How active credit investors can help flush out UK sewage pollution

UK water companies have attracted plenty of press attention and criticism in recent months. There has been an increased focus on their environmental performance, which the UK Environment Agency described in its report covering 2021 as “the worst we have seen for years”.

Lobbying groups such as Surfers Against Sewage have also had an impact with high-profile campaigns tracking and highlighting pollution incidents.

And some water companies are more indebted than the sector regulator Ofwat assumes when it sets prices, despite a heavy future investment need.

Using our influence for good

LGIM is one of the largest lenders in the sterling corporate bond market,¹ so it is naturally a first port of call for UK water companies wanting to borrow money for upgrades and to refinance.

We believe this role gives LGIM influence over management teams at the water companies, who seek access to competitive funding. LGIM directly engages when companies are marketing bonds, and also amplifies its voice through its leading role at UK industry body The Investment Association.

But investors need to engage well in advance of a borrower’s approach to the market, and in a broad way, if they are to maximise impact. For this reason, LGIM also proactively engages with other sector stakeholders such as regulators and industry bodies. We also, importantly, proactively engage with shareholders in the water companies where there is concentration of ownership.

Engagement can cover a wide range of topics, for example LGIM has been vocal on the topic of antimicrobial resistance (AMR), both at the corporate level as well as with global policymakers.

A delicate balancing act

With this level of influence comes responsibility. In particular, large investors like LGIM have a duty to limit exposure to companies that aren’t delivering for stakeholders. This can create difficult investment decisions, because weaker companies’ securities can trade at a discount. It can be difficult to judge when engagement might begin to bear fruit, justifying greater investment, and being underinvested at this point could result in missed trading gains.

In any case, at LGIM we believe that lending to stronger, better-run companies tends to generate improved outcomes in the long run. LGIM has a responsibility to maintain pressure on decision makers to steer underperforming companies back towards delivery for stakeholders.

If and when improvements are achieved, the universe of investable securities should expand. In this way, we aim to maximise long-term risk-adjusted returns for credit investors.

 

1. Source: LGIM data as at 22 March 2023