The Severn Trent takeover – corporate profiteering and tax avoidance on Britain’s water supply | openDemocracy
To the people of Ireland please note this is the future direction of your water system. Is this what you want?
Severn Trent is the latest water company to be targeted for takeover by a motley group of investment funds. An analysis of their past deals reveals huge profits, meagre tax bills and a seemingly casual approach to ethical concerns. Once again public assets are turned into wealth for the few.
As more and more people struggle to pay their water bills, the financial world has been getting itself into a lather over the attempted takeover of Severn Trent, the company supplying water across the Midlands and parts of Wales, by an investment consortium called LongRiver Partners. Severn’s board has so far rejected two offers but financial commentators reckon LongRiver will keep coming back until they get what they want (they have until 11 June to make a final offer).
People living in the areas that Severn Trent is ‘serving’ haven’t been asked about any of this, and they’re not going to be. The decision rests with Severn Trent’s board and shareholders, not the eight million people they call “customers”. As the water supply is a captive market (odd, given that privatisation is generally meant to get rid of monopolies and increase competition) they have no choice over who profits from them each time they turn on their taps.
But should they be worried? LongRiver is an unimaginative front name for a grouping of three investment funds: Borealis Infrastructure Management, the Universities Superannuation Scheme and the Kuwaiti Investment Office. Let’s look at each in turn.
Borealis, with its obscure name, central London office and slick website, at first glance looks like a typical investment fund, run to make some already-very-rich people even richer. But there’s a twist. It is actually owned by the Ontario Municipal Employees Retirement System, the pension fund for over 400,000 municipal workers of the Canadian province. Unfortunately its previous UK investments suggest it doesn’t take a public service ethos into its work.
In the last few years, Borealis has bought three other companies providing important services and infrastructure to various parts of the UK: Scotia Gas, which supplies gas to Scotland and other parts of England, Associated British Ports, which owns and operates 21 ports in England, Scotland, and Wales, and HS1, which operates the rail link between London and the Channel Tunnel. Their accounts show Borealis and its fellow owners (different for each company) are using financial structures that means huge payouts for them, but meagre amounts for the public purse.
All three companies have borrowed huge amounts to finance investment – around £4 billion for each company. The exorbitant debt levels of water companies privately owned by investment funds have been criticised by a range of bodies, coincidentally including Severn Trent, which even wrote a report about it.
However, it is the identity of some of the lenders that should raise eyebrows highest in the case of Borealis’ three companies. Look further into their accounts and it turns out they have borrowed huge amounts from subsidiaries of Borealis and their other owners. Scotia Gas and HS1 each owe around £500 million, while Associated British Ports owes over £2 billion. And the interest rates on these loans are far higher – between 10 and 12% – than they are paying to banks or other third parties for the rest of their debt.
The interest payments – around £70m for Scotia and HS1 in 2012, and £255m for Associated British Ports – on these loans help to slash, and sometimes completely wipe out, the companies’ taxable UK profits. Their corporation tax bills are therefore significantly reduced – and sometimes non-existent – while the interest is accrued annually to Borealis and the other owners whether or not the company has had a good year. This isn’t the only way to invest – Borealis and co could have put the money into the company as equity, and received dividends instead of interest. But dividends are paid after a company has been taxed, so do nothing to reduce that bill.
It gets trickier. If Borealis was lending from its home in Canada, HMRC would keep 10% of the interest payments through what is called “withholding tax”. But the loans have been made through the Channel Islands Stock Exchange. Thanks to a loophole HMRC knows about but refuses to close (called the “quoted Eurobond exemption”), no tax is withheld.
Perhaps unsurprisingly, this type of financing is already popular in the water industry. A Corporate Watch investigation earlier this year found seven companies are using this loophole. It is popular with a range of companies, from private healthcare company Spire to Classic FM owners Global Radio. But the most dispiriting thing about all may be that it is being done to ensure service workers in another part of the world can have as comfortable a retirement as possible.
Which leads us onto the Universities Superannuation Scheme. As its name suggests, it too is a pension fund, for university staff across the UK. The USS describes itself as an “active and responsible” investor that says its will take “material corporate, governance, social, ethical and environmental issues” into account when making investment decisions.
Its track record though, doesn’t provide much hope for the people who may soon be relying on it for their water supply. Its investment portfolio contains a range of companies not generally known for their social, ethical or environmental principles. Oil giants Shell and BP, currently under investigation for oil and petrol price fixing, to add to their other various misdeeds, are both in the top five, as is HSBC, itself being investigated for money laundering. There’s also Vodafone, which could teach even Borealis a thing or two about tax bills, arms company BAE, British American Tobacco and notorious mining giants BHP Billiton and Rio Tinto. The USS has also been criticised for its investments in companies profiting from illegal Israeli settlements in Palestine, for example Astom, a French company involved in the construction of a light railway in occupied East Jerusalem (see here for more details).
And don’t hold out too much hope that the Kuwait Investment Office, a sovereign wealth fund set up with the country’s oil revenues, will be keen to ensure water drinkers get a good deal. The fund’s managers may have first met their USS counterparts at the BP AGM, where they are a major shareholder. The fund also has a hugely valuable property portfolio, especially in the City of London, and bought sizeable stakes in both Citigroup and Merril Lynch when the credit crunch first hit, later selling its Citigroup stock for a tidy profit two years later.
So things aren’t looking good for Severn Trent “customers”. But are they that good anyway? The company’s shares are currently traded ‘publicly’ on the stock exchange, and a lot is being made in the press of the difference between the listed water companies and those owned by consortia like LongRiver, with massive debt and tax avoidance schemes more popular with the latter (download an ownership table here). But the similarities are greater than the differences.
It’s true that Severn Trent’s bills are lower than many of their peers, but they’re still pretty damn high – £311 a year is a lot to be paying for water. Bills have increased by 50% in real terms since privatisation in 1989. A parliamentary briefing produced last month estimated 23% of households across England and Wales “now spend more than 3% of their income on water and sewerage bills” and suggested water bills “might not be affordable for a large number of people”.
Rising bills – approved by the government regulator OFWAT – are justified as necessary for investment in creaking infrastructure. But the money is also going to satisfy shareholders’ demand for a return. Severn Trent paid out dividends of almost £160m in 2012 and has said they will be higher this year. There’s a reason its current management are holding out for more than a 16% premium on its current share value: they know guaranteed rising prices for monopoly control of a resource everyone needs is a deal they can charge extra for.
Add to this chief executive Tony Wray’s £1 million remuneration in 2012 – the second highest of all the water companies – and the £300 million it paid in interest on its £4bn of borrowings in 2012 and the investment figures start to look less impressive (there are no Borealis-style related party loans, but their banks and bondholders are charging them around 6% on average). And Severn Trent’s public listing hasn’t kept it scandal free. It had to pay a record £36m fine and promise to cut customer bills in 2008 after orchestrating what the Independent newspaper called “one of the largest customer overcharging scandals ever perpetrated in the UK”. It was fined £2m in the same year for falsifying leakage data.
So perhaps the choice we should be talking about is not private or publicly-listed, but private or public. Earlier this year, Corporate Watch calculated that £2 billion a year could be saved – or £80 per household – if the water supply was in public ownership. The government can borrow much cheaper than the companies and there would be no private shareholders demanding their dividends (see here for the full piece).
This isn’t to say that a public supply would automatically work well – the pre-privatisation supply was criticised for under-investing and lack of accountability – but there are many examples from around the world of water supplies being run more efficiently and democratically when public (see a short video on this here). And there’s certainly no shortage of examples from around the world of privatisation failing to provide a decent or equitable service,*. England’s water supply**, currently, is one of the them.
* See the Public Services International Research Unit website for more information
** Scotland, Northern Ireland and the rest of Wales have public or not-for-profit- supplies.
Water: A future look at what lies ahead for the Irish consumer
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.
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 (
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.”