Clause 2 — Financial assistance for major works

Part of Oral Answers to Questions — Prime Minister – in the House of Commons at 2:15 pm on 14 March 2012.

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Photo of Simon Hughes Simon Hughes Deputy Leader, Liberal Democrats 2:15, 14 March 2012

My hon. Friend is right. Perhaps it would helpful if, rather than trying to go round the circuit twice, I quickly summarise my letter to the Secretary of State in which I set out my concerns and the history of the matter, summarise the key points of her response, which deal exactly with my hon. Friend’s point about the mechanism regarding the tunnel, and then raise the three specific issues that should be addressed before colleagues and the Minister speak.

The provisions could, of course, apply to any water company. I am talking about Thames Water because we know that the Thames tunnel is the big project that the Government have in mind. However, the Bill relates not just to Thames Water, but to financial assistance for major works by any water company throughout the country, so the issues could relate to any constituency across the United Kingdom.

I will give a brief history. Thames Water was previously owned by the German utility company RWE. As I well remember, at that time it had one of the worst records for leaks and failed to meet its agreed targets for remedying leaks for four consecutive years. Despite that, RWE raised the dividend that Thames Water paid out to the company by 52%, took £216 million from the company and simultaneously announced a rise in profits as it prepared to sell the company on. At that time, Thames Water had a debt to capital ratio of about 45% and an excellent credit rating with all the major rating agencies.

Thames Water was bought by Kemble Water in 2006 in a deal worth £8 billion. Kemble Water is a financial vehicle for a consortium of investors, primarily made up of private equity funds led by Macquarie, the Australian bank. The deal included £3.2 billion of debt, which was incorporated into the company through whole company securitisation. That was undertaken for a special purpose finance company that Thames Water set up in the Cayman Islands, presumably to allow the owners of Thames Water to avoid taxes on the income that they received from the interest raised. That increased the debt ratio sharply to 67.9% of regulated capital value. The company has continued to borrow heavily and the debt to capital ratio has now increased to 72.9%.

That has happened at a time when Thames Water has paid extremely high dividends, which have regularly exceeded its earnings. For example, in 2010, the ratio was 141.5%. In other words, it paid out in dividends nearly one and a half times as much as it received in earnings. By contrast, South East Water, to take another local example, had a payout ratio of 48%—just a third of that of Thames Water. That strategy has had a serious detrimental effect on Thames Water’s credit rating. It has fallen from a corporate credit rating of A plus on the Standard & Poor’s rating scale when the company was bought by RWE in 2000 to a position today in which some of Thames Water’s debts have been assigned a triple B rating, which is considered to be the lowest investment grade rating possible.

For 10 years, Thames Water has been owned by two companies that have sought to extract the maximum possible value from the company. It has prioritised that over the necessary prudential financial arrangements that would have allowed it to make the large, long-term capital investments that it knows it has to make. As a result, Thames Water no longer has the capacity to access the finance required to make large infrastructure investments. It is not as if this project is a new idea. It has been, excuse the pun, in the pipeline for a long time.

The company has therefore asked the Government to provide financial backing for its Thames tunnel scheme. It is not yet clear to me why our Government should help this company after its years of excessive and unjustified borrowing and extraordinary dividend payments, which have eroded the company’s capital position. At the end of the Second Reading debate, the Minister said that the financial arrangements of the company are a matter for the regulator, Ofwat. That is in part true, but Parliament certainly has an interest and the Government must have an interest. If Ofwat’s controls are not sufficient, we need to address that. That is why I have raised this matter in the amendments.

Before the sale of Thames Water by RWE, Ofwat made a clear statement warning potential investors not to follow the very strategy that Kemble Water has since followed. Ofwat said that potential bidders should preserve Thames Water’s investment grade credit rating, which would have meant keeping the company’s debt to capital ratio below 65%. That is the link between solvency, external financial respect for the company and the percentage ratio, which my hon. Friend the Member for Cities of London and Westminster raised with me earlier. Since then, the regulator has, in effect, stood by and done nothing to prevent Kemble Water from further saddling the company with debt. Ofwat has stated that that is acceptable because the company has kept its investment grade credit rating. In fact, the credit rating has deteriorated to the lowest investment grade possible. Ofwat appears to have neglected the need for the company to incur more debt in the future to pay for large capital investments.

I am troubled that, unless we amend the Bill, there will be nothing to prevent that behaviour from continuing. I am trying to make the Government address how we will prevent it. I do not propose to force the amendment to a vote, but I want to hear the input of Members, if they want to contribute, and the Minister’s response. I am keen to ensure that we do not let go of this matter. My constituents want me to raise it now and the constituents of many colleagues in London have an equally strong vested interest in it.