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Thames Water and Holistic Corporate Governance

How the promise of infrastructure investment by privatised water companies has been shattered by poor governance, blind compliance and the incongruence of high debt and high dividends.

by Nigel Kendall

The background: privatisation of water infrastructure

For the first seventy years of the 20th century, the supply of drinking water and sewage removal was regarded as a public good, and delivered primarily through local authorities. In the 1970s these were amalgamated into larger, regional groupings, with the object of achieving the efficiency savings that should come with many fewer but much larger organisations.

The expenditure on infrastructure was thus facilitated through greater ease of borrowing by these large bodies, but the during this time, the requirement to replace ageing, Victorian pipework and related facilities also grew more urgent. So with the arrival of Thatcher’s privatisation initiative to cut the state’s involvement in loss-making industries, the solution appeared: privatise the water industry and shift the responsibilities and funding requirements from the Treasury to the private sector.

To make the investment an attractive proposition, the water companies were delivered free of debt so that the investing institutions could easily raise the funds required for infrastructure updating against the background of reliable, steady income. Moreover, the regulatory environment was made sympathetic through linking permitted changes in price levels to cost of living indices.

New investment was now becoming increasingly urgent, as the Thatcher government, as part of its clamp-down on public expenditure, had restricted the ability of the regional water companies to raise money in the preceding years. And the country was receiving challenges from Brussels regarding its compliance with EU water quality standards.

History of the privatised Thames Water

So let’s look at the subsequent history of one of the biggest water companies, Thames Water, with 15 mn customers, recognising that the lessons we draw apply to almost all the other privatised water companies.

The company was floated on the Stock Exchange in 1989, and twelve years later acquired by German utility RWE, which sold in 2006 to a consortium of funds. This group was led by Australian infrastructure specialist, Macquarie, and included a very large UK pension fund, a Canadian pension fund, several sovereign wealth funds including Kuwait, Dubai and China. Macquarie managed the investment on behalf of the others, and eventually sold its stake in 2016.

During this time, Macquarie operated through a complex structure of companies, resulting in very little tax being paid in some years, and over the period, in the classic private equity model, raised debt from £3.4bn to £10.8bn in 2017, and took out dividends of £3bn.

Currently, debt is running at £16bn, producing gearing of 77%, the highest of all the privatised utilities, and the company posted a loss of £82mn in its most recent reporting year. The result of the increased borrowing is a huge increase in interest costs, with the most recent average interest rate running at 13.4%, compared with 8.1% in the previous year.

However, Thames Water’s operating performance has been so poor that this year alone it has received fines of £20mn and £3mn. Notwithstanding its executives’ defence of its infrastructure spending, clearly this is nothing like adequate, and it has found itself under criminal investigation from the Environment Agency for its failings.

Less than twelve months ago, Thames Water published an assessment of its long-term viability, which it described as being in good financial health. In the past few weeks, the government has become so concerned that it raised the possibility of putting Thames Water into Special Administration, effectively treating it as bankrupt.

The company has been trying to raise £1.5bn from its shareholders in the past few weeks, and it has subsequently received a third of its target and promises of a conditional commitment to the balance over the next two years, with an indicative commitment to a further £2.5bn over the years to 2030. However, there is a natural reluctance on the part of its shareholders to risk good money after bad, and one of the major investors has already reduced its stake.

Meanwhile, its CEO recently resigned just two years into her eight-year contract, causing major concerns.

Holistic corporate governance assessment

The purpose of a business is to deliver goods or services to customers that they value, in such a way as to constitute a viable operation. The role of the board (as made clear in the UK Companies Act 2006), is to ensure that the executive delivers this objective in a way that takes account of the wishes of the key stakeholders and reflects the current views of society regarding culturally acceptable standards.

The demands of a powerful shareholder to deliver dividends simply represent one of the factors that the business has to take into account, and give an appropriate weighting, in planning its strategy and implementing its business plan. Failure to get the balance right will potentially result in failure of the business, and this is what has happened to Thames Water.

Let’s assess the performance of the business, and hence the performance of the board, under the following broad headings which constitute holistic corporate governance:


There are three aspects to consider here:

  • Ethical performance: no-one has accused Thames Water of practices that would be considered un-ethical, unless the release of sewage was found to be deliberate. Rating 7
  • Social practices: again, no-one has raised issues about the conditions under which employees work, or unacceptably low rates of pay or poor employment conditions. Rating 7
  • Environmental impact: here, the book has been thrown at Thames Water for the damage it has been doing to the environment. Rating 3

Business model

There are four aspects to consider here:

  • Business goal: the reason Thames Water was put into private ownership was to provide high quality provision of drinking water and sewage disposal services through necessary investment to make the infrastructure adequate for a long period ahead, and to make efficiency improvements to improve operating performance. Here, though the goal is still valid, the achievement has largely failed. Rating 3
  • Strategy to achieve it: probably the initial strategy was correct on paper, but the implementation has not delivered the proper amount of investment, while distributing large dividends to shareholders, and in the process building up huge borrowings. Whether this inadvertently ignored the likely future impacts of deficient infrastructure and interest rate risk, which points to incompetence, or deliberately ignored the possibilities, which flies in the face of the board’s duties under the Companies Act, the strategy clearly failed. Rating 2
  • Organisation and resources to deliver: the organisation structure and staffing may have been adequate, but the infrastructure clearly wasn’t, and the financial resources have been poor enough to bring Thames Water to the brink of administration. Rating 2
  • Accountability and transparency: as a private company, the disclosure requirements are limited, but while hardly trumpeting its failures, Thames Water hasn’t been accused of concealment of important information: Rating 6


The four main aspects to compliance are:

  • Companies Act: no-one has yet accused Thames Water of breaching the provisions of the Act, but surely they are vulnerable under the sections relating to the duty of the directors to look after the success of the business and safeguard its future. Rating 4
  • Company’s constitution: as far as we can tell, Thames Water hasn’t stepped outside what it is permitted to do under its Memorandum and Articles. Rating 9
  • Corporate Governance Code: no challenges here or qualifications from the auditors, so one assumes it ticked all the boxes regarding the important provisions of the Code. Rating 8
  • Industry regulations: Thames Water has received multiple fines for breaking regulations, which speaks for itself. Rating 2

Roles of the various parties and assessment of performance

Let’s now consider the behaviour of the main players in this story, over the years.

  • Board: no criticisms have been raised, publicly at least, about the competence of the directors or the effectiveness of the chairpersons, and they seem to have followed the requirements of the Corporate Governance code, but have they done their job over the years looking at their performance from a holistic corporate governance viewpoint in regard to the company for which they have been responsible? The answer must be a resounding NO. The comment of Sir Ian Byatt, who was Director General of Ofwat from 1989 to 2000, that nearly everyone on the board was an investor, hints at the reason for the board’s decisions. Rating 3
  • Stakeholders: taking the responsibilities of the main stakeholders in turn:
    • Customers: their only influence is to make a fuss about the company’s delivery of its services to them. Thames Water being a monopoly supplier, the customers can’t take their business to a competitor. Should they have made more fuss? Rating 6
    • Employees: the staff seem to have gone along with things, though unpublished expressions of dissatisfaction may have been widespread. If so, they had very little impact. Whistleblowing is notoriously dangerous, and there is no obvious record of any. Rating 5
    • Owners: the owners, led for a very significant period by Macquarie, clearly influenced the board’s decisions in relation to the direction of expenditure between infrastructure investment and distribution of dividends. Presumably the board was left with little choice over borrowing, though a truly independent board with integrity and a proper recognition of risk would have made different decisions, or resigned, making their reasons clear. Rating 1
    • Local communities: these made their concerns progressively clearer as time progressed and pollution and leakage became more obvious, and probably prompted the investigations which led to the fines. Rating 8
  • Regulator: the regulator has been criticised for a failure to monitor financial discipline on the part of the water companies, and operating under regulations which didn’t guard against financial engineering which would be detrimental to the companies. Overall, it oversaw an increase in borrowing by the privatised water companies over the years from zero to £60bn, while £70bn dividends were declared. Moreover, it is accused of allowing efficiency incentives which allowed partial profit retention to permit distribution of the extra profits rather than investment, and prioritising keeping bills low over infrastructure investment. Rating 4
  • Auditor: overall, all but three of the privatised water companies have one of the Big Four accountancy practices as their auditor. Thames Water has PwC. The expectation of the man in the street, and presumably of knowledgeable investors, is that giving companies a clean audit certificate indicates that they are financially sound, that their short to medium term future is secure, and that they are delivering the services that they advertise in a proper way. These are the leading global audit practices which have the capability to recognise and should surely draw attention to fundamental issues. The current state of Thames Water is a very poor reflection on the work of PwC. Rating 4


The general conclusion from observers is that re-nationalisation would provide no short-term or long-term answer, and beyond levelling criticism at the owners, the informed preference seems to be to tighten the regulation and hope the necessary investment can be found in the private sector.

However, there is surely a case to be made that enforcement of the provisions of the Companies Act regarding duties of directors to concern themselves with the on-going success and viability of the business is a response that is available now. Directors with integrity and taking their duties seriously would resign if pressure was brought on them to approve actions potentially detrimental to the future of the business. Surely this is the way to prevent similar damaging behaviour in the future.

And what about the auditors? Surely the safe harbour approach of ensuring that their client has ticked all the necessary regulatory boxes, while failing to draw attention to potentially catastrophic risks hidden by their clients cannot be acceptable in equity, even if permitted by accounting standards. These are supposed to be professional firms, not street traders.





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