New Twist as Water Utilities Turn on the Debt Taps
With great change coming down the pipe, sustainability-linked bonds could help the sector address its poor financial and environmental record.
The mounting need for debt issuance in the UK water sector could yield opportunities for increased use of innovative deal structures and greater investor engagement, according to new analysis.
In particular, sustainability-linked bonds (SLBs) could play more of a role in the industry’s capital structures, said the Anthropocene Fixed Income Institute (AFII), arguing they are particularly well-placed to improve issuer accountability to investors, while meeting sustainability targets.
The AFII paper noted that financial and sustainability performance are more closely tied together in the UK’s water utility sector than in most other industries, due to the fines and infrastructure investments imposed on firms by the regulator for failing to boost water quality and reduce negative impacts on nature.
“Most of their operations and capital expenditures are related to sustainability considerations in some form,” the report said.
This makes SLBs more suited to providing accountable debt finance to water utilities than use-of-proceeds ‘labelled’ bonds, which set metrics and goals for specific projects rather than company-level sustainability performance targets.
“SLBs have the potential to incentivise issuers to improve their sustainability in more meaningful and holistic ways. In our view, SLBs could help to rebuild trust and confidence in the water sector,” it said, adding that firms’ ongoing debt finance needs offered “an opportunity for investors to engage with issuers”.
Lack of trust
After years of mismanagement, many UK water utilities have faced large fines and incurred public fury over the poor quality of water and waste management services.
Last year, the country’s biggest water company, Thames Water, lost its investment grade status and was close to collapse. Last month, it secured a £3 billion rescue loan to avoid coming under government control.
The lack of public trust has resulted in increased regulatory scrutiny and government action. On 24 February, the Water (Special Measures) Act 2025 was passed into law, giving more power to regulators and pledging to put failing water companies under special measures.
Three days later, the independent body commissioned to conduct a “root and branch review” of Britain’s failing water sector launched a call for evidence, which is open until 23 April. According to Sir Jon Cunliffe, chair of the Independent Water Commission, the commission’s initial work has brought to light “serious and interlocking concerns”, which will require “ambitious changes to rebuild the trust in the system that has broken down on all sides – customers, environmental groups, investors and companies”.
These developments come on top of Ofwat’s price review final determinations on 19 December. The UK water regulator approved £104 billion in new investment over the next five years, including £44 billion for new infrastructure and resources, as well as a 36% increase in consumer water rates until 2030. In addition, performance targets have been set for water companies across 24 key performance areas.
Despite the needed investment, almost no one is happy with Ofwat’s decision. Six water utilities have already appealed to the Competition and Markets Authority arguing that the rate increase is not sufficient for infrastructure upgrades, while consumers are deeply concerned that water bills are increasing in the face of a cost-of-living crisis.
Sustainability-linked bonds
The water sector’s investment needs are substantial, as evidenced by Ofwat’s report. While revenues from higher bills will form part of the financing, the debt capital markets will also need to play a role.
Most UK water companies have been active issuers of bonds over the past five years, with two thirds of issuances being labelled bonds, primarily green and sustainable use-of-proceeds instruments.
“Clearly, ESG-oriented investors didn’t obtain the desired accountability and sustainability outcomes from the labelled bond issuances as they expected,” said Jonas David, Research Director at the AFII.
“There is a reckoning across all stakeholders that something has gone wrong and more must be done. We believe that strong accountability mechanisms are urgently needed to improve sustainability outcomes.”
According to David, the “holistic perspective” offered by SLBs provides strong incentives for the issuer.
SLBs issuance proceeds are linked to the attainment of key performance indicators which represent pre-defined sustainability targets, meaning they can deliver lower borrowing costs in the form of green premiums, or greeniums.
“Ofwat has outlined performance targets as part of a five-year roadmap in the price review final determinations that would align with an SLB structure linked to these targets,” he explained.
Investor engagement
In addition, SLBs could be used to give investors more leverage over their investments in the UK water sector. According to a recent AFII report, “SLBs can drive greater transparency on sustainability among issuers, while also providing a financial hedge against poor performance for investors.”
Increasing investor engagement is an important part of the solution, according to Cordelia Dower-Tylee, Responsible Investment Analyst at EdenTree Investment Management. In its 2022 ‘Conditions of Our Rivers’ report, the asset manager advised investors to renew engagement with UK water utilities to drive future performance and regulatory change.
“When speaking to water companies, the Environment Agency, Ofwat and Water UK, we consistently heard how under-engaged investors were. There is a historic engagement gap because much of the financing is debt,” she said. “Yet, Ofwat highlighted how important investor engagement is in driving change in the water industry. It’s a sector where – perhaps more so than others – environmental performance affects financial performance.”
The engagement opportunity afforded by new debt issuance should be taken to take a close look at all aspects of the issuer and its strategy, not just the deal structure, pointed out one head of responsible investment at a UK asset manager, who asked not to be named.
“Both credit and sustainability investors need to look at this much more holistically, because issues may lie with the underlying business, not with bond structures or step ups,” they said.
“Investors need to look at the management teams, sustainability of the capital structure, operational performance – all are important prerequisites before looking at individual instruments.”
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