Thames Water Part 1, How the Tap Ran Dry

Welcome to the 153rd Pari Passu Newsletter, 

Since launching the newsletter three years ago, we have never received so many requests to cover a situation like what we are finally publishing starting today. These requests have reasons to exist; this is an evolving situation with over $30bn of debt, multiple private equity buyouts, political and national involvements, and so much more. Here we can really say it: this is the perfect intersection of finance, law, economics, and politics; some are calling it The Restructuring of the Decade. So without any further ado, ladies and gentlemen, we are so excited to bring you a three-part (true) deep dive of Thames Water.

Thames Water needs little introduction. It supplies water and wastewater services to 16 million people, almost a quarter of the UK population, and sits on almost £23bn ($31bn) of debt. Its ongoing restructuring is one of the largest corporate restructurings ever in Europe. The case has attracted enormous political and media attention, with questions over who ultimately pays for decades of underinvestment and financial engineering. For investors, regulators, and policymakers, Thames Water has become the defining test case for how essential infrastructure is managed in the face of financial distress.

This is Part 1 of one of the biggest write-ups we’ve ever done for the newsletter, reflecting the scale and complexity of the Thames Water story. In this edition, we cover the privatization of the UK water sector in 1989 and lay out the regulatory framework that underpins the industry. From there, we track Thames Water through successive ownerships from RWE’s take-private in 2001, to Thames’ Whole Business Securitization structure under Macquarie. The themes of value extraction, regulatory limits, and chronic underinvestment form the backdrop of today’s crisis. Parts 2 and 3 will pick up in the late 2010s and dive into the ongoing restructuring, where creditors, regulators, and politicians are now locked in one of the most high-stakes corporate dramas Europe has ever seen.

Quick note before we get started, Pari Passu Research subscribers, check your inbox for an email including Parts 2 and 3. If your firm is interested in accessing the entire 18,000+ word research piece, including over 150 sources, you can simply upgrade and receive the entire deep dive today. You do not want to fall behind the competition!

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The Privatization of the Water Sector 1989

Consolidation to Crisis

Thames Water’s origins can be traced back to the 1600s, and its history is littered with scandals and tragedies. However, our story begins in 1973, and at this time, England & Wales had around 160 different water companies (a mix of private and publicly owned), 130 sewerage authorities, and 29 river authorities (public entities responsible for sewage efficacy and water conservation) [1]. The localisation of the water supply to this level made it very difficult to regulate and threatened the long-term health of the country’s water supply. For example, 60% of all sewage treatment works were estimated to have failed to meet 19^th-century standards in the 1960s [2]. So, Prime Minister Edward Heath introduced the Water Act 1973, which established 10 new regional water authorities (RWAs), which were based on the country’s dominant regional river systems [1]. These 10 RWAs were state entities that were given control of the water supply and sewage systems, effectively taking water completely into public hands. 

Fast forward to 1989, and these RWAs were very underfunded. The late 1970s and early 1980s marked periods of very high inflation in the UK, which meant the government became less willing to allow the RWAs to increase borrowings or increase charges to consumers to meet capital expenditure requirements [2]. An environment minister underscored how the “water industry needed a very large amount of investment, and it simply wasn’t going to get that if it had to compete with the demands for schools, police, roads, and the health service.” [3] Furthermore, the European Economic Community (which today is the European Union) introduced the Bathing Water Directive 1975, which set higher quality and environmental standards for bathing water, requiring significantly more capex [4].

The graph demonstrates the relative underinvestment in the water industry compared to 1974-75 levels. While daily operational expenditure remained steady, capex declined sharply from the late 1970s and stayed low throughout the 1980s. This was mainly because the government, facing high inflation and tight budgets, limited how much the RWAs could borrow or charge customers. This led to the water system and water quality seriously deteriorating. 

Privatization 

In one of the most radical and unpopular moves of her premiership, Prime Minister Margaret Thatcher (a Neoliberal who was much like Ronald Reagan in the US) privatised the 10 RWAs under the Water Act 1988. The RWAs were sold by issuing shares on the London Stock Exchange (LSE). In doing so, the government: (a) wrote off all debts of the RWAs that were worth £5bn, (b) gave the new companies a one-off subsidy tottalling £1.6bn across the water sector, and (c) sold the companies at a substantial discount of roughly 22% of the undertaking’s market value (the market value being the share price after the first week of trading) [6]. 

Thatcher’s plan was to make the water industry attractive to private investors to meet the sector’s capex needs, due to the UK’s restricted ability to borrow. These new privatised companies were responsible for the country’s water supply and distribution, sewerage, and sewage disposal [2]. Just so that you grasp the magnitude of this move, England & Wales were the only countries in the world at that time to have fully privatised their water supply and sewerage in this way [1] [4]. The largest of these new water companies became Thames Water, which traded on the LSE.

Why Privatising a Water Company is so Controversial  

Almost every issue with Thames Water’s financial distress today can be linked to this key moment. This is one of the most unique companies you will ever see, so we should spend some time developing a conceptual understanding of the challenges in having a privatised water and sewage sector. There are three interrelated points to understanding the optics around Thames Water’s controversy.

1. Natural Monopoly: This occurs when it is most efficient for a single provider to operate in a given area. The reason is simple: laying multiple parallel networks of water pipes and sewers would be extremely expensive, disruptive, and wasteful. Therefore, society builds just one system for one provider/company to manage. While this setup prevents wasteful duplication, it also eliminates competition. For customers, there’s no alternative to switch to if your local company is inefficient, overcharges, or allows service quality to decline. In most industries, competition compels firms to keep prices fair and standards high; in water, that pressure doesn’t exist. This is why privatizing a natural monopoly is particularly challenging: you are replacing a public monopoly (that is sensitive to public interests) with a private one that doesn’t have the usual safeguards that competition typically provides. 

2. Misaligned Incentives: In most private businesses, maximising shareholder returns is the primary goal, and the product or service is something customers can choose to buy or not buy. Water is different: it is a basic necessity with no substitute. Combine this with the fact that the water sector lends itself to being a natural monopoly, and we can see a key tension. 

   On the one hand, the private investor is generally focused on short-term profitability, cost-cutting, and returns on capital. As owners of a company that faces no competitive threat to its customer base, the company will have the ability to set high prices to maximise profits while also being incentivised to extract the company’s cash flows through dividends, interest payments, or financial engineering rather than committing to the costly, long-term investment required to maintain and upgrade infrastructure.

   On the other hand, because water is a basic necessity, its provision is politically sensitive. Any attempt to exercise monopoly pricing power or visibly underinvest in socially critical infrastructure will be brought under intense public scrutiny. Rising bills, deteriorating service quality, or environmental damage quickly attract public anger and political intervention. This political salience means that, unlike many other privatised sectors, water companies operate under intense scrutiny.

3. Regulation: Therefore, in the absence of competition, regulation must step in (taking the place of the market) to ensure private water companies serve public needs. We will cover the England & Wales water regulator and the relevant rules it imposes next, but we must conceptually understand why regulating private water companies is extremely difficult. 

   If regulation is overbearing, it risks discouraging necessary private investment. Restrictive price caps and forcing heavy capex may potentially starve the sector of funding needed to maintain and upgrade essential infrastructure. However, where regulation is too lax, the consequences fall squarely on consumers and the environment. Companies may underinvest in infrastructure, raise prices, or neglect sewage and water quality, knowing customers have nowhere else to go. This makes striking the right balance very challenging for regulators; getting this balance wrong leaves the regulator, at least, partially to blame for all the problems surrounding water companies.

Ofwat: Regulatory Primer

Ofwat, the Water Services Regulation Authority, is the regulator for water and sewage companies in England & Wales and was established as the RWAs were privatized in 1989. Its mandate is to achieve three things: protect customers, protect the environment, and make sure water companies can finance their long-term total expenditures. How it achieves and balances between these goals is key to understanding its role in Thames Water’s financial distress. However, regulation is extremely complicated (and delving too deep into it isn’t that fun), so here is a simple mental model followed by a breakdown:

• Price reviews determine the money coming in

• Regulatory Capital Value (RCV) x WACC sets the fair investment return

• Outcome Delivery Incentives (ODIs) move cash up or down for performance

• Ring-fencing to keep cash in the OpCo when risk rises

Price reviews set the money coming in

Every five years, Ofwat runs a price review. The result of these reviews is to create a revenue cap for water companies, effectively determining the price level they can bill to consumers. These five-year periods are also referred to as Asset Management Plans (AMPs)

The rough building blocks for the revenue cap calculations are [9] [10]:

• Totex (total expenditure): the efficient amount that Ofwat thinks the company should need to operate and invest.

• A fair return for investors on the asset base (via RCV and WACC, explained next)

• Performance adjustments: increase or decrease the caps depending on specific performance targets (ODIs, we will explain below) 

RCV x WACC sets the fair investment return

Two core terms outline what ‘fair’ investor returns in a regulated utility:

• RCV (Regulatory Capital Value): the regulator’s running total of the assets customers are paying for. It grows when new spend is added; it shrinks through an RCV run-off (similar to depreciation).

  To calculate RCV, we take the opening RCV from the start of the financial year, add inflation and investment, then subtract depreciation and capital grants. This gives the RCV at the end of the financial year [8]. Ofwat doesn’t use book value or market value because water companies are monopolies with no true market price for its assets, and market prices can swing wildly. 

• WACC (Weighted Average Cost of Capital): It is Ofwat’s view of what would be a fair blended cost of debt and equity. Ofwat then applies this allowed WACC to the RCV to calculate a ‘fair’ return on capital for investors. It is not a maximum limit: the point of the WACC is to assist in calculating the revenue ceiling. 

Altogether, as RCV grows with inflation and new capital expenditure, companies are incentivised to invest in long-term assets: each pound of efficient investment increases the RCV base on which Ofwat allows them to earn a regulated return (the WACC). In this way, RCV functions as both a measure of asset value and a mechanism that rewards continued infrastructure spending.

ODIs move cash up or down for performance

Outcome Delivery Incentives are like the ‘carrots and sticks’ that influence water companies behaviour by tying returns to outcomes the public cares about. It’s simple: meet or exceed targets to increase the revenue cap; miss or fail to meet targets, and the revenue cap will decrease [10]. For example, leakages and pollution levels falling foul of targets would incur penalties, reducing maximum revenue going forward.

Ring-fencing to keep cash in the Opco when risk rises

‘Ring-fencing’ typically involves setting legal or financial barriers that are designed to isolate one part of a company’s operations from the risks or activities of another part [12]. In the context of water companies, Ofwat imposes a ring-fence to ensure that the regulated company (the OpCo) maintains sufficient financial and management resources to enable it to carry out its functions in a sustainable manner [13]. It achieves this by setting license conditions, which OpCo needs to comply with to qualify as a water provider. 

The key ring-fencing rule for us to take away is that the OpCo must maintain an investment-grade credit rating, which was at least Baa3 [13]. If a water company falls foul of this, then there is an automatic cash lock-up. This cash lock-up blocks the OpCo from sending any money up to its parent company unless Ofwat approves it [13]. Thus, dividends or other similar payments are heavily restricted to keep cash inside the OpCo so that it can continue running the network and serving its consumers.

In sum, these four levers are the operating system of the privatised water industry. They decide how much money flows in, how much can flow out, and what happens when performance or finances stumble. Hence, we would be falling short in our analysis of Thames Water’s financial troubles without considering these key regulations. Let’s now return to Thames Water’s story.

From 1989 to 2006, the setup and early signs

Floating through the 90s

Now that we understand the framework Thames Water operates in, we can dive back in the story. Privatization in 1989 left the company debt-free and cash-rich after the government cancelled its debt and provided its subsidies. Sector infrastructure spending doubled in the early 1990s, and Thames Water completed its ring main (80 miles of new tunnels to transport drinking water) and upgraded its major treatment works in London [14] [15]. However, customer bills also rose roughly 33% in the first five years (5.9% CAGR). In response, Ofwat’s price reviews in 1994 (PR94) tightened control over the price increases, and in PR99, Ofwat actually cut bills by an average of 12% [14]. 

How was Ofwat comfortable cutting prices when capex was increasing? Originally, gearing (the industry-specific measure for ‘leverage’, which expresses Net Debt as a percentage of RCV) was expected to stay below 35%, but the bond market’s appetite for monopoly utilities and Ofwat’s willingness to tolerate higher leverage led to rising debt levels across the sector [14]. The justification was that if a company’s actual borrowing costs were below the level Ofwat assumed, the savings could be passed to customers at the next price review, enabling lower bills. In short: higher gearing → lower WACC → lower allowed return → lower bills. This shift towards embracing more debt created the financial environment for RWE’s 2001 takeover.

Into Foreign Ownership, the 2001 RWE transaction

In 2001, RWE, a German electricity and utilities company, made a move into water services by acquiring Thames Water for £4.3bn in cash [16]. RWE was acquiring several water companies around the world, including America’s largest water company, American Water Works, en route to becoming the third largest water utility in the world [17]. But focusing on what this meant for Thames Water, let’s see the impact of the transaction on the water company’s capital structures.

The 2001 deal was financed largely with new borrowings at this group level. You can see net debt rising from £1,810mm to £3,193mm. What is key to understand is that the transaction significantly increased obligations outside the regulated business. We will now look at the regulated operating company’s capital structure to judge financial resilience and the constraints on upstream cash.

Thames Water Utilities Limited (TWUL) is the licensed, ring-fenced operating company that provides water and wastewater services. Ofwat assesses financial resilience using gearing = Net Debt / RCV. The cap stack indicates pro-forma net debt of £2,169mm against RCV of £4,326mm, resulting in a gearing ratio of approximately 50%. Do note that Figure 6 also shows that net debt only increased in TWUL by £220mm, from FY 2000 to FY 2001 [19], illustrating that the £1.4bn increase in net debt across the group was mostly acquisition debt.

Note, we are not using leverage ratios (Net Debt / EBITDA) because Ofwat fixes Thames Water’s allowed earnings as a set return on its RCV. Thus, this asset base is effectively what services the debt, not a ‘market’ EBITDA. Here, credit analysis on water companies focuses on allowable revenues (and by extension RCV) because it represents the predictable baseline from which debt service is met, whereas the actual revenues can introduce noise (e.g., weather-driven consumption changes or operational disruptions that don’t affect RCV and thus earning capacity), obscuring the underlying regulatory strength of the business.

Another question you may have is, why is gearing only measured for TWUL and not the entire Group? Well, RCV exists only for the licensed business (TWUL), as that is where the ‘regulatory capital’ (the assets that provide water services) is. Assets elsewhere in the group are not regulated, hence do not form part of RCV.  Still, there are borrowings at holding and other subsidiaries outside the ring-fence. Those liabilities are serviced only if cash can be upstreamed from TWUL; therefore, it is still important to be aware of the whole group’s net debt.  This also makes it important to track TWUL’s dividend payments, since they represent cash leaving the regulated business, both to service parent company debt and to provide returns to shareholders.

Leaking cash and water under RWE, the early warning signs 2001-2006

There are many storylines to follow during this period that led RWE to sell Thames Water in late 2006. It also introduces us to several recurring patterns and behaviours of players in the Thames Water saga. Below is the company’s financial performance under RWE, and we will fill in the gaps to explain what was happening.

From FY 2001 to FY 2005, Thames Water’s finances were under persistent strain from low revenue growth and high operating demands. Revenues only rose from £1,029mm in FY 2001 to £1,336mm in FY 2005 (6.7% CAGR), constrained by Ofwat’s PR99 price review, which reduced allowed prices to consumers. 

Throughout the period, capital investment stayed high to address leakage and asset renewal. In particular, 2003 saw three major mains bursts, severe flooding, and one of the driest summers in a century, all of which needed increased capital spending. [22] Furthermore, by FY 2005, Thames had missed leakage targets for six consecutive years, prompting Ofwat in 2005–06 to impose a legally binding undertaking for Thames to spend about £150mm replacing 230 miles of mains by 2009-10, in addition to an already large 770-mile renewal plan for 2005–10 [23] [24]. As the table shows, all of this pushed capex above £500mm from FY 2003 onward. FCF even fell to £8mm in FY 2004 as a consequence of this increased capex.

Despite persistent cash flow pressure, TWUL continued to distribute large dividends, a lot of which were for RWE. In FY 2004 and FY 2005, it paid £137mm and £155mm respectively, even though FCF was minimal and substantial interest payments increased cash outflows (£130mm and £133mm in interest payments in FY 2004 and FY 2005 respectively). Once both interest and dividends were deducted, the company recorded sizeable cash outflows of (£259mm) in FY 2004 and (£45mm) in FY 2005. These distributions were therefore not entirely funded by an internally generated surplus but also by additional borrowing at the group level. The Group’s net debt increased from £2,876mm in FY 2003 to £3,433mm by FY 2005, while TWUL’s own net debt fell slightly and its gearing ratio dropped to 36% in FY 2005. At the same time, the group’s total dividends were significantly higher than those declared at TWUL: £259mm in FY 2004 (versus £137mm) and £325mm in FY 2005 (versus £155mm) [21]. This highlights how RWE extracted large sums from Thames Water by leveraging debt outside the regulated operating company, preserving compliance with Ofwat’s gearing level guidance while pushing indebtedness up at the group level.

This leads us to 2006. According to our estimates, FY 2006 was a poor year for Thames, especially when we look at its cash flows. Capex surged to £683mm, FCF fell to only £7mm, and net interest of (£140mm) left the company in negative cash flows before dividends†. However, this does capture the severe public and political criticisms Thames Water was under. During a severe south-east drought, the water company imposed hosepipe and sprinkler bans and sought (then withdrew) a drought order to reduce water supplies [25] [26]. Media coverage centred on the contrast between service restrictions and record leakage levels on the one hand, and continued profits (£432mm operating profit) and dividend payouts to RWE on the other. Members of Parliament (UK equivalent of congressmen/congresswomen) condemned  ‘the group’, which is beyond the TWUL dividends in our table, for paying about £270mm in dividends in 2006 to its German parent and more than £1bn over five and a half years, arguing this prioritised shareholder returns over infrastructure improvement [26]. With operational underperformance, hostile public opinion, and intensifying regulatory pressure, RWE opted to sell Thames Water later in 2006.

Macquarie’s acquisition in 2006 and the Whole Business Securitisation 

In October 2006, Macquarie’s infrastructure funds acquired Thames Water from RWE for around £8bn, comprising roughly £2bn in equity and £6bn of third-party debt [27]. Ownership was transitioned to Kemble Water Holdings Limited (KWHL), led by Macquarie and backed by institutional investors around the world.  

Beneath the surface, the acquisition also introduced one of the most complex and misunderstood financial structures at the time. Macquarie put in place a Whole Business Securitisation (WBS) structure. We have a post on WBS that is 100% worth checking out, but we will need to break WBS down in detail here, given how regulated water assets are and how unique this WBS is. Understanding how the structure worked is not only fascinating, but it also played a huge role in the Thames' financial challenges. First, here is a diagram of Thames Water’s corporate structure, which is still the same today.

We have three points we need to cover about this financing structure, which are the following:

1) The Ring-fenced Group: TWH, TWUL, and TWUF
2) The Common Terms Agreement (CTA)
3) The Kemble Entities outside the Ring-fence

1) The Ring-fenced Group: TWH, TWUL, and TWUF

Macquarie put Thames Water’s regulated business into a WBS credit box (the red box in Figure 8). In this box, all assets and cash flows are legally separated (hence ring-fenced) from the rest of the corporate group [29]. Thus, if an entity outside this group defaults, it would have no recourse to assets within this credit box. Inside this ringfence, there are three entities:

• Thames Water Utilities Limited (TWUL): The regulated and Ofwat-license OpCo that provides water and sewage services

• Thames Water Utilities Finance plc (TWUF): The company that issues bonds and on-lends the proceeds to TWUL

• Thames Water Utilities Cayman Finance plc (TWUCF): Similar to TWUF, but also allows the company to issue bonds to international capital markets

• Thames Water Utilities Holdings Limited (TWH): The company holds shares in TWUL and pledges them as collateral to secured creditors

All debt within this ringfenced group is governed by the Common Terms Agreement (CTA) [29]. This CTA effectively serves as the master document that binds all lenders across different instruments, maturities, and tranches under one unified set of rules. Let’s dive into the CTA and cover some of these key rules below.

2) The Common Terms Agreement 

We have selected the most important terms from the CTA that were relevant during Thames’ spiralling crisis in the late 2010s and 2020s. 

Classes of Debt: TWUF issues two classes of debt under the common terms: Class A (senior) and Class B (junior) [29]. These Class A and B may be familiar to some readers as they are the same Class A and B that went head-to-head in the contested 2025 Part 26A Restructuring Plan decisions. Class A is paid ahead of Class B in the cash waterfall, and Class B interest can be deferred if there isn’t enough cash after paying Class A interest, improving the senior class’s credit ratings [29].

Remember, Ofwat requires water companies to maintain an investment-grade issuer rating. The Class A / Class B tranching within the WBS helps not only to lower the cost of capital (most of Thames Water’s debt is Class A, as we will see shortly), but also to help meet Ofwat’s credit rating requirements (the regulator’s cash-lock up rule) by giving Class A debt stronger protections, which support its investment-grade rating [30] [32].

Refinancing risk: There are two specific rules [30]

• No more than 20% of RCV can mature in any rolling 24-month period

• No more than 40% of RCV can mature within an AMP’s five-year period 

These rules prevent large debt piles from coming due all at once, avoiding concentration risk that could overwhelm refinancing efforts or market capacity [31]. Think of it as smoothing the repayment timeline, so the company doesn’t hit a debt wall that it can’t refinance. Therefore, the WBS structure does not really have massive maturity walls, but needs to make steady debt repayments every year.

Pre-enforcement Cash Waterfall: This is an order in which cash must flow within the WBS; focus on the bold [29]. 

1. Operating costs and essential spend at TWUL

2. Senior hedging and fees

3. Class A scheduled interest

4. Top-ups to required liquidity reserves

5. Class B interest (can be deferred until Class A is fully repaid)

6. Upstream Dividends if no cash lock-up

The full pre-enforcement cash waterfall that includes the entire corporate structure’s debt will be discussed in the “The Kemble Entities outside the Ring-fence” section below. 

Collateral: It is not possible to grant creditors collateral over Thames Water’s assets due to their protected status and Ofwat’s license restrictions. Therefore, the collateral granted to WBS creditors is the TWUL shares held by TWH, which is why TWH was established in the acquisition [29] [31]. In the event of a default, WBS creditors cannot own the pipes; instead, they can control the company that owns the pipes by enforcing its collateral, a share pledge.

Pre-default Trigger Events: When financial covenants are not maintained, a cash lock-up can be enforced, prohibiting upstream transfers [31]. This mimics Ofwat’s cash lock-up rules, which impose a similar block when investment-grade ratings are lost. 

The two most important financial covenants for us are [36] [37]:

• Senior Debt Gearing ratio: Class A + B Net Debt as a % of RCV should remain below 85.0% to avoid lock-up (for context, this ratio was approx 55% post-acquisition). This is a similar gearing ratio that Ofwat uses to measure leverage, but the regulators do it as TWUL Net Debt / RCV.  

• Post Maintenance Interest Cover Ratio (PMICR): Cash from Operations of the Company, adjusted for RCV depreciation, divided by the interest paid on WBS debt. It measures the Thames’ ability to repay interest on available cash flows. The ratio should remain above 1.1x to avoid lock-up 

These covenants will be important for assessing Thames’ financial health, so we will need to assess financial performance against them. For Gearing, we will use TWUL Net Debt / RCV for the sake of simplicity, as the differences in figures will have no practical impact on our conclusions.

Events of Default and Standstill: An event of default triggers an immediate 18-month standstill in which secured creditors cannot accelerate repayment, seize assets, or terminate hedging, allowing the utility to keep operating [31]. A standstill cash manager takes control of cash, prioritising operating costs before scheduled debt service, which is supported by an 18-month liquidity facility to ensure timely payments [31]. 

If the default is not cured, creditors can appoint a receiver under the share charge to sell the regulated utility privately as a going concern, with sale proceeds distributed via the post-enforcement waterfall (which follows as (1) Operating Costs, (2) Class A, (3) Class B, then (4) Shareholders) [31] [33]. Accordingly, assets can never be liquidated, given how critical continuing water service is.

3) The Kemble Entities outside the Ring-fence

Moving outside of the three ring-fenced companies, we have Thames Water Limited (TWL) and an array of Kemble companies. Here is a guide to the rest of these companies, and we’ve put Figure 8 in again for you to see these entities side-by-side with the corporate structure chart [28].

• Kemble Water Holdings Limited (KWHL): The ultimate parent of the Thames Water group, owned by the Macquarie-led consortium of institutional investors.

• Kemble Water Eurobond plc (KWE): Issued unsecured shareholder debt to raise funds from Kemble’s equity investors to acquire Thames in 2006. 

• Kemble Water Finance Limited (KWFL) Raised the external acquisition debt from banks and capital markets lenders to help fund the 2006 takeover. Holds 100% of shares in Thames Water (Kemble) Finance plc and Thames Water Limited.

• Thames Water (Kemble) Finance plc (TW(K)F): Financing arm immediately below KWFL. TW(K)F was actually set up later in 2011, and it issued senior secured bonds that were guaranteed by its direct parent, KWFL, which also holds 100% of shares in TWL.

• Thames Water Limited (TWL) – Formerly the listed HoldCo when Thames Water was publicly traded on the LSE. Now holds pension obligations, non-regulated assets, and 100% of shares in TWH.

Lots is going on here, and there is a lot of debt spread across the corporate structure. So, let’s break this down; here is another diagram to understand how debt is serviced through this corporate structure

Thames Water’s financing is organised in several layers, each sitting above the regulated OpCo that produces the cash flow. Creditors at every level depend on distributions being passed upward from the utility. The whole group cash waterfall can be broken down into four distinct tiers [34]:

1. WBS Debt (TWUF at the OpCo level): At the base is the WBS. Debt issued by Thames Water Utilities Finance (TWUF) is secured directly on Thames Water Utilities Limited (TWUL) shares. Because TWUL generates the cash, these creditors are paid first, and dividends cannot be distributed unless the CTA’s financial covenants and Ofwat’s credit rating requirements are met. This makes WBS debt the safest and most senior part of the structure.

2. Senior Secured Term Loans (KWFL): Above the WBS sits Kemble Water Finance Limited (KWFL), which borrowed through senior secured term loans to finance the acquisition in 2006. Unlike the WBS debt, which has first call on TWUL’s revenues, these loans have no direct recourse to the operating company. They are only repaid if surplus cash flows upstream after the WBS has been satisfied. This means that, in practice, the Senior Secured Term Loans are structurally subordinated: if the WBS blocks dividends, KWFL’s lenders have no recourse to the operating company.

3. Senior Secured Notes: Thames Water (Kemble) Finance plc (TW(K)F) issued senior secured notes, which are fully guaranteed by its parent, KWFL. Like the loans, they sit above the WBS but rely on the same upstreamed cash. TW(K)F was set up in 2011 to raise additional debt funding for the OpCo (TWUL)’s activities. Although they are called "senior," they remain subordinated to the WBS like the KWFL Term Loans. and carry more risk than the term loans because they are structurally one step further removed.

4. Unsecured Shareholder Loans: Kemble Water Eurobond plc (KWE) borrowed money from its parent, Kemble Water Holdings Limited (KWHL), which is ultimately the external shareholders. These are unsecured loans that helped finance the 2006 acquisition as well, and they function as deeply subordinated financing. 

The major takeaway is that (2), (3), and (4) are all funded by TWUL through dividends. The tight control of financial and liquidity-related covenants that govern the WBS, combined with Ofwat’s credit ratings requirements, means that if TWUL is underperforming, a cash lock-up can be imposed. This leaves the debt outside of the WBS vulnerable. 

Post-Transaction Capital Structure

All of this now leads us to the post-acquisition capital structure in 2007. We’ve included both the TWUL and the Group’s Capital Structures. Note, there was no Class B debt issued until 2010. 

The Macquarie period 2007-2017: Debt, Dividends, and Underinvestment

Alright, back to the story. This is the most consequential period in the Thames Water saga. With everything we’ve learnt so far, we will be able to filter through all the noise you’d find elsewhere online to truly understand why Thames Water accumulated such an enormous debt pile.

Here is a snapshot of the 10-year period we’ve put together.

The simplest way to understand this period is by focusing on three main themes that persisted throughout. Some of these themes appear in the RWE period, but on a much larger scale here.

• Debt Redistribution & Accumulation

• Underinvestment and Poor Operational Performance

• Sustained Dividend Payouts

Debt Redistribution & Accumulation 

In the early years, Macquarie quickly refinanced its costly acquisition debt with cheaper securitized debt at TWUL. The Group’s net debt rose from £6.3bn in 2007 to about £9.6bn by 2013, a £3.6bn increase. However, TWUL’s share of the group’s net debt grew significantly faster in that period, rising from £3.2bn to £8.4bn, a £5.3bn increase. In FY 2007, TWUL’s share of the Group’s net debt was 51% and by FY 2013, this grew to 87%, indicating that debt was being shifted into the regulated entity (where borrowing costs were lowest due to the WBS), while some holding-company debt was paid off or restructured. Macquarie later noted, “more expensive holding company debt was exchanged for cheaper operating company loans,” which lowered the cost of capital and facilitated increased borrowing for investment, dividends, and parent-level obligations (all of which we will discuss shortly) [38].

Indeed, by 2017, TWF net debt had not only ballooned to £11.8bn, but also over £10.7bn of this was at the TWUL level, accounting for over 90% of the group’s net debt. During this period, Thames Water’s net cash interest costs averaged about £200mm annually, peaking at £270mm in FY 2017, which was a clear result of the growing debt in the regulated entities. These interest expenses had to be made all while FCF was persistently negative for the period, which meant that borrowing was necessary.

So, what did this debt mean for the key financial covenants that TWUL was being assessed by? 

• PMICR: fell from 3.2x in FY 2008 to 1.7x by FY 2017. This steady decline reflects the fact that cash generation after maintenance barely kept up with rising interest costs as borrowing mounted. By the mid-2010s, interest absorbed almost all post-maintenance cash flow, leaving very limited capacity to withstand adverse shocks (1.1x floor).

• Gearing Ratios: TWUL’s gearing rose steeply from 55% in FY 2007 to 83% by FY 2017, reflecting the progressive transfer of debt into the regulated entity. This sharp increase meant that by the mid-2010s, nearly all of the Regulatory Capital Value was effectively debt-funded, leaving only a thin equity buffer. At such elevated levels, Thames Water was operating at the upper limit of the CTA’s allowance (limit 85%).

Underinvestment 

Okay, so what exactly was Thames Water borrowing for? Well, firstly, Thames Water’s capex was substantial under Macquarie. The Australian bank claimed to have invested over £11bn into the network from 2006 to 2017, the highest of any UK water company in that period [38]. Annual capex rose from around £850mm in 2007 to over £1.3bn by the mid-2010s. On paper, Thames Water was spending at record levels. 

However, the effectiveness and focus of this spending have been questioned. Key service metrics either stagnated or declined, indicating underinvestment compared to the network’s needs. For example, ‘leakage’ saw only modest improvements and later worsened again. By 2017, Thames Water missed its leakage reduction target by a large margin, leading Ofwat to impose the maximum automatic penalty of £8.6mm for that year [41]. The company admitted it “let down customers” on leakage and had to advance £40mm in customer rebates as compensation. 

Thames Water’s environmental performance, measured by pollution incidents per year, remained poor and eventually led to record fines. In March 2017, Thames Water was fined £20.3mm for discharging large amounts of raw sewage into the Thames and its tributaries during 2013-14 [42]. This was the largest environmental penalty ever imposed on a UK water company up to that time. 

Regulators and critics linked these failures to decisions made during Macquarie’s ownership: delaying critical upgrades, performing inadequate maintenance, and prioritizing cost-cutting. In fact, by 2014, Thames Water had tried to shift the risk of building the long-overdue “super-sewer” (the Tideway Tunnel) to a separate entity outside of the Thames corporate structure [45]. Ofwat approved the creation of a new licensed company, Bazalgette Tunnel Ltd. (Tideway), to finance and construct the £4.2bn tunnel [44]. Tideway was owned by a consortium of infrastructure investors that were completely separate from Thames Water’s shareholders. It financed the tunnel through equity and long-term debt, backed by government support [51]. But crucially, Tideway’s revenues came from an extra charge on Thames Water’s customer bills (Normal Thames price limits from Ofwat Price Reviews + Tideway surcharge) [51]. This structure ensured the tunnel could proceed while keeping the debt off Thames Water’s already highly leveraged balance sheet, but customers, rather than shareholders, ultimately bore the cost. The Tideway Tunnel would be completed by 2025, but we won’t revisit it again. The most important takeaway is that it meant higher prices to customers, generating revenues that Thames could never enjoy.

Sustained Dividend Payouts

One of the most contentious aspects of the Macquarie era is that Thames Water became a dependable cash source for shareholders even when the business’s own cash flows did not cover expenses. The financial data in Figure 10 shows that Thames Water had a negative FCF in eight out of 11 years from 2007 to 2017. Cumulatively over the period, capital expenditures and interest costs exceeded internally generated cash, meaning the company had to borrow to fill the gap. 

Despite this, Thames Water paid dividends every year under Macquarie’s ownership. In FY 2007, TWUL distributed a large £656mm dividend. This one-time payout, nearly equal to that year’s revenue, was funded by new debt and effectively allowed the Macquarie group to recover a significant portion of its £2bn equity investment immediately. After this initial windfall, annual dividends remained high: between 2008 and 2014, TWUL paid about £200mm to £300mm annually in dividends to its parent, even though its FCF was often negative. Essentially, Thames Water had to have been borrowing to pay shareholder dividends, increasing its debt load.

The media focuses on the recipients of these dividends being the owners in the Kemble consortium, which included Macquarie’s infrastructure funds, foreign sovereign wealth funds, and UK pension investors. However, we know that not all the £2.7bn that TWUL paid throughout 2007-2017 was directly received by these shareholders. A large portion was used to service debt at the holding companies. According to Macquarie, about £879mm of TWUL’s dividends were passed directly to external shareholders, while roughly £1.8bn went toward interest and repayments on Kemble’s acquisition debt or remained within the group [38]. 

However, the press often claims that £1.2bn was eventually paid out to shareholders over the decade [46]. Why such a discrepancy? Well, remember that distributions to the owners came through several channels, not just dividends. Interest on shareholder loan to KWE, which was 11.00% on a £310mm principal, provided extra cash flows back to the same investors. By the end of Macquarie's tenure, about £277mm was received by them in interest payments, which the media views as further value extraction from the water company.

By 2017, a consensus was emerging among regulators and public commentators that Macquarie’s Thames Water had pushed the boundaries of the regulatory framework. Ofwat examined how Thames’s complex financial structure benefited investors without providing clear advantages to consumers or operations [43]. 

Macquarie, for its part, argued that customers weren’t harmed, pointing out that Thames Water met its regulatory investment requirements and maintained an investment-grade rating throughout [38]. Nonetheless, the overall impact of Macquarie’s financial strategy was clear: Thames Water ended 2017 with £10.8bn in net debt (up from £3.4bn before 2007), with a gearing ratio of 83%.

The Regulator?

Throughout this section, you may have been wondering, where was Ofwat in all of this? Indeed, much of the media does like to place the blame on Ofwat for this period. However, let’s return to our mental model to see why Ofwat was not able to intervene.

• Price reviews set the money coming in

• RCV x WACC sets the fair investment return

• ODIs move cash up or down for performance

• Ring-fencing to keep cash in the OpCo when risk rises

Ofwat’s most relevant lever for dividend control was the ring-fencing regime, under which an automatic cash lock-up would be triggered if TWUL’s credit rating slipped below investment grade (Baa2). Despite rising gearing and persistently weak post-maintenance cash generation, TWUL sustained a Baa1 rating throughout the 2007–17 period, largely due to the protections embedded in its WBS structure [47]. These safeguards allowed the company to keep paying dividends even during years of negative FCF. Thus, other than ODI penalties for poor performance, the regulator could not intervene to stop the value extraction. This is despite Ofwat acknowledging the excessive cash distributions to shareholders in the early 2010s [48].

Conclusion / Takeaways

The RWE and Macquarie years make one thing clear: the financial problems at Thames Water cannot be separated from the challenges of privatising a natural monopoly. Under RWE, we saw debt-funded dividends and the extraction of cash from the group even as operational pressures mounted. Under Macquarie, the shift to a securitised structure magnified leverage within the regulated entity, enabling sustained dividend payouts and value extraction despite negative FCF and mounting environmental failures. Both periods demonstrate how private owners, when faced with the incentives of a monopoly utility, repeatedly prioritised financial engineering and distributions over long-term investment.

This is the core dilemma of water privatisation. A monopoly utility with no competitive pressure will always be tempted to underinvest, cut costs, and push leverage higher, while regulators are left trying to strike a balance between affordability for customers, financial resilience for investors, and sustainability for the environment. Thames Water shows how easily that balance can break down. The issues that emerged under RWE and Macquarie were not isolated to poor management decisions, but also were the outcome of a system where essential infrastructure is run for private return.

Thames Water now faces a rapidly deteriorating situation. Are new owners able to come in to steady the company, or will regulators and government have to intervene more directly? The stakes are high, with billions in debt, crumbling infrastructure, and public trust at its lowest … the story is far from over.

In Parts 2 and 3, we will cover the ongoing, and very contentious, restructuring with all its twists and turns. From fierce public outcries on activist hedge funds to court battles and possible “nationalisation”, we are just getting started!

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