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The UK water industry has little obvious in common with the banking sector — unless you count lame jokes about liquidity problems caused by leaky pipes and the toxic assets otherwise known as sewage spills.
Yet the challenges confronting the likes of Thames Water and many others among the UK’s 17 suppliers of water and sewerage services do smack unnervingly of the issues that banks faced in the period running up to the 2008 global financial crisis.
There are half a dozen banking parallels, from which water policymakers could learn useful lessons as they prepare to publish in June the sector’s draft financial and regulatory regime for the five years from spring 2025.
The first, and most obvious, point relates to the unsustainable leverage across the system. A regime that has allowed Thames Water to run with gearing of 80-90 per cent is reminiscent of a banking system that allowed Royal Bank of Scotland to operate with a tiny core capital ratio. In 2008 it became the world’s biggest bank failure, requiring a £45.5bn government bailout.
This month, the parent company of Thames, the UK’s biggest water group, defaulted on a £400mn bond, part of the group’s £18.3bn stack of debt. Other water companies have high gearing too, built up in the decades since their 1989 privatisations. As debt costs have spiralled in recent years, and cash flows have declined thanks to weaker performance and larger regulatory fines, leverage multiples, comparing debt with operating profit, have ballooned. In Thames’s case, for example, the multiple has doubled to about 15 times, according to one investor. To compound the stretched financing, the assets they are backing have been artificially overvalued, according to Frédéric Blanc-Brude of data provider Scientific Infra & Private Assets, in much the same way that illiquid securities were overvalued on bank balance sheets.
A further point of comparison is excessive financial engineering. Bad mortgage lending to subprime US borrowers became a systemic problem in 2008 via whizz-bang investments in collateralised debt obligations. Similarly, the UK water sector has relied on “whole business securitisations”, and byzantine corporate structures, like Thames’s interlocking system of holding, operating and financing entities, which seem designed to confuse.
Investors’ bond holdings are insured in the same kind of way, too. The so-called monoline insurance market, which was almost destroyed in 2008 through its exposure to toxic bank securities, has underwritten a large portion of the bonds issued by the most indebted UK water utilities.
And then there is the public relations problem. Much like UK banking, whose services customers expect to get for free, there is a perhaps natural assumption that we shouldn’t have to pay for water either, since it is essential to life and falls from the sky. This, though, ignores the vast spending needed to update infrastructure.
Perhaps the most significant parallel between pre-2008 banks and pre-2024 water companies is ineffectual regulation. Water investors say the rules have been excessively restrictive — regulator Ofwat dictates investment levels and consumer charges. They have certainly been short-sighted, just as bank watchdogs were — a stubborn focus on consumer pricing rather than the broader health of the sector invited arbitrage and undermined investment.
Should all of this lead inevitably to bank-style bailouts if today’s stresses crystallise into failure? Hopefully not. A credible special administration regime exists to resolve troubled water operators. If necessary, this should allow equity investors to be wiped out, haircuts to be applied to debt investors and more sustainable structures to be relaunched. Economist Dieter Helm argues that one crucial reform would be to split sewerage responsibilities from water operators, allowing for investment horizons of 10 to 20 years instead of five, vital if they are to take on the climate-related infrastructure overhaul needed to keep untreated sewage out of our rivers and seas.
Even if you are upbeat about the prospects of resetting the UK’s privatised water sector, it is sobering to consider that private sector provision of water services is an oddity in the world — 90 per cent of countries, says Professor David Hall at the University of Greenwich, have state-owned water operations. And here’s an intriguing postscript: in the Netherlands, public sector water operators are funded by Nederlandse Waterschapsbank, a AAA-rated public sector water bank. In other words the common ground between water companies and banks is harnessed for the common good. And guess what: the Dutch water business is by some measures the best performing in Europe.
Letter in response to this column:
One flaw of the Bazalgette sewers we live with today / From Sam Dunkley, London W8, UK
