Water Industry (Financial Assistance) Bill

I do not want to misrepresent the position, and I do not have with me the full accounts over those five years—the Minister may be able to help us with that—but my understanding is that the reserves have reduced over that five-year period. That is one reason for my concern about the balance of decisions on dividend payments and capital retention. That should trouble us and cause us to ask questions. The figures that I have show that 2008 and 2009 were the only recent years in which dividends did not exceed profits. I understand that in 2010 there were £295 million of dividends and £237 million of profit after tax. Probably 30% or 40% more was paid out in dividends than received in income and earnings. The Secretary of State rightly says that Ofwat does not enforce limits on dividend payments. I do not dispute that in principle, but she states:"““However the licence conditions of each water company's licence include a requirement to ensure the dividend policy rewards efficiency and good management of economic risk, and will not impair the company's ability to finance its functions as a water undertaker…Ofwat does not place a cap on levels of gearing. Instead, it determines a notional capital structure for an efficiently financed and operated company for the purposes of setting the cost of capital and assessing the financeability of the price limit it sets. This approach is consistent with the approach Ofgem has adopted in its regulation of the gas and electricity sectors. In the last two Price Reviews this nominal capital structure assumed that water companies would have gearing””—" the figure that I have mentioned before—"““in the range 55%-65%; this was a modelling assumption and not a requirement. The requirement was that they should maintain an investment grade credit rating, plus some headroom and it is this together with the regulatory ring fence that provides the protection for customers. Several of the large water and sewerage companies have a similar gearing ratio of around 80%.””" I pause there to note that if the licence conditions are meant to be about both the ratio and the credit rating, it seems to me that we again have cause for concern. The Secretary of State continues:"““The regulatory ring-fence also requires a company to ensure that it, or any Associated Company, maintains an issuer credit rating which is an investment grade rating. If a company's investment grade is threatened, the cash lock up provision within the licence means that if a company is placed at the minimum level for investment grade (i.e. BBB- or equivalent)…the Appointee cannot transfer cash or other assets to an Associated Company without the prior consent of Ofwat.””" Thames Water is moving slowly down towards that position. She continues:"““Moody's provides a corporate family rating of Baa1 to the whole business securitisation that encompasses Thames Water Utilities Limited. Standard & Poor's do not provide an equivalent rating for whole business securitisations; instead they rate individual bonds…These bonds are rated in the range A- to BBB…These credit ratings are very similar to other water and sewerage companies and provide headroom against the floor for investment grade credit quality.””" However, it remains the case that we have seen a drop in the credit ratings of Thames Water collectively, and some of its activities particularly. That should start ringing alarm bells with us. The Secretary of State ends:"““Finally, discussions with Thames Water on financing the Tunnel are ongoing. Achieving best value for money for customers and safeguarding taxpayers are top priorities for Government””." I wish to mention two other matters, if I may. I am conscious that this is a much longer speech than I would normally want to make, but I am dealing with all my amendments together and this is a fairly complex issue. Ofwat's statement of its position is that the ring-fencing licence conditions require a company to"““conduct its business as if the regulated business were substantially its sole business””" and"““have adequate financial, and facilities and management resources to carry out its regulated activities and to confirm each year that it will do so for the following 12 months.””" A further condition is that a company must"““ensure that its dividend policy will not impair the company's ability to finance its functions””." I am not sure that Thames Water has done that. It seems to me that its dividend policy has impaired its ability properly to carry out its functions, but it has put it in a position whereby it may not be able to finance on its own, or principally, a project that it knew it would want to finance. Ofwat states:"““Our long established policy is that it is for each company and its management to determine a capital structure that is appropriate for its circumstances. But our view is that if investors choose to adopt highly geared structures, it is right for customers that both those investors and the companies bear the risks associated with their choice of financial structure.””" That is fine, but now the company is coming to the Government to ask for help to support it. Finally, Ofwat states that capital restructuring generally"““involves the replacement of equity capital with debt capital. This can have a tax benefit.""Consistent with our view that capital structures are a matter for the companies, we set the price limits for companies on the basis of a notional financial structure for an efficiently operated and financed company””." The Secretary of State also made that point. Ofwat continues:"““We do not set the cost of capital on the basis of each company's actual capital structure.""However, in setting price limits, we separate the treatment of tax from the cost of capital. This includes tax as a company-specific cost based on the company's actual gearing projections.””" We could well do the following things. First, if we applied the equator principles, we would put in place a credit risk management framework for determining, assessing and managing environmental and social risk in project finance transactions, which is recognised in this country and around the world. Equator principles financial institutions—there are four eminent ones in the UK, Barclays, HSBC, Lloyds and Standard Charters—commit to"““not providing loans to projects where the borrower will not or is unable to comply with their respective social and environmental policies and procedures that implement””" the equator principles. There are 76 financial institutions in 28 countries that have adopted the principles, covering more than 70% of international project finance debt in emerging markets. If we were to have that accountability mechanism, which would allow communities to have redress when companies do not meet environmental and social norms, that would provide added reassurance that companies involved in financing large infrastructure projects would uphold high standards. That would apply not just to the water industry but to public financing as a whole. My amendment 5 suggests that no financial assistance be given to a company with a debt to equity ratio of more than 65%. That ratio is a measure of a company's financial strength and demonstrates how much the company has borrowed against its assets. It has a direct effect on a company's credit rating, and consequently on its ability to borrow on the financial markets. I appreciate the Government will not accept the principle of the amendment today, but they might do so in the other place or in another way. If they did so, they would send a message to water companies that if they want Government support to build new infrastructure, they will need to demonstrate that they have the financial strength to be a credible and reliable partner of the Government. That is also the purpose of amendment 10, which would require any company seeking financial support to come forward with a business plan. Any bank or building society would ask that safeguard of any business in our constituencies. They would say, ““Show us your business plan. We'll then tell you whether we are willing to lend you the money.”” A reputable bank involved in financing an infrastructure project would demand to see a business plan, but so far, Parliament is being asked—unless I am corrected by the Minister—to allow the Secretary of State to give financial assistance to water companies, which may include grants, loans, guarantees, indemnity or equity, without any obligation on the Government to seek such guarantees. We should be concerned about that not just because of the recent history of Thames Water, but for the reason given a moment ago by my hon. Friend the Member for Cities of London and Westminster and given the history of the private finance initiative. The previous Government went through a period of giving blanket permission—effectively—to engage in large-scale infrastructure projects financed by PFI, to build hospitals, schools and many other things. The Treasury Committee has made it clear that PFI projects often lead to higher costs and produce poorer-quality buildings and services. It has said that those costs are eventually borne by the taxpayer, and that PFI projects were unacceptable if the costs were simply diverted to private profits in the private sector for companies that pay little or no tax. A further disadvantage of PFI—this was touched on by my hon. Friend the Member for St Ives—is that the asset passes from the public or accountable sector into the private sector. We therefore lose the asset and the revenue stream to the public purse. We do not reduce the public's payment, which in the end is more expensive.