Water & Wastewater Treatment

8 | may 2015 | WWT | www.wwtonline.co.uk Comment T he tide of low activity in UK water mergers might be about to change. Jonson Cox, Ofwat's chairman, said the watchdog was open to new ideas on how to reshape the water sector at a recent meeting of the Policy Exchange. Cox said that while comparative regulation had been useful, going forward Ofwat no longer endorsed retaining an arguably excessive number of independent comparator operators as the primary means of gauging competition and efficiency in the water and waste sector. Compared to the normal merger regime which regulates only those mergers which substantially lessen competition, the current special water regime has undoubtedly stifled merger activity in this sector. Ofwat are not, Cox stressed, supporting either the consolidation or de-consolidation of the sector. Rather, the UK authorities are open to views from both sides. For those favouring greater consolidation, Cox noted, merging parties could not simply justify a merger on Water sector M&A - opening the floodgates? Hints from Ofwat suggest that a relaxation of rules governing mergers and acquisitions could be on the cards for the water sector efficiency or scale grounds, as the two were not necessarily related. By contrast, Cox suggested, the water sector could be "vertically de-consolidated" by breaking up water and wastewater companies into separate businesses, because the logic of vertical integration does not necessarily follow where investors are primarily incentivised to acquire a water company's asset base rather than its retail business. If anything, Cox considered that de-consolidation could be simpler on the merger process, because it could be more justifiable to merge water only companies or wastewater companies together. Deals in the water sector have been restricted by the unpalatable UK merger control regime, whereby most water to water company mergers are automatically referred for an in-depth (Phase II) merger investigation before the Competition and Markets Authority (CMA). But this will change once Section 14 of the Water Act 2014 is brought into force, sometime during 2015-2017. Section 14 gives the CMA a degree of discretion when considering whether a Phase II investigation is necessary for a particular qualifying merger, displacing the current mandatory and lengthy process. Section 14, like the current position, requires the CMA to consider in particular whether a prospective water to water merger will make it harder for Ofwat to assess competition comparatively between the UK water companies in the future. But even if these changes will make it harder for Ofwat to regulate, the CMA must carry out a new balancing exercise to see whether this detriment can be counteracted by customer benefits likely to flow from the water to water merger. Section 14 and Ofwat's new view are likely to open up the sector for greater M&A activity because dealmaking will become more certain. In our view the May 2013 sale of South Staffordshire Water and Cambridge Water by Alinda Capital Partners to KKR for an undisclosed fee demonstrates how water and wastewater assets are still appealing additions to any diversified investment portfolio - provided the bidder is not already invested in the sector. The three listed companies that will be closely followed by the market for a potential public takeover are Severn Trent Water, United Utilities and South West Water. The demand for water assets will continue to be led by large infrastructure funds. Despite the growth of infrastructure funds since the early 2000s, infrastructure remains an alternative asset class. Since the pedigree of a fund manager has grown in importance for investors, the funds market has become more concentrated with key players. The likely scenario of either consolidation or de-consolidation will be that more water assets will be owned by a diverse range of specialist funds. The watchdog will have to take this into consideration when reshaping the market. This article was co-authored by Elaine Gibson- Bolton, Partner, and Hardip Singh Syan, Trainee Solicitor at King & Wood mallesons LLP. ElainE Gibson-bolTon, ParTnEr, EU COmPETiTiOn and rEGULaTOry TEam KinG & WOOd maLLESOnS LLP

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