Ofwat has told Thames Water that it does not expect dividend distribution by a regulated water company to be rationalised “primarily by reference to an amount required to service an obligation of another group company.”

The comment comes in a letter to Thames Water providing feedback from Ofwat following the regulator’s review of the financial data and information submitted in the company's Annual Performance Report for the year ended 31 March 2023. The letter includes general observations applicable to the wider sector and feedback on matters specific to Thames Water.

Ofwat has written similar letters to the other regulated water companies which also include comment on their own particular issues.

Commenting on Thames’ dividend disclosure, dividend reporting and transparency, the letter says:

“The company's disclosure explained that whilst the Board determined it was not appropriate to pay a dividend to external shareholders for 2022-23, paying a dividend of £45.2 million to service the debt obligations of a holding company and group related costs was in the overall interests of the company (namely due to its importance in the company maintaining access to funds).

“Notwithstanding the importance of taking wider factors into consideration when reaching a conclusion on whether it is reasonable and appropriate to make a dividend distribution, for clarity we do not expect a dividend distribution from a regulated company to be rationalised primarily by reference to an amount required to service an obligation of another group company.”

Ofwat also told Portsmouth Water, South East Water and Yorkshire Water that it did not expect "a dividend payment to be rationalised primarily by reference to an amount needed to service an obligation of a related company"   with regard to their own dividend disclosures.

The regulator also told Thames that although the company’s dividend yield of 1.2% was 'significantly below the 4% Ofwat yield guidance reflecting the disappointing operational and financial performance', Thames had failed to clearly set out how the dividend level was assessed and determined in the context of its performance. It was “not evident from the company's reporting” how the 1.2% yield compared to Ofwat’s expectations and providing a breakdown and/or further detail in the company's reporting would “improve transparency.”

With regard to the Long Term Viability Statement (LTVS) provided by Thames, Ofwat said it noted “an overall improvement in the transparency of the company's LTVS.“

However, while the LTVS was “clear on the assumptions underpinning the Board's conclusion”, including in regard to new shareholder funding and continued access to debt finance, the LTVS had not been “sufficiently clear “ in certain areas.

The LTVS had included “only summary comment” that credit ratios neared Event of default thresholds at certain points under a combination of stress testing scenarios performed by Thames.

The letter says:

“Information was limited or absent regarding the outcomes of the individual scenarios tested, the ability to maintain an investment grade credit rating, potential for entering cash lock-up across the scenarios, and the Event of default thresholds.”

As a result, commentary on the mitigations available to address the potential impacts and outcomes of the stress testing was general and not all mitigations might be available or appropriate in all scenarios. In addition, “there was no information on the scale of the mitigation that might be required or the potential consequence of certain mitigation - such as the impact of delaying capex spend.”

Ofwat also criticises Thames Water for continuing to “incorrectly report a business retail margin” pointing out that “the company does not operate or have a separate business retail price control.” The water company chose to exit the retail water market and transfer all its retail activities for its business customers to Castle Water prior to the market opening to competition in England in April 2017.

The letter states:

“Whilst not material, the company does not operate or have a separate business retail price control, and therefore all relevant revenue and cost should be captured in the household retail margin.”

Ofwat has told Thames Water that it expects the feedback points raised “to be considered and addressed” in the company's dividends disclosure next year – the regulator also expects to see “an improvement in reporting transparency next year.”