Water companies seem resigned to long-disputed licence changes

Modifications coming down the line to water company licences echo the bitter stalemate of 2012 when Section 13 made headlines as Ofwat and those it regulates were at loggerheads. But 2023 is a very different time to 2012, Utility Week spoke to senior industry figures to understand what's changed.

Water companies appear resigned to accept changes to company licences that ensure performance is central to remuneration decisions.

Through powers granted in the Environment Act, Ofwat will be able to modify company licences without consent of the company. This power is being wielded to stop dividend payments, if the regulator believes the company has insufficient headroom. This was announced last month following discussions over recent years.

Senior figures in the water industry have indicated to Utility Week that boards will not appeal against the changes, despite some ill-feeling towards them.

Companies have until next month to reject Ofwat’s decision by seeking an appeal through the Competition and Markets Authority, but under powers granted to the regulator through the Environment Act universal agreement is not required to modify licences.

It brings to a close a controversial issue which began a decade ago when the Section 13 debacle led to a stand-off between the water regulator and the sector – making headlines and requiring government intervention to keep the water industry on course.

Giving the regulator the ability to modify companies’ licences without the consent brings Ofwat in-line with other regulatory bodies including Ofgem, which has been able to change licences since 2000 when the energy regulator was formed with the merging of gas and electricity bodies.

Back in 2012 the strength of feeling against such a modification, which was driven by then-Ofwat chief executive Regina Finn, bubbled up to a bitter standoff between the regulator and the companies it regulates. Ultimately the dispute was only resolved with the entrance of a new chair to keep the peace and broker a deal to keep all parties happy.

That agreement included the caveat of powers being granted to Ofwat at a later date. The Environment Act 2021 was the vehicle to enable that. Any licence changes remain subject to the undertaker (the water companies) being able to appeal to the Competition and Markets Authority against a proposed modification.

The window to appeal runs to 1 May but conversations with the sector suggest the mood is far removed now from a decade ago.

Tightening how company dividends are awarded echoes the 2012 tensions when Ofwat wanted a way to stop unscrupulous investors funnelling money from companies to pay sizeable dividends. Most infamously Thames Water was stripped out, but it wasn’t the only one – Southern, Yorkshire and Anglian were all left highly geared.

To stabilise this and ensure companies could carry out statutory duties, Ofwat began intervening. Dividends were lowered or completely stopped and equity was needed from shareholders to put right what had been done – although it wasn’t necessarily the same shareholders that asset stripped the companies who were then paying up.

A deal was brokered in 2012 by the then newly appointed chair Jonson Cox to keep companies, their investors and the regulator itself happy.

Investment has always been a crucial part of the private water sector so remaining attractive to the investor community is essential. Maintaining investment grade securities ensures companies have headroom to carry out statutory duties, but Ofwat – under Regina Finn – moved to formalise this expectation by modernising licences, which set a floor for the ratings.

Ofwat could not impose it, but it was made clear government would grant these powers.

This longer term approach is intended to address higher gearing, stop asset stripping and ensure financial resilience by addressing problems and exploring if there are other factors impacting the companies’ finances.

The changes now are similar to what was proposed in 2012, but sector insiders told Utility Week that while a few may not be happy about the changes, it is unlikely we will see appeals to the CMA – which would be costly and potentially damaging to a company’s reputation.

The industry has been constantly under fire from politicians and the media for the past couple of years with sewage making headlines weekly. Insiders have suggested that it would be foolhardy to appeal against a decision on remuneration at a time when anger over bonuses and dividends abounds. Executive pay has separately come under fire by the regulator, which set out policy to tighten links between performance – particularly on environmental issues – and salaries or bonuses.

The relationship between regulator and the companies is also much improved now than it was in 2012, an insider said. Many attribute previous problems of Section 13 in 2012 solely to the poor handling by Regina Finn and as those wounds healed, so did the relationship.

Insiders added that water companies and the regulator are now in agreement that they need to pull together to rebuild public confidence and deliver resilient services.

With so much to be done to address water supplies, protect rivers, deliver environmental programmes there is no space for in-fighting.