Our finances explained May 2014
Contents Page 3 Chief Executive s introduction Page 4 Thames financial highlights Page 5 Executive summary Page 6 Investment the facts Page 7 A brief history of Thames and investment Page 8 A track record of improvement Page 10 Keeping bills low Page 12 Who owns Thames? Page 13 Debt is not a dirty word Page 14 Profits: How much we make and where it goes Page 15 Our capital structure and financing Page 16 Paying our fair share of tax Page 17 Political support for capital allowances Page 18 Nothing to hide in the Cayman Islands Page 19 Regulation of the water industry Page 20 Thames Tideway Tunnel Page 22 Annex A: Investment information Page 23 Annex B: Dividend payments 2 Our finances explained Thames Utilities Ltd (TWUL) will be referred to as Thames throughout this document. References to we, our, us and the company relate to Thames.
Chief Executive s introduction The roots of our business are in public service and go back more than 400 years. That public service ethos hasn t changed. The service we provide is the most fundamental of all at the heart of daily life for the 14 million people we serve. Getting it right is genuinely a matter of vital importance. It s something we work on every day of the year and we never forget it is paid for by our customers. We ve had some great successes, such as hitting our leakage targets for eight years in a row and delivering water quality among the best in the world. We ve had our setbacks too, which is why we re working hard to improve our customer service and reduce pollution incidents. We live in an era when population growth is driving increased demand for water, which in turn requires more wastewater to be treated and recycled safely to the environment. This places growing pressures on our networks of pipes and treatment works, which in many cases date back more than a century. Operating, maintaining and improving those networks requires continued investment, year on year, looking not just at the needs of this generation but also planning responsibly and efficiently for the long term. In addition to this, the quality standards for drinking water we provide and the environment we protect increase along with the demand for improved levels of service. Yet for many of our customers the cost of living is rising and the affordability of every household expense is a real and immediate cause for concern. This means the way we finance our business and fund the work we need to do is more than ever a legitimate matter for scrutiny. Our economic regulator, Ofwat, is currently reviewing our business plan for the period from 2015 to 2020 and the outcome will set price limits for that period. That is undoubtedly the most important factor for customers. Knowing the process is independent of the company, and of any political pressures, should be an important source of reassurance. The way we finance the company to deliver the agreed outcomes in our business plan is, within the limits set by our licence from Ofwat, a matter for us to decide. However, I am absolutely clear we have a responsibility to explain our financing in an open, honest and transparent way, pointing out the implications for both shareholders and customers. We recognise we need to improve how we do this and I welcome the opportunity to have more and better conversations about our finances. I believe the best way to initiate those discussions is to give you the facts, after which we will be happy to expand on any subjects covered. The work we do matters, to our customers and to the environment. But so does the way we do it and the way it is funded. This document aims to give you the facts on our financing, from where the money comes from, to how we spend it. With big investment and service challenges ahead of us, what we do and how we do it will remain big questions for us and for all the people we serve. If you would like to discuss any of the contents of this report, we would be pleased to hear from you. Martin Baggs Chief Executive Officer the work we do matters. But so does the way we do it and the way it is funded Our finances explained 3
Thames financial highlights Financial measure 2013 ( s, millions) Turnover (income from customers) Operating profit (turnover, less operating costs) Net interest expense (interest payable on net debt) Profit before tax (profit after interest) Taxation (corporation tax payable on profit) Capital investment (expenditure on our assets) Net debt (Debt finance less cash balances) 4 Our finances explained 2012 ( s, millions) See section on... 1,792 1,695 Customers (pages 10 and 11), which explains what we are doing to help disadvantaged customers pay their bills. 549 644 Profits (page 14), and how they are influenced by external factors. 405 423 Debt (page 13), which explains the importance of our investment grade credit rating in securing efficient financing. 145 222 Dividends and profits (page 14). 1 0 Tax (page 16), which sets out the benefits of capital allowances for our customers. 1,038 1,126 Investment (page 8) 8,373 7,776 Debt (page 13). Thames maintains an investment grade rating.
Executive summary Investment We currently invest in excess of 1bn a year, more than at any other time in our history, and three times more than the amount spent under public ownership. Bills Even with record levels of investment, our customers pay some of the lowest charges in the industry. We offer assistance and advice to help all our customers reduce their bills, with extra support for the most disadvantaged, including a social tariff. Tax We pay our fair share of tax. Our corporation tax payments are delayed through the Government s system of capital allowances designed to encourage investment in infrastructure. Without capital allowances customers bills would be higher as corporation tax payments are among the costs Ofwat takes into account when setting price limits. We gain absolutely no tax advantage through incorporating companies overseas. Their use is solely to address restrictions governing the repayment of acquisition debt, and this is a normal approach adopted by a number of UK-based companies. Ownership Our investors, many of whom represent pension funds, look for stable returns over the long term. They are exposed to financial risks - such as the costs of dealing with extreme weather - so our customers don t have to be. Dividends Profits are far smaller than our investment programme. For every 1 going to Thames s shareholders, we invest more than 6 in improving our network and on the day-to-day running of the business. Thames Tideway Tunnel We are promoting the Thames Tideway Tunnel which is urgently needed to tackle discharges of storm sewage, but the project is expected to be delivered by a specially-created Infrastructure Provider, with its own licence from Ofwat. This approach reflects the exceptional construction risk inherent in a major tunnelling project. The Government has agreed in principle to provide contingent financial support for this risk, and this will help keep costs down for customers. Our finances explained 5
Investment - the facts Thames invests more than 1bn a year*, more than at any other time in our history. This commitment to our future has allowed us to keep the bills of our 14 million customers low while maintaining and improving vital infrastructure. Thames, under Kemble Group ownership, is investing nearly 350m more a year* than under previous private sector ownership. According to Ofwat, the industry as a whole has doubled the level of investment in infrastructure since privatisation but Thames has gone further - our annual investment currently stands at more than three times the amount spent under public ownership. Under current ownership** shareholders have reinvested almost 400m of post-tax profits. By the end of the current regulatory period shareholders will have reinvested almost 150m of cost savings from infrastructure projects. For every 1 going to Thames s shareholders, we invest more than 6 in our infrastructure and the day-to-day running of the business. * in 2012/13 prices **From Dec 2006-30 Sept 2013 6 Our finances explained
A brief history of Thames and investment Average yearly investment in 2012/13 prices Up to 1989 * 323m Up to privatisation In the decade before privatisation the nationalised water industry was under significant pressure. The Government was looking for ways to reduce its spending. At the same time, new European water quality regulations were set to significantly increase the investment required to update the UK s ageing water infrastructure. Faced with the conflicting requirements for a reduction in Government spending and a significant increase in investment, the decision to privatise the water industry was implemented in 1989. 1989-2001 580m Rebuilding infrastructure as Thames Plc (floated on the London Stock Exchange) One of the main reasons for the privatisation of the water industry was to correct the many years of underinvestment the sector had seen while under public ownership. Thames immediately set out to improve its infrastructure. This included the construction of the Thames ring main and major upgrades to all of London s major treatment works. This work was completed by 1997. 2001-2006 660m International expansion as part of RWE After the acquisition of Thames by the German utility company RWE in 2001, Thames accelerated the rate of its international expansion. Segregating its domestic investment spending, the business acquired the USA s largest privately owned water company, American Works. By the time the expansion had reached its peak Thames had 70m customers in 23 nations. 2006-2015 ** 1.08bn Kemble Group ownership Since the business was acquired by national and international investors, known as the Kemble Group, all global interests have been sold or closed. Operational performance has significantly improved with the total focus on the UK. Thames has hit its leakage targets for the last eight years and is currently investing 1bn a year in 2012/13 prices. Source: Thames published accounts * Period covers five years immediately prior to privatisation (1984/85-1988/89) ** Source: 2013/14 unaudited accounts. Forecast for 2014/15 Our finances explained 7
A track record of improvement Record levels of investment under the company s current ownership have delivered significant improvements for customers. The task we face is to sustain the improvements and face future challenges head on. Spending more for the future Since privatisation in 1989, the water industry in England and Wales has invested 116bn to renew and improve the infrastructure on which homes and businesses rely, transforming drinking water quality and sewage treatment standards. Levels of investment have risen under private ownership, and continue to grow. Thames is currently investing a record 1bn a year, 90% more than in the period immediately following privatisation. It has been suggested we are reducing the amount we invest. This is untrue, as the chart on the right clearly shows. While investment in the first three five-year regulatory cycles following privatisation was largely unchanged in real terms, it has very significantly increased since the company was acquired by the Kemble Group in 2006. We also invest more than any other UK water company (see chart on page 22). Investment per regulatory period (2012/13 prices) Source: TWUL published accounts 2.9bn 3.1bn 3.0bn Desalination plant at Newham, east London 4.5bn 5.6bn 1990-1995 1995-2000 2000-2005 2005-2010 2010-2015 * A more detailed year-by-year breakdown of investment over the period since privatisation can be seen on page 22. Our successes Under current ownership we have: Renewed 1,400 miles of ageing water mains, helping us to hit eight consecutive leakage targets and to reduce overall leakage by a quarter. Built the UK s only desalination plant of its kind, helping to protect our customers from severe restrictions on water use during drought. Protected many families and businesses from the devastating effects of sewer flooding, with schemes such as a 17.5m project in Maida Vale, west London, which will benefit 350 homes. Invested to boost the quality of the tidal River Thames, with a 675m improvement programme at five sewage works, and the 635m Lee Tunnel - the largest UK water infrastructure project since privatisation. Consistently delivered at least 99.97% compliance with stringent tap water quality tests - among the best in the industry. Since 2009/10, maintained a maximum 100/100 rating for ensuring security of supply - a measure of a company s ability to provide enough water for its customers. Maintained almost 100% compliance with environmental consents at all of our 350 sewage works since 2007. 8 Our finances explained * Source: Unaudited accounts for 2013/14. 2014/15 are forecasts
Our water quality is among the best in the industry Meeting future challenges Much remains to be done to ensure customers in London and the Thames Valley continue to receive water and wastewater services fit for the twenty-first century - and the future holds greater challenges still, including: Meeting the growing expectations of our customers Population growth, driving increased demand for water and placing a growing pressure on our sewers Climate change, which is set to increase the risk of extended droughts, and severe weather leading to flooding Maintaining and renewing our pipes and treatment works, which in many cases date back more than a century Achieving more challenging quality standards for the drinking water we provide and the environment we protect Our future priorities include protecting more homes from sewer flooding. By far the largest scheme will benefit thousands of homes in the west London boroughs of Kensington and Chelsea, and Hammersmith and Fulham. In addition to flood relief schemes outside the capital, we will also investigate how to prevent heavy rainfall soaking through waterlogged soil into our sewers at locations in Oxfordshire, Berkshire, Gloucestershire and other counties. The Thames Tideway Tunnel will tackle frequent discharges of storm sewage to the capital s main river. Assuming the project goes ahead as expected, it will be delivered by an independent Infrastructure Provider with its own licence (see page 20 for more detail). We intend to carry on with our work to progressively meter all buildings in our supply area, which is fundamental to ensuring we have enough water to meet future demand. Not only will the smart meters we install provide our customers with data that helps them take control of their bills, it will help us locate leaks from our pipes and those owned by our customers. We have also identified the need for a major new source of water by the middle of the next decade and are assessing whether this should take the form of wastewater recycling, a transfer from elsewhere in the country, or a major new storage reservoir. The challenges we face, and the investment needed to address them, make our financial arrangements all the more important. Above all, financing our business efficiently is fundamental to our plans to continue investment in vital infrastructure improvements so our customers receive value for money. Our finances explained 9
Keeping bills low Even with our record levels of investment, our 14 million customers continue to enjoy some of the lowest charges in the industry and we have measures in place to make our bills more affordable for the most disadvantaged. Thames customer bills are one of the lowest in the UK behind only Severn Trent and Northumbrian - 40 below the average for the sector. 495 485 440 437 431 410 Average water and wastewater bills of water and sewerage companies 2014/15 Source: UK bill summary 373 370 364 333 This is despite the Greater London region presenting some of the toughest challenges facing any water company and the need to replace some of the oldest water infrastructure in the world in one of the most congested and fastest growing cities. The water companies discharging waste water to the sea have already undertaken significant investment to meet EU bathing water standards. While Thames does not discharge to the sea, other legislation, such as the Urban Waste Treatment Directive, now requires significant investment - to deliver projects like the Thames Tideway Tunnel. However, our water bills are still expected to remain below the average for the sector by 2020, despite the costs of the Thames Tideway Tunnel project. South West Wessex Dwr Cymru Southern Anglian How we help For most of our customers, their water bill is a relatively small proportion of their household costs, but we know some people struggle to pay their bill. Support for customers includes: 1. The introduction of a social tariff in April 2014 - a year earlier than planned - in recognition of the need to support customers struggling with their bills. The tariff will halve the bills of those households who are least able to pay, assisting a predicted 37,000 customers by 2020 United Utilities Yorkshire Thames Northumbrian Severn Trent 2. Sure which is a Government mandated scheme for qualifying metered customers. Around 6,500 of our customers currently benefit from this tariff 3. Home visits to help metered customers who have difficulty in paying bills to save water 4. Free water-saving gadgets which continue to be available to all customers 5. Free leak repairs on customer-owned pipes connecting properties to mains supplies 10 Our finances explained
6. Our Customer Assistance Fund. This independently managed fund makes contributions to customers arrears. It helped around 3,500 customers in 2012/13. An expected one-off tax credit of 10m in 2013/14 will be added to the fund, more than doubling the amount available over the next four years 7. An Independent Trust Fund which provides grants to support money advice, debt counselling and financial literacy. In exceptional circumstances, it can provide help with other essential household costs Providing value for money In addition to the help we offer customers struggling to pay their bills, we aim to keep the bills of all our customers as low as possible. This includes managing the water and wastewater networks we operate efficiently and effectively, and innovating to get the best possible value for our customers. One of our most significant innovations is a 250m programme to install thermal hydrolysis plants at our larger sewage works. This technology helps us extract as much renewable power as possible from the sewage treatment process, reducing both our reliance on traditional energy sources and exposure to high energy bills. Like all taxes, corporation tax payments are among the costs Ofwat takes into account when setting price limits. The benefit to customers of capital allowances in delaying tax payments is worth around an 8 reduction from current household bills. In order to keep customers bills down we use debt to finance the substantial majority of our investment programme. We receive tax relief on the interest payments on this debt. The benefit of tax relief on interest costs is worth nearly 16 off current customer bills. What your water bill pays for Our bills are among the lowest in the country, at around 1 a day on average for both water and wastewater services. This cost not only pays for clean water to the home but upkeep and investment in the pipe networks, collection and treatment of sewage, and advances our research. For every 1 customers pay today, we spend a total of 1.25*, with the shortfall coming from reinvested profits and other sources of capital, such as additional shareholders funds and loans. We also manage the company s finances to put downward pressure on customers bills. Delaying corporation tax through capital allowances, which provide tax relief on capital investment in infrastructure, is a good example. *Based on the 2012 forecast for the current regulatory period Our finances explained 11
Who owns Thames? Thames is owned by a group of long-term investors, most of whom are investing on behalf of pension funds in Britain and around the world. They include the company s second largest shareholder, the BT pension fund. The water industry attracted these investors due to the relatively stable regulatory regime under which it operates; while the investors remain attractive to the industry as they provide long-term stability which is good for financing and our customers. Dedicated pension funds own more than 26% of Thames, but many of our other investors are also funded at least in part by pension funds. The proportion of the company owned either by dedicated pension funds, or partly pension-backed funds, stands at around 70%. The chart on the right provides a general overview of the ownership of Thames. 19% Sovereign wealth funds 20% Partially pension backed 9% Other investors 26% Dedicated pension funds 26% Macquarie - managed funds The Government certainly agrees. On the news the China Investment Corporation had decided to acquire 9% of Thames, the Chancellor of the Exchequer, George Osborne, remarked in January 2012: This is a significant step by China. It is a vote of confidence in Britain as a place to invest and do business. This investment is good news for both the British and Chinese economies. Shareholders are exposed to external risks, such as interest rate fluctuations and the cost of fixing problems caused by extreme weather, so our customers don t have to be. While reductions in interest rates have benefited the company by bringing down interest payments, these reduced payments will benefit customers through lower bills in the next regulatory period. Our shareholders are looking for stable returns over the long term. However, returns have fallen over recent years. In 2012/13 post-tax profits fell by almost a third. 12 Our finances explained The nationality of our owners makes no difference to the day-to-day provision of services for our 14 million customers in London and the Thames Valley. The capital (debt and equity) market is global, and as a company investing 1bn a year in its infrastructure, Thames needs access to it continually. If this market was restricted to UK-only participants it would not be as competitive, or as efficient. It would lead ultimately to greater costs for customers. The 2012 drought followed by widespread sewer flooding, significantly increased our operating costs. As a result, distributions to shareholders fell by more than half, although investment has remained more than 1bn a year.
Debt is not a dirty word Thames holds investment grade credit ratings which have allowed us to finance our record investment programme of more than 1bn a year and keep costs down for customers. Maintaining a good credit rating is very important to us. Our gearing has risen, as the graph on the right shows, but our credit rating remains at investment grade under the current ownership. Percentage of gearing (net debt regulated capital value) Source: TWUL statutory accounts, interim accounts to 30 September 2013 100% Under our licence we are required to maintain an investment grade credit rating. We currently have a rating of A3/ A-, significantly higher than the minimum of BBB-/Baa3. 67.9% 74% 71.9% 76.8% 77.7% 76.8% 77.2% Ofwat expects us to finance our functions efficiently. The debt raised to finance our activities is sourced entirely from third party investors (banks, investment funds and other financial institutions). The majority of the debt is raised by the company s financing subsidiaries which are resident in the UK for tax purposes. 44.4% 49.8% Interest rates vary, depending on market conditions when the company needs to access the financial markets, but looking at the entire portfolio of around 8.5bn of net debt outstanding at 31 March 2013, the average interest rate for the year was around 5%. 0% 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14* Debt helps finance investment such as work to replace pipes and reduce leakage Our finances explained 13
Profits: How much we make and where it goes Contrary to reports, we have not seen record profits in recent years. In fact our operating profit has fallen. Ultimately, profits are far smaller than our 1bn a year investment in upgrades to our ageing pipes, sewers and other facilities. Profits have been influenced by several factors, including: Challenging targets for companies set by our regulator Ofwat Extreme weather events, combined with major changes to legislation, such as the transfer of ownership of private sewers, have significantly increased operating costs The severe economic downturn which has driven up bad debt and other costs How much goes to shareholders? Dividends have played a crucial role in the successful privatisation of the water sector. Companies are expected to reward their investors for the capital they have injected. As long as a stable and consistent regulatory system continues to underpin our business, we can continue to attract the sort of investors looking to make a long-term commitment, with a return on their investment delivered over many years. This long-term approach helps us fund our investment, while keeping bills as low as possible. 375m 425m 481m 549m 601m 631m 649m 663m 694m 714m 537m 504m 518m 487m 497m 595m 522m 639m 690m 761m 648m 664m 549m 1990/91 1991/92 1992/93 1993/94 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 AMP1 AMP2 AMP3 AMP4 AMP5 Asset Management Period To put our dividend payments into context, for every 1 going to Thames shareholders we invest more than 6 in improving our network and on the day-to-day running of the business. Under the current ownership we have retained 20% of post tax profits up to 30 September 2013 in the business. Based on market valuations our investor yield in 2012/13 was around 5%. To see a breakdown of our annual dividends see Annex B on page 23. Operating profit* since privatisation (2012/13 prices) Source: TWUL published accounts rebased to 2012/13 prices * Operating profit = turnover, less operating costs 14 Our finances explained
Our capital structure and financing Dividends are dwarfed by the equity and debt shareholders have raised. The use of debt to fund infrastructure improvements has helped keep customers bills down. Our debt financing activities supplement the revenue we receive from our customers. Without it bills would be significantly higher. As is the normal practice of any UK company, we receive tax relief on the interest payments on this debt. Under water industry regulation, all debt at the holding or Kemble level is the responsibility of shareholders - customers are not asked to bear the risk of this debt. This diagram shows a summary of our current financial structure. It shows money entering and leaving the business from investments, interest and dividends. It does not include money from bills or capital or operational expenditure. Investment in 2006 2.31bn Includes 2bn of equity and 0.31bn of loans from shareholders External borrowing 750m 1 2 Kemble Holdings Ltd * Kemble companies ** Dividends in 2012/13 92m Includes 17m of interest payments and 75m of dividends to shareholders Payment in 2012/13 92m External interest in 2012/13 60m 1 2 3 In 2006 our investors paid nearly 2bn of equity into Kemble Holdings to finance the acquisition of Thames, as well as 310m in the form of loans. Shareholders have received an average annual dividend and interest payments of 159m since 2007/8. These companies borrowed 750m to fund the acquisition of Thames. They paid 60m interest on that debt. They also borrowed 2bn from Thames, and paid us 40m in interest in 2012/13. We ve borrowed 8.4bn - mostly to fund vital improvements to our infrastructure. In 2012/13 the net interest charge on this debt was 446m and the dividend payments were 231m. Borrowed 2bn Net payments 152m External borrowing 8.4bn 3 Thames companies *** Dividends of 231m less interest and other intra-group payments of 79m Net external interest in 2012/13 446m *Kemble Holdings Ltd: includes Kemble Eurobonds Plc. **Kemble companies: includes Kemble Finance Ltd, Thames (Kemble) Finance Plc and Thames Ltd. ***Thames companies: includes Thames Utilities Holdings Ltd, Thames Utilities Ltd, and a number of property and dormant international subsidiaries. It also includes two financing arms: Thames Utilities Finance Ltd and Thames Utilities Cayman Finance Ltd Our finances explained 15
We have invested to increase the amount of renewable energy we produce, including at Riverside sewage works in Essex Paying our fair share of tax We pay our fair share of tax. Our corporation tax payments are delayed through the Government s system of capital allowances designed to encourage investment in infrastructure. Without capital allowances customers bills would be higher. Media coverage of our tax liabilities has not adequately explained that the Government incentivises infrastructure investment through the longstanding policy of granting capital allowances to provide tax relief. Some reports have created the impression we have deliberately sought to escape paying our fair share of taxes, which is simply not the case. The tax relief we receive is through policies designed by the Government, used in the manner and spirit intended. All active companies in our group are UK tax resident, and the Kemble Group has not diverted profits into tax haven jurisdictions. We contribute around 150 million annually to the public purse in other taxes, including central and local government business rates, PAYE, national insurance and environmental taxes. Capital allowances Designed to incentivise growth, capital allowances have been a feature of the United Kingdom s tax system since 1878, and are part of many modern economies. They aim to encourage firms like us to invest in modernising vital plant and machinery by providing tax relief on the investment. Capital allowances allow companies who are investing heavily to delay, not avoid, payment of corporation tax. The Government uses such tax policies to ensure the United Kingdom remains competitive in the global economy, as well as encouraging employment growth. The withdrawal of capital allowances would result in either our customers bills being higher or there being less investment to improve our pipes, sewers and other facilities. Our deferred tax provision, representing the cumulative amount of tax delayed by capital allowances, is around 900m. Delaying corporation tax through capital allowances benefits our customers. Like all taxes, corporation tax payments are among the costs Ofwat takes into account when setting price limits. If we were to stop investing, this deferred tax would become payable over the remaining life of our assets. The benefit to customers of capital allowances in delaying tax payments is worth around an 8 reduction from current household bills. 16 Our finances explained
Political support for capital allowances Ministers from both parties in Government, and members of the Opposition, have made it very clear capital allowances are intended to incentivise investment to benefit the wider economy; and companies are expected to claim the allowances they are entitled to. In June 2013, Richard Benyon MP, the then Minister, told the House of Commons: I would be cross if water companies were not using [capital allowances] because it would mean our constituents would be paying more for their water or there would be less investment in repairing and improving our infrastructure. In May 2013, David Gauke MP, Exchequer Secretary to the Treasury, set out the Government s support for capital allowances in a speech: So let me make one point clear. When we bring in a tax relief we want companies to use those tax reliefs. They are entirely legitimate, they are entirely legal, and they shouldn t as sometimes is the case be confused with tax avoidance. claiming capital allowances which recognise asset depreciation is not tax avoidance. In May 2013, Danny Alexander MP, Chief Secretary to the Treasury, said: So we ve worked hard. to make our tax system an asset for the country and to ensure it supports rather than hinders growth and investment. The measures we ve taken during that time cutting corporation tax capital allowances to bring forward investment in plant and machinery have been specifically designed to ensure that Britain is the best place in the world to invest and grow a business. In 2013, The Labour Party set out its support for tax relief for businesses in its policy document Corporate Tax: Transparency and Reform, published by the Shadow Chancellor, Ed Balls MP: Sometimes there will be good reasons why companies pay little tax some companies invest large sums in research and development, assets and infrastructure. We want that real investment here in Britain and we should encourage it, even when it temporarily reduces the tax those companies pay. Our finances explained 17
Nothing to hide in the Cayman Islands Our Cayman incorporated financing companies are tax resident in the UK and file full returns with HMRC. The location of incorporation has provided no tax advantage to Thames, or any of its group companies. Businesses with group companies incorporated in the Cayman Islands often attract scrutiny from those concerned about tax avoidance. However, there are other reasons, beyond tax, why businesses choose to have companies incorporated overseas within their group structures. The use of the Cayman Islands incorporated vehicles was solely to address restrictions under UK company law governing the repayment of acquisition debt. The use of a company incorporated in a non-uk jurisdiction is a structure mirrored by a number of UK-based companies. All debt used to finance the regulated business is raised from third party banks, bondholders and financial institutions and interest costs are passed through to Thames. The recharge from our Cayman incorporated companies is fully taxed in the UK and totalled 263m in 2012/13. 18 Our finances explained
Regulation of the water industry The water industry regulators The companies that make up the water industry operate as regional monopolies. In the absence of competition, prices are controlled by the independent regulator, Ofwat. The standard of drinking water we provide to our customers is strictly regulated by the Drinking Inspectorate, while our management of the environment is overseen by the Environment Agency and Natural England. While not a regulator itself, the Consumer Council for (CC) ensures customers are provided with a strong voice in the price setting process. Ultimately, however, it is Parliament that sets the overarching policies that define the sector and its long-term goals. Ofwat and investor confidence Ofwat exists as a proxy for competition in a monopoly market and scrutinises water companies extensively as part of its role. It defines its key functions as: Keeping bills for consumers as low as possible Monitoring and comparing the services the companies provide Scrutinising the companies costs and investment Encouraging competition where this benefits consumers To achieve these objectives, it controls prices and sets standards for performance. It does this independently of Government. These safeguards not only provide protection to customers but they also create a level of predictability in the market that is very attractive to a particular type of investor; those looking to invest for the longer-term with a relatively secure return. These investors, perhaps understandably, often take the form of pension funds. This successful market design, embracing transparency and stability, has ensured the industry has been able to attract over 116 billion of inward investment since privatisation, driving up performance to levels never seen under public ownership. However, investors in the water industry do not receive guaranteed returns on investment. The impact of bad weather, for instance, can result in significant increases in operating costs which investors have to bear. But the unique appeal of the water industry to long-term investors is finely balanced. Given that the primary concern of most pension fund managers is security of return, any potential threat to Ofwat s consistency of approach can have a significant impact on the perceived risk of the industry - and increase the rate of return expected by investors accordingly. Our finances explained 19
Thames Tideway Tunnel Most of London is served by a combined sewerage system, collecting sewage together with rain water runoff. The system was designed by Sir Joseph Bazalgette in the 1850s to overflow into the tidal River Thames following particularly heavy rainfall via a network of combined sewer overflows (CSOs). This prevents the back up of sewage flooding properties and streets. The sewers were built to last and are in good condition. They have sufficient capacity for dry weather flow but population growth and the development of land which was previously able to absorb rainwater means many of the main sewers operate at close to maximum capacity much of the time. The Thames Tideway Tunnel (TTT) will deal with the discharges from the unsatisfactory CSOs, which collectively discharge 50-60 times in a typical year, totalling 18 million tonnes. The TTT is included in the Waste National Policy Statement and is a nationally significant infrastructure project. It is the most cost-effective solution to the discharges and the only option that meets the timescale set by Government and the environmental standards adopted by the Environment Agency. It involves the least overall disruption to residents, businesses and transportation. The role of the Infrastructure Provider The Thames Tideway Tunnel is expected to be delivered through the formation of a new regulated business, separate from Thames, dedicated to the implementation of the project. Under the provisions of the Flood and Management Act 2010, a specially created Infrastructure Provider (IP) is planned, which will receive its own licence from Ofwat. Under the plans the IP will build, own, finance, operate and maintain the project and will be regulated by Ofwat. To enable the IP to raise the finance it needs and successfully implement the project, Ofwat has agreed a number of specific adaptations to the usual regulatory regime. Because of the risks inherent in executing a project of this nature, the Government has agreed in principle to provide contingent financial support to the IP under a Government Support Package (GSP). This support will help to facilitate the financing of the project in the private sector and keep costs down for customers. Environment Minister Lord De Mauley said contingent financial support would only occur in the case of unlikely events such as severe debt market disruption, significant cost overruns due to extreme tunnelling conditions and limitations on commercially available insurance. The IP is expected to enter into contracts for the construction of the project procured by Thames on its behalf. The role of Thames Thames has been working with the Department for Environment, Food and Rural Affairs (Defra), HM Treasury (Infrastructure UK) and Ofwat on the development of the project. It began the tender for the main construction works in 2013 and will start a separate tender for the IP itself later this year. The company is the developer of the project and, in addition to the formation of the IP, is responsible for securing planning consent - and acquiring the land needed to construct the project. All water and sewerage infrastructure improvements within a water and sewerage company s regions are paid for by all of its customers. The project s cost will therefore be spread across Thames s 14 million sewerage customers, including those outside London. Thames will enter a contract with the IP under which it will collect revenues and pass them onto the IP. Thames s draft business plan for 2015-2020, submitted to Ofwat in December 2013, shows average household bills rising by 40 before inflation, over the period, to pay for the tunnel. The cost of the project could add a maximum of 70-80, before inflation, to average bills by the early 2020s compared to 2011. 20 Our finances explained
Thames has so far funded around 641m in development costs for the Thames Tideway Tunnel Around 1.4bn of the Thames Tideway Tunnel s construction cost will be financed by Thames and 2.8bn by the IP. Thames s contribution will fund development costs, enabling works and interface works. To date, Thames has funded around 641m in development costs, including 323m on land acquisition. Funding and finance The IP is expected to incur a capital expenditure of approximately 2.8bn (in 2011 prices). It is assumed the IP will be restricted to a leverage covenant of 70% net debt to regulated capital value. The financing structure for the IP will be determined by the winning bidder but could include sterling bond issuance, bank lending and loans potentially from the European Investment Bank (EIB). The equity risk profile of the IP will be similar to a businessas-usual regulated water/waste-water company in England and Wales, although there may be a premium required by the market due to the IP being the first of a kind. The Thames Tideway Tunnel and our dividends It has been suggested that if Thames had paid out lower dividends over recent years it would be able to fund the cost of the Thames Tideway Tunnel. This view does not stand up to scrutiny: The Thames Tideway Tunnel presents significant construction risks that, if undertaken by Thames itself, would lead to a significant downgrading of our credit rating. This would, in turn, make it more expensive to fund our business and, ultimately, lead to unnecessarily high bills. It is a well-established principle that the users of our networks should pay for the construction and maintenance of assets this is the intention for the project. To do otherwise could constitute a departure from the full cost recovery principle, as mandated within the Framework Directive. The Thames Tideway Tunnel is unique in its size and scale. A unique delivery method - the creation of a separately regulated entity supported by the government - is the most cost effective way to construct the project for customers. The debt in the IP is expected to achieve an investment grade rating and this will be a condition of its licence which mirrors the existing licence requirements of the other water companies. Our finances explained 21
Annex A: Investment information and sewerage company capital expenditure (2012/13 prices) Source: and sewerage regulatory accounts *Thames statutory accounts 930m 1,161m 1,038m Thames capital expenditure since privatisation (2012/13 prices) Source: Thames published accounts 274m 346m 503m 274m 265m 318m 222m 277m 227m 520m 495m 555m 133m 151m 127m 406m 468m 350m 629m 725m 760m 111m 155m 215m 252m 419m 389m 636m 618m 594m 612m 434m 470m 593m 685m 696m 638m 466m 537m 634m 713m 649m 647m 780m 1,060m 1,126m 854m 930m 1,161m 1,038m 1,119m 1,380m Anglian Dwr Cymru Northumbrian Severn Trent 2010/11 2011/12 2012/13 South West Southern United Utilities Wessex Yorkshire Thames * 1990/91 1991/92 1992/93 1993/94 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 AMP1 AMP2 AMP3 AMP4 AMP5 Asset Management Period * Unaudited accounts for 2013/14 and forecast for 2014/15 * * 22 Our finances explained
Annex B: Dividend payments Some reports have claimed we have put the longterm stability of the business at risk by paying out dividends that have exceeded our profits Since acquisition, our dividends have equalled 80% of our profits - retaining 20% of post tax profits within the business. Year Thames dividends (, million) 2007/08 102.0 2008/09 222.0 2009/10 307.9 2010/11 271.4 2011/12 279.5 2012/13 231.4 2013/14: half year 128.5 This table shows the dividend flowing from Thames to Kemble Group (KW). Year Kemble dividends (, million) 2007/08 102.0 2008/09 222.0 2009/10 191.0 2010/11 150.0 2011/12 200.0 2012/13 92.0 2013/14: half year 50.0 This table shows the amount of this dividend KW pays to its shareholders as dividends and interest on shareholder loans. Source: statutory accounts Our finances explained 23
Contact us Email ourfinances@thameswater.co.uk By post Our finances explained, Thames, Clearwater Court, Vastern Road, Reading, Berkshire RG1 8DB This leaflet can be supplied in large print, braille, or audio format upon request. 24 Our finances explained 12559 03/14