The water industry in England and Wales has been the subject of some awful performance politics. First, give the water company executives a good kicking. Let the public think that failures will lead to directors being locked up. Put the blame on them. Next, give OFWAT a good kicking too. Say it’s a failed regulator and you are going to abolish it. It’s all the fault of the executives and the regulator.
Blame-shifting has one more twist – the easy one: blame it all on the previous government.
There is nothing novel or surprising about all this. It’s the sort of strategy that Alastair Campbell and Peter Mandelson perfected back in the Blair government. It’s what politicians do.
But what to do about it? Resort to the age-old trick: buy time by announcing a review. In the meantime, stick with the Treasury instructions to avoid Thames Water (Thames) going into Special Administration and thereby keep at bay the agitation from backbenchers for renationalisation.
Performance politics does not make the problems go away. On the contrary, in front and centre stage, the sorry tale of failures at Thames unfolds. Thames itself tried to win the public over by featuring its management on the BBC Panorama documentary, “Thames Water: Inside the Crisis”. It was a PR disaster for Thames. The BBC series “Paul Whitehouse: Our Troubled Rivers”, and the Channel 4 drama documentary, “Dirty Business”, on the work of Ash Smith and Peter Hammond, both tell a very different story.
To keep those backbenchers at bay, the costs of Special Administration (claimed to be £4 billion) and of renationalisation of the water industry (claimed to be £100 billion) were played up. The first is just plain wrong: the Special Administration legislation, amended following the Water Industry (Special Administration) Regulations that came into force on 19th March 2024, provides for the Treasury to be first in line to get any costs back it incurs. Given that Thames’s regulated asset base (RAB) is approaching £20 billion, it is impossible to believe that the company sold on could be worth less than £4 billion. As for nationalisation, there are lots of arguments against it, but the £100 billion is not one of them. If the government nationalised the water companies, it would get the assets (including the RABs) set against government bonds to finance the acquisitions. In balance-sheet terms, it is neutral. That’s how nationalisation was done back in 1947–48 in much more dire economic circumstances.
Many costs of the performance politics strategy are now playing out, but perhaps the worst is the open goal it provided to the lead bondholders of Thames. They have played a good game, and they are very good at it. It all started back in June 2023 when Sarah Bentley, the CEO, abruptly resigned, followed in March 2024 by the major shareholders walking away from providing further financial support and then writing off their equity.
Sir Adrian Montague had by this stage become chair of Thames Water, and he quickly oversaw the appointment of Chris Weston as CEO, starting in 2024. There was to be a “turnaround plan”, but one which depended on sorting out the company’s financial position.
Three years on, the lead bondholders are still in “negotiations” with OFWAT, and the government is still committed to preventing a Special Administration Regime (SAR). There is, as yet, no agreed financial plan. There is still the option to put Thames into Special Administration, and there is little evidence of a turnaround in the operations and investment programme of the business. So far, the negotiations have taken almost as long as the First World War, though are not yet on a par with the Ukrainian War.
How could it take so long to sort out the Thames mess? How could OFWAT and the government allow this to drag on so long? Thames has clearly breached its licence, it has failed on credit ratings, and it has failed to deliver even the most basic services that in the twenty-first century should be expected of a water and sewerage company. There might be legal action if a special administrator is brought in. But, at any stage, had ministers said they were minded to call in a special administrator, had OFWAT opined to this effect, Thames Water would have been put out of its misery.
Instead what has materialised is a textbook case of what happens when distressed-debt global players get into the act. Exploiting distress is what they do, and, in the case of Thames, some of the most professional and skilled players have joined the game. First, buy the debt at a discount. Second, try to eliminate the other bondholders. Third, demand that regulators bend to their requirements, including over fines. Fourth, offer to put more money in, write down the debt and not take dividends, but only if OFWAT concedes to their demands. Fifth, having gained de facto control of the board, provide the licence-holding company with an emergency loan at high interest rates and with lots of costs attached, to try to keep it out of administration. Dangle another loan in front of the board when it runs out of money again this autumn.
Along the way, the lead bondholders tried to sell the business to a preferred investor, KKR. The process was at best opaque. Other bidders were kept out of the process, and Thames paid for the due diligence reported to be around £20 million on KKR’s behalf. KKR then walked away.
Whilst it is not difficult to see why the Treasury might want to hold off a SAR for fear that the government’s backbenchers would use this as a route to full nationalisation, it is not so clear why an independent regulator would do so. In OFWAT’s defence, under enormous political pressure, and having seen the government in effect force out its chief executive, it is perhaps surprising it has held out so long. This is perhaps the last chance to uphold the principle of independent regulation by defying the Treasury and calling in a special administrator. Not only would this demonstrate OFWAT’s independence, but it would also maintain an essential feature of regulation – the failure mechanism for dealing with failed companies: Special Administration.
Let’s put it another way. If OFWAT caves in to political pressure, all utilities will know that they can negotiate their way out of Special Administration and thereby avoid paying the full price of failures. A vital part of the architecture of independent regulation will have gone. It is no surprise, too, that the review led by Sir Jon Cunliffe proposed a supervisory regime borrowed from the banks, which would in practice bury the Special Administration regulatory tool. If OFWAT fails now, not only will this be hung around its neck, but the further politicisation of UK regulation will be inevitable. That, as the Treasury should reflect on, will have a chilling effect on foreign investors, and see them calling at the Treasury’s and the PM’s door to push their interests whenever “problems” with regulators arise.
So after three years, here we are, and, more importantly, here is the sorry state of the sewage spills and poorly maintained sewerage and water systems. No operational turnaround that properly matches the scale of Thames Water’s problems is in sight, and for the very good reason that Weston gave when he started: it all depends on sorting out the finances and putting Thames on a stable and sustainable financial basis.
It is not just the time this has all taken. It is also all about the costs. These are truly staggering. Whilst customers might think that the prime and sole job of the licensed board is to focus relentlessly on the operations, maintenance and investments, and that this is what the board should spend the company’s revenues on, in fact the last three years have seen more than £0.25 billion spent on advisers’ fees and yet more on creditors’ fees. Think what that sum could have done if spent on the licensed activities of the business.
This is best described as a huge scandal, and notwithstanding the protestations to the contrary, a lot of this will end up on customers’ bills. Think of the terms of that £3bn emergency loan, and presumably the next one. Think of how costs are hard to allocate precisely between the necessary business activities and the special interests of the lead bondholders. Boundaries are inevitably blurred when it comes to cost allocations. To be clear, Thames Water is a monopoly and, as a monopoly, there should be no confidential and private information. We should expect to know all the details, and we should expect the due diligence done for KKR to be made public and available to all possible bidders. There might even be some interesting questions KKR asked, and some revealing awkward information Thames disclosed which we (and OFWAT) should know about.
Three years ago, I wrote that the most likely outcome would be that Thames would limp on, and that “the can will be kicked down the road and with it the dire performance may continue”.[1] Chris Weston could write at the end of 2024 that: “we’ve reached key milestones in establishing a more stable financial platform”.[2] If only…
How long will this drag on? Another three years?
The answer is that it might well, and especially if OFWAT caves in to the lead bondholders’ demands. It would be a bad mistake for the government to assume that getting OFWAT to agree to the lead bondholders’ demands will mean that the government can relax and focus on other things. On the contrary, kicking the can down the road makes an eventual SAR, and nationalisation more generally, more rather than less likely. It’s a temporary expedient, not a sustainable platform. If the current government survives through to 2029, Thames will be very much up there as part of its legacy – unless, at this last moment, the government reasserts the importance of independent regulation, ensures that there is an SAR, and gets Thames broken up and passed into the hands of new owners who can get on with that ever-elusive “turnaround plan” promised in December 2023. That way, too, the customers can avoid picking up the bill for what can only be called the obscene costs of three years of “negotiations”. Perhaps when the board of the licensed company is confronted with another costly loan to keep it afloat, it might this time itself recognise that the interests of its customers and the wider environment are better served if it says no, and instead asks itself to be put out of its misery and into Special Administration.
[1] Helm, D.R. (2023), “What to do about Thames Water“, 30th August.
