Reforms confirmed today by Ofwat could see the most highly geared water companies forced to share up to £230 million with customers over the period 2020-2025.

The reforms are set out in a 75 page position statement on PR19 business plans published today by the water sector regulator.

Introducing the statement, Ofwat said:

“While standards are rising overall and there are examples of water companies providing great service, there continues to be widespread concern that companies do not always operate or behave in the way expected of them. “

“Alongside high profile service failures, concerns have been raised about high dividend payments undermining the long term capacity of companies to perform; levels of executive pay being out of step with what has been delivered for customers, and complicated and potentially risky financial structures which not only call financial resilience into question but suggest that owners are more interested in financial structure than delivering a great service.”

Ofwat set out a package of reforms in July aimed at ensuring that the decisions water company boards reach on debt levels, dividends and executive pay align more closely with their customers’ interests. The reforms followed a three week consultation which concluded on 17th May.

As a result of the reforms, the regulator said any water company which continues to have debt substantially in excess of the level used by Ofwat to set price controls will be required to share any benefits they accrue with customers.

The companies must now outline how they will do this in business plans to be submitted to Ofwat no later than 3 September.

All of the water or water and sewerage companies subject to the PR19 price controls responded to the May consultation, while 11 responses were received from investors (or groups of investors) in companies. Except for one response, these represented views from investors in companies with gearing in excess of 70% as at 31 March 2017.

The regulator said the engagement and responses received to its consultation on the issues had revealed a mixed reaction to the proposals. Some consultation responses questioned the economic case for change, suggesting Ofwat’s approach was “detrimental to the predictability of the regulatory regime” or arguing that higher returns associated with higher gearing reflected an increase in risk to equity holders.

Ofwat said it had recognised the importance companies and their investors place on the predictability of the regulatory regime and had “hoped and expected” that further changes would not be needed after publishing its PR19 methodology.

However, the need to look again to ensure the regime sufficiently aligns company and investor interests to the interests of current and future customers had “become clearer” since its publication.

“It has been reinforced by the failure of the sector as a whole to sufficiently recognise and respond to criticism from multiple stakeholders. It is our responsibility to be prepared to address such issues, even when it creates some degree of additional, short term, uncertainty", the position statement says.

As part of the reform package, Ofwat is also requiring water companies’ boards to boost transparency around dividends and levels of executive pay.

Ofwat will require each water company to show clearly how it is linking performance-related executive pay to stretching performance for customers. The companies will also need to explain clearly how decisions on dividends are made and how they relate to the delivery of companies’ obligations.

Commenting on the reforms, Ofwat Chief Executive, Rachel Fletcher said:

“With this package of reforms, we are reducing the incentives for financial engineering, making sure that any companies which do benefit from high levels of debt share any gains with customers. This is another step we are taking to secure a fairer deal for customers.

“At the same time we are ensuring that water companies are open and transparent about what they pay out to their top executives and their investors. This openness is essential for customers to have confidence in their water company.”

In the introduction to the position statement, she said:

“These decisions stem from concerns we have had for several years and where some but not sufficient progress has been made.”

Ofwat said it expects the regulatory burden on companies resulting from the decisions in the statement to be minimal.

Click here to download the position statement.