some form of "fit and proper person" or probity test on all private owners of public service utilities. This requires identification of owners/controllers and proof of adequate corporate and financial governance measures and experience

  Hence, one concludes that UK regulatory regime for (Private Equity) investment in public services is, at least, out-of-step with other nations, and also inadequate.

2.   Is there sufficient transparency on the activities, objectives and structure of private equity funds for all relevant interested parties?

  What are the effects of the current corporate status of private equity funds, both their domicile and ownership structure?

  (a)  These questions are best answered by three examples.

  Thames Water: since last October, as a customer of Thames Water, I have been trying to find out as to whom and where are the investors controlling Thames, the largest water utility in the UK (13mn customers). To date, I have failed!

  Para 4.31 of the Feb 2007 Ofwat Consultation Paper into the recent takeover of Thames demonstrates clearly that a group of "Macquarie Bank investors", under the name of "Kemble Water International Holdings Limited", some of whom—possibly all—are domiciled in Luxemburg, control the strategic direction of the Company and, possibly more.

  To date the Company Secretary has refused to divulge to me the identity and domicile of such investors, and OFWAT, The Consumer Council for Water, the Freedom of Information Act, the OFT, the Competition Commission, my Member of Parliament, and the Parliamentary Ombudsman have been unable to assist me to force the Company to reveal such information. Yet Thames enjoys a monopoly position as a provider of an essential public service to 20% of the UK's population and London!

  OFWAT has a duty under the Water Industry Act 1991 to "safeguard the future" of the water utilities for the benefit of customers. If OFWAT does not know who are the service providers, what chance is there of the future being safeguarded??

  [Note: Under the Water Industry Act, if I receive water services, I have a duty to pay. I also have no choice as to my supplier of this essential public service. The fact that I do not know who may be the beneficiary of my payments is not covered by the Act. This seems contrary to natural justice!].

  (b)  GCHQ: Integrated Accommodation Services plc, "IAS", is the owner and is the concessionaire under a PFI/PPP arrangement for the GCHQ building. The ownership of IAS at the outset (yr 2000) was: Carillion [40%], Group 4 [40%], and BT [20%]. Carillion was in charge of construction and Group 4 in charge of site security, accommodation availability, maintenance and service (eg manage the security staff: ref HC (955, p. 22)).

  In May, 2004 it was announced that Group 4 had sold off its GCHQ investment to two Private Equity funds. In May 2005, under the Freedom of Information Act, I requested from the FCO (who has responsibility for GCHQ) details as to the identity and domicile of the shareholders of IAS. The FCO responded that they did not hold such information!!

  (c)  Water Treatment Effluent Disaster (Edinburgh): in April 2007 a faulty pump at a PFI waste treatment plant at Seafield near Edinburgh, serving 800,000 people and operated/controlled by Thames Water, failed and may have caused an environmental disaster in the Firth of Forth. It may also, in time, give rise to local health concerns to a wide section of Edinburgh's population.

  As mentioned earlier, Thames is controlled by an offshore Private Equity company based in Luxemburg. Seafield, which is controlled by Thames, will, like many such PFI/PPP projects, indubitably be set up as a limited liability company. In 1999 Seafield won the PFI concession to build and operate the treatment plant, and raised £5 million of equity capital and £95 million of debt as funding: a highly geared financial structure.

  In the current scenario of pending environmental disaster, if insurance monies are inadequate to meet claims, there will be minimal capital in the Seafield company available to cover shortfalls. Secondly, the owners, ie Private Equity shareholders of Thames, will be largely unidentifiable and offshore, so outside UK jurisdiction. Thirdly, the Private Equity fund managers will, under the financial arrangements made with their fund, carry no responsibility or liability.

  Is this scenario desirable? I think not, but this is the creation of Private Equity.

3.   Has there been any evidence of excessive leverage in recent transactions and what systematic risks arise in consequence?

  This question is best answered by reference to two examples: in the water utility and road transport sectors respectively. To these should be added the comments made in 2 (c) above in this context.

  (a)  Water: in the early 1990's, shortly after privatisation, the rating eg Standard & Poors, Fitch, etc, of the average water utility was "AA-", ie comprised a "very strong capacity to repay debt". Now, 15 years on, the majority of water utilities have a "BBB" rating or thereabouts, ie "protection of interest and principal is moderate", just above the investment/sub-investment ("junk") rating watershed.

  (b)  When the rating agencies all express concern at the steady decline of the investment grade status of the UK's private water companies' debt, as they have in recent months, the time has come to worry!! Thames' debt is only one notch or so above ";junk" status. The financial structure for Thames proposed by the new Private Equity owners, which increases leverage, will increase, rather than reverse, this trend.

  [NB. Thames is currently rated "BBB-", one grade away from being sub-investment level. Its debt can be described as where "protection of interest and principal is moderate". Thames is, therefore, nine levels below "AAA" status!]

  (c)  In this context, I have expressed concerns to Ofwat over their over-reliance under their regulatory regime on ratings to assess the financial health of UK's private sector water utilities. Ratings are useful, but not the only tool to be used. Secondly, it is somewhat alarming that there seems to be no "Plan B" for when a water utility does slip into "junk" status.

  (NB. The Wessex Water case, oft cited by OFWAT et al. as an example of recovery in such circumstances, is hardly appropriate. The problems at Wessex were not so much a problem of Wessex, as a utility, but the problems of their non-UK parent at the time, Enron. It is also worth recalling that the rating agencies placed Enron debt well into investment grade status up to a few days before Enron collapsed!).

  (d)  Transport: a casual glance at the (unaudited) accounts of Midland Expressway (the M6 Toll Road), owned and controlled by Private Equity (a Macquarie offshore investment fund), shows (end-2005) that the company has a negative net worth of £67 million, issued capital of £1.5 million, and paid no income tax to the Exchequer. With £800 million or more of debt and £1.5 million of equity capital, the project company, M6 Toll, is indeed highly leveraged!!

  In August 2006, Midland raised £1 billion of new debt, paying off what was outstanding (£650 million) of the original debt, and paid its offshore Private Equity shareholders a dividend of £392 million!!!—a return on equity of over 200% per annum since the start of operations in 2001!!!

  (e)  The main conclusions drawn from these two examples are:

    (i)  in the context of Private Equity investors in public utilities, there needs to be (a) a rescue plan in place in the event of default; and (b) requirements (eg on-demand performance bonds) under the licences to incentivize utilities against possible default. These are issues for sector regulators;

    (ii)  lenders to privately-owned/quoted public service utilities seemingly are also attracted by the high(er) margins (ie returns) that some of these Private Equity transactions represent, leading them into imprudent lending. That is an issue for the FSA, as deal collapse could place some banks in peril; and

    (iii)  Private Equity investors are not averse to paying themselves excessive profits/dividends, when the opportunity arises!

4.  Are developments in the environment and structure of private equity affecting investments in the long-term?

  Yes. Again, the answer is best provided through example.

  (a)  In the periods 2001-02, 2002-03 and 2003-04, before the takeover of South East Water by Private Equity (Macquarie Investment Fund, ie Private Equity), some 60% of profits on average were distributed as dividends, the balance retained in the company boosting internal capital.

  After the takeover, the dividends in 2004-05 and 2005-06 represented 150% and 250% of funds available for distribution, ie the company was distributing dividends to its shareholders (in the tax-haven of Luxemburg) more money than the utility was generating as profit, ie the company was eroding its capital base. Some might call this "asset stripping".

  In addition, in 2005-06 this erosion of shareholder capital amounted to £26 million. This will constrain South East's ability to raise funds for new investment in the future.

  (b)  To constrain such activities, OFWAT on occasion imposes "ring-fencing" on dividend payments. However, it is not beyond the accounting profession to devise methods (eg shareholder loans, consultancy fees, etc.) to circumvent such constraints and to minimise taxation for the Exchequer. Conclusion: sector regulation is ineffective on this issue.


  The over-riding conclusion is that the intervention of Private Equity as an investor class in private sector, public service utilities in recent years has shown clearly that the financial and operational regulation for such utilities is out-dated and needs adjustment to be able to provide the public with the service protection they deserve.

April 2007

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