Ofwat’s chairman, Jonson Cox, has today called on the water sector to “hit refresh and offer a renewed commitment to customers”.

Speaking at the Water UK City Conference 2018, Jonson Cox said the water sector should view the current scrutiny it faces as an opportunity for renewal.

Despite some good progress, Cox warned: “now is not the time to sit still and look back at all that’s been achieved.” “I don’t think the sector has gone far enough. A renewed effort is needed,” he said.

Aggressive dividends at heart of public distrust

He told delegates that aggressive dividends were at the heart of the public distrust, saying Ofwat had intervened on this in 2013 when some highly leveraged companies (HLCos) were distributing to their investors amounts that, if continued could distribute cash equal to a large part of value of the regulated equity in just five short years - not sustainable in the public mind.

Addressing customer concerns, Cox went on to say:

” What must customers feel about the headlines we’ve all read recently? They read of high dividends, high debt, complex holding company structures and off-shore companies, be they in the Channel Islands or the Cayman Islands.

“The apparent one-sided benefits from these practices, enjoyed by the HLCos, bring doubt and consternation and are not seen as consistent with public service behaviour. The more they read about it, the less they like it.”

The Ofwat Chairman drew explicit attention to recent media coverage:

• Secretary of State, Michael Gove: “It is undeniably the case that privatisation and the injection of private capital has brought in investment which has improved infrastructure. But if …. public support is to remain durable, we can’t have offshore tax havens and other jurisdictions being used … to provide corporate benefits……...”
• Shadow Chancellor, John McDonnell: “The next Labour government will call an end to the privatisation of our public sector, and call time on the freeloading water companies that have a stranglehold over many working households”
• Financial Times: “Water privatisation looks little more than an organised rip-off. Quite why this natural monopoly should not operate through not-for-profit public interest companies is ever less clear”.

Customers have sense ...their water co ... is more interested in boosting financial returns

Customers do not, Cox warned, “have the sense that their water company is on their side, but rather that it is more interested in boosting financial returns.”

Cox further warned that “damage to the reputation of the sector is caused by companies who have what the public see as inappropriately aggressive financial structures for a public service utility” which is damaging the whole industry. Responsibility for fixing this must sit, Cox said, “squarely with the relevant companies ….CEOs and regulated company Boards need to face up to this urgently.”

"Except for a few notable performance failures, principally in London, the challenges to the sector are about corporate behaviour and aggressive financial structures," he said.

The sector must, Cox said, think in terms of the renewal of this public service, where customers and society come first.

In a public service company, he said the company would be expected to share its success with customers at least as much as with shareholders and to have regard to the perception of fairness.

Cox said a progressive company’s dividend policy might include an outperformance dividend, set in a way that ensured cash to investors was matched first by cash to customers in the form of bill reductions. It would also have “strong regard” to employee interests ensuring that fair and appropriate payments were made pre-dividend to employee interests including pension deficits

The Ofwat chairman asked:

“Doesn’t that begin to sound more like a public service utility than, at the opposite extreme, the type of dividend policy that might be perfectly acceptable for private equity in competitive markets?”

Unless companies can meet Ofwat test  they may need to "replace some of the equity earlier taken out”

In closing, Cox urged water company investors and executives to be “right on the front foot trying to contribute urgently and positively to Ofwat’s programme.” There is nothing in this he said, for a responsible long-term investor to fear.

However, he warned that Ofwat would be expecting to see sound, stress-tested capital structures in PR19, not just solutions which simply ‘scrape by’ into AMP7, commenting:

“Unless companies can meet this test, they may need to replace some of the equity earlier taken out.”

In December, Ofwat published the methodology for the upcoming price review in which it set out plans for the lowest ever cost of capital for a regulated utility, which could lead to a decade of falling water bills.