Utility Week

12 | 9TH - 15TH NOVEMBER 2018 | UTILITY WEEK Policy & Regulation 12 | 9TH - 15TH NOVEMBER 2018 | UTILITY WEEK Policy & Regulation Analysis I n recent months, utility stocks have suffered despite their proven ability to deliver decent dividends. Both National Grid and Severn Trent have seen their shares fall by around 10 per cent over the past year. Within the water sector, the ongoing peri- odic review – along with the aggressive pro- posed 2.4 per cent weighted average cost of capital (WACC) figure – has weighed heavy on the share price. The Labour Party's renation- alisation proposals are undoubtedly a further negative, especially for overseas investors wary of assuming significant political risk. Currently, the seemingly endless Brexit debate – and its many shenanigans – domi- nate UK politics; and, in the opinion polls, the two leading parties are level-pegging. However, unless the Conservative Party runs up a decent lead in the opinion polls, it is dif- ficult to see how under current legislation an early general election could be called. Nev- ertheless there will be an election by 2022 at the latest – something that the discerning investor will be taking into account. In its 2017 manifesto, the Labour Party pledged to "bring key utilities back into pub- lic ownership to deliver lower prices, more accountability and a more sustainable econ- omy". Aside from its radical railways policy, the Labour Party is also focusing on "regain- ing control of energy supply networks … and transition to a publicly owned decentralised energy system", and has a commitment to "replace our dysfunctional water system with a network of regional publicly owned water companies". Also on the Labour Party's hit list is Royal Mail, whose shares have plunged recently following a savage profit warning. Little, though, has been said about British Tele com, where a future Labour government's priority would be to bring about a nationwide rollout of fibre-optic cable. Compensation While these pledges may seem clear-cut, they inevitably raise a ra of questions about how any renationalisation strategy would be undertaken and to what extent exist- ing shareholders would receive appropriate compensation. Designing an effective compensation regime would be a complex affair. In the lead-up to any general election, the share prices of utility stocks would be volatile – and would surely fall further if the Labour Party secured a decent working majority. Then there is the issue of the unquoted utility companies. Many are either subsumed within larger organisations or are private equity-owned. But, in terms of shareholder compensa- tion, there are some precedents worth con- sidering. The credit crisis of 2008/09 saw Royal Bank of Scotland (RBS) receive an unbelievably vast injection of £45.5 billion of taxpayers' money whereby the government secured close to an 80 per cent equity stake in the bank, most of which it still holds. Non- government RBS shareholders simply saw the value of their shareholding plummet as RBS's share price collapsed. A more relevant precedent may be Rail- track, the predecessor of Network Rail, which the Labour government hastily nationalised in 2001 once it had become clear that Rail- track had grossly underestimated the costs of ongoing asset maintenance requirements. Aer lengthy wrangling, Railtrack sharehold- ers eventually received 262.5p per share, com- pared with the issue price of 380p when the company launched in 1994. In the interim, the share price had gone past the £17 mark. Prior to that, the bitter debate over nationalising the shipbuilding yards in the late 1970s saw the industry become part of the public sector. The Aircra and Shipbuild- ing Industries Act 1977 set a valuation prec- edent in that compensation to shareholders was based on the average share price leading up to the preceding general election in 1974. Significantly, renationalisation com- pensation has oen been paid for by the issuance of government bonds – a policy that the shadow chancellor, John McDon- nell, has proposed to implement to fund renationalisation projects if the Labour Party were to win the next general election. Currently the yield on 10-year Treasury stock is under 2 per cent, well below the cost of equity finance. As such, new bond finance would lower the average WACC – and theo- retically could help cut utility bills. Alternatively, a compensation formula based on prevailing regulatory asset values (RAVs) could be used. Whatever formula were adopted, though, would be very complicated given the very diverse ownership arrangements in the utility sector. Many utilities, especially the water companies, are private equity-owned, while others are controlled by overseas own- ers; importantly, National Grid holds assets worth many billions of pounds in the US. Legality Legality is a further renationalisation issue. It is something that leading City law firm Clifford Chance has addressed in its detailed publication UK Nationalisation: The Law and the Cost. Clifford Chance expressed doubt that the Human Rights Act 1998, which incorporated the European Convention on Human Rights into UK law, would prevent the implementation of a utility renationalisa- tion policy. However, the European Court of Human Rights has set down two basic rules, relating to the payment of reasonable compensation and to the adoption of a reasonable valua- tion method to assess that level of compen- sation; neither are clear-cut figures. The most recent challenge to renationali- sation in the UK courts was made by North- ern Rock shareholders. Zero compensation was awarded. However, Northern Rock, through its reckless overnight funding pol- icy, was clearly bust – a scenario that would not apply to the UK's utility companies. A more promising route for oppressed shareholders could lie through bilateral investment treaties (BITs). Most UK BITs have been concluded with emerging economies, such as China (including Hong Kong) and The deep, dark waters of utility renationalisation Any attempt to bring the public utilities back into state ownership will be a fiendishly complex affair, as Nigel Hawkins explains.

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