UK utility investors prepare to fight with nationalisation in prospect

Plans by the Labour party to nationalise swaths of the UK’s telecommunications infrastructure have intensified a sense of alarm in the utility sector, with investors scrambling to protect their holdings in case the December 12 election leads to a Jeremy Corbyn-led government.

Investment funds have already seen share prices drift in sectors such as water and energy over concerns that a Labour government might expropriate them at less than market value.

That uncertainty has now extended to the telecom sector with news that Labour plans to break up BT and take its network-owning Openreach division into public ownership. Nationalisation would threaten not only BT shareholders, but also companies that have invested billions of pounds in private telecoms, whose interests could be jeopardised by the proposed policy of offering free broadband to all British customers.

Lawyers warned that investors would not simply accept these losses if Labour sought to implement their pledges. “If Jeremy Corbyn actually makes it to Number 10, expect to see them come out of the defensive crouch and fight,” said one lawyer who declined to be identified.

International private equity, pension and sovereign wealth funds have piled into water, telecoms, and electricity assets in the UK in recent years, considering them a safe haven that delivers stable and generous returns.

These calculations have been thrown into doubt by Labour’s pledge of nationalisation — and its apparent popularity. The share prices of regulated utilities have historically risen steadily in line with their regulated capital value (RCV) — an inflation-linked asset figure on which they are allowed to earn a return.

“But this simply hasn’t happened since the 2017 election,” said Colm Gibson, managing director of the consulting firm Berkeley Research Group. “It appears that this is when renationalisation became a real possibility in investors’ minds.”

Labour has said that parliament, not markets, will determine the compensation a future government would offer utility investors. Party figures have also intimated that prices could be based on utilities’ book value or RCV minus their net debt — both measures that could spell heavy losses.

This has galvanised investors into taking steps to protect their interests. These include reorganising their holdings to create the option of bringing lawsuits under bilateral investment treaties (BITs) between Britain and around 90 other countries, including Hong Kong and Malaysia, which are designed to protect investors from state interference and unfair expropriation.

In the past fortnight, National Grid and SSE Energy, large listed groups which own electricity networks in England and Scotland, revealed they had shifted their UK regulated operations under new offshore holding companies in Switzerland, Hong Kong and Luxembourg. The Swiss and Luxembourg entities offer potential protections under the Energy Charter Treaty, an international agreement that covers cross-border energy investments.

Shareholders in unlisted water utilities have already taken action. For instance, the Canada Pension Plan Investment Board routed its 33 per cent stake in Anglian Water through a Hong Kong subsidiary earlier this year.

BT shareholders, who face the possibility of substantial chunks of the group being expropriated in return for uncertain compensation, have more limited options. Restructuring their holdings in Openreach would be difficult in the short term.

Instead the legal front line is likely to shift to Openreach’s competitors — such as its largest rival, Virgin Media — whose investments could become worthless if a future government offers broadband services for free.

Any legal challenges are likely to centre on whether Labour’s plans infringe European competition law.

Lawyers admit that none of the legal avenues available to investors are foolproof. Rob Wilkins, partner at law firm Pinsent Masons, warned that those seeking international protection under BITs would have to prove that the nationalisation was somehow “unlawful”, which would not be simple.

While it might be reasonable to argue that broadband services in specific areas where there is a position of market failure requires public subsidy, it is harder to argue that free fibre-based broadband is a universal necessity

Nationalisation is generally allowed where it is “for a public purpose, non-discriminatory and in exchange for fair and adequate compensation, and carried out in accordance with the terms of national law”, said Mr Wilkins.

In practice, say lawyers, cases are likely to hinge mainly on whether the level of compensation was reasonable. Many BITs do not specify that payment must be at market value, and have carve-outs for governments to pursue wider public policy objectives.

Ellen Fraser, partner at Baringa’s energy, retail and utilities practice, said that relying on treaties would not “protect [investors] entirely but will give them some protection from below-market-price” compensation.

These treaty protections might anyway be lost were it successfully argued that investors had restructured purely to thwart a foreseeable government intervention.

Attempts to block free broadband are not straightforward either. According to James Webber, antitrust partner at Shearman & Sterling, nothing in principle stops EU member states subsidising a monopoly service they deem to be of social importance — for example a ferry service on an uneconomic route to an island community, or an ambulance service.

Challenges are therefore likely to centre on whether it is proportionate to create such a widely available special service, such as national broadband, for free and whether this step would discriminate against competitors.

According to Tim Cowen, an antitrust partner at law firm Preiskel, this would be difficult for any government. “While it might be reasonable to argue that broadband services in specific areas where there is a position of market failure requires public subsidy, it is harder to argue that free fibre-based broadband is a universal necessity,” he said.

“There are also spillover and market-distorting effects on to other markets such as mobile, which would clearly be affected by free fibre-based broadband,” he said.

Labour’s John McDonnell has already indicated that the party might seek to “come to an agreement” with Virgin to bring other broadband providers “within the ambit” of its proposed free service.

Concerns about nationalisation are likely to outlive this month’s general election — whatever the result. “Even if Labour loses this time, the threat is simply deferred until the next election, which could be sooner than people think,” said another adviser to utility companies.

Meanwhile the spectre of renationalisation is stalling deals. CityFibre, a broadband infrastructure provider, put a £200m agreementto buy TalkTalk’s fibre business on ice after Labour’s announcement.

Ms Fraser worries that the threat of nationalisation is already stifling investment in the UK at a time when energy players are seeking to shift away from fossil fuels to renewables. “A lot of them are really struggling to get investments signed off. Why would you invest where there is significant financial risk.”