Doubts raised over Ofwat’s new powers

Doubts have been expressed over the changes Ofwat has made to water company licences as part of its moves to strengthen financial resilience.

Through powers granted in the Environment Act, Ofwat will be able to stop dividend payments, if it believes the company has insufficient headroom.

However, doubts have been raised about the new powers and one water company insider told Utility Week that the licence modification lacked justification.

“Financial resilience was a big issue for Johnson Cox, I’m surprised it didn’t disappear when he left as there wasn’t a lot of evidence for it in the first place,” the insider said.

The modifications, the source suggested, are not needed. They added that the industry would not necessarily accept the financial resilience problems Ofwat’s proposals imply exist and the modifications suggested would not only offer no benefits, but are potentially damaging.

They added: “This industry has weathered the global financial crisis, gotten through Covid-19 without furloughing. Water companies have no problems raising debt and if we need to fund investments, we have no problem raising equity.”

Ofwat said boards will be expected to take greater account of environmental performance and customer service when agreeing any dividends. Feargal Sharkey, punk turned river activist, took to Twitter to highlight company directors have had a legal duty to consider the impacts of operations on the community and environment since 2006.

Sharkey tweeted: “Ofwat claim they’re going to stop WCs paying dividends. In reality about 20% of your water bill goes towards paying tax free interest on the vast debts WCs have accumulated, that’s were all the financial action is not dividends but Ofwat already knew that, didn’t you.”

In recent years Ofwat has demanded companies do more to ensure they are financially resilient to shocks or pressures the business may face. As public sentiment against water companies grows, the regulator applied pressure to link dividends and pay to performance, particularly environmentally.

Ofwat’s chief executive David Black said too often this was overlooked.

“That is why we’re implementing changes that will allow us to better hold companies to account and take enforcement action when they get it wrong,” Black said. “We hope the introduction of these new powers will focus minds around company board tables on the importance of responsible decision making and openness with customers and other stakeholders. And if that isn’t the case, we will act.”

Licences will be modified to require companies to take account of service delivery, investment needs and financial resilience when considering dividends.

Also announced today [20 March], each company must maintain a strong credit rating and if downgraded, Ofwat can stop dividend payments.

Companies are already required to have an investment grade credit rating – which is not easy to gain but demonstrates strong, financially resilient businesses.

Mechanisms already exist to restrict dividend payments if a company’s investment grade rating slides, but this modification would increase the threshold at which dividends cannot be paid although not significantly.

“The threshold doesn’t actually make it any better and it will incur costs for investors,” an industry source said. “It’s not addressing a clear problem, and to the extent the problem exists, it’s not a very good solution, because it won’t improve the situation.

“Ofwat is suggesting there is a financial resilience problem, which doesn’t exist, and is putting forward a license modification that will only irritate every investor in the sector, and probably drive away private capital.”

Sector-wide investment needs mounting to billions of pounds to address storm overflows, guaranteeing resources and other pressures imply a need to attract private capital, an industry commentator explained.

“Getting a decent return on that investment will be pretty important,” they said. “So that modification will actually create costs for consumers. Investors will price that added risk in. If, according to this license condition, investors might not earn a dividend some years then that risk will be priced in.”

Rebecca Pow, water minister, said Ofwat now has the power to “clamp down on excessive cash pay-outs” when performance or financial resilience are not adequate. “It is wrong for water companies to be responsible for environmental damage and poor performance but not face the penalties. It has been happening too often and it needs to stop.”

Ofwat said it wants to improve the transparency and consistency of company licences, which was highlighted in recent letters detailing what the regulator expects of financial reporting.

It consulted last year on licence modifications. Other steps to improve resilience have been blocking intercompany loans and calling out companies for transparency.

CCW, the water watchdog welcomed the protections for billpayers. Mike Keil, senior director of policy, research and campaigns, said: “Customers expect their money to be spent wisely by water companies and protected if things go wrong. This is an essential part of building trust between water companies and the people they serve.”

The licence changes are anticipated to be implemented by 17 May 2023.

As a licence modification, companies have the right to appeal the change to the Competition and Markets Authority (CMA), which removed Ofwat’s gearing outperformance mechanism from business plans of the companies that appealed their PR19 final determination.