Vidett’s Mike Birch analyses developments in the water sector and what they mean for trustees of schemes attached to water companies, with regulatory and political shifts potentially affecting covenant strength.
Water companies are in a “perfect storm” of political and public concern, a challenging settlement with the sector regulator Ofwat, and a period of transition to a new regulator that is expected to take a more robust approach to enforcement.
In this environment, it is important for trustees of schemes attached to water companies to keep a balanced approach and to separate the issues from the noise and emotion.
And there is a lot of noise! Thames Water’s debt restructuring continues inching towards a solution, but it is not there. South East Water’s chair and chief executive have resigned after MPs said they had lost confidence in management, and its main shareholder described the sector as “uninvestable”.
Channel 4’s recent docudrama ‘Dirty Business’ has brought the UK water sector into sharp public focus. Based on a decade-long investigation, it tells the stories of whistle-blowers and individuals who believe their lives have been impacted by sewage-polluted water.
Cutting through the noise for trustees
Operating in a sector subject to such public scrutiny and distrust can be wearing – I say that as someone who worked in banking during the global financial crisis. People can ignore the external commentary on the basis that the commentators don’t understand the industry, or they can become too focused on every new issue.
As ever, the middle ground is generally the best course, recognising the sector’s fundamental strengths and contribution, while understanding the real shift in political expectations and the impact this will increasingly have across the sector. At its simplest, having the leadership, focus and resources to deliver improved services to meet rising expectations will be what distinguishes the companies that will continue to prosper from those that won’t.
Trustees need to understand where their employer sits on the spectrum, from financially strong to potentially stressed, and how quickly that position could shift. The current situation reflects long-standing challenges, not sudden shocks.
Some companies are operating with limited cash reserves, relying on creditor support, or signalling plans for restructuring or fresh capital that have yet to materialise. The persistence of these unresolved operational issues shows a fragility that may be easy to miss if trustees focus solely on headline figures.
Issues affecting covenants
For years, water companies operated in a relatively forgiving regulatory environment, with strong political pressure to keep customer bills low. The trade-off was less visible at the time, but it is now becoming clear.
Underinvestment in key areas such as sewage treatment, infrastructure resilience, leakage prevention and long-term supply reliability has now become the key regulatory focus.
Public anger has prompted a fundamental change in regulatory approach. Unfortunately, while Ofwat’s replacement has been announced, it will take several years to establish, giving uncertainty over the regulatory environment that companies will be operating in.
Meanwhile, the industry needs to raise significant funds to invest. One thing is certain: public and political focus means that the response to problems will be increasingly punishing.
Why this matters for pension trustees
The regulatory environment is tightening, not loosening. Plans for a consolidated regulator signal a desire for more robust oversight. At the same time, companies are committing to significant infrastructure investment. Delivering all of this will not be straightforward. Constraints around engineering capacity raise the possibility of missed targets, which are unlikely to be tolerated.
“In a sector facing sustained scrutiny and rising expectations, trustees cannot afford to take a passive approach.”
Mike Birch, Vidett
Trustees should also consider downside risk. Recent discussions have made it clear that government-led special administration is no longer a theoretical scenario and that pension schemes may not automatically remain attached to the employer in the way previously assumed.
For trustees, there are several important points to consider.
- Look beyond financials. Operational performance will determine covenant strength.
- Understand investment plans and delivery expectations, particularly regulatory commitments.
- Maintain close relationships with employers and understand performance against delivery commitments and the quality of their relationship with Ofwat.
- Keep a close eye on funding and liquidity.
- Consider downside scenarios, including restructuring or special administration.
In a sector facing sustained scrutiny and rising expectations, trustees cannot afford to take a passive approach. Staying close to financial and operational realities will be essential in protecting member outcomes. This is also in the interests of employers. Well-informed trustees are generally able to respond to issues more appropriately and work constructively together.
Mike Birch is a client director and professional trustee at Vidett.
