NEW ISSUER REPORT. Table of Contents: Analyst Contacts: INFRASTRUCTURE SEPTEMBER 15, 2015

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1 SEPTEMBER 15, 2015 INFRASTRUCTURE NEW ISSUER REPORT Bazalgette Tunnel Limited Government-Designated Infrastructure Provider to Construct, Own and Operate the Thames Tideway Tunnel London, United Kingdom Table of Contents: TRANSACTION OVERVIEW 2 RATING RATIONALE 5 COMPLEX CONSTRUCTION WORKS WITH TUNNELLING UNDER URBAN AREA BUT WITH THREE EXPERIENCED CONSTRUCTION CONSORTIA 7 GOVERNMENT SUPPORT PACKAGE PROVIDES SIGNIFICANT RISK MITIGATION DURING CONSTRUCTION PERIOD 9 STRONG LEGAL AND REGULATORY FRAMEWORK SUPPORT BTL S CREDIT QUALITY 10 LOW OPERATIONAL LEVERAGE 11 FINANCING STRUCTURE PROVIDES ADDITIONAL CREDITOR PROTECTION 12 APPENDIX 1 LICENCE CONDITIONS 15 APPENDIX 2 GOVERNMENT SUPPORT PACKAGE 20 APPENDIX 3 GROUP STRUCTURE AND OWNERSHIP 23 Analyst Contacts: LONDON Stefanie Voelz Vice President - Senior Analyst stefanie.voelz@moodys.com Neil Griffiths-Lambeth Associate Managing Director neil.griffiths-lambeth@moodys.com Bazalgette Tunnel Limited (BTL) is a new special purpose company formed to construct and operate the Thames Tideway Tunnel (TTT), a 25 kilometer (km) tunnel underneath the River Thames in London. The tunnel will collect and store excess storm water and sewage, presently discharged into the river, for subsequent treatment and release and will require investment of approximately 4.2 billion of which around two-thirds will be spent by BTL. BTL is owned by a consortium represented by Allianz Capital Partners, the Amber Infrastructure Group, Dalmore Infrastructure Investments LP and DIF, a Dutch fund management group. We assigned a Baa1 corporate family rating (CFR), with a stable outlook, to BTL in August 2015 after it was awarded its licence by the Water Sevices Regulation Authority (Ofwat), the economic regulator for water and sewerage companies in England and Wales. The assigned rating reflects the following considerations:» Complex construction works with tunnelling under a major metropolitan area. The Tideway Tunnel is a large and complex project with construction expected to take around six years before system testing and acceptance. Tunnelling is challenging, all the more so in an urban environment and with the involvement of multiple contractors and other stakeholders. As positives, the construction counterparties include contractors with valuable experience in comparable projects including the Crossrail works and the Lee Tunnel (which will connect to the TTT). However, the interface between the various contractors and other relevant parties - including (1) the government; (2) regulators; and (3) Thames Water creates additional complexity. Thames Water, for example, remains responsible for necessary land acquisitions, preparatory works and the integration of the TTT tunnel assets into its own sewerage network as well as collecting BTL s allowed revenues from its customers.» As a government-designated infrastructure provider, the first of its kind under regulations introduced in summer 2013, BTL benefits from strong government support to complete the project, which is seen as the most economic and cost-efficient solution to current discharge pollution of the River Thames. A comprehensive government support package, which includes (1) insurance of last resort provision; (2) liquidity in case of market disruption; (3) contingent equity support; and (4) compensation payments if the project is terminated for becoming unviable, will somewhat mitigate the construction risk.

2 » A strong regulatory framework, albeit with novel and untested features, provides for regulated revenues during the construction period, with a forward-looking mechanism taking into account the planned investment profile. Ofwat, which has an established track record in excess of 20 years for transparently regulating the water and sewerage companies in England and Wales, is overseeing the regulatory approach.» Significant funding needs will require ongoing access to capital markets during the construction period. Shareholders commitment to provide upfront equity of around billion provides significant funding at the initial stages of the project. A 1 billion 10-year committed revolving credit facility is also available from day 1 to support ongoing capex requirements. Access to additional funding will likely be required from around 2017/18, just after the major tunneling works have commenced. To successfully conclude the project, BTL will need ongoing market access to cover its financing and refinancing needs. However, the liquidity embedded within the financing structure ensures that BTL can withstand market disruption of at least 24 months, without delaying the construction works.» Highly covenanted financing structure provides additional creditor protections. The financing structure adopted by BTL is broadly similar to those for highly-leveraged UK water and sewerage companies, including Anglian Water Services Limited (Baa1 stable) and Thames Water Utilities Limited (Baa1 stable). While we consider the covenant and security package to be modestly weaker than precedent transactions, key credit-enhancing features, such as (1) cash-trapping triggers; (2) 12-months forward-looking liquidity reserves; (3) step-in rights for creditors to agree a remedial plan; and (4) standstill arrangements providing time to agree an organised sale of the business in a default situation, support the Baa1 CFR. Transaction Overview The Thames Tideway Tunnel will be a 25 km tunnel running underneath the River Thames through London. It will collect and store excess storm water and sewage, currently discharged into the Thames, and transport it via the Lee Tunnel (construction of which was completed by Thames Water in 2014) for subsequent treatment at Beckton Wastewater Treatment Works in East London. EXHIBIT 1 Thames Tideway Tunnel and Lee Tunnel Source: BTL This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on for the most updated credit rating action information and rating history. Current discharges of storm water and sewage into the river are in breach of the European Urban Wastewater Treatment Directive and could lead to the European Union imposing fines on the UK government. The Department of Environment, Food and Rural Affairs (DEFRA) estimates that fines in excess of 100 million per annum are possible, based on the duration and seriousness of any infringement of the Directive. 2 SEPTEMBER 15, 2015 NEW ISSUER REPORT: BAZALGETTE TUNNEL LIMITED:

3 Background: London s Victorian sewerage system was designed by Sir Joseph Bazalgette in the late 19th century to collect both sewage and rainwater run-off and to deliver it to treatment plants prior to its discharge into the environment. Recognising that the system may not be able to cope with exceptionally heavy rainfall, the original design incorporated overflows so that excess water would flow into the river rather than flooding houses and streets. Built with a capacity for four million people, this system has come under increasing pressure as the population of London has risen to around eight million and new buildings and roads have reduced the amount of natural drainage in the city. As a result, London s sewers now discharge about 39 million tonnes of untreated combined storm water and sewage into the Thames in a typical year. Discharges can occur around times per year and can be triggered by as little as 2 mm of rainfall. Various solutions to the sewage problem were considered, with the combination of an interception tunnel to store and transfer stormwater and excess sewage from the overflows being considered the most efficient solution in terms of overall costs and estimated timeline to complete. The TTT project is part of a programme of works known as the London Tideway Improvements, which also includes construction of the Lee Tunnel and the upgrade of the main sewage treatment works, including Beckton and Crossness. There are currently 57 combined sewer overflows (CSOs) along the Thames, which will be affected directly or indirectly by the TTT project. The Environment Agency (EA) has identified 36 as being unsatisfactory; TTT will control 34 of these while the adjacent Lee Tunnel will control the remaining two. Once completed, the tunnel system will provide storage capacity of up to 1.5 million cubic metres (1.2 million m 3 for TTT and 0.3 million m 3 for the Lee Tunnel), cutting discharge into the river by more than 90%. The TTT project includes:» A 25 km main tunnel of m diameter, starting at 30 m depth, falling to reach around 65 m depth at Abbey Mills pumping station.» Two connection tunnels of 4.6 km length and 5 m diameter linking Greenwich pumping station to the main tunnel, and a 1.1 km long and m diameter connection of two CSOs in South West London to the main tunnel.» 24 construction sites, with 16 interception points to one or more existing CSOs, five major tunnel construction sites and three other sites. Following its licence grant, BTL stepped into the construction contracts initially procured by Thames Water (to replace Thames Water as the employer). BTL will manage the construction and, following testing and acceptance of the tunnel, maintain and operate the asset. Given the scale and complexity of the TTT project, the construction works will be carried out by three independent contract parties. An alliance agreement between Thames Water, BTL and the three main works contractors is intended to incentivise the parties to work together where appropriate and to ensure efficient procurement, cooperation and integrated use of resources. An interface agreement between Thames Water and BTL regulates the different work streams undertaken by Thames Water and BTL on various sites and how they overlap. Furthermore, during the construction period, Thames Water, the government and BTL will form a liaison committee, which will also include representatives from Ofwat, the EA and an independent technical advisor (TA). The purpose of the liaison committee is to, inter alia, (1) monitor the expenditure forecast and any predicted cost overrun; (2) discuss changes and amendments (other than due to change of law) and 3 SEPTEMBER 15, 2015 NEW ISSUER REPORT: BAZALGETTE TUNNEL LIMITED:

4 variations proposed by any member of the liaison committee or required under the Thames Water/BTL licences or by the EA; and (3) facilitate dispute resolution. Thames Water has been and will continue to be closely involved in the project, including the outline design and interface with its existing network and technology. Thames Water has procured the construction contracts for BTL through a tender process, which commenced in July 2013 and was completed in March Thames Water also oversaw the tender for BTL, is conducting part of the preparatory construction work, and will sign off the testing and acceptance of the asset once construction has been completed. As part of an operations and maintenance (O&M) agreement between Thames Water and BTL, Thames Water will be in charge of operating and maintaining the IT and monitoring systems, equipment, pumps, hydraulics and control plants. The asset condition, operation and maintenance of the main tunnel, drop shafts and connection tunnels between shafts and the main tunnel remain BTL s sole responsibility. Thames Water will also be responsible for collecting BTL s licensed revenues as part of its sewerage charges to customers, and will enter into a revenue agreement with BTL to regulate the cash flows between these two entities. Under its licence, BTL is insulated from bad debt risk during the construction period, but, during the operational period, can enter into direct charging arrangements with the end consumer at any point in time (subject to applicable notice periods). In that event BTL will in the same way as other existing water and sewerage companies also be exposed to bad debt risk. Exhibit 2 summarises the transaction parties. EXHIBIT 2 Transaction Parties Source: 4 SEPTEMBER 15, 2015 NEW ISSUER REPORT: BAZALGETTE TUNNEL LIMITED:

5 Rating Rationale The Baa1 CFR assigned to BTL reflects the following strengths:» Strong political will to complete this project with overall cross-party support; the tunnel is considered to be the most economic and cost-efficient solution to address non-compliance with the EU Urban Wastewater Directive.» Strong government support package to provide mitigation for construction risk, including (1) insurance of last resort provision; (2) 500 million liquidity in case of closed financial markets; (3) contingent equity support; and (4) compensation payment in the event of project discontinuation (e.g., if the project becomes technically and/or financially unviable).» Strong regulatory framework, albeit untested for BTL, based on established principles for existing water and sewerage companies (including the option for interim price determinations from 1 April following the post-construction review) and overseen by the same regulator, Ofwat, which has a track record of transparent and predictable regulation in excess of 20 years.» Additional licence protections during construction, including a return on 12-month forward-looking regulatory capital value (RCV), protection against movements in market interest rates for incremental financing, and remuneration for capex spent up to 130% of P50 risk-adjusted base costs.» Strong contractual framework, which addresses the interface between different contractors and provides incentives to work for overall completion of the project.» Liaison agreement and regular frequent meetings between BTL, Thames Water, government representatives, Ofwat and an independent TA to assess progress of the project, potential for cost overruns and/or delays and agree any necessary mitigation plans.» Accelerated equity funding provides significant funding commitment in early stages of the project. BTL s overall credit quality is constrained by the following weaknesses:» Significant construction risk given complex tunnelling works in a congested urban area.» While the project benefits from a strong contractual framework, the division of works between different contractors gives rise to risks, and interests may not always be aligned.» Interface with, and reliance on Thames Water, which is responsible for early preparation works, land acquisition, ground condition surveys as well as acceptance testing.» Ongoing financing risk during the construction period, which exposes BTL to potential negative capital market sentiment.» Risk of recovery below 100% of the RCV in certain termination scenarios, albeit risk not dissimilar from that faced by existing water and sewerage companies under the special administration regime.» BTL is a newly founded entity, with limited management track record, although event risk mitigation will be embedded in licence conditions and finance documentation.» Regulatory risk, in line with existing water and sewerage companies, from post-completion review, including incentive/penalty regime for capex overspend and re-setting of the allowed return on capital in regular (currently five-yearly) intervals, albeit with increased exposure for BTL towards adjustments in the allowed return, given the comparably larger contribution of the return allowance to BTL s revenue building block. 5 SEPTEMBER 15, 2015 NEW ISSUER REPORT: BAZALGETTE TUNNEL LIMITED:

6 » The single asset nature of the company and the underground location of the asset could create additional challenges should exceptional maintenance capex be required during the operational period. The assigned Baa1 CFR takes into account the significant construction risk, linked to extensive tunnelling through London, notwithstanding the involvement of experienced contractors with a track record of successfully completing other major tunnelling projects across London. It also reflects risk mitigation through (1) a government support package that provides additional funds in certain defined circumstances and enhances senior debt recovery in most scenarios; (2) a strong regulatory framework that ensures ongoing revenues based on a forward-looking capital expenditure forecast; and (3) a financing structure that ensures that BTL will maintain a prudent financial policy. The upfront provision of billion of equity and shareholder loan notes in combination with a proposed 1 billion 10-year revolving credit facility will provide solid liquidity in the early part of the major construction works, which reflects positively in our assessment. The upfront provision of equity also enhances recovery prospects during the construction period for future senior lenders in the event of project discontinuation, when compensation would be payable by the UK government as part of the government support package. In relation to the financing structure, we consider the arrangements to be supportive of the Baa1 CFR. However, we also view the overall covenant and security package as modestly weaker than for comparable transactions in the UK water sector. Once operational, BTL will exhibit a very similar risk profile to existing UK water and sewerage companies. On the one hand, we expect the continuing opex and capex requirements to be limited. On the other hand, the unique features of the TTT project imply that operational and financial implications could be more adverse in the event of asset failure. Also, the substantial amount of initial funding, to be raised within a relatively short time frame, exposes BTL to a higher portion of embedded cost of debt within its financing structure than most other UK water and sewerage companies. However, this risk is mitigated by Ofwat s indication that it would take this into account when setting the allowed return for BTL at its regular price reviews during the operational period. The rating outlook is stable, reflecting the TTT project s strong resilience to downside scenarios, taking into account the funding, liquidity and compensation payments available under the government support package, which provide significant risk mitigation in severe and unlikely downside scenarios. It also reflects the financial flexibility provided by upfront equity funding and forward-looking liquidity reserves. An upgrade of the rating is unlikely over the construction period. Upward pressure could develop after successful handover and acceptance of the TTT assets, subject to (1) BTL establishing a track record of successful operations and conservative financial policy, and (2) a continuing transparent and predictable regulatory approach. Downward rating pressure could arise in the event of material construction delays or other unforeseen construction problems that result in increasing reliance on the liquidity and funding provided under the government support package, or increase the likelihood of project discontinuation. In addition, unfavourable regulatory developments, adverse changes to the government support package or lengthy disputes between the various stakeholders in the application of funds and/or government support, would likely result in a rating downgrade. Finally, difficulties in accessing funding as and when needed during the construction period could exert downward rating pressure. 6 SEPTEMBER 15, 2015 NEW ISSUER REPORT: BAZALGETTE TUNNEL LIMITED:

7 Complex construction works with tunnelling under urban area but with three experienced construction consortia Construction work is expected to commence in July 2016 and conclude in the autumn of 2022, at which point the TTT assets will be connected to the Lee Tunnel. This will be followed by a commissioning period and extensive testing of the asset s performance under various weather conditions to achieve acceptance by February Given the size of the project, with core construction works estimated to amount to around 1.6 billion, and to limit risk exposure to a single contractor, construction will be split into three different major works contracts:» West: A 6.9 km tunnel from Carnwath Road riverside to Acton storm water tanks, seven construction sites and seven tunnel shafts.» Central: Two main tunnel drives (5 km Kirtling to Carnwath Road and 7.6 km Kirtling to Chambers Wharf), nine construction sites and eight tunnel shafts.» East: A 5.5 km tunnel from Chambers Wharf to Abbey Mills, eight construction sites and five tunnel shafts. EXHIBIT 3 TTT works will be split into three sections Source: BTL 7 SEPTEMBER 15, 2015 NEW ISSUER REPORT: BAZALGETTE TUNNEL LIMITED:

8 Each contract will follow a similar pattern, with works including (1) pre-site mobilisation design and consent; (2) site preparation; (3) shaft construction; (4) tunnel construction; (5) secondary lining (6) connection to existing sewerage network; and (7) site demobilisation and landscaping. To date, Thames Water has undertaken thorough site investigations to assess the ground conditions for the project, with numerous surveys of boreholes and sewers. In addition, BTL is in a unique position of benefiting from significant and recent tunnelling experience across London, including most recently the Jubilee Line extension, London power networks replacement and expansion, the Crossrail works, the Lee Tunnel and the Northern Line extension. The project team also studied similar tunnelling projects across the world, including in the US, Singapore, Hong Kong and Australia. Based on the ground conditions found in the tunnelling area, different techniques and equipment will be utilised.» In the Central and West locations, ground conditions are largely London Clay and Lambeth group' comprising gravels, sands silts and clays, requiring a tunnel boring machine capable of holding up soft ground by maintaining a certain pressure while progressing through the build-up of the tunnel.» The East construction area s ground conditions are mostly chalk, requiring a tunnel boring machine that offers an enclosed working environment in areas with high water pressure. Conditions are similar to those for the Lee Tunnel, where construction started in 2010, with tunnelling (commenced in 2012) successfully completed in January 2014 in line with its planned timetable and around budget (of overall 635 million). The Lee Tunnel is expected to become operational by the end of The bidding process for the construction joint ventures concluded in March 2015, with contracts awarded to the following consortia, which all have significant experience of previous major tunnelling works underneath London s centre.» Central: Ferrovial Agroman (UK) Limited and Laing O Rourke Construction Limited, with existing experience in the Crossrail construction and Northern Line extension» West: BAM Nuttal Limited, Morgan Sindall PLC and Balfour Beatty Group Limited, with significant existing experience in the Crossrail construction» East: Costain Limited, Vinci Contstructions Grand Projects and Bachy Soletanche Limited, with existing experience in the Crossrail construction and Lee Tunnel works, the latter of which exhibited similar ground conditions to the eastern part of the TTT project Each construction contract 1 specifies a target price, to which a pain/gain share incentive mechanism will apply. The target price will be subject to change with respect to certain defined compensation events, including a change to the works specifications, archaeological finds, restricted site access and unexpected site conditions. The contract will also include certain target and milestone dates, which, however, can also be changed if a compensation event occurs. The relevant construction contracts address the risk-sharing between BTL and the contractors, with joint responsibility, inter alia, for changes to the works information and design, general liability up to an agreed cap, break-down and non-performance of equipment. BTL remains responsible for general liability beyond the contractors cap, risk of cost escalation, changes in law after two years from contract start date (unless foreseeable), site conditions and availability (incl. archaeological finds), and force majeure. 1 Each contract follows NEC3, a contract standard also applied to the London Olympics and Crossrail works. Originally launched in 1993, and then known as the 'New Engineering Contract', NEC is a family of contracts that facilitates the implementation of sound project management principles and practices as well as defining legal relationships. The NEC is currently in its third edition (NEC3). The suite is made up of 29 documents - contracts and their associated guidance notes and flow charts. The contracts can be used to procure any type of project, large or small across the areas of Works, Service and (from mid 2009) Supply. 8 SEPTEMBER 15, 2015 NEW ISSUER REPORT: BAZALGETTE TUNNEL LIMITED:

9 For all three major works contracts, the contractors will provide performance security, including (1) a performance bond equal to 10% of target price; and (2) a 3% retention (cash or bond); with a maximum liability cap of the larger of 100 million or 25% of contract value. We believe that the availability of three construction consortia provides significant protection in a constructor replacement scenario, as other experienced contractors will be on site and familiar with the project, likely reducing the time and cost in a replacement scenario. Unusual for most construction projects, BTL will benefit from revenues during the construction phase. The licence provides for revenues on the basis of a return allowed on forward-looking capex up to the so-called threshold outturn amount. As the threshold outturn includes a significant risk buffer on the base case cost estimates, the ongoing return allowance and resulting cash flow predictability should ensure that BTL remains able to attract additional capital to fund the construction. Government support package provides significant risk mitigation during construction period The government support package (GSP) is designed to mitigate key risks during the construction period, primarily by ensuring that sufficient funding will remain available in the event of cost overrun and/or delay. It will also provide senior debt compensation if the project does not achieve construction completion. Overall, the GSP includes (1) insurance cover of last resort, for insurance agreed by all parties to be necessary but not available in the market or to a lesser extent than needed; (2) liquidity support in case of market disruption in form of a 500 million Market-Disruption Facility; (3) contingent equity funding in the event of construction cost overrun above the defined threshold outturn amount (equivalent to 130% of the P50-risk-adjusted construction costs), from which point BTL s existing shareholders are no longer required to provide additional equity injections; and (4) compensation for discontinuation of the project. In our view, the most significant risks to the project are around time and cost overruns, which could ultimately lead to termination of the project if considered unviable by the parties. We expect the GSP to be available in the most severe outcomes, particularly as project discontinuation compensation will be paid in all circumstances (even if the determination of the compensation amount may differ). Some elements of the GSP could fall away under certain circumstances, the so-called GSP Failure Events. 2 However, compensation for project discontinuation will still be paid, albeit excluding amounts for capital expenditure incurred during a GSP Failure Event. Given initial upfront equity funding, there is significant buffer for senior debt available in a scenario of reduced discontinuation compensation. In addition, insurance cover, which we consider most valuable in a cost overrun or delay scenario, will continue to be available in all circumstances, albeit at increased cost. Nevertheless, we believe that the overall benefit of the GSP is somewhat constrained by the GSP Failure Events, which create an element of uncertainty around the availability of the protection provided to senior lenders. However, the transaction s financing agreement allows senior creditors upon request and approval by the 2 A GSP Remedy Event, which if unremedied would lead to a GSP Failure Event, is triggered by (1) breach of minimum financial parameters, restrictions on distributions or other obligations by BTL under the financing documentation, which may have a GSP Material Adverse Effect; (2) BTL s failure to comply with the approved project completion plan under the shareholder direct agreement; or (3) any event of default under financing arrangements which has or is reasonably likely to have a GSP Material Adverse Effect. Financial covenants take into account that the RCV will be reviewed post-construction and additional expenditure will be subject to efficiency test with the potential for log down of the post-construction RCV. The same definition will apply to the ratio test for GSP Failure Event. Given that equity sponsors commit to provide equity upfront to the threshold outturn amount, a breach of the financial leverage covenant is unlikely, unless the project will experience a cost overrun above the threshold outturn amount. Therefore, triggering a GSP Material Adverse Effect due to breach of other obligation becomes relevant. A GSP Material Adverse Effect is defined as a material adverse effect on the Government s rights, obligations or liabilities under the GSP, or a material increase in likelihood that the various elements of the GSP will be used, which remains somewhat subjective. Please see also Appendix 2. 9 SEPTEMBER 15, 2015 NEW ISSUER REPORT: BAZALGETTE TUNNEL LIMITED:

10 regulator and Secretary of State to participate in discussions of any potential remedial plan, which we consider positive in the context of the risk that a potential unavailability of certain aspects of the GSP poses to lenders. Strong legal and regulatory framework support BTL s credit quality BTL has been set up under the Water Industry (Specified Infrastructure Projects [or SIP]) (English Undertakers) Regulation 2013 (which came into force in June 2013), the framework for which was introduced within the Floods and Water Management Act The regime allows the government or Ofwat to require that projects of a size or complexity that could threaten the ability of an existing water and sewerage company to provide services to its customers be put out to tender, to be delivered by a thirdparty infrastructure provider rather than the existing company. The main benefits of this approach seen by government are (1) ring-fencing the risk of major projects; (2) introducing competition to ensure best value for money outcome for customers; and (3) market-testing finance as well as construction costs. The TTT project was specified by the government in June 2014, and Ofwat designated BTL under the regulations and granted the company its licence in August BTL s principal obligations under the licence are to design, construct, own, operate and maintain the 10 SEPTEMBER 15, 2015 NEW ISSUER REPORT: BAZALGETTE TUNNEL LIMITED:

11 substantial adverse effects ( shipwreck clause ) will also apply, with the same thresholds as seen for existing water and sewerage companies. 3 Furthermore, the licence includes an adjustment mechanism in relation to the base case forecast costs due to (1) changes in the project specification notice; (2) a relevant change in law; and (3) a change in the project s fixed requirements, where a single event resulting in allowable project spend to acceptance increasing or decreasing by more than 10 million. If one of the above trigger events or several in aggregate are likely to result in an increase or decrease of overall expenditure by more than 2%, an adjustment to charges may be considered. Ofwat will perform a post-construction review following acceptance of the project, which involves extensive performance testing under a variety of weather conditions. At the post-construction review, the RCV will be adjusted for any under-or overspend relative to the base case forecast, where BTL will have to bear 40% of any overruns. Further delay adjustments may also apply. We note that the financial covenants, included within the financing structure, will reflect cost overruns and construction delays and their resulting penalty adjustment within the calculation of the RCV at each covenant test date. This ensures that BTL will not be at risk of an immediate covenant breach after the post-construction review. The first standard periodic review will take place in 2029 to apply from 1 April 2030, unless acceptance has not occurred by 1 January The revenue building block during the operational period will be comparable to existing water and sewerage companies, and also takes into account recent and ongoing changes to the regulatory approach. Aside from the above revenue conditions, the licence includes the standard financial ring-fencing conditions that currently apply to UK water and sewerage companies, and the requirement to maintain an investmentgrade rating. BTL will be subject to a special administration regime that is similar to the proceedings applied to the existing water and sewerage companies. During the construction period, the GSP provides additional protection in a special administration scenario, requiring the government to offer to acquire BTL if any special administration is not concluded within 18 months (at this point the government can also elect to discontinue the project). When making an offer, the government is not obliged to pay an amount equivalent to the then RCV, and lenders may then suffer losses. Overall the risks to creditors of special administration are similar to those for all regulated UK utilities, and a rating for TTT well in excess of those currently seen for such companies is not anticipated. Low operational leverage The operational period will commence after testing and acceptance of the tunnel by Thames Water. BTL will continue to operate the tunnel under its licence granted by Ofwat and will be subject to regular price reviews, in line with the other water and sewerage companies in England and Wales. BTL will be in charge of operation and maintenance services for all tunnels and tunnel shafts, with the principal maintenance activity related to regular inspections (in ten-year intervals). Thames Water will be responsible for the technical monitoring equipment and interface with its own sewerage assets. 3 The materiality threshold for an IDoK assumes that the net present value of the loss of revenue or increase in costs over a 15-year period (usually the five years of the current pricing period and ten years forward from the end of the period) must be equal to at least 10% of annual turnover (this corresponds to about 1% of turnover on an annual basis). The materiality threshold for the shipwreck clause is 20% of annual turnover instead of the 10% applicable for an IDoK. A company can apply for an IDoK under previously defined aspects - that is a notified item - or for a relevant change in circumstance (e.g., change in law). The shipwreck clause applies if circumstances change beyond a prudent company s control. 11 SEPTEMBER 15, 2015 NEW ISSUER REPORT: BAZALGETTE TUNNEL LIMITED:

12 Similarly to operational UK offshore transmission owners, we expect the tunnel assets to be largely passive infrastructure, requiring limited routine operation and maintenance. The costs under the planned inspection and maintenance regime will typically be modest, with the major tunnel asset having a design life of around 120 years. Overall capex requirements during the operational period will also be significantly lower than for existing water and sewerage networks that require renewal and potentially strengthening. However, we note that BTL could face additional risks if major maintenance works were required, with the tunnel location adding complexity to any necessary repair works. Generally the operations should be straightforward and operational leverage should be lower than for other water and sewerage assets. The main risk is related to periodic regulatory reviews, with a reset in the allowed return on the RCV expected every five years. Given the long life of the asset, which is expected to be fully depreciated over a 120 year time horizon, the depreciation amount will be relatively modest (for comparison, existing water and sewerage companies have an average depreciation rate for existing assets of around 4% across the existing water and sewerage companies in England and Wales, suggesting an average asset life of 25 years). Therefore, pure funds-from-operations-(ffo)-based ratios may appear comparably weak. BTL is expected to have limited additional funding requirements over the operational life of the project, but will need to refinance its existing debt. Concentration risk on refinancing will be limited by restrictions on maturity concentration. In addition, initial guidance by Ofwat suggest a higher proportion of embedded cost of debt (90% rather than 75% for the existing water and sewerage companies) to apply for the regulator s determination of allowed returns to be set at regular price reviews during the operational period. Financing structure provides additional creditor protection The transaction includes a covenanted financing structure that is broadly similar to those applied for other highly-leveraged UK water and sewerage companies, e.g. Anglian Water Services Limited (Baa1 stable) and Thames Water Utilities Limtied (Baa1 stable). The full equity commitment of around billion will be provided upfront in instalments in line with the investment schedule, such that debt would only need to be raised at a later stage, estimated to be 2017/18. 4 The terms of any senior debt to be raised are set out in a common terms agreement (CTA) between BTL, the bond trustee, the authorised credit facility providers, the hedge counterparties and the Secretary of State for Environment, Food and Rural Affairs, as discontinuation creditor and provider of the market disruption facility. In addition, a security trust and intercreditor deed (STID) sets out the different priorities of claim of various creditors and the mechanisms for acceleration and enforcement action. 4 60% of the equity commitment will be provided in form of deeply subordinated and very long-dated shareholder loans, with interest and principal repayment subject to the restricted payment conditions within the financing agreement. 12 SEPTEMBER 15, 2015 NEW ISSUER REPORT: BAZALGETTE TUNNEL LIMITED:

13 Under the documentation, the following financial covenants apply: EXHIBIT 4 Financial Covenants Financial Ratios Distribution lockup tests Trigger Events (also distribution lock-ups) Additional Indebtedness Events of Default Senior Average FFO ICR <1.40x Senior FFO ICR <1.30x <1.10x Senior RAR >70% >70% >70% [1] >80% Note: [1] Additional Indebtedness raised for capex and working capital requirements as well as to refinance existing debt can be raised as long as the Senior RAR does not exceed 80%. All ratios will be tested semi-annually on 31 March and 30 September and calculated on a 12-months forward and backward-looking basis. During the period where the Senior RAR remains below or equal to 30% (Low Leverage Period), financial ratios will be calculated for information purposes only. Source: BTL s Finance Documentation As part of the CTA senior lenders, including future bondholders, will also benefit from a range of creditenhancing features typical for project or highly-covenanted corporate finance transactions. These features can be split into those reducing the probability of default, such as:» restrictions on business activities and limitations on further indebtedness;» forward-looking projections reviewed by an independent TA;» distribution lock-ups ensuring cash is retained in the event of financial downside scenarios; and» the requirement to maintain at least 12-month forward-looking liquidity, including a debt service reserve as well as sufficient funds for all operating, capital expenditure and working capital requirements. In addition, the following features allow senior creditors to take corrective action to prevent a default or to enhance their recovery prospects in a default scenario:» event of default financial covenants;» cash waterfall and designated accounts; and» a security package (albeit restricted by the licence). While we consider the arrangements to be supportive of the Baa1 CFR, we view the overall covenant and security package as modestly weaker than for comparable transactions in the UK water sector, owing to, for example:» the use of an FFO interest cover ratio rather than an Adjusted ICR (which would include regulatory depreciation where applicable): FFO can be influenced by decisions taken by the company or the regulator on the speed of cost and investment recovery. During the construction period, this will not be relevant as the majority of BTL s revenue is the regulatory return on its RCV. However, during the operational period, FFO may be influenced by the amount of total expenditure remunerated through revenues and the companies depreciation policy. Separately, we also note that the FFO Interest Cover may be significantly lower than seen for other water and sewerage companies given that we expect ongoing operating and maintenance expenditure to be low and the asset life to be rather long. 13 SEPTEMBER 15, 2015 NEW ISSUER REPORT: BAZALGETTE TUNNEL LIMITED:

14 » a looser hedging policy, particularly, the absence of restrictions on swaps with breaks: While the GSP includes requirements to restrict hedging arrangements if certain levels of notional or mark-tomarket values are breached, there is no general restriction in the operating period that would limit the amount of swaps being entered into or on what terms (e.g., with breaks that could give rise to liquidity risks).» event of default financial covenant breaches subject to equity cure provision: The retrospective application of an equity cure can frustrate step-in rights for creditors and keep a project on drip feed, when an earlier restructuring may have been more appropriate. However, the financing terms include a limited window (20 business days from the covenant compliance certificate date) during which the equity cure can be applied. Also, it cannot be used more than twice in any five-year period or on two consecutive calculation dates. Any equity injection will have to be applied to reduce the outstanding senior debt pro-rata, thereby improving senior creditors recovery prospects. 14 SEPTEMBER 15, 2015 NEW ISSUER REPORT: BAZALGETTE TUNNEL LIMITED:

15 Appendix 1 Licence Conditions BTL was designated by Ofwat as the infrastructure provider for the TTT project on 13 August 2015, and granted a licence which came into effect on 24 August BTL s principal obligations under the licence are:» To design, construct, finance, test, commission, operate and maintain the IP Regulated Assets in line with the project specification notice and the licence to achieve acceptance by the Longstop Date (which is 18 months after the planned acceptance date of 28 February 2027);» From the date of Acceptance, to own, finance, operate and maintain the IP Regulated Assets so that they are available for use and the Thames Tideway Tunnel is capable of being operated in accordance with the environmental permits and the agreed operating techniques. The licence sets out the detailed formula for the calculation of the revenue allowance, which differs for the construction and operational periods. The construction revenue formula will apply from licence award until 1 April following the post-construction regulatory review (which itself will be conducted after acceptance) and is calculated as follows: Allowed Revenue = (Return on Capital + Liquidity + Opex + Financing Cost Adjustment + Tax) +/- Revenue Adjustments +/- Building Block Reconciliation Adjustment + Additional Return on Capital Building Block + Additional Liquidity Building Block» Return on Capital: The allowed return will be calculated as the real weighted average cost of capital bid by BTL for the period up to and including 1 April 2030 (bid-wacc) multiplied with the forecast yearaverage regulatory capital value (RCV), inflated by RPI as applicable. The year-average RCV will take into account the RCV value as published and confirmed by the regulator plus any actual, estimated and forecast spend applicable for the relevant charging year.» RCV: Ofwat shall publish the actual RCV (reflecting actual project spend) in 2014/15 prices as well as inflated by RPI to the current price value at the relevant charging year. The licence wording suggests that RCV numbers in 2014/15 prices will be available within 6 months, whilst RPI adjusted RCV may carry a two-year lag.» Liquidity: During the construction period, BTL will also earn a return calculated as the bidwacc multiplied with the incremental capex to be spent in the following charging year (i.e. the difference between the year-average RCV projected on a one-year forward-looking basis and the forecast yearaverage RCV of the relevant charging year).» Opex:. It is assumed that all cost during construction will be capitalised, so the opex allowance would be zero (the licence allows for future adjustment in the event of accounting changes resulting in cost no longer eligible for being capitalised).» Financing Cost Adjustment: This is designed to provide protection against movements in market rates, given BTL s ongoing funding needs during the construction period. The adjustment will apply until 31 March A base reference point (historic one-year trailing average of the iboxx BBB UK nonfinancials with 10+ maturity at 31 March 2015, deflated by ten-year BoE zero coupon inflation rates) will be set and compared against an annual reference point (value of the same one-year trailing average index at 31 March each year). Depending on the difference, a risk sharing mechanism will apply between BTL and Thames Water s customers, which are paying the charges calculated on the basis of 15 SEPTEMBER 15, 2015 NEW ISSUER REPORT: BAZALGETTE TUNNEL LIMITED:

16 BTL s allowed revenue. The adjustment applies to the incremental debt-funded year-average RCV for the relevant charging period.» Tax: The tax allowance, if any, will be based on actual tax payment expectations, and is unlikely to apply during the construction period. The tax allowance may (upon election by Ofwat) also include any tax due to the financial accounting of the TTT asset and such asset being classified as lease, and resulting in an additional accounting profit.» Revenue Adjustment: There will be a revenue adjustment for bad debts and other under- or overrecovery of revenues, subject to a two-year lag. For the first two charging years, no adjustment will be made.» Reconciliation Adjustment: There will be an annual NPV-neutral reconciliation adjustment to reflect the difference between actual and previously forecast values of the Return on Capital, Liquidity and Financing Cost Adjustment building blocks for the preceding year. The true-up adjustment for the Return on Capital calculation will also reflect any potential differences in actual construction price inflation applicable to the capex spend versus RPI, and the relative price effect (RPE) estimate reflected in the year-average RCV calculation.» Additional Return on Capital and Liquidity Building Blocks: This building block will take into account any additional return and forward-looking liquidity in case of adjustments to the revenue and cost structure following an application for Increase in the Allowable Return (IAR). Any IAR determination follows an ex-ante approach, unless BTL elects and the regulator agrees to an ex-post approach. Additional allowable project spend will be subject to a cap and an annual expenditure profile as determined by the regulator. The allowed revenue for the post-construction review, after project acceptance, shall be calculated as follows: Allowed Revenue = (Return on Capital + Opex + Tax + Financing Cost Adjustment +/- Revenue Adjustment) Delay Penalty +/- RoC Reconciliation Adjustment» Return on Capital: This will be calculated as the real weighted average cost of capital multiplied with the provisional post-construction RCV, inflated by RPI as applicable. If acceptance occurs before 1 May 2028, the bid-wacc will be applied; if acceptance occurs on or after 1 January 2029, Ofwat will determine the real WACC to apply (where acceptance occurs 1 May January 2029, the new WACC to be applied from 1 April 2030 will be determined at first periodic review). Note that based on the above the bid-wacc will apply until 31 March 2030.» RCV: the RCV at the post-construction review will be subject to adjustments reflecting the under- or overspend against the original base case forecast in line with an incentive/penalty factor derived from Ofwat s capex incentive scheme (CIS), whereby BTL will retain 30% of any savings or bear 40% of any overspend. A Delay Penalty adjustment may also apply (see below).» Opex: The opex allowance will be determined by Ofwat taking into account the amount forecast by BTL in its post-construction review business plan.» Tax: Tax allowance, if any, based on actual tax payment expectations.» Financing Cost Adjustment: As the bidwacc will continue to apply until 31 March 2030, the same financing cost adjustment as during the construction period will be applied, in the event of changing interest rates for any incremental expenditure.» Revenue Adjustment: This will adjust for any over- or under-recovery with a two-year time-lag. 16 SEPTEMBER 15, 2015 NEW ISSUER REPORT: BAZALGETTE TUNNEL LIMITED: