Like the Icelandic sagas, the Thames Water story just keeps giving, even if sagas always come to an end, however much the protagonists try to head off the inevitable. OFWAT, Defra and the Treasury, having dug a hole, just keep digging. This hole is all of their own making. The regulatory regime is designed to deal with failure, as every good regulatory regime should be. There is a licence, there is the law, and there is special administration when they are not met.
The government and, for reasons it is increasingly hard to understand, OFWAT are determined to prevent special administration. Why? Because the government fears its backbenchers will use special administration to force through renationalisation. For OFWAT, answering the “why” question is harder. Presumably regulation is not so independent of government as its architects thought it would be. One way or another, regulators are doing the government’s work for it.
As part of the “anything but special administration” strategy, all sorts of misinformation is spun, with consultants and advisors doing the (very profitable) work for the company, and with ministers being very economical with the truth.
Item one in the misinformation game is to play up the costs of special administration. Special administration is misleadingly labelled as “nationalisation”. It isn’t. Then a really big number is put out to scare off those who respond by welcoming the prospect of nationalisation. Scaring the horses with a nice, neat round number of £100 billion as the cost of renationalisation of the industry is the tactic. It is wrong, as will be explained below.
Item two of the spin is the ridiculous cost estimate put out that special administration of Thames Water would cost the government £4 billion. It is rubbish: the government should recover its costs from the sale of Thames, and Thames offered for sale would receive bids way in excess of £4 billion. The net cost to the Treasury should be zero.
Item three is the discrediting of serious bidders. First, they were refused the opportunity to bid by Thames Water itself, under pressure from the creditors and KKR, which was at that stage preparing to bid. Now the bidders face much more insidious attacks. Former security people are hauled out to say what a threat CKI would be to national security if it controlled Thames, but not following through with the obvious conclusion that if CKI is indeed such a threat, it should be forced to divest its control of London’s electricity network and its stake in Northumbrian Water, and indeed anything it owns in the UK. And just in case the scare story about China’s influence didn’t do the job, the claim is made that CKI is not proposing to spend as much in the current period to 2030 as Thames Water’s creditors are offering. This is important but not quite what it seems. The practical problem is how so much could be spent so quickly and efficiently: do not take at face value any of these claimed expenditures. Other bidders are not even given the time of day by the Thames board.
All of this reveals a very important further reason for special administration. The Thames board is controlled by a small group of the main creditors, and it is they – not the board – who are calling the shots. Board members admitted as much at an earlier EFRA Select Committee meeting.[1] This is not right: the board of a utility holding a licence should be in control. It can’t be that creditors control them – and their decisions. The admission that the creditors are in control should ring an alarm bell. Even more so, it is important to ask whether these creditors are fit and proper people to run a water company. For in the saga so far, the lobbyists and advisors have sought to show that CKI is not a fit and proper owner of Thames. Why, then, should we not ask – and expect the board and the regulator to answer – whether the lead creditors meet this condition. As with most spin campaigns, the spinners lose a sense of balance and perspective, and reach for any argument they think helps their case, and ignore the inconvenient facts. The fate of the UK’s largest water company should not be determined by PR companies and lobbyists. It is far too serious.
1. DEFRA’s £100 billion
With this in mind, the latest specific in the saga is Defra’s policy paper on why it would cost £100 billion to nationalise all the water industry.[2] It is misleading, simplistic and wrong, but then these are not seen as reasons why the claims should nevertheless not be deployed. Perhaps Defra thinks the neat round number of £100 billion will hold up to scrutiny? The Select Committee might carry on its good work in asking a lot of questions about this policy paper. Let me help it on this path.
Defra sets out three assumptions:
- that the regulatory capital value (RCV) of the water sector is the closest proxy for the total value of the sector’s debt and equity;
- that the total cost of nationalisation would reflect the cost of purchasing the equity in companies and the cost of taking on their existing debt liabilities;
- that it is not appropriate to apply a discount or a premium to the RCV, given the significant uncertainties and possible variation between companies.
Taking each in turn.
i. “The RCV of the water sector is the closest proxy for the total value of the sector’s debt and equity”
The RCV is an accounting number. The value of debt and the value of equity are company-specific numbers. Investors will have the RCV in mind, amongst many other considerations. There have been very few, if any, transactions in the water sector over the last 35 years that have equalled the RCV. Whilst most transactions have been in excess of the RCV – largely as a response to the real interest rate being almost always to date below the one set by OFWAT, and because the weighted average cost of capital (WACC) created a massive incentive to financially gear up the companies – some have been below. The great financial engineering is now over, so many more might now go below the RCV, as did Welsh Water and Southern Water. The conclusion that follows is that the market value of the RCV and the value of debt + equity are almost never equal to the RCV. If the RCV is the basis for nationalisation, it will involve either over- or underpaying. In the case of Thames Water, it would be a gross overpayment.
The claim made in Defra’s paper is that the RCV is the closest proxy. The obvious response is “closer than what?” One proxy is the actual market value of the company, and, if not, the listed companies are used as proxies. It is not necessarily the right one, and it should be adjusted for company failures to properly maintain their assets. But the RCV is neither the only nor the right proxy.
The market value includes investors’ assessment of the risks the company faces, the relationship between the WACC and the actual market cost of debt and equity, and an assessment of the scope for outperformance.
Given that the WACC averages between the cost of equity and the cost of debt, it gives excess returns to debt and deficient returns to equity. The actual gearing will be relevant. All of these considerations appear to have passed DEFRA by.
The conclusion is that assumption (i) is wrong.
ii. “The total cost of nationalisation would reflect the cost of purchasing the equity in companies and the cost of taking on their existing debt liabilities”
The above neatly illustrates an inconvenient truth for DEFRA. If assumptions (i) and (ii) are correct, then outright nationalisation would lead to it paying a higher price than the government would if it brought the water companies from a special administrator.
The example of Thames Water illustrates why assumption (ii) is wrong. Would a government or any other bidder to the special administrator pay the cost of actual debt liabilities, given that these may exceed the valuation, once account is taken of licence failures by the company? In the case of Thames, it is widely assumed that B-class debt holders will be wiped out and A-class debt holders will take a haircut. There is no case for taking on all the existing debt liabilities.
In the case of Thames Water’s equity, the existing owners have written this off, arguing that the business is uninvestable.
A special administrator, selling the assets on to a new buyer, is under no obligation to protect the bondholders. That is a key reason these bondholders are so determined to prevent special administration.
If the government were to follow assumptions (i) and (ii), then it is actually now in the interests of the bondholders to campaign hard for immediate nationalisation.
The conclusion is that assumption (ii) is wrong.
iii. “It is not appropriate to apply a discount or a premium to the RCV, given the significant uncertainties and possible variation between companies”
The starting point of any acquisition by the state is an assessment of the liabilities and the assets. The liabilities arise in particular when a company has failed to meet its licence conditions, and when it has failed to properly maintain its assets and meet the requirements of environmental law. That’s clearly the case when it comes to Thames Water.
A number of water companies have liabilities beyond those provided for in periodic reviews. There is no obvious reason why the state should double pay, taking on both the additional liabilities and hence the remedial capital maintenance and paying the value of the RCV and taking on all the existing debt liabilities.
The conclusion is that assumption (iii) is wrong.
2. The relationship between the above and special administration
A special administrator takes over the failing company (such as Thames Water). It does not pay for the equity and debt. Rather, the administrator sequestrates the income of the business paid for through customer bills and other sales, keeps the business running and offers it for sale to any and all bidders. It will be very cash-rich – the customers’ bills include a return on the RCV, and hence the cash income exceeds the costs of running the business by a very wide margin. The bidders assess the value and risks and liabilities, and then bid above or below the RCV. The administrator receives the monies from the sale, and then deducts the administration costs and any specific costs incurred by the Treasury (for example, in guaranteeing operating and capital contracts).
It is open for the state to bid to the administrator if it wishes to nationalise the company. A bid by the state is then compared with those from others, and the administrator, subject to the special duties of a “Special Administration Regime” (SAR), adjudicates between the bids.
This is the correct way to identify the value of the business if the government wants to nationalise the company. The returns on the RCV will be part of all bidders’ considerations.
The SAR is designed to make sure that the business continues on a sustainable basis. It is not nationalisation; it is a special guarantee to give the company breathing space before being sold on.
3. Thames Water’s creditors’ plan
Whilst the creditors have been seeking to preserve as much of their investment as possible, the government has moved to consult on giving OFWAT the power to vet water company senior directors. In the case of Thames Water, the chair and financial director confirmed to the EFRA Select Committee that the creditors were in control of the company.
This sits very uneasily with this proposed new duty on OFWAT. If the question is whether the proposed new chair and chief executive that the creditors select and control are fit and proper persons, then in effect OFWAT should be asking whether these major distressed-debt players meet this requirement, as they in effect determine the strategy of the company.
This illustrates a central question with the proposed vetting process. Is it about control or is it about who occupies the posts on the board of the licensed company? At the heart of the problem is whether the board can take decisions against the wishes of the company’s investors. In the case of publicly quoted public limited companies (plcs), it is a transparent position subject to resolutions at the annual general meeting (AGM). In the case of privately owned companies, it is far from transparent. So far, there is no evidence that the independent directors have stopped the direction of Thames Water being driven by these major creditors.
4. Conclusion
Defra should do its homework properly and stop quoting a crude total number of £100 billion. As it itself concludes: “The true enterprise value of water companies could indeed be higher or lower than Defra’s estimate.” It should go one step further and state that this value is almost certainly not equal to the RCV. Defra incorporates it as one factor in assessing value, but it is seriously incomplete. In the case of Thames, a special administrator would almost certainly achieve a price which is at a significant discount to the RCV, and the debt holders would take a haircut.
If Defra wishes OFWAT to vet the leading board members, then it should ensure that the regulator also vets the controllers. What is needed now is for Defra to put Thames into special administration, instead of putting out simplistic and ill-thought-through “assumptions” to support an implausible, very big round number. Whilst it is at it, Defra might think through the clarity of the role of the board and its responsibility under an element of listing, rather than where all the equity is private.
Sagas come to an end. As long as the government and Ofwat carry on dithering, there will be yet more instalments of this unfolding mess at Thames Water before it finally collapses.
[1] Environment, Food and Rural Affairs Committee (2025), “Oral evidence: Reforming the water sector”, HC 588”, 13th May.
[2] Defra (2025), “Nationalising the water sector: how we assessed the cost”, 16th September, policy paper.
