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Thames Water’s biggest creditors have told the UK’s water regulator that a proposed £3bn emergency loan cannot be used to pay fines.

Britain’s largest water company, which receives all of its income from its 16mn customers, has calculated that it will receive fines totalling about £400mn by March 2027, according to documents seen by the Financial Times. Penalties expected to land next year alone include a £44mn fine for allegedly paying excessive dividends, and another £135mn in environmental charges for sewage pollution.

The troubled utility secured an emergency loan last month worth as much as £3bn from its largest creditors — which include US hedge funds such as Elliott Management, alongside UK asset managers — to help it avoid renationalisation. But these lenders have insisted to both the utility and to Ofwat that they will not allow the proceeds of this loan to be used to pay financial penalties, according to people familiar with the discussions.

The creditors’ intervention comes as Thames Water prepares for a decisive high court hearing this month, where it hopes to agree the loan in order to help it avoid a Christmas cash crunch.

The spectre of fines has made Thames Water’s negotiations with the creditors behind its £19bn debt pile increasingly fraught, however, as the lenders argue that the company needs “breathing space” from regulatory fines to stabilise the business.

Representatives of both the utility and these creditors have told Ofwat that an agreement on the size and timing of fines is deemed essential. They claim that penalties could immediately wipe out a significant chunk of its dwindling cash balance, according to people familiar with situation.

One proposal pushed by Thames Water and its creditors was for Ofwat to consider ways of levying these fines that did not require immediate cash payments, those people added.

Uncertainty over the utility’s total exposure to fines could also undermine parallel plans to raise billions of pounds in equity, the people familiar with discussions said.

Castle Water, the company founded by the treasurer of the Conservative party, Graham Edwards, is in discussions to take a majority stake in Thames Water, the FT reported in October. CK Infrastructure, which owns Northumbrian Water, is also in discussions to bid.

The discussions over fines underscore the delicate balancing act Ofwat must undertake as it seeks to crack down on water companies’ failings amid significant public anger, while keeping bills at a sustainable level for customers. At the same time, the regulator must try to prevent water companies from sinking into special administration. 

An agreement to lessen the immediate burden from fines was originally expected to be a feature of the “special turnaround oversight regime” that Ofwat unveiled for Thames Water in July.

While there was no mention of such an arrangement in Ofwat’s final announcement, Thames Water has not paid any fines for more than a year, with penalties over alleged breaches of dividend rules last year still under consultation. 

Ofwat has endorsed Thames Water’s £3bn emergency loan as a “positive step” towards “a market-based solution to the company’s problems”, but the financing arrangement has generated controversy because of its hefty cost and onerous terms. 

As well as charging near 10 per cent interest and other costs that could run as high as £800mn, the lenders will drip-feed proceeds of the loan into the utility on a monthly basis, in order to protect themselves in the event of a special administration.

Thames Water is also on the hook for fees for advisers, including the creditors’ advisers, expected to run into hundreds of millions of pounds.

The utility has codenamed negotiations around this loan “Project Willow”, in reference to the thirsty tree that grows by bodies of water.

Thames Water has faced criticism from its lower-ranking bondholders for not considering alternatives to the expensive funding, after the utility dismissed their offer of a £3bn loan at a cheaper cost and with fewer strings attached as too difficult to implement.

Ofwat said it would “continue to hold all water companies to account”.

The watchdog added: “In the past year, we have penalised the sector £158mn for poor performance. In August, our investigation into Thames Water in relation to the management of their wastewater treatment works and networks led to us proposing an enforcement penalty of £104mn.”

Thames Water and its creditors declined to comment.