Friday, June 10, 2011

Tallinn Water Fight

In previous postings I have sounded warnings that Estonian privatization policy risks becoming incoherent. I have pointed out that few of the larger privatizations have gone without problems, and that far from being the poster child for economic reform, Estonia risks becoming known as an unreliable and even cantankerous privatization partner- which could have a significant financial impact in the future.

The failure of the Estonian Rail privatization now seems set to be compounded by the failure of the Tallinn Water company sell off. Some politicians have suggested that my views "as the view of one person" carry little weight, and it is true that my thoughts on the blog are entirely personal. However, they are views which, nonetheless, are informed by more than two decades of activity at reasonably senior levels at major firms in the City of London. Neither are my views given in the service of any sectional interest, but rather because I want to contribute positively to the country of which I am a resident and I fear that the success of Estonia as a whole may be imperiled by poor decision taking. I do not want to see the government of Estonia take decisions that I believe are not in the best interests of the country, or even in the longer term interests of the political parties that comprise the ruling coalition here- whatever the short term political temptations may be.

The history of the privatization of the Tallinn water company is, in many ways, a great success. The privatization of the water utility has resulted in large scale investment in new technology and dramatic increases in the quality both of drinking water and also sewerage. There is no doubt that from the point of view of investment, the consortium led by United Utilities has delivered a modern and efficient company that offers high quality water services.

The quid-pro-quo of this investment is that the shareholders are entitled to a return on the money that they invested. Because the provision of water and sewerage services is as close to a natural monopoly as you can get, under most privatizations these returns are closely regulated under the terms of various agreements, often including the sale-purchase agreement itself. So it is with Tallinna Vesi. However there is now a dispute, since the government of the Republic of Estonia is now vetoing price increases that even it implicitly accepts are clearly mandated by the terms of the original agreement.

In a letter to shareholders, The Estonian Ministry of the Economy, complains that the shareholders of Tallinna Vesi have been putting forward black propaganda against Estonia, in order to support price increases which it clearly believes are unjustifiable. However, in the same letter, it is pointed out that the selling party under the privatization agreement is the City of Tallinn, and the Government of the Republic can not be bound by the terms of an agreement that it was not a party to. The implication is clear: under the terms of the original agreement, the Republic accepts that prices should rise in the way that the company now wishes, however it disputes the right of the City of Tallinn to enter into such a long term binding contract.

By saying that the Republic will not be bound by terms agreed by the City of Tallinn, the Government effectively says that the City of Tallinn acted beyond its powers in the matter of the privatization, that is to say in legal terms that the City of Tallinn acted ultra vires. If that is so, then the privatization agreement that the United Utilities consortium entered into in good faith is clearly cancelled, and the shareholders are entitled to seek redress in the courts. Yet the government does not say this, they say only that the government will not be bound by pricing terms agreed under the original agreement. Yet they do not seriously suggest that investors acted in bad faith in this matter, so it is not the consortium that is at fault: even the Government is suggesting that the fault lies on the Estonian side, between the Republic and the City of Tallinn.

The problem is that the original agreement was approved by the Government of the time- the first item of due diligence would be the proof that the city of Tallinn had the powers to negotiate the terms of the sale. So it will be hard for this government to retrospectively argue that the City of Tallinn overstepped their powers. There will, I expect, now be protracted court proceedings that will hinge on whether of not the City acted ultra vires. If it did, then the agreement as a whole may indeed be cancelled, with messy ramifications. If it did not act ultra vires, then the next step will be to establish whether the regulatory regime recently put into place even has the powers to vary the terms of the original contract unilaterally- and here it will not just be a subject of Estonian law, but also European Union competition directives. The third question will be that even if the competition authority has those powers, did it act reasonably in this case? This litigation is therefore going to protracted and expensive, yet the government is offering a simple "take it or leave it" approach- no negotiation is on offer from the government side. Yet the Republic can not be sure of a legal victory, and in my view such a maximalist position carries significant risks.

The letter to shareholders is a clear indication that the government is on shaky legal ground. Even if the City of Tallinn only acted unlawfully in the matter of the post-privatization regime, those terms were a full component of the terms of privatization and their cancellation entitles Tallinna Vesi to seek legal remedy either from the City of the Government. If the Competition Authority has the power to vary the terms of the original agreement, why has it acted in such secrecy- failing, as the Company alleges, to even communicate with the Tallinna Vesi board? Meanwhile, the company insists that it has acted in good faith and has more than matched the investment expectations laid upon it since the Privatization took place. If the company has indeed acted in good faith, why- except for purely short term party political reasons- is Estonia seeking to vary the terms?

To my mind the government of Estonia risks getting itself into real trouble: any future privatization will now be considered in the light that the government may subsequently unilaterally alter the terms. This imposes a political risk which substantially increases the cost of investing in Estonia. From the point of view of Estonia, this reduces the price that investors are prepared to pay for Estonian assets. Secondly, acquiring a reputation of being investor unfriendly is something that, once established in investor perception, is very difficult to shake off.

It is in this light that allegations of corruption acquire a more sinister tone. Estonia is not a perfect state of laws- no country is. Yet, there has been a growing sense that a few bad apples have the potential to cause significant future problems. The price increases that the Tallinn Water company propose are unquestionably politically unpopular, but attempting by personal fiat to alter them opens to the door to changes by subsequent ministers that may be rooted more in personal gain than political popularity. It is critical that Estonia keeps her reputation for fair dealing and honesty.

There is now a breakdown in trust between the shareholders of Tallinna Vesi and the Government of Estonia. This may be remedied in the courts, but if the Government were to lose, despite the warnings they have received, then it may take a lot more than a ministerial resignation or two to repair the damage. Even a legal victory for the government, doubtless after years of litigation, would be a Pyrrhic victory- it would show the government failed to communicate to investors, and was unprepared to address legitimate grievances.
Having one privatization - Estonian Rail- fail, might be considered a misfortune. To have Tallinna Vesi fail too looks like a lot more than simple carelessness.

2 comments:

Anonymous said...

Could you imagine to publish same type of biast crap in some better-developed countries? For example in Germany? Tallinn Water profit in second quarter was 53%:))) Everyone knows that investors are skipping every law possible.
Also everyone knows that British businessman are in Estonia tight group of beer-minded friends who do business in a pub and have extremely arrogant attitude. So now they help eachother to show Estonia in a bad light.

Cicero said...

I am biased... biased in favour of Estonia, and if I like beer, I drink it 95% with Estonians! I do not do any business with other Brits in Estonia.

Also it is not true that any investors routinely break the law- there are ethics in business, as well as laws, and most people obey both.

I am deeply concerned about how the government policy towards TV may effect other potential investments and I would be no friend of Estonia if I did not speak up. Tallinna Vesi is an Estonian company, supported by British investment and management, that is true. Yet the management could have come from anywhere else and the investment been in any other country, and the questions would still be the same.

Your Q2 profit number is, like everything else in TV, dependent on how you measure it- no accountant would agree with you, though.

TV is being attacked for political reasons- and that is dangerous. It is bad news for any of us who care about Estonia (in my case for over 30 years) and really want her to succeed.