Canada Pension Plan Investments, the largest direct investor in infrastructure globally, is warning that over recent years - particularly in the period following the launch of the PR19 price review- there has been a marked deterioration in the attractiveness of UK water as an investment proposition.

The warning comes in CPP Investments' response commenting on two Working Papers published by the Competition and Markets Authority as part of its inquiry into appeals by four water companies against Ofwat’s Final Determination in the 2019 Price Review.

Writing to Kip Meek, Chair of the CMA PR19 inquiry, Scott Lawrence MD and Head of Infrastructure at CPP Investments said:

“The scale and long-term nature of infrastructure businesses should deliver relatively low risk equity exposures which investors are willing to price competitively. However, this requires both political stability and regulatory clarity, giving investors the ability to generate long term returns commensurate with that risk profile.

“ To the extent that we perceive that the political and regulatory risks of a particular market are no longer commensurate with the returns on offer, we will seek investment opportunities elsewhere.

“Until recently, the defensive fundamentals and index-linked revenues of the UK water sector, matched with an independent and stable regulatory regime and the UK’s status as an attractive and welcoming market for foreign capital, combined to make the UK water sector an attractive market for private investors such as ourselves.

“However, over recent years (and particularly in the period following the launch of the PR19 price review) there has been a marked deterioration in the attractiveness of UK water as an investment proposition.”

According to Scott Lawrence, this view is shared by many of its peers in the infrastructure investment community - evidenced by a general lack of interest from new private investors to enter the sector. “Indeed, despite the perceptions about a “wall of capital” (committed funds pursuing infrastructure investment opportunities), the UK water sector has not recently attracted investment interest,” the letter says.

He goes on to point out that investors have instead pursued water investment opportunities in other jurisdictions such as France, Spain, the United States and Latin America.

CPP Investments is a professional investment management organization that invests the funds transferred to it by the Canada Pension Plan that are not needed by the CPP to pay current benefits on behalf of 20 million contributors and beneficiaries. CPP Investments is today the largest direct investor in infrastructure globally, with net assets of more than £265 billion as at 30 September 2020.

A significant investor in the UK since 2006, as at 30 September 2020, CPP had approximately £10.5 billion invested across a variety of interests, including sizable infrastructure investments in Anglian Water Group, Arqiva and Associated British Ports.

In 2006, it joined a consortium of investors to take Anglian Water private, and CPP remains the largest shareholder in the company with a 32.9% stake.

Scott Lawrence told Kip Meek that CPP’s global investment program provides it with a unique level of insight into each regional infrastructure market and sector, enabling it to compare and contrast investment opportunities and reassess the risk/reward profile as markets evolve.

The “well documented uncertainties” caused by the Brexit vote (as well as concerns around potential renationalisation ahead of the 2019 General Election) has also contributed to the deterioration of investment confidence, he said.

"We firmly believe that a fair balance was not struck in Ofwat’s proposed 2020-25 price control for Anglian Water"

However, he gopes on to explain that this did not prevent infrastructure investors making significant other UK investments in sectors such as electricity grids, telecoms and renewable energy, commenting:

“Rather, it is our view that the key driver has instead been an increase in regulatory risk and uncertainty in the water sector.

“We believe that the role of the regulator when setting prices is to strike a fair balance between supporting necessary investment, allowing a reasonable return for investors, and addressing other critical issues such as climate change and security of supply, while keeping bills affordable for customers.”….

“However, we firmly believe that a fair balance was not struck in Ofwat’s proposed 2020-25 price control for Anglian Water. The final determination placed too great an emphasis on short term headline bill reductions to the detriment of securing and incentivising longer term sustainable investment in the network that customers had clearly signaled they wished to see.”

According to Lawrence, it is “fair to say” that the response of infrastructure investors to the “unbalanced and negative skew of risk and return” reflected in the PR19 final determinations will be to continue to seek (and support) superior water investment opportunities in Europe, North America, and South America.

“The overall attractiveness of the UK as a destination for broader infrastructure investment in the eyes of investors such as ourselves has been diminished as a result of the PR19 process, “ the letter says.

However, it also points out that while the CMA’s provisional findings published in September 2020 would result in an extremely challenging five-year business plan for Anglian Water, CPP Investment does in fact support many of the conclusions, including the acknowledgment of the financeability duty and the need to attract future investment in the sector, reflected in the provisional WACC.

With the publication of the provisional findings, it was also clear that "a robust process was being run, with the CMA taking an independent view from both the appellant companies and the economic regulator", supported by its own analysis.

“In that context, the tone of the response from Ofwat to the publication of the CMA’s provisional findings was concerning,” Scott Lawrence says in the letter.

"CMA’s proposed reduction in the WACC from the provisional findings serves to make the UK water sector .. a significantly less attractive sector for investment”

CPP Investments believe that the CMA’s proposed reduction in the WACC from the provisional findings serves to make the UK water sector” a significantly less attractive sector for investment”, with the risks assigned to investors(such as ODIs, unfunded debt and unfunded totex) not being commensurate with the afforded equity returns.

Scott Lawrence warns:

“ The lower WACC raises the risk of an exit of capital from the sector and puts at risk future investment. Investors such as ourselves will be far less likely to support ambitious business plans in future price reviews, with negative consequences for all stakeholders”

“ As a long term investor in Anglian Water, this is particularly concerning given the need for a further step change in investment as the company seeks to meet its carbon goals, improve asset resilience, support growth and enable environmental improvements.

In CPP Investments view, removing the cost of efficiently incurred historic long-term debt from the overall WACC calculation sets “an unwelcome precedent” for responsible long term investors in the sector.

The letter concludes:

“We trust that as you finalise your findings you reconsider the position as set out in the WACC consultation documents so as to deliver a fair regulatory outcome, balancing the interests of all current and future stakeholders, allowing investors a reasonable return on their investment, and averting the risk of dissuading requisite future investments in the water sector.”

Click here to download the letter in full