Leaking away: The financial costs of water privatisation


As water bills rise again, an investigation by Corporate Watch into the finances of the 19 water and sewerage companies in England and Wales has found:

– Almost one third of the money spent on water bills goes to banks and investors as interest and dividends.

– People are paying £2 billion more a year – or around £80 per household – than they would be if the water and sewerage supply was publicly financed.

– Six companies are avoiding millions in tax by routing profits through tax havens, using a regulatory loophole the government has chosen to keep open.

– The CEOs of the 19 water companies were paid almost £10m in salaries and other bonuses in 2012.

Click here to download a pdf version, including all tables and statistics

When the water regulator Ofwat announced last week that water bills would rise by 3.5% to an average of £388 a year, it promised to “make sure customers get value for money.”

But while helplines report that record numbers of people are being forced into debt by their bills, and 3.4 billion litres – almost a quarter of the supply – leak out of water pipes every day, water companies continue to be a huge source of income for banks and financial investors.

Since the water and sewerage service was privatised in England and Wales in 1989, the companies have been bought and sold by a variety of conglomerates, investment funds, banks and pension funds from around the world. Only four companies out of 19 – Severn Trent, United Utilities, South West* and Dee Valley Water – are still publicly listed on the London stock exchange. Increasingly, their owners have looked to raise the money to run the supplies by taking loans from banks, or issuing bonds (essentially IOUs) to be bought by investors and speculators.**

Going through the most recent accounts of all 19 water companies in England and Wales, as well as those of their associated subsidiaries and parent companies, Corporate Watch has found that, between them, they have amassed a staggering £49 billion in total borrowings (download the full finances and ownership table in the pdf here)

They paid more than £3 billion in interest payments on these borrowings in 2012, in addition to £884 million in dividends to their owners.

The water industry’s total revenue in 2012 was £10 billion, meaning almost one third of the money spent by people on water bills in England and Wales went to paying the interest on the companies’ debts or as dividends.

When asked about this, the companies all said they had to borrow to fund the much-needed improvements in the system. Southern Water, which takes care of water and sewerage in Kent, Sussex, Hampshire and the Isle of Wight, said the ‘right’ combination of debt and equity helps reduce customer bills:

“customers pay for the ongoing financing cost, rather than full construction cost at the time of building a new asset or improving existing assets – similar to the way in which an individual would choose to take out a mortgage to facilitate purchase of their house. Shareholders provide the equity to support the financing, and provide the financial buffer to protect customer bills from cost shocks during a five year regulatory period.”

In the current economic context, borrowing may well be the only way to finance investment. And it is true that some are more indebted than others. The private equity-owned companies such as Thames Water or Anglian Water have more debt in relation to equity than the companies that are publicly listed on the stock market, for example United Utilities or Severn Trent (Thames and Southern are more ‘leveraged’, in financial jargon). Severn Trent told Corporate Watch that companies should be encouraged to raise finance “in a way that incentivises shareholders to invest their own money, where appropriate, and not always to rely solely on increasing already record levels of industry debt.”

But no matter the relative strengths of their balance sheets, just like the companies winning contracts under the Private Finance Initiative, all the water companies are paying far more to borrow this money than the government would if the supply were public. The UK government can borrow much more cheaply than companies because it is regarded a more secure investment.

In other words, if the water and sewerage system was in public ownership, borrowing and financing costs would be much lower. The Public Services International Research Unit at Greenwich University has previously estimated savings of £900 million a year based on industry figures from 2004-5.

Corporate Watch has now found that, given the government does not have to pay dividends to shareholders and is currently paying around 3.5% a year on the 30-year bonds it is issuing (compared to the overall 6.2% rate the companies are paying) it would only pay £1.9 billion in interest payments for the same amount of money currently held by the companies (including their total debt and equity).

Almost £2 billion a year could therefore be saved if the financing for the water supply was raised publicly. This could either be reinvested in the system to address problems like leakage, or help reduce customers’ bills. If it was all taken off bills, the average saving per household would be around £80 a year.

Money from bills is also going on the salaries, bonuses and other benefits going to the water companies’ CEOs. They amounted to £10 million in in 2012 (see table below) after rising for many years previously. All the companies say this is necessary to attract the right people. United Utilities, whose CEO Steve Mogford was the highest paid, earning £1.4 million in 2012, told Corporate Watch:

“The company’s remuneration arrangements are designed so that the overall level of remuneration is sufficient to attract, retain and motivate executives of the quality required to run the company successfully. The company does not pay more than is necessary for this purpose.”

When Corporate Watch showed Ofwat the figures comparing public and private borrowing the regulator did not dispute them but said: “Private investment in the sector since privatisation has led to significant improvements in the supply of water and sewerage services, there has been a significant reduction in the number of pollution incidents and customers receive world class drinking water.”

Others dispute the private sector has been more efficient. A 2007 by the Public Services International Research Unit paper (see here) concluded “The historical evidence on the UK water industry, the actual experience under privatisation in England and Wales, and global experience all indicate that the industry would be at least as efficient under public ownership.” The paper also says much of the investment in the system has been driven by targets set by legislation, which would have been the case whether the supply was public or private.

Channelling profits, leaking taxes

More money that could be re-invested or taken off bills is leaking out through tax avoidance.

All water companies enjoy various tax benefits. They are allowed to defer tax during periods of heavy spending on infrastructure for example, to encourage them to invest. They can also deduct the interest payments on their borrowings from their taxable profit.

However, Corporate Watch has found that six of the water companies – Northumbrian, Yorkshire, Anglian, Thames, South Staffordshire and Sutton and East Surrey Water – are artificially adding to their debts by taking high interest loans from their owners through the Channel Islands stock exchange. The interest payments further reduce their taxable profits in the UK and, thanks to a regulatory loophole, go to the owners tax-free.

In the most brazen case, Northumbrian Water is paying 11% interest on just over £1 billion of loans it has taken from the Cheung Kong group, a Hong Kong-based conglomerate run by Li Ka-Shing, the world’s ninth-richest person.

The loans represented almost half of the £2.4 billion that Cheung Kong paid to buy Northumbrian in October 2011, with most of the rest invested as equity. If the company had invested it all as equity, any dividend payments would not have been deducted from the Northumbrian group’s UK profits.

The companies are borrowing from subsidiaries of their owners based overseas. They can receive the interest payments tax-free because they have issued the loans through the Channel Islands stock exchange as ‘quoted Eurobonds’. Usually, when a UK company pays interest to a non-UK company, it has to ‘withhold’ 20% of the payments and give it to the UK tax authorities. But if the loans are issued as quoted Eurobonds on a ‘recognised’ stock exchange, such as the Channel Islands’ or the Cayman Islands’, they benefit from an exemption that means no withholding tax is taken off.

Northumbrian Water’s loans are described in the company’s annual accounts as “shareholder loans” but Corporate Watch has found they are listed on the Channel Islands stock exchange, and thus benefit from the quoted Eurobond exemption.

Interest payments on the loans were only £50 million in the 2011/12 tax year because Cheung Kong only took over Northumbrian half way through it. Even so, combined with the interest payments on its other debt, the company did not pay any UK tax in 2012, even after it declared an operating profit of £154 million.

Over the next full tax year, more than £100 million will be deducted from Northumbrian’s profits just from the shareholder loans, potentially avoiding around £24 million in UK corporation tax. This money is then leaving the UK through a complex web of subsidiaries ultimately leading to the Cheung Kong group.

At least one of these subsidiaries, Cheung Kong Infrastructure (Holdings) Ltd, is registered in Bermuda, a tax haven. Corporate Watch asked Northumbrian if the others were based in tax havens and why its owners had chosen to invest so much as Eurobonds. The company did not respond to the questions directly but said it “complies stringently with all corporate reporting and regulatory reporting requirements as set out by Ofwat, our primary regulator.”

If the subsidiaries lending the money are based in tax havens, they will not pay any corporation tax on the interest when they receive it there either.

The Yorkshire Water group, which is owned by investment funds based in the US, UK and Singapore, and HSBC bank, accrued £66 million in interest payments on £844 million of quoted Eurobonds in 2012. This, together with the interest payments on its other debt, helped it pay just £100,000 in corporation tax on an operating profit of £335 million in 2012. Corporate Watch asked the company for a comment but did not receive a reply.

Thames Water, part-owned by the Australian Macquarie investment bank and sovereign wealth funds from China and Abu Dhabi, confirmed the interest payments on its £310 million of quoted Eurobonds from its owners are tax deductible.

Combined with its other debt, these helped the company wipe out an operating profit of £577 million, meaning it received a tax credit in 2012. Thames paid £165 million to its shareholders in 2012.

Anglian Water, which is owned by Canadian and Australian pension and infrastructure funds, confirmed the “loan notes” listed in its accounts are quoted Eurobonds and tax-deductible. A spokesperson for Anglian said this was “typical for private investors into UK infrastructure assets”.

Anglian paid £151 million to its owners in 2012 but just £1 million in tax in 2012 after an operating profit of £363 million.

Sutton and East Surrey said it would be “inappropriate” to answer any questions regarding its finances as it was in the process of being bought up by the Sumitomo Corporation of Japan. South Staffordshire Water confirmed the “loan notes” listed in its accounts were quoted Eurobonds.

Southern Water, which is owned by UBS bank and an investment fund, also owes £566 million to its owners in quoted Eurobonds. The company said at least some of the interest on them is not tax deductible.

HMRC almost closed the quoted Eurobond loophole in October last year, noting some companies were using it “for the purpose of circumventing the requirement to deduct tax at source rather than being directed at the raising of third party finance” but decided against it.

All the companies using the quoted Eurobond exemption have subsidiaries or related parties in tax havens. This makes scrutiny of their finances much more difficult, if not impossible, as countries such as Jersey or Guernsey require far less corporate disclosure than the UK. Kemble Water International Holdings, for example, the majority owner of the Thames Water group, is registered in Guernsey. Corporate Watch asked Thames Water if it would be possible to see its accounts but was told they were not publicly available.

Corporate Watch asked Ofwat if it was concerned that several companies are owned by or have transactions with tax havens, and if it would recommend regulating the water industry so companies cannot use tax havens. The regulator said it “does not have the power to prevent any change of ownership. However, following a change of ownership we consult on the ability of new owners to be the fit and proper owners of a regulated water company. We have made a number of amendments to the regulatory ringfence conditions in companies’ licences to ensure we regulate companies within larger groups effectively and provide reassurance that the companies remain able to finance their regulated activities.”

* Through its owner the Pennon Group

** Corporate Watch asked all the companies who held their bonds. None of them would say, often because they do not know as the bonds are traded after they have been originally issued.