Firms spurn competition watchdog's bid to cut cost of capital

Northumbrian Water, Anglian Water, Bristol Water and Yorkshire Water have pushed back hard on the Competition and Markets Authority’s (CMA) latest position on cost of capital. In working papers earlier this month, the CMA proposed a material decrease of 0.3% on the weighted average cost of capital (WACC) set out in its Provisional Findings last autumn.

Northumbrian Water called the latest thinking “theoretically inconsistent, contains errors and its approach alters the balance of risk between customers and shareholders… despite strong statements from the CMA of the importance of the financeability cross check, the notional company is now unfinanceable”.

Yorkshire argued the WACC drop should not be considered in isolation but “must include an ‘in-the-round’ assessment of the overall package” adding: “Contrary to regulatory best practice, there is no consideration of the overall package of targets, and there is an inherent disconnect between the targets that Ofwat has set and the evidence of what is achievable by an efficient company …An appropriate WACC cannot be considered in isolation from these asymmetry concerns but, in YWS’s view, the cost of capital working papers fail to do so, resulting in material errors of fact and assessment.”

Anglian said it “strongly disagrees” with the CMA’s altered approach to cost of debt “which underfunds Anglian’s efficiently incurred cost of embedded debt by 45bps. This would leave Anglian’s notional company significantly underfunded”. It also argued the new approach to aiming up on the cost of capital (cut by the CMA from 50bps in the Provisional Findings to 25bps in the January paper) was “supported neither by sound reasoning nor by robust evidence”.

Bristol had two principle concerns: “Firstly, the complete absence of any reference to the cost of capital relevant to Bristol Water that is so important to our redetermination and our financeability, and secondly the substantial changes in the CMA’s approach to key aspects of cost of capital from the Provisional Findings without adequate justification.”

For its part, Ofwat said it now largely agreed with the CMA’s approach to the cost of debt “though we remain concerned that the CMA has not engaged adequately with the reasons for considering an outperformance adjustment to the allowed cost of debt, and includes an unnecessary uplift of 5-10 basis points to its actual benchmarks”. On cost of equity, it argued: “We continue to disagree that such aiming up is necessary for water.” The regulator also set out an extensive list of issues raised in its representations on risk and return and cost of capital that the CMA had not addressed.

The parties kept their initial responses to the cost of capital papers relatively brief, saying they would submit full responses by the 27 January deadline after a round table discussion held on 20 January.

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