Environment, Food and Rural Affairs CommitteeWritten evidence submitted by T Martin Blaiklock, Consultant, Infrastructure & Energy Project Finance

1. The Minister states in the preface to the White Paper that the “privatisation of the water sector has been a success story”. Financially, I maintain that this claim is questionable.

2. One of the avowed objectives for the privatisation of the UK’s water sector, as evidenced by the Water Industry Act 1991 and the numerous share flotations on the London Stock Exchange by UK water supply companies at that time, was the spread of ownership of said companies within the private sector investor community.

3. Twenty years on and we find that in the South-East** no water company is currently a UK-quoted company, or is, indeed, a quoted company anywhere else. Was that the intention?

[** A comparable analysis has not been taken for other regions of England & Wales

The following companies fall under OFWAT’s “South-East” regulatory jurisdiction:

Thames Water (the UK’s largest private water company).


South East Water.

Sutton & East Surrey Water.

Southern Water.

Veolia Central.


4. This scenario raises serious questions of governance and financial sustainability of England & Wales’ private sector, public service water utilities,—which are, in effect, regional monopolies. As a consequence of these ownership developments, there is no forum for stakeholders or customers to hold directors and owners to account for their actions. The only constraints on the water companies’ proprietors are the Licence agreements, plus Conditions “P” and “F”, as imposed and policed by OFWAT.

5. Recommendation 1: no matter the ownership of the England & Wales water companies, each year the owners, directors and management of each water utility,—plus indeed OFWAT too,—should be held accountable publicly to its customers. Further, currently OFWAT undertakes two “road shows” per year with the City. Customers should also be notified, invited and able to attend such meetings.

6. Apart from shareholding structures, all of the South-East’s water companies are owned and controlled, at least financially, by offshore entities (see analysis later in this Paper). This has implications, not only for taxation,—the Exchequer loses tax revenues,—but also ultimately for governance and accountability. No “fit and proper person” test is imposed on utility owners by OFWAT, as is required in other jurisdictions.

7. Recommendation 2: a “fit and proper person” test should be applied to the ownership of such private sector monopolies. Further, this standard should be underpinned by an “on demand” bond reflecting adherence to public interest performance criteria.

8. With respect to ownership, the current OFWAT licensing regime allows changes of ownership to take place without any specific referrals (competition issues apart), eg the recent sale of 9.9% of Thames by Macquarie to the Abu Dhabi Investment Agency for an undisclosed sum. Is it justifiable that the details of such sale should remain undisclosed for the UK’s largest private water utility?

9. Recommendation 3: any changes of shareholding exceeding 5% share capital should be referred to OFWAT for approval (which should not be unreasonably withheld), and the details of any such transaction made publicly available.

10. Finally, after many years the UK Government has woken up to the fact that such public service utilities are ideal investments for pension funds and life insurance companies, who seek long-term, low risk, income-producing investments to cover their short and long-term liabilities. More recently, some sovereign wealth funds (“SWFs”) have also been attracted to the sector, albeit that such SWFs have less of a direct social remit than pension and life funds.

The fact is, however, that now nearly all the investment opportunities for UK pension funds and life insurance investors in the UK water sector are effectively closed off, as the owners of said water companies are mostly non-UK funds and investors,—who additionally enjoy UK tax benefits which UK funds do not. A UK Government “own goal”!

11. Recommendation 4: UK life insurance and pension fund investors in UK water utilities should enjoy the same UK tax benefits as non-UK investors in this sector.

12. The table overleaf shows some key financial performance parameters for the South-East Water Companies. It will be seen that Thames and Southern represent approx. 80% of the region’s water services suppliers. It will also be seen that, along with Sutton & East Surrey, they are the most indebted (as defined by leverage).

13. Typically, a private sector public service utility will have leverage in the 50–60% range, eg as in the UK and European power sector and some water utilities. This allows the company to have adequate financial strength to fund their capital investment program using their own balance sheets. However, since privatisation and, particularly since some companies have become de-listed, the leverage levels for UK water companies have increased significantly, viz. the figures for Thames and Southern with >80% leverage. This inherently weakens financially such companies.

14. Much of this increased leveraging has come about by the owners/shareholders paying themselves higher annual dividends than the company generates profits, ie an activity commonly called “asset-stripping”.

15. Examination of Thames’ accounts over the years demonstrates this trend:

Thames Water [£ mn.]




Shareholder Equity




Long-Term Debt




Balance Sheet Total Assets




Since 2003, there has been effectively zero growth in shareholders’ equity. Any surplus equity value has been distributed through dividends. The increase in leverage over this period, from 55% to 82%, is clearly seen.

16. The major change in leverage arose in late 2006early 2007, when RWE, the German energy utility and previous owners, sold Thames to Kemble representing a group of offshore (Luxemburg) Infrastructure Funds (ie private equity), managed by Macquarie Bank (Australia). During 2006–7 RWE paid themselves dividends of £535 million, that is one third of Thames’ Balance Sheet equity,………………………….… and OFWAT just looked on!

Since then, Thames’ dividends have not exceeded profits, except for 2010–11.

[Note: in 2010–11 Thames also provided a £1,865 million unsecured loan to its (offshore?) parent company, assumed in the Accounts as a “current asset”, albeit not expected to be repaid within 12 months. No further explanations are provided!].

17. Southern and Sutton & East Surrey show similar trends which, whilst not in any way illegal, have done nothing to enhance the financial strength of these utilities when they are faced with significant funding requirements for future capital investment.

18. On the other hand, Veolia Central shareholders paid themselves dividends amounting to seven times profits in 2010. This came about by revaluing the company assets, which allowed the issuance of a £200 million bond issue (which increased leverage accordingly), and using the proceeds to pay dividends!

19. Another oft used route to extract “dividends” out of private, public service utilities is via shareholder loans at elevated interest rates, which circumvent income tax, particularly for offshore investors. Such a mechanism is not uncommon in PFI deals, eg London Underground PPP, when owners/investors provided “equity” in the form of shareholder loans at 19% interest, whereas market rates were closer to 5%. The use of such mechanisms in the water sector appears not so prevalent, however, as in other sectors

20. As part of a water company’s licence, they have to maintain (Standard & Poor’s) Investment Grade rating status (ref. Condition F). At privatisation in 1991, the floated water utilities were all deemed well into Investment Grade. Since then their rating has diminished such that their status is often just a “notch” or two above Junk Bond rating. So far licence default has not arisen, but worryingly OFWAT does not appear to have a “Plan B” should such event arise.

Unfortunately, ratings have a habit of changing over time, sometimes quite suddenly!

21. OFWAT, to be fair, imposes a ring-fencing, cash lock-up mechanism on utilities should their financial status come under threat, but in my view this is inadequate and a short-term expedient with limited impact on utilities’ management (eg if the money has already flown the company, such constraint is ineffective!).

22. Recommendation 5: the requirement to maintain Investment Grade status is inadequate. Water utilities should be required to maintain a maximum leverage of, say, 60 or 65%.

23. Recommendation 6: shareholder loans at inflated interest rates should be outlawed for such public service companies.

24. Recommendation 7: water utilities should not be allowed to pay out dividends to shareholders in excess of the accounting after tax profit for the year in question.

Notwithstanding that finance is not a prime focus of the White Paper, I hope the above comments demonstrate that the future health of the sector is increasingly coming under threat and the opportunity should not be missed to strengthen the role of OFWAT to police the sector in financial matters.

I trust, therefore, that the Committee will take my comments into account in their deliberations.

Background on T.M. Blaiklock

I have been a consultant, banker and practitioner in infrastructure and energy project finance,—PFI, PPP and the like,—for the last 35 years or more, with both UK and wide overseas experience. Over the last three years I have given more than 50 two–four day seminars on these topics internationally, eg World Bank/IFC, EBRD, banks, governments, etc.

5 January 2012

Prepared 4th July 2012