Water industry regulator Ofwat has today published new holding company principles on Board leadership, transparency and governance.

The document sets out the three principles which Ofwat considers should guide the governance arrangements of the holding companies of the water companies in England and Wales – namely, transparency, managing risk and supporting long-term decision-making.

Ofwat has defined the holding company as the company which the regulated company states in its accounts to be its ultimate controller (and any intermediate companies between it and the regulated company).

Coverage of the principles is limited to the areas where Ofwat considers that the activities of the holding company could have the greatest direct impact on the regulated company.

The document sets out the following principles Ofwat thinks each holding company should consider adopting voluntarily in order to demonstrate that it is operating to the highest standards.

1. Transparency

The holding company structure should be transparent, and explained in a way that is clear and simple to understand, The place of the regulated company within the group structure must be clearly defined and it should also be clear which company is the holding company.

According to Ofwat, some of the regulated companies operating in the sector are members of larger group structures that can be “complex and difficult to understand” and “opaque structures can damage the legitimacy of the regulated company and the sector as a whole. “

The role of each of the companies that have links or interests in the regulated company within the group structure should also be clearly explained, together with details of which country each company is registered in. There should also be no hidden beneficiaries of the regulated company within the structure, with investors in the holding company clearly set out.

The principles say the holding company should also provide information on debt and equity structures – including the capital structure of any other company with links to or interests in the regulated company if this assists transparency – together with information about holding company board members . The holding company should also explain which matters that impact on the regulated company are reserved to the holding company board e.g. a decision to appeal a price control determination.

2. Managing risk

The document states:

 “the holding company will manage its risks in such a way that the regulated company is protected from risk elsewhere in the group”

Ofwat says it expects the regulated business to be protected from risks in other parts of the group, so that the customers of the regulated company are not subject to service or cost issues as a result of activities elsewhere in the group.

It also wants the holding company to provide the regulated company with the information that it “reasonably requests” about the activities of the wider group, together with access to the information that it legitimately needs about the wider group to “assure itself that it is not at risk from activities elsewhere within the group. “There should also be disclosure of any issues at the group level which could materially impact on the regulated company.

Most of the water companies already have an obligation to make sure the regulated company board is composed in such a way that the directors are able to act independently of the parent company. 

Where potential conflicts exist between the interests of the regulated company and those of other group companies (including holding companies), the regulated company and its directors are already required to ensure that they should have regard exclusively to the interests of the regulated company.

3. Supporting long-term decision-making

Finally, Ofwat says that the holding company should support the regulated company in operating in a sustainable way (including making long-term decisions) in line with the long-term nature of the water sector to ensure it is in a position to meet the medium to long-term challenges which it faces e.g.  population growth, climate change. The document states:

“The holding company should support the regulated company so that it can make strategic and sustainable decisions in the interests of the regulated business for the long term.”

Ofwat - new principles are no more onerous than current requirements

The regulator is currently looking for a self-regulatory approach – the principles say that the holding company, together with the regulated company, can decide how best to make the disclosures but they must be easy to find and presented in an accessible form e.g. via the regulatory accounts or annual report.

However, the regulator does not believe the new principles are excessive, commenting:

“These principles do not place requirements on a holding company that are any more onerous than what is currently implied by the undertakings which a regulated company is required to secure from the ultimate controller. “

“We see the involvement of investors as beneficial to ensuring that regulated companies are protected from any adverse impacts from the group structure of which they are a part.”

The principles represent the minimum Ofwat considers should apply to any holding company operating in the sector. The regulator said it intends to examine the way in which the regulated companies and their holding companies adhere to the principles and will step in where it considers that there are failures in disclosure or that the principles are not being met.  

It will be interesting to see whether any of the companies will choose to go further. Even more interesting to see whether any of the holding companies choose not to fully comply via what appears to be an escape clause option based on the following provision:

“Where a holding company does not meet a principle which we have set out, it may instead choose to provide an explanation of why that is the case and the approach that it has taken to meeting the spirit of the proposals. “ 

Click here to download Board leadership, transparency and governance – holding company principles in full.