Jeremy Warner's Outlook: Thames cannot deliver the water even though profits are in full flood. You couldn't make it up

Praise from Balls for the FSA; Misys tests the rules on buyouts; Now there's a thing: Aznar joins Murdoch
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The Independent Online

Not since the chief executive of Yorkshire Water was caught nipping across the county border to take a bath at a time when standpipes had been imposed on the streets of Bradford has the water industry suffered such a devastating public relations disaster.

Despite being given a massive, inflation-busting price increase by the water regulator to pay for infrastructure improvements, Thames Water has missed its water leakage targets by a country mile. There's already a hose pipe ban in place; Thames is also in the midst of seeking permission for a much more draconian drought order.

In normal circumstances, poor rainfall might seem to justify both these measures, but when the company is losing 30 per cent of the water it produces through leakage, equivalent to 357 Olympic sized swimming pools every day, and has been granted permission to raise prices by 24 per cent over and above the rate of inflation between 2005 and 2010, there's plainly something of a problem.

There may be no water, but one thing still flowing like the Ganges in full flood is the profits. These are up by more than 30 per cent. With characteristic insensitivity, RWE, the company's German owner, has also chosen to increase the dividend it pays itself by 53 per cent to £216m.

Thames Water is no longer a publicly quoted company, so the chief executive, Jeremy Pelczer, can presumably hope to escape the fate suffered by his luckless, one time counterpart at Yorkshire Water. He was fired along with the chairman.

Even so, it is clear from the comments made yesterday by the water regulator, Ofwat, that there's harsh treatment in some shape or form on the way. In extremis, the regulator could strip the company of its licence, though this seems rather unlikely given that RWE is planning to sell anyway. Yorkshire Water never suffered this fate, and nor did South West, guilty of the arguably more heinous crime of poisoning its customers. Seven Trent also escaped such treatment after fiddling the books so as to bolster the case for price rises.

Yet a fine of close to the maximum 10 per cent of turnover - equal to £140m - seems more than possible. This is hardly the most auspicious of backdrops to RWE's attempt to refloat the company on the stock market.

I'll no doubt be accused of making a cheap point, but if this were not warning enough of the dangers of highly leveraged takeovers of our core utility assets, I don't know what is. Whatever the regulator does to prevent it, the priority for such acquirers is to make the assets sweat until the debt is paid off. The Prime Minister is frankly being naive when he insists that leveraged foreign takeovers such as Ferrovial's bid for BAA are good for Britain.

Despite the looming water crisis, Thames Water actually spent less last year on capital investment than the year before, though for what it is worth, the company blames Ken Livingstone's opposition to a desalination plant on the Thames for this. Wouldn't it be better to fix the leaks before investing in highly energy-intensive new sources of supply? The London Mayor is not alone in thinking so.

As it is, the company hopes to avoid the regulator's whip by promising to spend £150m over and above that already agreed fixing the problem. It's not easy, given that large parts of London are still reliant on Victorian mains, which are disruptive to replace.

But nor is it impossible. There really is no excuse for failure to supply customers with the product they are paying for. Water metering may be the best long-term solution to Thames' problem, forcing customers to put a proper value on what is an increasingly scarce resource, but it doesn't cut much ice with the public at a time when so much of the stuff is going down the drain.

Praise from Balls for the FSA

That Ed Balls, the Economic Secretary to the Treasury, should think the Financial Services Authority "a national asset worth preserving" is not altogether surprising, for if anyone can take credit for the policy that created it, then it is Mr Balls, back then a young adviser to the Chancellor, Gordon Brown. Even so, he's ordered a National Audit Office review of the record. Is he bowing to the Prime Minister, who has described the FSA as little short of a carbuncle on the face of productive enterprise, or is this just routine?

Whatever the answer, it is not hard to predict the NAO's conclusions. For wholesale markets, the FSA has been a success, making a valuable contribution to London's leading position as an international financial centre. By applying a light touch, principles-based approach to regulation, the FSA has allowed firms to prosper here while at the same time lending markets an integrity they often lack elsewhere.

On the other hand, the FSA's record in regulation of retail financial services has been little short of disastrous. By overburdening the industry with heavy-handed and often counter-productive solvency and point-of-sales regulation, it has helped all but destroy the incentive to save and deprived millions of investors of the superior rates of return enjoyed in wholesale markets.

The FSA is valiantly trying to correct this perception. In Sir Callum McCarthy, the chairman, financial regulation could hardly hope for a more reasoned and intelligent champion. Unfortunately, it is for many already too late.

Misys tests the rules on buyouts

Management teams that bid for their companies always face an obvious conflict of interest. They wouldn't be buying unless they expected to make a great deal of money on the purchase. Since they know the company better than anyone, there will always be the suspicion that anything they bid is likely to be a severe undervalue. Though they are meant to be working for the shareholders, and are certainly paid by them, all too often their intention is to steal the company from them.

A case in point might be Misys, the banking and healthcare software company which recently announced that it had received an approach from senior managers. This presumably means Kevin Lomax, the chief executive, though laughably the company refuses to spell this out. Mr Lomax made a great play of his corporate governance duties while warring with Paul Myners over the succession at Marks & Spencer, but they have not been much in evidence at Misys, which has rowed with its shareholders over executive pay.

Mr Lomax now appears so disillusioned that he wants to get out of the publicly listed sector altogether. Misys is setting about consideration of any offer in an entirely appropriate way by establishing an independent committee of directors.

Yet however much due diligence rival suitors do - Misys has also received a couple of other private equity approaches - they can never know as much as the chief executive about the business and its potential. Mr Lomax seemed to concede that prospects were still pretty good in a trading update yesterday.

The dangers of conflict of interest are even greater in people businesses such as Misys. If the management bid is rejected, the strong likelihood is that executives then become disaffected or leave altogether, making the company worth less than the management was bidding.

The introduction of a simple rule by the Takeover Panel might help correct this problem. Managements should be allowed to bid only once, so that if they are subsequently outbid by a rival, they are barred from re-entering the fray. This would ensure that executive bids are made at something close to fair value. As it is, many management bids are just a try on. Regrettably, they all too often succeed.

Now there's a thing: Aznar joins Murdoch

Jose Maria Aznar, former prime minister of Spain, has been rewarded for towing the line on Iraq - a policy which lost his party the general election - by being appointed a non-executive director of Rupert Murdoch's News Corp. If nothing else, this should make board meetings a laugh as he barely speaks a word of English. It gives a whole new meaning to the concept of the non-executive poodle.

j.warner@independent.co.uk

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