If you would kindly rip up the regulatory system, move the goalposts on sewage and spills and promise not to fine us too much, we’d be delighted to rescueThames Water. If these requests cause you political difficulty, dear secretary of state, consider how much worse it could be if you end up controlling this failing company yourself. Do you really wish to be responsible for every burst water main in London and every drop of effluent in Didcot?
That seems to be the pitch from the 100-plus group of lenders to Thames Water who are now the only game in town in terms of a “market-led” recapitalisation, the alternative to special administration, AKA temporary nationalisation.
It is expressed in the bland language of “regulatory support”, but the meaning isn’t hard to translate. A “rebased” performance target is a lower one. A “pragmatic approach to historic and future legal and regulatory compliance” means letting Thames off substantial financial penalties – maybe a billion or two over the next five to 10 years – that would otherwise come its way.
If the proposal sounds outrageous (it does), in one sense you can’t blame the creditors for giving it a go. Sir Jon Cunliffe’s Independent Water Commission,in its interim report last week, nodded to the general idea that failing water companies will need a helping hand from regulators to haul themselves off the floor. “The commission is of the view that a more formal framework for supporting companies to turnaround performance may be needed, to avoid a future ‘doom loop’,” the report said.
The use of the loaded “doom loop” phrase will have delighted the creditors. It is exactly how they describe Thames’s predicament of fines out to the horizon. If you want to improve the assets, goes their argument, something has to give – and would have to give even under a nationalised setup.
There are, though, at least two enormous difficulties to the creditors’ plan. Most obviously, how could Steve Reed, the environment secretary, possibly sanctionlegal immunity for serious environmental crimesfor private sector owners of Thames? Remember Reed’s refrain every timehe bashes a bonus: “With this government, the era of profiting from pollution is over.” It is hard to walk back that statement.
Second, even if the Cunliffe commission’s thinking provides philosophical support for regulatory “flexibility”, the final report is still a couple of months away, and parliamentary scrutiny will be needed before the regulatory system for the water industry could be changed fundamentally. The timeframe is beyond the would-be new owners’ plan for recapitalising Thames.
Thus, if the creditor group has any prospect of getting its proposal to fly, a few of its big numbers will have to look very different from the ones presented in the self-serving outline version. In short, the senior lenders are being far too greedy in imagining they can escape with writedowns on their debt of just 20%, the ratio implied by the proposed £3.2bn hit to total A class debt of £16bn.
Come on. The haircut for lenders cannot be that light. The market value of the debt is already implying 30% writedowns. Some of the opportunistic vulture funds are thought to have got in at as low as 60p in the pound; Reed and Ofwat, the water regulator for England and Wales, would look like fools if they approved, in effect, hefty day-one paper profits for them.
But it is – just about – possible to imagine a deal in which Thames pays its fines upfront, as it were, in the interest of allowing managers to concentrate on the day job of running the business rather than hiring lawyers to fight Ofwat and the Environment Agency. Add £1.6bn as a settlement of outstanding bad behaviour and in effect you’d get a haircut for senior lenders of 30%. Or maybe the figure would have to be closer to 40% to allow Reed to save face.
Sign up toBusiness Today
Get set for the working day – we'll point you to all the business news and analysis you need every morning
after newsletter promotion
Alternatively, the environment secretary may decide that negotiations are a waste of time, that legal shenanigans don’t work, or that regulatory get-outs set a bad precedent, or that Thames is too far gone. It would be a reasonable point of view: if you really want to clear the decks, special administration is the surest route. The next step – deal or no deal – looks to be genuinely in the balance; don’t underestimate the government’s desire to avoid nationalisation.
Haircuts of only 20%, however, just don’t work. If the bondholders wish their inflammatory proposal to be taken seriously, they should be told to come back with a proper number, or have one imposed on them.