The government has begun discussing contingency plans that include the possibility of placing TW into a special administration regime (SAR) that could take the company into temporary public ownership and result in financial losses to the current shareholders.
The Company is currently owned by private funds, which are largely offshore holders. England and Wales privatized the water industry in 1989 through the Water Act 1989. It was privatized principally to raise revenue and to rely on the capital markets to fund the future large capital requirement of the industry. To counter the potential negative effects of a natural monopoly, the Water Act 1989 also established the Office of the Director General of Water Services (Ofwat) as regulator, whose duties include ensuring that water and sewerage companies properly carry out their functions and are able to finance them.
Currently, a consortium of pension funds, sovereign wealth funds, and private equity investors own the Company. Two of the largest Canadian public pension funds and exclusive asset managers (the Large Canadian Public Pension Funds)—Ontario Municipal Employees' Retirement System (OMERS) and British Columbia Investment Management Corporation (BCI)—own approximately 31.8% and 8.7% of the shares, respectively. Other investors are the United Kingdom's Universities Superannuation Schemes with 19.7% of the shares, Luxembourg's Infinity Investments SA (9.9%), China Investment Corporation (8.7%), Hermes GPE (8.7%), Queensland Investment Corporation (5.4%), Aquila GP Inc. (5.0%), and Stichting Pensioenfonds (2.2%).
An aspect of the ongoing debate on the viability of the private ownership model for natural monopolies is whether this type of investor is responsive enough and ready to inject capital when needed.
We note that OMERS and BCI, similar to other large Canadian public pension funds, are long-term investors committed to sustainable investing. In order to fulfill their mandate, they seek to make investments that match the risk/return profile of their clients and plan members. Robust governance frameworks that include prudent and proactive risk management support this process. To mitigate risk, their portfolios are highly diversified by geography, asset class, sector, company names, and investment strategies. This results in lower exposures to a single name performance.
If the investment in TW results in a financial loss to OMERS, the impact to its credit profile will be immaterial, given its highly diversified portfolio and limited exposure to single names. As of December 31, 2022, OMERS Finance Trust, the financing subsidiary of OMERS, had outstanding debt guaranteed and with recourse to OMERS of $11.4 billion, equivalent to 8.5% of adjusted net assets, which provides considerable cushion for asset-base movements. Nonetheless, it is also worth noting that, as a general principle, the Large Canadian Public Pension Funds typically prefer to engage with portfolio companies and related stakeholders to create value rather than divest their investments. This has resulted in strong performance and returns over the years. As a long-term investor, OMERS’ performance is better measured using long-term returns. Over the last 10 years, OMERS delivered an average 7.5% return on its investments, which exceeded its 7.4% benchmark. Consistent with this performance, OMERS delivered a 4.2% return in its fiscal year ending December 31, 2022, despite challenging market conditions that saw steep declines in public equity and bond markets. Similarly, BCI (although we don’t currently rate it), has a successful track record as an engaged investor, delivering an average 10-year return of 8.5%, which outperformed its benchmark of 7.2%, and an annual return of 3.5% in the fiscal year that ended in March 31, 2023.
It is also important to consider that the collapse of TW could potentially lead to reputational risk for OMERS and BCI and to the consortium in general, which could limit future investment opportunities in natural monopolies in the UK. This possibility is relevant to the ongoing debate on the viability of the private ownership model for natural monopolies and how responsive the current consortium of private foreign investors has been to TW. It appears that although the current business model has flaws, aspects of the current financial and operational problems in TW are the result of mismanagement prior to the sale to the current consortium in 2017. The current shareholders seem to be more responsive.
According to TW's latest interim financial report, to support TW in the delivery of its updated business plan, the current shareholders contributed an aggregate of GBP 500 million in equity, which was made in March 2023, and provided an Equity Support Letter that sets out further shareholder support. In addition, the consortium has not taken a dividend since it invested in TW, although the Company has paid internal dividends that were used to fund interest obligations and activities of other group companies. TW has also stated that the Company has maintained a strong liquidity position that included GBP 4.4 billion in cash and committed credit facilities as of March 31, 2023, and continues to keep Ofwat informed on progress of the company’s turnaround and engagement with shareholders.
In conclusion, although the situation continues to evolve, we expect the impact to the credit profile of OMERS and BCI to be immaterial, with reputational risk being mitigated by their engagement in the ongoing constructive dialogue.
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