ESG integration in UK water companies

Water companies are an essential part of the UK’s infrastructure. At Royal London Asset Management we have a history of research and engagement with UK water utility companies dating back to 2018.

Why are bondholders well suited to engage?

This is a sector that has received considerable poor publicity over past years, and as it remains an important area for debt finance, we believe our active engagement with issuers is vital. Engaging with water companies allows us to look more objectively beyond the headlines and immediate financial impact of fines and ensure appropriate stakeholder representation on important social and environmental issues. While these issues, in isolation, are unlikely to materially impact the credit worthiness of the sector given the regulated nature of returns, with consumer finances becoming more strained and the political landscape more volatile, a clearer demonstration of public utilities’ ‘licence to operate’ is more important than ever. As long-term stewards of our clients’ investments, and major investors in UK utilities, we will continue to scrutinise and challenge our borrowers on this basis.

How to measure a company’s performance

The Environmental Agency publishes annual scores on nine of the UK’s water and wastewater companies, known as the Environmental Performance Assessment (EPA). The scores can be useful in assessing a company’s environmental performance through six indicators. However, we believe that these scores alone do not adequately capture exposure to climate physical risks, in addition to social aspects such as affordability. Furthermore, the scores currently make it difficult for investors to understand the nuances of each individual company.

Water and sewerage companies – Environmental Performance Assessment 2021

Note: These results are drawn, in part, from information submitted by the companies and may change as a result of subsequent audits and checking.

Source: Environment Agency & Natural Resources Wales [6]

The Watsit score

Although having the EPA score can be useful for focusing on a fixed range of environmental metrics, it can be difficult to assess a company’s ESG (Environmental, Social and Governance) performance beyond the indicators provided. As a result, we have developed a more holistic proprietary scoring system to measure a company’s performance based on 17 underlying data points forming the Royal London Asset Management Water Situation (Watsit) score [7]. The Watsit score covers a broad range of indicators to incorporate physical climate adaptation and biodiversity risk, in addition to social metrics such as how the company supports their vulnerable customers through affordability schemes. We also utilise data points from the Environmental Agency and Ofwat (the Water Services Regulation Authority), as well as quantitative and qualitative research from various company reports. The analysis and scoring methodology of the Watsit allows for more informed risk identification, which we believe improves the integrity of our lending and provides important context for our evaluations of bond pricing.

Following the completion of our initial Watsit assessment for the sector, we were able to put the information to use when a water company came to market with a new bond issue in February 2023. Our analysis allowed us to quickly consider the relative environmental and social performance of this company compared to their peers, without having to rely on a single EPA scoring, adding to the considerable comfort already provided by the highly regulated nature of the sector.

Next Steps

Our Responsible Investment team will be initiating a collaborative engagement to encourage best practice in adaptation to physical climate risks, biodiversity, and affordability in 11 water companies. To learn more about this engagement, please look out for our Phase 1 water report coming out later this year.  

Footnotes

1. Refer to the EPA metric guide for more detailed information (www.gov.uk/government/publications/water-and-sewerage-companies-in-england-environmental-performance-report-2021)
2. of sewer length
3. The figure in brackets is the combined self-reporting percentage for just sewage treatment works and pumping stations - this must be 90% or more for a green rating
4. with numeric water quality limits for treated wastewater at sewage treatment works and water treatment works
5. Water Industry National Environment Programme
6.  Water and sewerage companies in England: environmental performance summary graphic 2021 (publishing.service.gov.uk)
7. Please note the score is there to help Royal London Asset Management give a general overview of the sector compared to its peers and may conclude on an opinion that is different to the score when more qualitative factors are introduced.

Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.