Recommendation 5

Financial fragility of a few large companies in the sector is leading investors to lose confidence in regulation as well as the sector. We need to return to a water sector that is low risk and low return. Currently, company group structures are complex, and some companies in groups are not regulated by Ofwat at all, and excessive dividends have been paid in the past. The regulatory environment needs to change to prevent a repetition in the future. Companies have high levels of debt and charged large amounts on interest on their inter-company loans, and 10 companies did not generate enough income in 2023–24 to cover their interest payments. Three companies (including Thames Water) now cannot pay out a dividend without Ofwat’s permission. Untargeted regulation contributed to downgrades of the credit-worthiness of the whole sector in 2018 and again in 2024, alongside concerns about financial performance. There is also the immediate prospect of Thames Water becoming insolvent and having to enter the Special Administration Regime. Decisions are needed to secure the future of water supply to millions of customers. Ofwat and Defra have not been clear on what might happen under the Special Administration Regime, including the costs for customers. All of this has contributed to a rise in the sector’s risk profile. Ofwat has consequently increased the amount customers have to pay in their bills to cover returns for investors, which reflects the sector’s higher risk profile. recommendation Over the course of the next six months Ofwat should review its powers and capability to ensure it can take action needed to improve the financial resilience of the whole of the sector, and be clear in public about what is likely to happen and who will bear the costs in the event of a company insolvency.