Thomas Sharpe KC has written an article for The Financial Times on recent secondary legislation in the water industry that facilitates Ofwat or the government placing companies into Special Administration - not merely for insolvency, but also if water companies are considered to be failing to meet their statutory obligations.
Colm Gibson, managing director in Berkeley Research Group’s economic regulation practice, also contributed to the article. First published in The Financial Times on 13 March 2024, the article can be found below and on The Financial Times website here.
The political temptations of ‘nationalisation-lite’ at Thames Water
By Thomas Sharpe
The writer is a KC specialising in energy and natural resources law. Colm Gibson, managing director in Berkeley Research Group’s economic regulation practice, also contributed
As concerns about England’s privatised water companies grow and MPs debate the government’s contingency plans for the potential collapse of Thames Water, ministers have quietly introduced amendments to the special administration regime (SAR). It leaves shareholders facing the possibility of having ownership of the businesses forcibly taken away while leaving them dealing with the debt.
The move offers an alternative to nationalisation but will make it more difficult for investors to raise legal challenges against the regulator or the special administrator.
There are lessons here, and a warning for shareholders in all regulated companies providing essential services — that their investments are at risk if they don’t take an active role in ensuring that the assets are well run.
When the UK’s utilities were privatised in the 1980s and 1990s, it was acknowledged that a “simple” insolvency — if such a thing ever existed — would not be fit for purpose. Instead, the SAR was designed to prioritise and secure the continued provision of essential services to customers, and compliance with safety and environmental standards, rather than winding up a utility provider (and possibly paying off creditors).
This regime has never been used by Ofwat, not even when Wessex Water’s owner, Enron, collapsed in spectacular fashion two decades ago. But now, given the problems besetting the water industry, Labour and the other opposition parties have made it clear that they think implementing it would be the best course of action in response to the crisis at Thames Water.
Investors’ defences against the SAR often rest upon a range of pre-prepared legal claims for compensation. A large proportion of UK infrastructure is owned by overseas investors and the water sector is no exception. But in addition to claims under international investment treaties, investors know Ofwat has a duty to act in the manner it considers best to ensure companies can finance the proper carrying out of their functions. This includes “in particular through securing reasonable returns on their capital”. If a water company were to be put in to special administration because it was insolvent, investors could argue the regulator has failed to meet this duty, causing them loss.
Having never been tested in this regard, the effects of the legislation are far from clear. But whether these claims have merit or not, they are firmly understood by the investors and their advisers as an avenue worth pursuing.
The new SAR makes it easier to place water companies in special administration — particularly if they are considered by the government or Ofwat to be failing to meet their duties “to such an extent that it is inappropriate for the water industry company to hold its appointment or licence”.
While the legislation does not specify benchmarks, one can easily guess the criteria that Ofwat or policymakers might be tempted to use, based on the recent public outcry over issues such as sewage pollution, storm overflows, flooding during the winter and lack of supply in the summer.
Furthermore, we are heading towards an election this year and polling shows that nationalisation of utilities is a popular policy among voters on both the left and right. SAR is a form of “nationalisation-lite”, allowing for water companies to be taken away from their investors without the need for them to be paid with taxpayers’ hard-earned money — at least not without a fight. But it could well leave the investors stuck with some or even all of the debt — around £18bn in the case of Thames Water.
This option could prove tempting for politicians looking for broad public support and keen to avoid extra strain on the exchequer. Investors and water companies alike: you have been warned.