Moody's ratings agency has said today while the credit impact of environmental, social and governance (ESG) factors on UK water companies has been limited so far, this is likely to change in the face of growing impacts of climate change and population growth.

The detailed analysis in Moody’s new report attributes this in part to the regulated nature of water companies' activities and a tariff framework which largely allows them to recover efficiently incurred costs.

However, looking further ahead, this is likely to change in the face of the growing impacts of climate change and population growth.

Image: National Framework for Future Water Resources Future pressures on water resources nationally and by region in millions of litres per day (Ml/d) by 2050 ( no action scenario)

Stefanie Voelz, Vice President - Senior Credit Officer and sector analyst commented:

"That said, we see risks of future water shortages because of climate change and population growth, with England's southeast most exposed."

"To mitigate these risks, significant additional investment will be required, and the associated bill increases will add to affordability pressure."

Rising affordability constraints, which focus governments and regulators on the size of water bills have contributed to calls for nationalisation of the industry, she added.

According to Moody’s, any meaningful impact on individual issuers’ credit quality has – to date – been mostly linked to financial policy decisions, positively as well as negatively.

In the latter case, this has primarily resulted from some companies taking financial policy decisions to the detriment of creditors as they try to increase leeway under their financial covenants in light of lower regulatory returns and cost allowances.

The ratings analyst points out that long-term investment and resource planning to improve resilience against climate change are incorporated into the regulatory process, with companies able to recover efficient costs.

Nevertheless, the UK government estimates that, without action to manage demand, overall water supply will need to increase by around 25% between 2025 and 2050, with southeast England most exposed.

Commenting on social and governance risks, Stefanie Voelz said:

“Social risks are evident and could grow. Water companies and regulators have sought to address criticism over operational performance, bills and dividend payments. The opposition UK Labour Party, however, has argued for nationalisation. Further bill increases to address long-term resilience and supply constraints will add to affordability pressure.”

“Typically, governance risks are low, but some issuers’ financial policy decisions have affected their credit quality. As a heavily regulated sector, there is strong oversight of board composition, with majority representation of independent nonexecutive directors holding companies’ management to account. However, individual companies’ financial policy decisions have affected credit risk – positively as well as negatively.”

With regard to environmental factors, the report says that overall, the water and sewerage companies (WaSCs) in England and Wales face relatively low environmental risks compared with other industries, but exposure to water shortages is rising.

According to Voelz, the investment needs for the sector will continue to rise over the next 30 years.

“The regulated nature of companies' activities and their investment requirements, including a forward-looking allowance for efficient cost, have been key in ensuring that environmental risk, while present and growing, has not affected credit quality.

“However, there is an inevitable and high risk of exposure to water shortages, which is likely to grow with climate change.

“Therefore, investment needs will continue to rise over the next 30 years and the resulting increase in regulated assets and their remuneration will have to continue to be supported by the regulatory tariff framework in order to avoid negative credit implications in the future.”

Click here to access further information about the report