Written evidence from Kate Bayliss – SOAS UNIVERSITY OF LONDON (TWW0024)

1. This submission is directed primarily at points 1, 2 and 8 of the questions raised by the Committee and draws heavily on a paper that we published earlier this month in the academic journal New Political Economy, available here. Our paper shows that the nature of investors in England’s water companies has changed dramatically since privatisation in 1989. Notably, since the 2000s, private equity investors have played an increasing role in the ownership of water companies. In our paper list the ultimate owners of England’s water companies and show that these are predominantly institutional financial investors.

2. The type of owner makes a difference to how companies are operated. There is a growing literature that raises concerns regarding the role of private equity in corporate ownership, indicating that these owners are associated with a more aggressive approach to securing shareholder returns, risking increased inequality and financial instability.[1] There are well known examples of corporate collapse resulting from the activities of private equity owners such as in the case of Debenhams and care home chain  Southern Cross. In our paper we show that the entry of private equity investment into England’s water sector has also seen the use of financial engineering to create returns for shareholders. Some issues we highlight include: 

• Increased debt levels – private equity investors restructure the company finances, typically leading to high debt levels with part of the cost of buying the water company allocated to the utility itself so that the debt is then serviced by the bills of end users. High debts have been accrued at the same time as dividends are paid to shareholders.

• Complex agency relationships - the ownership of water companies by infrastructure funds managed by private equity investment companies creates complex incentive structures, especially when these funds are of a fixed duration. Private equity asset managers are incentivised to maximise financial fund returns in a short timeframe. This is the focus of the investment, rather than the long-term prosperity of the company.

• Impenetrable financial flows – funds flow to and from an extensive array of holding companies in the corporate group, some of which are registered offshore in ways that are difficult to trace so that it is not possible for an outsider to tell where water bill payments end up.

• Lack of transparency – private equity-owned companies are subject to less scrutiny than companies that are listed on the stock exchange. With some owned via parent companies registered offshore such as in Jersey, transparency is further compromised. Southern Water for example is owned by Greensands Holdings registered in Jersey.

• Such a system for providing water raises major concerns for social equity as households, many of whom struggle to pay, finance returns to the world’s wealthiest via the consumption of water.

3. With a policy focus dominated by creating competition (Ofwat has a duty to “further the consumer objective to protect the interests of consumers, wherever appropriate, by promoting effective competition”) the actions of the regulator are directed towards steering consumers and companies to operate as if they were in a market. The price control system is supposed to mimic a perfectly competitive market and a substantial share of regulatory energy has been devoted to getting companies to be responsive to customers. But this framework is far from reality and prevents the regulator from intervening in the corporate practices where shareholder returns are made such as in corporate debt and dividend payments as these are considered to be “market outcomes”.

4. Social policy in water (as documented in another paper available here) is viewed from the perspective of the business case and each company has their own system for this. Since the social tariff is funded by other residential bill payers it must be approved by the other customers that are funding it. As such, social policy is infused with a sense of charity rather than progressive redistribution, social equity or human rights. Moreover, social policy with its attention to affordability is not able to address the fundamental inequalities within the system by which water is provided.

5. The regulatory structure is depicted as an external rule-setting process but as we show in our paper, there are inherent contradictions between Ofwat’s requirement to protect consumers at the same time as fulfilling its duty to “secure that the companies can (in particular through securing reasonable returns on their capital) finance the proper carrying out of their functions; and further the resilience objective to secure the long-term resilience of companies’ systems and services to consumers”. These latter functions require regulatory stability. But as we saw in the last price review, measures by Ofwat to curb the excessive financial extraction practices by water companies (to protect consumers) led to a downgrading of company credit ratings which makes it harder for them to finance investment, potentially undermining the ability for investors to finance investment. Regulatory decisions cannot be neutral and efforts to tilt the balance in favour of consumers inevitably impinge on investors and this meets with resistance. A number of official reports, including from the UK’s, National Infrastructure Commission indicate a systemic bias towards investors in the infrastructure regulation.

6. There is no reason why our water bills should be used to sustain such an extensive complex financial architecture via offshore jurisdictions. Considerably more could be done to increase pressure on water company shareholders to operate in the social interest such as enforcing higher disclosure on shareholder returns, requiring broader stakeholder representation on the Board of Directors, preventing ownerships via tax havens and banning certain ownership types such as fixed term funds. But Ofwat has been slow to respond to the financial engineering practices and still the response is limited. Our view is that Ofwat is caught in an impossible bind trying to protect the needs of consumers at the same time as ensuring that companies can finance investment. PR19 with its tensions between Ofwat and the CMA are indicative of the competing pressures and contradictions in the water sector.

7. With a regulatory toolbox which is oriented around correcting imperfections to an imaginary market structure, Ofwat does not have the tools to deal with the predatory practices of sophisticated financial investors and inevitably can only intervene after the event by which time some of the investors (as with Macquarie in Thames Water) have sold up and moved on. Ofwat’s mandate could be changed to one that is required to prioritise social equity and environmental sustainability directly. However, given the weight of financial interests and the contradictions and contestations in the sector, it seems unlikely that modifications to the current structure could be sufficient to create a water sector that is governed in the interests of society and the environment. I would recommend a further inquiry to consider whether an alternative system for providing water would be better suited to meeting the public interest.

24 June 2022