A future Labour government risks provoking a “flood of claims” under international law if it tries to nationalise some of the UK’s key utility companies at below market prices, according to lawyers advising businesses on how to protect themselves.
Investors seeking compensation could bring lawsuits under bilateral investment treaties (BITs) between Britain and various territories and countries, including Hong Kong and Malaysia. These pacts are designed to protect investors from state interference and unfair expropriation.
Some investors already have these rights by virtue of their nationality, including YTL, the Malaysian group that owns Wessex Water, and Cheung Kong, the Hong Kong-based investor that controls several large UK energy distribution networks.
But their number could increase sharply should other investors seek protection by deliberately restructuring their utility shareholdings through BIT jurisdictions, said lawyers with expertise in this area.
“If Labour broke with international norms by expropriating investments for less than market value, then the general perception by investors that this was unfair means many would be unlikely to sit back — a flood of litigation would be inevitable,” said Dan Neidle, a partner at law firm Clifford Chance.
This could complicate Labour leader Jeremy Corbyn’s plans to buy up key utilities — including National Grid — relatively cheaply. While there is no certainty that any legal challenge by investors under a BIT would ultimately be successful, such claims could drag out Labour’s nationalisation of energy and water companies for years.
BITs were originally designed to protect shareholders from capricious policies designed to devalue cross-border investments. First used by western companies that bought assets in emerging markets, they have evolved into genuinely two-way treaties as developing Asian countries have themselves become big overseas investors.
The BITs are not designed to stop expropriation, but to make sure it takes place at a “fair” price. Investors take that to mean the market value that prevailed immediately before the asset’s impending expropriation became public knowledge.
Of 25 groups slated for nationalisation under Labour’s plans, 12 have major shareholders entitled to BIT protection by virtue of nationality.
Other investors are now looking at securing such protections. Canada Pension Plan Investment Board (CPPIB) is reportedly rerouting its 33 per cent investment in Anglian Water through a Hong Kong subsidiary. IFM, an Australian fund manager with a 20 per cent stake, is taking similar steps, said people familiar with the situation. CPPIB and IFM declined to comment.
Another lawyer, who declined to be identified, was aware of two or three investors reshuffling their holdings so they could take advantage of BIT protection. “It’s comparatively simple for financial investors to do so because they already have Singaporean or Hong Kong subsidiaries,” said the lawyer.
Investors are reaching for BITs (and also the Energy Charter Treaty, an international agreement that covers cross-border energy investments) because of fears about Labour’s approach to nationalisation.
Having promised to buy back the water and energy distribution companies, the party has warned that compensation might not be based on market value.
Labour politicians have suggested using other measures such as the net asset value of an entity or alternatively its “regulatory capital value” (RCV) — a sum assessed by the industry watchdog on which utilities are permitted to earn a return. The party has not yet officially spelt out precisely which route it will adopt.
Buteither method, if adopted, could leave investors nursing big losses. For instance, shareholders in the water company Severn Trent could lose 75 per cent of its £4.7bn market capitalisation if it were nationalised at net asset value, or 20 per cent under the RCV-less-debt approach.
Despite the threat of investor losses, utilities have held back from restructuring their operations to secure BIT protection because of fears about reputational damage.
Labour’s present intention is to buy only utilities’ regulated subsidiaries from their holding companies, and not whole groups. Bosses have shied away from rearranging groups so as to introduce overseas holding companies above threatened subsidiaries, and thereby protect all shareholders.
“There is a worry that doing this would be seen as trying to frustrate the policies of an elected government,” said the lawyer who did not want to be named. Steps that pushed up purchase prices would make it harder for Labour to cut bills for customers — one of the stated objectives of nationalisation.
There is also a fear the tactic could be ineffective. “If you try to protect a subsidiary through an intermediate company in a BIT haven, the government could simply nationalise the whole group, rendering the exercise redundant,” said Professor David Hall, an academic close to Labour.
This has led companies to look to investors to make their own individual arrangements. “It is basically up to them to decide what protections they think are both effective and appropriate,” said one water company chief executive.
For all the interest in BITs, there is no certainty they will provide adequate investor protection in practice.
Many do not specify that compensation must be at market value, and have carve-outs for governments to pursue wider public policy objectives.
Totis Kotsonis, partner at law firm Eversheds Sutherland, said investors able to rely on BITs were not guaranteed a better position than those who could not. “Ultimately how effective this route would be in offering better protection would depend on the method used for calculating any compensation,” he added, saying that most treaties did not prescribe any method.
Meanwhile Labour has warned that it will not be passive. Shadow chancellor John McDonnell recently said that a future Labour government would “find a mechanism” to claw back ownership of stakes held by investors who tried to shelter behind overseas treaties.
Prof Hall claimed the investor-state dispute settlement provisions in BITs were postcolonial relics of the Ottoman “capitulations” — extraterritorial privileges that were once enjoyed in 19th century Turkey by citizens of western powers.
“It is a democratic anomaly that foreign investors should have rights to hinder acts of elected governments in the 21st century,” he said.
