Market View: Brexit and the water sector

Exit from the European Union could have a profound impact on the strategic direction of the UK water sector.

The impact may not be immediately felt – however, the absence of EU law driving water and environmental policy could see the UK change focus and diverge from a path that has driven standards for over 25 years. The UK may have more flexibility to innovate or to decide to give state financial support to the sector.

For now, the UK is still part of the EU and is subject to exactly the same rules and regulations as before the 24th June. This will be the case until the UK exits the EU.

The European influence

Through various directives and policies, the EU has been the driving force behind many investment decisions for over 25 years. These drivers come from various directives such as the Water Framework and Drinking Water Directives. Many other pieces of EU legislation, covering issues such as emissions, procurement, state aid and competition affect the sector.

Despite a great deal of EU legislation, industry structures and strategies remain diverse across member states: from liberalised markets to publicly delivered services, with a wide range of waste management and water resource strategies.

What now?

Once the mechanisms are in place for exit, there will no doubt be a period of searching questions about the UK’s vision for water and sewerage policy.

However, price review and business planning processes have been completed for the foreseeable future, with companies implementing their investment plans for the next few years. The next price review will bring with it new challenges. It is fair to assume that the stability or otherwise of the enduring legal and policy frameworks that will provide the basis of PR19 investment decisions may be a material Brexit issue.

It is difficult to judge the immediate consequences of Brexit at this early stage. However, below are some points for water and sewerage companies to consider as the situation develops:

• Has there been a “relevant change of circumstances” under Condition B of the Instrument of Appointment, which would benefit from a referral to Ofwat for an interim determination? Possibly too early to tell, but something to keep a close eye on.
• Market and financial volatility will inevitably alter many of the assumptions that formed the basis of current commercial agreements, investment planning and price control decisions. We would expect all of these to be looked at carefully as the situation develops.
• Review existing and long term contracts and other arrangements which are linked to the single market’s four fundamental freedoms: Freedom of movement of people, goods, services and capital. This is in order to identify where the biggest risks lie should these principles change.
• Note also that counter-party risk is a potential issue: it is clear that UK corporates are being monitored very closely by the rating agencies. Credit cover and payment terms should be kept under review.
• In 2015 around 21 per cent of the €7.8 billion invested in the UK by the European Investment Bank was on water sector projects. There must be a risk that future projects will not receive such funding because the UK is not a member state.

Given that the legislative framework for European water policy has largely been transposed into domestic legislation, it would be a significant task to start again from scratch. While there is potential for divergence, some changes are probably more likely than others. It would be politically difficult for future governments to lower existing drinking water quality standards but the UK could decide not to follow EU practice when it comes to quality standards.

It might be more foreseeable that some environmental quality standards could be trimmed, under the justification of economic development, growth and jobs. Some of the more contentious areas of the Water Framework Directive, such as the ‘one-out-all-out’ principle, could be revised, if not abolished completely. Additionally, principles such as cost recovery for water services could receive more flexible treatment in the future. Much depends on the political direction of a future administration.

The UK could also use any greater freedom to set standards that allow more projects to get consent from environmental regulators. Would there be more opportunities for innovation? While the policy direction in the future may be significantly different to that of today, it is important to remember that policy is not created in a vacuum. EU policy will continue to develop through technical, academic and policy expertise, and will still influence future UK water strategies.

Conclusion

The long term impact on the water sector is uncertain. There are some areas where change might be more likely, such as environmental quality standards, but even then political challenges exist. Changing existing standards may be difficult, but a lot will depend on the policies of the UK government and not on membership of the EU. However, Europe is an influential leader in water policy and therefore likely to continue to influence UK policy approaches post-Brexit.