Philipp Kurek discusses the importance of investment protections for Thames Water investors in Infrastructure Investor

By Philipp Kurek

Partner Philipp Kurek discusses the importance of Thames Water investors considering potential protections for current and future investments in the company.

Philipp’s article was published in Infrastructure Investor on 1 February 2024, and can be found here. The online version was published on 26 February 2024 and can be found here

Concerns for the future of Thames Water reached fever pitch in summer 2023 as fears intensified that the company, which serves about 25% of English households, may collapse. Around the same time, it emerged that the government was drawing up rescue plans in case emergency renationalisation of Thames Water was required. Ultimately, the threat of nationalisation appears to have been narrowly avoided when investors agreed a turn-around plan and injected significant additional capital into the company.

However, after surviving a tumultuous 2023, Thames Water is facing many more challenges in the years ahead, with the company’s future in private hands less than certain. As matters stand, Thames Water has debts of more than £18 billion, with £190 million due as early as April this year, and £1 billion of debt needing to be refinanced by the end of 2024. In addition, Thames Water must raise at least £3.25 billion of new equity by 2030 in order to continue operating. Yet, in December 2023, Thames Water admitted that it did not have enough money to pay back its debts by the time the looming deadlines would materialise. Shortly thereafter, it was reported that Thames Water’s biggest investors significantly wrote down the value of their respective stakes in the company. All the while, Thames Water is also facing considerable regulatory uncertainty relating to permitted increases to customer bills and limits on potentially significant regulatory penalties for performance failures such as sewage outflows and leakage.

Whilst Thames Water’s shareholders have, thus far, reiterated their long-term commitment to the business and willingness to continue providing additional funds, subject to certain conditions, and the threat of nationalisation appears to have been avoided for the time being, investors in Thames Water would be well advised to consider carefully the potential protections applicable to their existing, and any future, investments in the company.

To that end, it is important for investors to not only consider protections available under applicable contracts, regulations, and national legislation, but also often overlooked protections afforded by international investment laws that may be applicable to such investments, as well as steps that could – and should – be taken as a matter of priority to maximise the protections afforded by such international laws.

Investment treaties as the source of additional rights and protections

One key source of international investment protections are international investment treaties concluded amongst two or more states, which require each state to offer investors investing in its territory certain protections. Moreover, and importantly, most treaties also give investors the right to commence international arbitration proceedings directly against the host state for alleged breaches of such protections by the host state (including actions or omissions by state entities, organs, regulatory bodies (such as Ofwat, the English Water Services Regulation Authority) and other state representatives).

Which investors and types of investments benefit from treaty protections?

It is important to note that not every investor benefits from investment treaty protections. Whether or not an investor can avail themselves of the protections afforded by the investment treaties entered into by the UK – and has a right to bring a direct claim against the UK for alleged violations of these protections – depends on the particular terms of each treaty as well as the timing and structure of the relevant investment.

The UK is party to more than 100 investment treaties with countries around the world, with each treaty generally affording certain protections to foreign investors from the countries with which the UK has concluded an applicable investment treaty.

Some treaties (e.g., the treaty between the UK and the UAE) offer protections to qualifying investors by reference to their nationality or the country of their incorporation (e.g., incorporation in the UAE). In this respect, many treaties do not require that the relevant investment is held directly, or that that ultimate beneficial ownership or control needs to be in the relevant treaty jurisdiction – thus effectively affording treaty protection to investors provided they hold their investment through a qualifying holding company in the relevant treaty jurisdiction. Other treaties, however, such as the treaty between the UK and Colombia, contain more restrictive terms, requiring investors to have substantial business activities in their treaty home state (thus effectively excluding pure holding/post-box companies from the treaty’s scope).

Moreover, whether or not an investor may avail themselves of treaty protections also depends on the treaty’s definition of qualifying investments, though most treaties adopt a very wide definition and often cover “every kind of asset” owned or controlled by qualifying investors, including direct and indirect shareholdings, debt, bonds, contractual rights, and other financial interests.

What protections are afforded by investment treaties?

Whilst the protections afforded by a treaty also depend on the specific terms of each treaty, most treaties provide for some key protections that would be highly relevant to investors holding a direct or indirect financial interest in Thames Water.

Most importantly, investment treaties generally contain protections against unlawful expropriation, including any direct or indirect nationalisation of an investment unless such expropriation/nationalisation is accompanied by prompt, adequate and effective compensation, is carried out in the public interest, in accordance with due process, and is non-discriminatory. In other words, any nationalisation that would substantially deprive investors of the economic use or value of their investment without payment of fair market value compensation, or which illegitimately discriminates against some investors in favour of others, could engage the UK’s liability under applicable investment treaties.

In addition, most investment treaties also impose an obligation on host states to accord foreign investments “fair and equitable treatment” – a very broad standard which, amongst other things, has been held to require host states to protect investors’ legitimate expectations, maintain a stable and predictable legal and business framework for investments, act proportionately in relation to measures affecting foreign investors, act with procedural fairness, due process, and transparency, comply with contractual obligations, and refrain from arbitrary and discriminatory conduct. Thus, any intervention (or lack thereof) by the UK government or Ofwat that violates those protections, even if it falls short of renationalisation, could equally give rise to treaty claims against the UK.

Actions Thames Water investors would be well advised to take now

At this stage, it is not clear what form UK government intervention in Thames Water may take (if any), including any future regulatory actions by Ofwat, or even whether such intervention may lead to the nationalisation or expropriation of shareholder, bondholder, or other contractual rights – and if so, in what manner affected investors would be compensated.

However, given these uncertainties, investors (including shareholders, bondholders, and any others with a direct or indirect financial interest in Thames Water) would be well advised to carefully consider not only the protections available to them under relevant contracts and national laws and regulations, but also whether their current investment structure affords them the above treaty protections and the ability to bring potential claims directly against the UK government in international arbitration.

To the extent existing investments do not currently benefit from applicable treaty protections, investors should note that it is perfectly acceptable – and common – for investors proactively to structure, and restructure, their investments in order to secure and maximise applicable treaty protections, provided any such restructuring takes place before the relevant dispute has become reasonably foreseeable.

Given the events of 2023, and the challenges ahead, investors would be well advised to consider any potential restructuring as soon as possible so that it can be implemented in an orderly and tax efficient fashion and in good time before any dispute that may arise.

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