Water industry regulator Ofwat wants a number of the UK water companies to take further action on the governance code each company submitted in April 2014 setting out their arrangements to meet its principles on Board leadership, transparency and governance.

Ofwat is expecting all of the regulated companies operating in the water sector in England and Wales to meet the series of principles, published in January 2014,  as a minimum. 

Following examination each of the companies’ codes, the regulator has now identified “a small number of areas” where some companies have further to go to fully meet the principles.

The paper says there are two key areas where Ofwat considers that some companies have more to do:

1. the composition of the board and the balance of independent non-executive directors;
2. describing clearly the role of the regulated company in determining and directing strategy.

Where this is the case, the regulator is now following up with individual companies.

Overall, the regulator has welcomed the positive way in which companies’ boards have responded, in particular evidence that some companies are taking a leading approach and providing examples of best corporate governance practice, that go beyond the principles.

According to Ofwat, the companies have developed different styles for their codes, ranging from precise and detailed codes to high-level customer-focused statements on how the company meets the principles. However, in a few cases, the codes are light on detail or repeat the principles without fully setting out how the code will be implemented.

On transparency, while “a few” companies’ codes set out in full detail how they will report in a transparent way, others have provided much less detail on how they will ensure they report in a transparent way.

On Ofwat’s principle which requires the regulated company to act as if it is a separate public listed company, most companies’ codes state that the company will comply with this principle and made clear statements that the regulated company board is in control of the business, with strategic decision making performed at this level. However, some companies did not go as far as others in making strong statements about the strategic leadership of the regulated company board, or say explicitly that the regulated company board was in full control of the business.

On the requirement for independent representation on the regulated company board, Ofwat described this as “ the area where a number of companies need to make  significant changes to meet our principles, including changes to the composition of their boards.”

 Ofwat’s concerns include:

• a few cases where companies’ proposals do not meet the expectation in the principles that independent directors (including an independent chairman) are the largest group on the board.
• the need to refresh board membership. Ofwat says that any term beyond six years for a non-executive director should be subject to particularly rigorous review and notes that a number of companies have board members that have served for longer than the term, of nine years, suggested as a maximum in the UK Code.
•  some companies have told Ofwat they will not have an independent chairman, or that their chairman does not fulfil the definition of independent as set out in the UK Code. Ofwat said that chairmen that have had a connection with the shareholder prior to appointment or who chair the holding company board cannot be regarded as fully independent.
• some of the companies’ codes did not give Ofwat confidence that the companies would meet the standards set out in the principle which require that board committees operate at regulated company level and there should be a majority of independent members on the audit and remuneration committees.

However, Ofwat said it recognises that, in terms of the financial skills of the committee members, it may take time for some companies to refresh the membership of their board committees. However, they will have to put a plan in place to ensure that the membership of their board committees will meet the standards set out in the principles by 1 April 2015.

Next steps for Ofwat

Ofwat said that where it has seen areas where companies do not meet the principles or have not produced a code that meets expectations, it will now work with them to ensure that this is rectified.

In the summer, the regulator will examine each company’s reporting of its 2013-14 performance in order to understand how it is meeting the principles and its code in practice, followed by publication of the findings.

The regulator will allow companies the period to 1 April 2015 to ensure that they meet the principles in full. Ofwat said:

“We will continue to shine a light on this area in order that the sector retains its legitimacy with customers.”