Welcome, then, 34 years after privatisation, to a new era of get-tough regulation in the English water industry. The Environment Agency will have powers to levy unlimited financial penalties on companies for pollution offences. Over at Ofwat, the economic regulator is changing companies’ operating licences so that dividends cannot be paid to shareholders if balance sheets are too flimsy or if environmental performance is too poor. It’s all backed by the government’s new and wider-ranging “plan for water” that landed on Tuesday.
Convinced? Well, after three decades of demonstrably soft regulation, the only rational response is to believe in the new era when you see it. That is not only because the government’s headline-grabber about a ban on plastic in wet wipes has been round the policy U-bend twice already, as the campaigner Feargal Sharkey noted.
The proposal for unlimited fines, for instance, is the government’s “preferred option” from its menu of choices, but the chair of the Environment Agency has already said it is not his. Questioned by a select committee of MPs last month, Alan Lovell wasn’t even keen on raising the cap on civil penalties – currently a feeble £250,000 – to £250m. “I think it should be in double figures of millions,” he said. “My personal view is in the £10m to £25m range.”
Lovell offered reasons: the agency will still prosecute in the most serious cases and courts already have unlimited fining powers; and double-digit sums still “hurt”. Even so, one might have expected more boldness from the new chair of an agency that has been lambasted for its timidity over many years. He is meant to be a figure to be feared.
Ofwat’s new authority over dividend payments may therefore be the one that concentrates more minds in boardrooms because most investors in water companies come to the sector in search of safe and regular income. A higher threshold for debt ratings will apply from 2025 with the threat of a cash “lock up” if companies are deemed insufficiently financially resilient to do their job. The reform is sensible: it is surely not a coincidence that the sector’s worst offenders, Southern and Thames, were two that took the biggest overdoses of debt.
The companies still have a fortnight to appeal to the Competition and Markets Authority (CMA) over the licence modification, so this change is not in the bag yet. But, on the assumption that it happens, it is – potentially – important in changing incentives. Analysts at Jefferies noted that Ofwat’s guidance even expects companies to adopt a more cautious approach on dividends in cases where investigations are merely ongoing.
The open question, though, is how the setup will work in practice. In theory, Ofwat will be better placed to insist that companies’ owners dig deep and shift from a mindset of dividend collection to one of growth and accelerated investment in new infrastructure. If shareholder dividends have to be trimmed for a decade in order to keep customers’ bills lower than they would otherwise be, that would be more than justified by history. The English water and sewerage companies have famously paid £66bn in dividends since privatisation while taking on £54bn of debt.
But it ain’t straightforward. Arguably, Ofwat has already spent a decade trying to recover its credibility after a five-yearly price review for the 2010-15 period that was disgracefully generous to the water companies. The next two settlements were tougher but, critically, four companies took the unusual step of appealing to the CMA in 2019. They won: they were allowed slighter higher returns than the regulator had intended.
The long-term implications of that decision have yet to play out. If Ofwat pushes harder for the 2025-30 period, for which the to-and-fro starts next year, would the companies appeal again? Was an incentive created to “lawyer up” and test the system?
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The answer Jonson Cox, a former chair of Ofwat, gave to the latter question at a House of Lords committee last year offered an insight. “It is completely brutal, and clearly Ofwat, as a public authority, does not have the right to go and hire magic circle law firms. It is brutal. That characterises not just what happens in an appeal but the whole decision-making,” he said.
Licence modifications – overdue by at least two decades – should strengthen the regulator’s hand. So, too, does the public’s disgust at the state of the waterways. In the end, though, this is about regulators policing their beats properly, making strong judgments and making decisions stick. Anyone who remembers the 1990s, when anger with the water industry over boardroom fat cats and dirty rivers was almost equally intense, will treat talk of a reset with caution. We have been here before.
