Ofwat faces rising tide of criticism as water sector crisis deepens

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Angry protests over sewage pollution at beaches around England and Wales have until now been aimed at the UK’s privatised water companies.

But the risk of a financial collapse at Thames Water, the largest and most indebted water monopoly, has placed regulator Ofwat more directly in the line of fire.

Set up in 1989 to monitor the newly privatised water industry, the watchdog has been accused by politicians and experts of failing to deliver the financial or management discipline that was promised 34 years ago.

Added to the list of accusations are regulatory capture and a watchdog in thrall to the very companies and people it is expected to oversee.

Lord Andrew Tyrie, Tory peer and former chair of the Competition and Markets Authority, has called for a thorough review of regulation in the UK, saying some regulators had been “captured by vested interests”.

A regular churn of staff between the regulator and water companies — not least the appointment of former Ofwat chief executive Cathryn Ross as the new interim co-CEO at Thames Water — has added to a sense that the watchdog is overly cosy with investors and water companies at the expense of consumers.

Ofwat said it follows standard civil service procedures.

But Jonathan Portes, professor of economics and public policy at King’s College London, said it “doesn’t have to be the case that there’s corruption or even implicit rewards”.

“It’s just that the regulators spend more time talking to investors and companies than they do to consumers,” he said.

At the time of privatisation, the companies were encouraged to borrow to invest in infrastructure and improve services. But much of that debt has been used to pay dividends instead, according to a 2017 study published by Greenwich University.

“Regulation was flawed from the outset in that it provided no checks to financial engineering and excessive borrowing,” said Dieter Helm, professor of economics at Oxford university.

Asked at a House of Lords committee hearing this week why Ofwat had not raised concerns earlier over Thames Water’s debts, David Black, the chief executive of Ofwat, said he had been hamstrung by a lack of powers.

“If we went back to the early 2000s, regulators across all sectors took a relatively hands-off approach to [borrowing],” he said, adding that some of the “legacy financing structures need to be brought up to date”.

Now the water and sewage monopolies have £60bn in debt and the government is on standby for a corporate collapse or temporary nationalisation. A growing number of members of the public would like to see that made permanent, according to a YouGov poll last year.

There are other regulatory failures that need to be addressed, too, say experts.

Ofwat sets how much companies can charge customers, as well as their expenditure on infrastructure such as sewers, reservoirs, pipes and operations every five years. But its rules have been designed to reward efficiency: companies that spent less were allowed to keep some of the profits. 

That incentive has failed to deliver the infrastructure needed for an expanding population.

“If you want to win the efficiency competition, you cut short-term costs sharply and that’s what they did,” said Helm. “After more than 30 years all the consequences of those past decisions are showing up in the state of the assets now.”

In recent years the regulator has been given more power to bare its teeth. Until 2022 Ofwat was unable to make changes to licences without the approval of every company in the sector. Even now companies require a 25-year warning if their licence is going to be terminated. 

And no licence has ever been revoked — even Southern Water, which was on the brink of financial collapse and had received a £90mn fine in 2021 for deliberately tipping sewage onto beaches for several years.

“The licences are ill-defined, that makes it very hard to take licenses away,” said Helm.

The regulator has this year tightened licence conditions on the credit ratings it requires so it can block dividends if the company looks financially vulnerable. It will also require boards to take account of environmental and customer performance targets when they decide to make payments to shareholders. It remains unclear how those changes will play out.

Other issues include the regulator’s reliance on monopolies monitoring themselves, leaving companies to choose the extent to which they divulge information. Data on water leakage and sewage overflows are reported by the monopolies to Ofwat, for example.

When Ofwat has tried to take action, it has not always succeeded. In 2019 four companies claimed to the CMA that the regulator’s targets on performance and return on profits were too stringent. The companies won.

In response to the CMA ruling, Ofwat noted that it had “no confidence that these higher returns will translate into investment services for the benefit of consumers and the environment”.

The legal challenge was expensive, costing the companies at least £140mn, and adding at least £15 a year to customer bills, even before adding in the consulting and legal costs, according to CMA data.

The companies have strong financial incentives to get the outcomes they want and are willing to pay for it, said Portes.

“It’s regulatory asymmetry where all the weight and analysis is coming from one side. On the other hand you have the regulator and civil servants and that’s not even to mention the consumers, who have no lawyers or money on their side at all.”

Now, campaign groups such as Windrush Against Sewage Pollution are forcing greater transparency, through monitoring pollution in rivers and lakes themselves.

But while any improvements will require cash, raising the prospect of significant increases in bills from 2025, the issues are at least being openly acknowledged.

Thames Water’s Ross told a recent meeting of environmentalists: “It’s going to take cash to solve those problems; and every penny we get is going to come from our customers.”