We need to talk about Southern Water, regulation and ESG

The UK utility's repeat offences that led to a record-breaking fine raises serious questions about how asset managers are held to account.

Sorry doesn’t seem to be the hardest word for Southern Water. The UK utility has repeatedly apologised over the last 12 years as it racked up a litany of fines for sewage leakages.

Last week, it was “profoundly sorry” after the regulator Ofwat delivered its largest fine to date, landing the group with a £126 million ($158.9 million; €139.9 million) blow. This time, apologies nor fines should cut it.

The company was found to have failed to operate several wastewater works properly, leading to spillages into the environment between 2010 and 2017. Ofwat also said Southern Water had deliberately manipulated and misreported data from the sites to avoid £91 million in penalties under the regulatory regime, with the watchdog pointing the finger at senior management officials as part of the process.

A “culture of manipulation was the norm” at the company, according to Ofwat’s report, and Southern Water had shown “scant regard for its responsibilities to society and the environment”, said Rachel Fletcher, chief executive of Ofwat.

Yet this is a company that in the 12 years since being acquired by infrastructure funds managed by JP Morgan Asset Management, UBS Asset Management and Hermes Investment Management has consistently shown this “scant regard”. Lord Thomas of Cwmgiedd, the UK’s former Lord Chief Justice, said “there is a persistent record of criminality and offending by this company”. That was in 2014 and things have not improved.

The ownership consortium, which also includes Whitehelm Capital, has maintained a collective silence on the issue – JP Morgan, UBS and Whitehelm all declined to comment, while Hermes did not respond to a request for comment – perhaps hoping the fine will be paid and the incident will blow over, as has happened with the previous fine and the fine before that and so on.

Some will at least have to explain themselves to their investors, with one LP in the UBS fund telling Infrastructure Investor it has asked UBS to explain the impact of the fine on its investment and what measures it plans to take going forward. UBS is putting a paper together on the issue to investors imminently, this LP said.

The repetitive nature of the company’s behaviour raises questions about Ofwat and the wider regulatory system. Financial penalties and appearances in courts clearly do little to encourage reform.

There is, of course, one group in Britain that has a stated desire to go beyond fines. The Jeremy Corbyn-led opposition Labour Party’s industry-wide nationalisation policy may not be the cheapest or the fairest, but it gains credit after events such as last week’s. The UK government last year removed Virgin and Stagecoach from the East Coast rail franchise and a similar discussion needs to be held with Ofwat about Southern Water’s ability to run wastewater services.

The £126 million is comprised of a £3 million fine and a £123 million rebate to customers. The former figure is a reduction from £37.7 million because Southern Water was “co-operative” with the investigation, a situation that would be laughable were it not so tragic. And while the matter is still open to consultation, the £123 million to customers feels more like gesture politics than addressing Southern Water’s environmental damage.

The episode is a breach of practically every ESG scenario in the book, despite Southern Water receiving a five-star accreditation from benchmarker GRESB Infrastructure in 2017. If Southern Water was willing to lie to Ofwat, did it also misreport data to GRESB?

We posed that question to the benchmarker, which relies on asset managers submitting their own data, but the organisation declined to divulge whether Southern Water had indeed disclosed it was under investigation.

Until 2018, GRESB’s system was largely score-based. Last year, the organisation changed its submission form allowing companies to report incidents such as an Ofwat investigation. According to Rick Walters, director of GRESB Infrastructure, the organisation may look to include external research in the future.

This needs to happen soon, especially as “ESG has become the primary determinant of long-term performance”. That’s according to one Anton Pil, managing partner at JPMorgan Global Alternatives, writing for us in February.

Write to the author at zak.b@peimedia.com