Canadian pension funds face reputational risk over Thames Water chaos

Morningstar analyses impact of potential losses amid furore

Canadian pension funds face reputational risk over Thames Water chaos

DBRS Morningstar has published a commentary shedding light on the financial implications faced by Canadian public pension funds in light of the Thames Water events.

Key points discussed in the commentary include:

  • The UK government initiated discussions on contingency plans for the potential collapse of Thames Water, including the prospect of temporary public ownership, which could lead to financial losses for existing shareholders.
  • Ontario Municipal Employees Retirement System (OMERS) and British Columbia Investment Management Corporation (BCI), two of the biggest Canadian pension funds, own significant stakes in Thames Water, with approximately 31.8% and 8.7% of the shares, respectively.
  • In the event of a financial loss resulting from the Thames Water investment, OMERS' credit profile is expected to be minimally impacted due to its diversified portfolio and limited exposure to individual companies.
  • The collapse of Thames Water may pose reputational risks for OMERS, BCI, and the consortium of investors, potentially affecting future investment opportunities in UK natural monopolies. However, their active involvement in constructive dialogue and recent capital injection help mitigate these risks. Additionally, the current shareholders have not received dividends from Thames Water.

Thames Water, the UK's largest water utility company serving a quarter of the population, faces financial difficulties as it grapples with the need for infrastructure upgrades, mounting debt, and performance issues such as sewage discharges and leaks.

Contingency plans were discussed, including the potential of placing the company under a special administration regime (SAR), resulting in potential financial losses for existing shareholders.

The company, previously privatized in 1989, is currently owned by a consortium of pension funds, sovereign wealth funds, and private equity investors. Two of the largest Canadian public pension funds, OMERS and BCI, own substantial shares.

Amid the ongoing debate on private ownership models for natural monopolies, the resilience of OMERS and BCI comes to the forefront. These long-term investors are committed to sustainable investing and employ robust governance frameworks and proactive risk management. Their portfolios are highly diversified, reducing exposure to individual company performance.

Even if OMERS were to experience a financial loss in its investment in Thames Water, the impact on its credit profile would be negligible due to its diversified portfolio and limited exposure to single names.

“As of December 31, 2022, OMERS Finance Trust, the financing subsidiary of OMERS, had outstanding debt guaranteed and with recourse to OMERS of $11.4 billion, equivalent to 8.5% of adjusted net assets, which provides considerable cushion for asset-base movements,” the DBRS Morningstar commentary said.

“As a general principle, the large Canadian public pension funds typically prefer to engage with portfolio companies and related stakeholders to create value rather than divest their investments. This has resulted in strong performance and returns over the years.”

OMERS' long-term performance has been strong, with returns exceeding benchmarks over the years. BCI has also had a track record as an engaged investor, delivering returns that outperformed benchmarks.

“It is also important to consider that the collapse of Thames Water could potentially lead to reputational risk for OMERS and BCI and to the consortium in general, which could limit future investment opportunities in natural monopolies in the UK. This possibility is relevant to the ongoing debate on the viability of the private ownership model for natural monopolies and how responsive the current consortium of private foreign investors has been to Thames Water,” the DBRS Morningstar commentary said.

“It appears that although the current business model has flaws, aspects of the current financial and operational problems in Thames Water are the result of mismanagement prior to the sale to the current consortium in 2017.”

The current shareholders have demonstrated responsiveness, injecting equity and providing ongoing support.

“In addition, the consortium has not taken a dividend since it invested in Thames Water, although the Company has paid internal dividends that were used to fund interest obligations and activities of other group companies. Thames Water has also stated that the Company has maintained a strong liquidity position that included GBP 4.4 billion in cash and committed credit facilities as of March 31, 2023, and continues to keep Ofwat informed on progress of the company’s turnaround and engagement with shareholders,” the DBRS Morningstar commentary said.

"We expect the impact to the credit profile of OMERS and BCI to be immaterial, with reputational risk being mitigated by their engagement in the ongoing constructive dialogue.”