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Environment, Food and Rural Affairs Committee

Oral evidence: Thames Water, HC 1704

Wednesday 12 July 2023

Ordered by the House of Commons to be published on 12 July 2023.

Watch the meeting

Environment, Food and Rural Affairs Committee Members present: Sir Robert Goodwill (Chair); Ian Byrne; Rosie Duffield; Barry Gardiner; Dr Neil Hudson; Robbie Moore; Mrs Sheryll Murray; Cat Smith; Julian Sturdy; Derek Thomas.

Business and Trade Committee Members present: Darren Jones; Alan Brown.

Environmental Audit Committee Member present: Philip Dunne.

 

Questions 1-205

Witnesses

I: Alastair Cochran, Joint Interim CEO, Thames Water, Sir Adrian Montague CBE, Chair, Thames Water and Cathryn Ross, Joint Interim CEO, Thames Water.

II: David Black, CEO, Ofwat and Iain Coucher, Chair, Ofwat.

III: Rebecca Pow MP, Minister for Environmental Quality and Resilience, Department for Environment, Food and Rural Affairs and David Hill, Director General Environment, Rural and Marine, Department for Environment, Food and Rural Affairs.


Examination of witnesses

Witnesses: Alastair Cochran, Sir Adrian Montague and Cathryn Ross.

Q1                Chair: Good morning. Welcome to this joint session of the Select Committee on Environment, Food and Rural Affairs; we are joined by colleagues from the Environmental Audit Committee and the Select Committee on Business and Trade, including their Chairs.

We are pleased that the witnesses could come along at such short notice. We have some fairly pointed questions to ask. There has been a lot of media interest in this session.

I will start off with Mr Cochran, I suppose. Have you been at Thames Water the longest of the three witnesses?

Alastair Cochran indicated assent.

Q2                Chair: You have. So where did it go so horribly wrong?

Alastair Cochran: I was brought in with a whole new executive team to turn around this business. The business matters; it serves 15 million customers—

Q3                Chair: It went wrong before you arrived, and you were trying to fix things.

Alastair Cochran: Our job, collectively, is to turn this business around. We know that performance, operationally and financially, has not been where it needs to be. We have been very transparent about that. We are very focused on turning the business around, and ensuring that it remains financially resilient, delivers a better service for our customers and improves its operational and environmental performance.

Chair: When Sarah Bentley left, did she give a reason? Was it because she felt that she was failing to deliver the turnaround, or that the demands of shareholders or investors were unacceptable? Did she give any explanation when she went?

Sir Adrian Montague: May I step in?

Q4                Chair: Yes, Sir Adrian, and welcome. Sorry—we should have had our witnesses introduce themselves. Starting with Alistair, just introduce yourselves and your roles. Sorry, I omitted to do that at the beginning.

Alastair Cochran: Thank you. I am the interim co-CEO of Thames and the chief financial officer.

Cathryn Ross: I am the other interim co-CEO of Thames, with Al. My substantive role is director of strategy and external affairs.

Sir Adrian Montague: As of Monday, I am the new chairman of Thames.

Q5                Chair: Thank you. Sir Adrian, you were going to come in on that particular point about Sarah Bentley leaving, I understand.

Sir Adrian Montague: I think Sarah’s resignation was a surprise. I think, perhaps, she had got to the point of feeling that the burdens of office were considerable. It was an entirely personal decision with which, I think, we had no involvement.

Q6                Chair: You have been unable to raise the £1 billion you need to maintain your financial position. What impact will that have? Why have your investors been unwilling to support you?

Alastair Cochran: Perhaps I can pick that up. We have very patient shareholders, and they have been incredibly supportive of this business. They have already provided £500 million of equity this year, in March, which was fully drawn by the company. They have offered the largest equity support package to the UK water industry since privatisation in the form of £750 million over the next few years. They have indicated that a further £2.5 billion of equity would be required to turn the business around in the next price control period between 2025 and 2030. They have been incredibly supportive.

To the specific question of why £750 million now and not the £1 billion that was indicated before, first, as I say, it is a bigger commitment in aggregate. Secondly, it reflects the phasing of when the company needs the money. We will continue to spend, as planned, £11.5 billion in real terms in this regulatory period; there is no change in that. But practically, we cannot spend efficiently any more than £750 million in this price control period. So it supports our record levels of investment in customer service, in operational performance and in environmental performance, but we are getting the money when we need it.

In practice, we face a number of very practical problems around deliverability, so the phasing reflects what we can deliver efficiently. There are well-documented supply chain constraints affecting the industry, ourselves and the UK. We have a very, very significant investment programme; we are effectively spending 1% of the UK’s construction budget.

Q7                Chair: So were Ofwat wrong when they said that you needed to raise £1 billion to deliver on your investment plan?

Alastair Cochran: Ofwat was simply, I think, repeating what it was indicated this time last year would be required. What shareholders said in June 2022 was that they would provide a commitment for £500 million, which we have now drawn. They indicated that another £1 billion may be required for this price control period and that further equity may be required beyond that. What we have now announced is, in addition to the £500 million we have drawn, £750 million for this AMP, which is what we can efficiently spend on behalf of customers, and, indicatively, a further £2.5 billion, subject to the price control determination in the next period.

Q8                Chair: I suppose if I were a shareholder of Thames Water—I guess every university lecturer in the country and lots of people working in Ontario are shareholders—I would be worried about the situation with regard to my investment and any likely dividends. I might be less worried if I were also the organisation carrying the debt. So to what extent are your lenders—the banks and other organisations that have lent you this massive 80% slice of the company—the same people as your shareholders, or have you gone on to wider financial markets to raise the money?

Alastair Cochran: We have very diversified sources of funding, but many of them in the UK are the same individuals. Pension funds also lend money in the form of debt capital. You are right to highlight that our owners, our shareholders—over three quarters of them, actually—are pension funds in the UK and Canada, predominantly. And therefore we are very mindful that we need to ensure that we deliver them a return so they can pay their pensioners their pensions.

Q9                Chair: Is it a little bit like the sort of cosy arrangement I might have if my wife lends me £100,000 to buy a new tractor and I pay her an interest rate above and beyond the market rate? I wouldn’t be too worried about that, because it’s all within the same family. Is it that sort of situation? Could that characterise how some of your debt is structured within the company?

Alastair Cochran: I don’t think so. We actually raise debt very, very efficiently. Our effective cash cost of our debt last year was 2.3%, which is very, very low. That reflects our balance sheet—the strength of that balance sheet—and our investment in a great credit rating. Critically, this industry relies on investing for the long term, for the benefit of—

Q10            Chair: But half your debt is linked to inflation, which of course has risen dramatically since last year. I can remember, more than a decade ago, having a meeting with Kelda Group, who ran Yorkshire Water at the time, and they were borrowing money at a higher rate of interest than I could borrow money at as a simple peasant farmer in North Yorkshire.

Alastair Cochran: I can’t speak, obviously, for that situation, but what I can say is that 97% of our debt is fixed in real or nominal terms. That is part of a prudent strategy to ensure that we manage our interest costs. As I said, our total cash interest cost last year was only £235 million. That reflects a conscious policy to ensure that we do hedge the risk of interest rates, among other things, and inflation.

Q11            Chair: But half your debt is linked to inflation, so you are more like the person with a mortgage who finds that their renewal has come up than somebody who has fixed it for five years at the sort of rates you could get last year and for the previous seven or eight years.

Alastair Cochran: Indeed, but, like all companies, we ultimately have to borrow money at the prevailing rate when we borrow new money. That will reflect the Bank of England’s interest rates at the time.

Q12            Alan Brown: Alastair, what is Thames Water’s debt, and how much has been paid in dividends since privatisation?

Alastair Cochran: The current level of net debt is £14 billion. That compares with a regulatory capital value—the value of the business—of £19 billion, which gives you the 77% gearing rate. In total, the dividends that left the company since privatisation are about £3 billion. If you would compare that with how much equity investment has been already put into the business—or will be put into the business as part of this equity support package—that is about £4 billion. In essence, the current set of shareholders, who have not taken any dividends at all, will be committing the best part of £4 billion of equity to this business.

Q13            Alan Brown: I have seen much higher figures on dividends. Is that £4 billion robust? But even then, that is £4 billion that is paid to shareholders that could have been invested elsewhere, surely.

Alastair Cochran: Indeed, but we are investing almost—we invested a record £1.8 billion last year. We will maintain those record levels of investment going forward. In fact, we fully expect investment levels to have to increase in the next price control as we seek to improve asset resilience but also improve environmental performance—

Q14            Chair: Is that dividends to external shareholders or to the core investors in the company?

Alastair Cochran: That was total dividends to—so, last year, for example, we paid £45 million to service debt at the ultimate holding company. But, to be absolutely clear, our current shareholders have taken no dividends since 2017.

Q15            Alan Brown: Either way, in your figures, roughly 33% of debt equates to dividends.

Alastair Cochran: I’m sorry?

Alan Brown: Roughly 33% of your debate is equivalent to the dividends that have been paid out.

Alastair Cochran: In terms of that simple maths, absolutely, that is correct.

Q16            Alan Brown: Can I ask about Thames Tideway? How is that funded?

Alastair Cochran: That is funded by an entirely different regulatory price control. It is not funded by Thames; it is a different company that is independent of Thames.

Q17            Alan Brown: And do Thames investors get any returns from Thames Tideway?

Alastair Cochran: Not directly.

Q18            Alan Brown: Okay. It is also underpinned by the regulatory asset base model. How much cheaper has that made it, because that is obviously underpinned by the UK-wide Exchequer?

Alastair Cochran: Sorry, is your question—

Alan Brown: With Thames Tideway, the infrastructure is funded under a regulated asset base model, which is risk sharing with the UK taxpayer. How much of a benefit does that bring?

Alastair Cochran: That, as I understand it, helped to reduce the cost of the funding of that project.

Alan Brown: By how much?

Alastair Cochran: I don’t know; you’d have to ask Tideway.

Q19            Alan Brown: What was the original estimate for Thames Tideway, and what is the current construction estimate?

Alastair Cochran: As I say, I am not the best person to ask, because it is an entirely independent company.

Alan Brown: Okay. I don’t think that I’m getting any more there, Chair.

Chair: Thank you very much. We will move on to Philip Dunne, who chairs the Environmental Audit Committee and has been very involved on water quality, particularly in our rivers.

Q20            Philip Dunne: Thank you, Chair. I would like to touch on some of the regulatory challenges that the company faces. I think, Mr Cochran, you became finance director after the record fine of £20 million in 2017 for sewage leakage, and then the repayment to customers of £120 million for water-supply leakage problems. However, you were in post last week when the company was again fined more than £3 million by Ofwat for, according to the citation, deliberately misleading Ofwat. Is there a culture of ignoring regulatory requirements in the company?

Cathryn Ross: Shall I pick that up? Yes, so—

Philip Dunne: Is that “Yes, there is a culture”, or “Yes,” you will answer the question?

Cathryn Ross: Yes, I am going to pick up your question and answer it. You are right. Last week, we had the decision from the judge in the Crawley prosecution case. That case dates back to 2017, so it is rather historical in nature. There is no doubt that we caused a serious pollution incident in the Crawley stream. We have apologised unreservedly for that. The judge in that case did find that we had deliberately misled the Environment Agency. I have been through the case file; I have read everything. I do not see that, but obviously we completely respect the judge’s decision.

In terms of your point on culture, one of the things we have done over the past couple of years, particularly under Sarah’s leadership, has been to really change the values and behaviours and the culture across the company. Historically, we were a company in which bad news travelled upwards too slowly. I think people were afraid to say how things really were on the ground. One of the things we have achieved over the past couple of years has been to turn that around, and it is really helping us to be honest within the company about the challenges we face, so that we can address them and make improvements.

Q21            Philip Dunne: Are you included within the companies being investigated by Ofwat and the Environment Agency for breaches of licensing for sewage discharges?

Cathryn Ross: We are.

Q22            Philip Dunne: How many cases are being investigated at the moment?

Cathryn Ross: At the moment, we have two large investigations. We have one being conducted by the Environment Agency in relation to compliance with flow-to-full treatment, and then we have another one being conducted by Ofwat on the same issue. I believe Ofwat is also contemplating whether we are in breach of section 94 of the Water Industry Act 1991, which is on the provision of effectual drainage. They are considering multiple instances under that broad heading, but there are just those two investigations.

Q23            Philip Dunne: Ofwat and the Environment Agency have indicated that they are looking at over 2,000 breaches across the industry. Can you tell us what proportion of that, if you do not have a specific number, are by Thames Water?

Cathryn Ross: I do not have the specific number with me. I certainly think that Thames would represent a large proportion of that. We have been very open and transparent about the extent to which we are discharging untreated sewage into rivers. We have also said that that is unacceptable, and we have been fully co-operative with the investigations that are being run by both Ofwat and the Environment Agency.

Q24            Philip Dunne: This is my final question. The Government have announced today that they are removing the cap on fines for breaches of licence permits. Have you made any assessment of what that might mean for Thames Water, in the event that these investigations lead to fines?

Cathryn Ross: We have not assessed the impact of that particular change, no. The one thing I would say is that, although I can understand why the Government are doing what they are doing, we are committed to becoming more compliant with this legislation. We are committed to delivering better against the expectations of the public in respect of river health. Almost regardless of the level of financial penalties, we would stay committed to those goals, because it is simply the right thing to do, and that is what the public expect.

Q25            Philip Dunne: This is a culture change that we can look to for the future.

Cathryn Ross: It is.

Q26            Philip Dunne: Which I assume you endorse, Sir Adrian.

Sir Adrian Montague: Absolutely. Respecting our environmental obligations and respecting our obligations regarding drinking water are the fundamental bedrocks on which a successful company culture is based. One of the important contributory factors is the culture of the people at the coalface—I am probably mixing my metaphors. I have started to talk to people on the ground, and they are very committed to customer service. They are the best advocates for the business. We must empower them and let them do their business going forward.

Q27            Chair: Can I ask the witnesses to speak up a little, please? Cathryn, I want to go back to what you said about the leak near Gatwick where lots of fish were killed. I read about that, and it was a genuine mistake or technical fault that caused it. The problem was the cover-up afterwards. The judge, Christine Laing KC, said that she believed there had been a “deliberate attempt” to mislead the Environment Agency, by omitting water readings and submitting a report to the regulator denying responsibility. Are you saying you do not agree with that? You said that it was accidental, not deliberate, that misleading readings were given and responsibility was denied.

Cathryn Ross: Let me recap. First, let me say that I absolutely accept the judge’s decision; there is no equivocation on the judge’s findings. What happened in that case was that we had two pumps working to pump sewage in the sewage treatment works, and one of them started to work constantly, to pump sewage directly from where the sewage came in—

Q28            Chair: Into the storm water tank. We are not denying that there was a technical fault; it was the cover-up that I think the judge was drawing attention to, and indeed the attempt to mislead Ofwat about what had happened.

Cathryn Ross: To clarify, it was the Environment Agency, rather than Ofwat, but the point still stands.

We conducted two separate investigations into what happened following this malfunction of a pump. One of those investigations concluded that there were multiple factors that could have contributed to the pollution incident, and it wasn’t clear that it was our error. A different investigation, conducted by a different team, concluded that it was in fact to do with an error made by Thames Water, in not sorting out the malfunctioning pump.

Those two investigations happened in parallel. They were conducted by separate teams; those teams did not talk to each other. When we were asked to submit our investigation to the Environment Agency, the investigation that got submitted was the one that had said that it wasn’t our fault. We should have sent both those investigations and all the underlying data to the Environment Agency—which in due course we did, but of course what appeared, if you were looking at this from the Environment Agency’s point of view, was that Thames Water had said that the incident wasn’t its fault when it knew that it was. I can absolutely see how that comes across. I think it was an error on our part, rather than a deliberate intention to mislead, but I completely respect the findings of the judge.

Sir Adrian Montague: Can add a coda to that? It is very early days for me—I have been in the chair for two days—but I have a lot of experience of dealing with other utilities, and I think the change—

Barry Gardiner: Could you speak up, please?

Sir Adrian Montague: I am sorry. The change that needs to occur within Thames is that we should treat all our regulators as partners; we must be on an open-book basis with the regulators. We must treat them as people who have the interests of the industry and Thames’s customers at heart, and we must help them by being very transparent in what we do. That is the tone, I think, that we need to set from the top. 

Barry Gardiner: Mr Cochran, you have painted to my colleagues a very good picture of the state of the company, but in May of this year, JP Morgan’s report said it had poor financial performance. You have been the finance officer since 2021. The report said there was weak operational performance and a stretched balance sheet. It referred to the enforcement cases coming from Ofwat and portended stricter Ofwat dividend policy in the future. You have chosen to make 151 of your staff redundant; that was on 20 June, just a month after that report. Are they paying the price for your failure?

Alastair Cochran: We were very clear on Monday, when we released our results, that our operational and financial performance wasn’t where it needed to be. We have been very transparent about that. We know that we need to improve performance for our customers.

Q29            Barry Gardiner: You haven’t been transparent about that for the past two years, have you, since you have been financial director? Let us look at the figure that you discussed with my colleague earlier—£14 billion of debt. I think that note 18 of your accounts shows that your borrowings are £15.7 billion. How does that reconcile with the £14 billion that you were talking about earlier?

Alastair Cochran: The £14 billion, just to be absolutely clear, is our statutory measure of net debt. For covenant calculation purposes, which is what we report in terms of gearing, it is £14.7 billion, and that takes account of what is called debt accretion—the additional costs for hedging inflation and other risks.

Q30            Barry Gardiner: That is £14.5 billion, isn’t it?

Alastair Cochran: it is £14.7 billion.

Q31            Barry Gardiner: I thought £14.5 billion takes the form of your whole business securitisation—a structure that you have used to borrow against your highly regulated assets.

Alastair Cochran: Net debt on a covenant basis is £14.7 billion. To get to the 77% of gearing, which is the lowest level of gearing in the last decade, which we announced this week—

Q32            Barry Gardiner: Sorry, it is the lowest level of gearing in the last decade that you have announced, but the second highest in the sector.

Alastair Cochran: Indeed, but—

Q33            Barry Gardiner: Yes, indeed. When you were controlling Ofwat, Ms Ross, I thought that you said that the ratio should be 60%, not 77% and not 80%.

Cathryn Ross: The 60% gearing that we were using when I was at Ofwat, and in fact that Ofwat has been using right up until the last price review, is the notional level of gearing that Ofwat uses to input into the formula that is used to determine the weighted average cost of capital.

Q34            Barry Gardiner: But did you recommend 60%? Yes, you did, didn’t you?

Cathryn Ross: No, we were using a 60% assumption for the purposes of calculating the weighted average cost of capital in a price control.

Q35            Barry Gardiner: So you weren’t concerned at all that in that period the company had over 80%?

Cathryn Ross: I will fully acknowledge that views have moved on, but our view at the time was that a company’s choice of capital structure was a matter for the company itself, and that the shareholders bore the risk of that.

Barry Gardiner: Right. Now that views have moved on, what discussions have you had with the Government on the potential nationalisation of your company?

Cathryn Ross: None.

Q36            Barry Gardiner: None. Why do you think it is being talked about in the press so freely?

Cathryn Ross: I can say that over the last couple of weeks I have read a lot in the press. Some of that was rather more outlandish than perhaps we would have liked. I think—

Q37            Barry Gardiner: One of the things that may be outlandish, and perhaps Mr Cochran can come to this, is the way in which you structured—what was it?—£560 million of debt, just in case the Government should have to take over the company. Do you want to comment on that, Mr Cochran?

Alastair Cochran: Which debt are you referring to?

Q38            Barry Gardiner: This is the amount of money that would be payable from your debt. The Government would have to pay off £560 million to your debtors.

Alastair Cochran: I don’t recognise that figure, but—

Chair: I think what Barry is referring to is when Mr Corbyn was leader of the Labour party, and there were manifesto commitments to—

Q39            Barry Gardiner: I think I will say it in my own words, Chair, thank you very much, okay? There was talk about the nationalisation of the water company at that time, but since then, public opinion has moved on. Public opinion has gone from 79% of people being opposed to privatisation to 83%, because of the way in which your companies have been failing to meet the public’s expectations. Nationalisation seems to be a pretty popular thing among the public, and maybe that is being referenced in the press. My question is about the way you included a clause in a previous debt issue that would require the Government immediately to pay off around half a billion pounds of debt in the case of nationalisation. You don’t recognise that clause?

Alastair Cochran: I don’t recognise that clause, no.

Barry Gardiner: Sir Adrian, you seem to want to come in there.

Sir Adrian Montague: I was going to address the question of nationalisation very briefly, if that would be helpful.

Q40            Barry Gardiner: Let us finish with Mr Cochran first. Could you write to us and tell us whether such a clause was included in a previous debt issue? If it was, why was it, and what would the implications of that have been for the Government? Thank you.

Alastair Cochran: I will do that.

Barry Gardiner: Sir Adrian?

Sir Adrian Montague: I was going to address your question on nationalisation. If you go back to the very dawn of the private ownership of these utilities, the rationale was to empower the utilities to borrow privately, and to use private sector capabilities and performance in the operation of the utilities. We say that we have much more to do in that area, but the key thing is to remove from the Treasury the burden of funding the improvements in the water sector that we are now managing privately. That was the driver of privatisation.

Q41            Barry Gardiner: But the problem, Sir Adrian, has been that although there has been substantial investment in the infrastructure since privatisation—I absolutely agree with you on that—it hasn’t been enough, has it? That is exactly the point of the questions from my colleague, Mr Dunne, to your colleague earlier.

Sir Adrian Montague: Indeed, we have to increase the flow of that investment. That is what our refinancing package is aiming to do.

Q42            Barry Gardiner: But the structure of the company—not when you were there, Sir Adrian—allowed an Australian bank to leverage the fact that you were a regulated asset to extract money, did it not?

Sir Adrian Montague: Yes, I think there was a flow of dividends from the company under previous ownership. It is, for us, quite a long time ago, Mr Gardiner. I think it reflected a slightly different—

Q43            Barry Gardiner: It reflects the state of the company now, doesn’t it, Sir Adrian?

Sir Adrian Montague: It reflects, I think, the state of what the markets were and the practices at that time. I can’t—

Q44            Barry Gardiner: Those practices are still going on, aren’t they? Macquarie is doing the same in other regulated industries. Actually, I believe you are on one of Macquarie’s companies, Cadent, and Cathryn Ross is on British Gas Transmission, aren’t you?

Cathryn Ross: National Gas Transmission.

Q45            Barry Gardiner: Which are both Macquarie companies. It seems there is a very cosy arrangement here.

Sir Adrian Montague: I have to correct you, Mr Gardiner: they are not Macquarie companies. They have a range of international investors in them, including, in my case, Chinese and Qatari investors. They are all very responsible investors. They are all seeking to improve the performance of the companies. That is the case here. It was probably the case when Macquarie owned a major stake in the company. I cannot answer to that myself, but that is—relatively speaking—ancient history to us because Macquarie exited in 2017.

Barry Gardiner: You and I have a different definition of “ancient”, Sir Adrian.

Sir Adrian Montague: Perhaps it reflects my age.

Q46            Rosie Duffield: Following on from Barry Gardiner’s question, 278,418 people have signed the petition to bring water companies back into national ownership, and I helped some of my constituents deliver that petition to Downing Street around Christmas last year, because it was started by a group in my constituency. Obviously, you do not think that would work, but do you understand why the public would like our Government, or whoever, to be responsible for water companies, so that everything is transparent? It is not as though we can shop around as customers; this is a vital utility. We do not know who all these investors from foreign countries are who own our utilities. Can you understand why the public want transparency, so that we do not have to do inquiries like this?

Sir Adrian Montague: Public ownership seems to be the answer to many questions. When you conduct a real evaluation, I think private ownership is still the way forward. That is a personal belief—I have been associated with private sector operations all my life. I can understand the frustration of customers who want improvements. We would love to deliver all those improvements overnight, but it will take time. We will try very hard to bring the customers with us. Our frontline employees serve customers every day. They are very much in touch with everything that happens on the ground. We also need to be in touch with things that happen on the ground, and we have to improve our standing with customers; we are absolutely agreed on that, but I think the way to do that is through continuing with the private sector model, not reverting to the public sector. That would be my instinct.

Q47            Rosie Duffield: On the ground in Whitstable in my constituency, there is lots of poo and sewage, so it would be nice to improve that. Anyone else want to come in on that?

Cathryn Ross: The only thing I would add is there is obviously a perfectly reasonable national policy debate about ownership models. I think that is perfectly legitimate and absolutely normal in a democracy. Our job at Thames, and this is what Adrian was talking about, is to keep the taps flowing and the loos flushing, and to improve our performance under whatever model the Government of the day decide on. That is what we will keep focusing on.

Q48            Derek Thomas: Cathryn, we just heard your chairman talk about wanting a closer relationship—partnership was the word used—between Thames Water and Ofwat. You are a previous chief executive of Ofwat. Does the trend of Ofwat staff seeking high-paid positions in the industry affect its ability to regulate water companies?

Cathryn Ross: The first thing to be clear on, which I am sure you know, is that I left Ofwat in January 2018. I went to work for BT for three and a half years before I applied for the role at Thames Water, so there was quite a gap between me leaving Ofwat and joining Thames, which is quite important. Personally, I think there is an important role for a better understanding between companies and the regulator of what each is trying to achieve, and how the regime works.

I am immensely proud of my time at Ofwat. I think Ofwat people do an incredibly difficult job every day. They are very passionate about the water sector, and about wanting to deliver for customers. I came into a water company that is facing considerable challenges and a massive turnaround; bringing that understanding of what the regulator is trying to achieve, which is very much in common with what we are trying to do at Thames, is helpful. I think that mutual understanding is beneficial.

Q49            Derek Thomas: While you were chief exec, you delivered a strategy on building trust and confidence in water services. Has that been delivered?

Cathryn Ross: It is a work in progress.

Q50            Derek Thomas: I am a west Cornwall MP, so you might understand why I ask that question. What was your view on Macquarie’s approach to Thames Water while you were CEO of Ofwat in 2013? We’ve covered it briefly, but was the relationship, and the way it built up debt, a concern when you were chief exec?

Cathryn Ross: Let me go back to that time, which, as I said before, feels like quite a different world. Things have moved on a lot. When I joined Ofwat, the zeitgeist was very much that decisions around capital structure were a matter for companies and their investors, and their investors were at risk for that. As a regulator, we would keep a weather eye on things and be ready to act, but only when acting was necessary. Things like the requirement in licences to maintain an investment-grade credit rating were really important, but beyond that, if a company chose to gear up, essentially its equity was bearing more risk and that was a choice for its equity. Even as I was leaving Ofwat in 2017-ish and then after I left in 2018, views were moving on quite considerably. As you have seen in more recent years, Ofwat has taken a keener interest in what it calls financial resilience, which is a broader concept, and then, as part of that, capital structures, which has culminated in more recent licence modifications.

Q51            Derek Thomas: Given that financial resilience and the extraordinary pressure on Thames Water today, do you expect or intend to increase customer bills in the near future?

Cathryn Ross: In the near future, no. We are currently in the price control settlement that was established by Ofwat in 2019. Ofwat cannot reopen that, so those price limits will hold until 2024. We remain restricted by the PR19.

Q52            Derek Thomas: Until next year?

Cathryn Ross: Exactly. Beyond then—we have already talked about this, I think—there is no doubt that there is a substantial need for more investment in the sector as a whole, including in Thames. Thames is not alone here. We have said repeatedly that we have an ageing asset base. We have assets that are not as resilient as our customers and the environment would expect them to be. We also have a lot of new infrastructure that we need to invest in to meet the challenges of climate change adaptation and population change. That will need to be funded. It is an unfortunate truth that the only source of ultimate funding for that in the current model is the customer. The really important thing is that we as a water company are as efficient as we possibly can be, so that a customer does not pay a pound more than they need to. But it is also important, going back to our previous conversation, that we can access capital markets, so that we can finance that investment and smooth the cost over decades, rather than having to recover all that cost in, let’s say, a five-year period—in that case, the bills would be substantially higher.

Q53            Derek Thomas: At the moment, if you were to put prices up, customers would feel that they are just paying for the failure of Thames Water. How are you going to approach the work you need to do between now and next year in order to restore trust, so that when people’s bills potentially increase, they recognise that it is to pay for the service they receive, not the way the company is run?

Sir Adrian Montague: There are two elements to this. We must deliver on our promises, and we must be much better at communicating with customers. It is a long, hard road, but that is what we will have to do.

Chair: I will ask Darren to come in, who is Chair of the Business and Trade Committee. We are pleased to have you as our guest.

Q54            Darren Jones: Thank you, Sir Robert. Good morning, everybody. Cathryn Ross, in 2014, as chief executive of the water regulator, you signed off the business plans for the water companies, didn’t you?

Cathryn Ross: I did.

Q55            Darren Jones: You have just said that at that time, you thought it was okay for those companies to increase their debts because it was their risk. Is that right?

Cathryn Ross: Yes.

Q56            Darren Jones: What would have happened at the time if any of the water companies had gone bankrupt?

Cathryn Ross: Oh gosh, let’s just take a step back—

Q57            Darren Jones: No, if you could answer my question: during the time when you were CEO, if a company had gone bust, what would have happened?

Cathryn Ross: What would have happened in the event of a bankruptcy or insolvency is that the special administration regime that is set out in the legislative framework would kick in. That is a decision for the Secretary of State. When I was at Ofwat, our expectation would have been that we would advise on that, but it would have been a decision—as I think it still is—for the Secretary of State.

Q58            Darren Jones: In plain English, that means that it would have had to be nationalised, and taxpayers would have to pick up the bill. That’s right, isn’t it?

Cathryn Ross: Not necessarily.

Q59            Darren Jones: Under the special administrative regime, either you sell the business to someone else as a growing concern, as we have seen in the failure of the energy market, or the Government have to pick up the bill, as they had to do with Bulb Energy. Ultimately, taxpayers would have been on the hook, wouldn't they?

Cathryn Ross: In the event that the company could not be sold as a going concern, yes, there would be some liabilities that had to be met, and they could be met by the taxpayer or passed on to future customers, depending on the regulatory regime at the time.

Q60            Darren Jones: We are here today because Thames Water, which you now run, is in a position where the Government are having to plan to renationalise you, because of the failure of your finances. However, as the chief executive of the regulator, in 2014 you signed off Macquarie ramping up the debt from £3 billion to £10 billion, while taking out nearly £3 billion in dividends, and often paying dividends higher than the profits that the company made in particular years. The reason why we are in this position and why taxpayers are potentially on the hook for billions and billions of pounds of national borrowing is that you as the chief executive of the regulator, and the regulator, failed in delivering your statutory duties. Do you want to apologise to the public, Ms Ross?

Cathryn Ross: I do not accept that characterisation of Ofwat’s price control in 2014. The other thing I would say is that special administration is a matter for the Government, but special administration is very much a nuclear option. There is a very high bar if the Government are to decide to put a company into special administration. One of those triggers would be insolvency and the other would be, perhaps, persistent and severe breach of our licence. We are not close to either of those two triggers—you heard our CFO talking a little while ago about the fact that we have £4.4 billion of liquidity. We are a long way off that insolvency trigger and a long way off the conditions for special administration being met.

Sir Adrian Montague: May I just add something?

Q61            Darren Jones: When I am ready, Sir Adrian—forgive me. Ms Ross, you just said that you did not accept that characterisation of the 2014 price review, but you have just admitted to the Committee that you signed off the business plans that allowed Macquarie to increase the debt, which has got Thames Water into the position it has been in. The regulator facilitated the problem, didn’t it?

Cathryn Ross: Let me clarify. In 2014, the Ofwat board, not just the Ofwat chief executive, issued a set of final determinations—that is correct. Those final determinations set out what the company needed to deliver for its customers and the environment, and the amount of money that it could recover from its customers to do that. That is all they did. Then, of course, the incentive framework that Ofwat puts around that determines the amount of money that the company actually makes.

Ofwat policy at that time—it has moved on since—was that if the company made the profit under that regulatory regime, it was up to the company to decide what it did with it. If it chose to pay that profit out of the company in distributions, it was free do so.

Q62            Darren Jones: Ms Ross, let me ask the question in a different way. Two of the statutory obligations of Ofwat, the water regulator, when it was set up were: first, to protect the interests of customers; and, secondly, to ensure that the privatised water companies could finance themselves. Are you seriously telling the Committee today that, on both those measures, you as the chief executive of the regulator at the time succeeded in delivering those statutory obligations, given the context in which you are here before the Committee today? Are you really saying that that was a success?

Cathryn Ross: At the time, when I was at Ofwat, and I believe this to be true today, everyone took their statutory duties incredibly seriously—

Q63            Darren Jones: But did you perform them?

Cathryn Ross: We were exercising our functions in pursuit of our statutory duties. Whether every decision we made was perfect with the benefit of hindsight, possibly not, but that is exactly what we were trying to do.

Q64            Darren Jones: With the benefit of hindsight, would you like to apologise to taxpayers for being here and potentially putting them in this position where, yet again, another regulated market might collapse, exposing them to billions of pounds?

Cathryn Ross: If you are asking for an apology from Ofwat—

Q65            Darren Jones: I am asking for an apology from you, Ms Ross.

Cathryn Ross: I will not apologise for my role as chief executive of Ofwat, no.

Darren Jones: You do not want to apologise. Okay, thank you.

Q66            Barry Gardiner: On the question just asked by my colleague, if a company goes into special administration, the shareholders take the hit if it is not financially viable. That is what shareholders are for, and that relates to the earlier question about the £560 million. The process, however, need not be renationalisation as such. You could set up regional local authority bodies to take over, and transfer the company as a going concern to those regional local authorities, could you not?

Cathryn Ross: That would be possible, yes.

Q67            Barry Gardiner: That is, actually, the way in which many countries in the rest of the world run their water industry, isn’t it?

Cathryn Ross: As I said before, there is a perfectly reasonable debate to be had about the right structure, ownership model and so on.

Barry Gardiner: The question was simple: that is the way that many other countries in the world run their water industry, isn’t it?

Cathryn Ross: Yes, there are a variety of models, and that is one of them.

Q68            Barry Gardiner: And they do it more successfully in many cases than we happen to have done, don’t they?

Cathryn Ross: I can’t comment on that.

Q69            Barry Gardiner: In terms of the questions that my colleague, Philip Dunne, put to you earlier—

Cathryn Ross: I do not have the comparative information about the performance of different regimes.

Barry Gardiner: I am astonished. Okay. Thank you.

Q70            Chair: A couple of final questions. You have very high levels of gearing, as we have already mentioned. You just talked about long-term investment and how you are looking at decades ahead. Do you think it was a mistake by the company to have so much of its debt—about 50%—linked to inflation rather than taking out more long-term deals, given that it is such a long-term business? Was that done maybe because the people lending to the company were so closely connected to the company? I know you referred to that, but is it the case that the shareholders coped without a dividend because they are getting these interest payments, in many cases?

Alastair Cochran: We managed our balance sheet to reflect the period we are investing in, so we have debt that is up to 40 years in tenor. The average is about 13. Critically, the shareholders have put in additional equity to ensure we retain that strong balance sheet so that we continue to be able to borrow money at an efficient rate of interest and—

Q71            Chair: Your credit ratings have bombed of late, haven’t they?

Alastair Cochran: We still retain an investment grade credit rating—a triple B credit rating, which is a strong investment grade rating. That allows us to borrow money efficiently and therefore we can keep customer bills down.

Q72            Alan Brown: I want to ask Alastair about evidence. We have a briefing. Thames Water Utilities accounts show that cumulative dividends paid out £7.2 billion, so why did you give a much lower figure?

Alastair Cochran: Let me provide you with an analysis after this Committee.

Alan Brown: That would be very good.

Philip Dunne: On that specific point, it would be helpful if you could, in your reply on dividend payments, separate those that are payments to equity shareholders and those that are characterised as dividends in the accounts but are within the financing structure funding debt payments.

Q73            Barry Gardiner: The statement about shareholders not taking a dividend was only referring to the normal shareholders, not the debt financing.

Alastair Cochran: That is absolutely correct. They have not taken any income from their investments.

Q74            Chair: Ms Ross, having been involved with Ofwat and with Thames Water, do you think the remit of Ofwat could be extended to look a little more deeply into the financing structures in water companies, rather than just the relationship between the provider and the customer, to get a better picture of where that debt is and how exposure might be. I don’t think most people were aware that you were so exposed to high inflation in terms of your debt repayments.

Cathryn Ross: In terms of Ofwat’s remit, that is exactly what Ofwat has been doing in recent years. You can ask them more about it because that was carried on after I left. But certainly from about 2017, if I recall that correctly, and certainly through 2018 and more recently, they have been paying a lot more attention to what they refer to as financial resilience. Part of that is about gearing and the appropriateness of the capital structure for the investment programmes that are needed. I think that is entirely appropriate.

Q75            Chair: Thank you. Before we let you go, Mr Cochrane, you talked about 151 redundancies. Are those going to be voluntary redundancies? People working in the company will be worried about their jobs and their future. Will they be compulsory redundancies or are you confident you can fill those redundancies with either early retirement or voluntary redundancies?

Alastair Cochran: To the best of my knowledge, we have not announced a redundancy programme.

Q76            Chair: I think the figure I saw was 151 redundancies.

Alastair Cochran: As I say, to the best of my knowledge we have not announced a redundancy programme. In fact, we have been hiring people consistently. For example, we onshored our customer service-facing team into the region as part of our turnaround plan and continue to insource activity so that we can get an operational grip on our business to help part of the turnaround.

Chair: I can see Barry is champing at the bit.

Q77            Barry Gardiner: Mr Cochrane, when I mentioned that earlier, why did you not immediately say that? I am astonished.

Alastair Cochran: I am delighted to be able to clarify that—

Q78            Barry Gardiner: You missed the point when we talked about it earlier.

Alastair Cochran: I missed that part of the question. I am sorry.

Chair: Okay. We have put the record straight.

Q79            Barry Gardiner: Chair, if I may, I have one further thing. Given that inflation is going to rise and your interest on your debt is going to rise, is it the case that prices will go up for customers?

Alastair Cochran: Under the regulatory model, prices are indexed to inflation.

Q80            Barry Gardiner: Why is it that you and others, indeed, in Ofwat and in Government have been saying that there is no possibility that bill payers will see their bills rise?

Cathryn Ross: I think if anybody has said that, that is not—

Q81            Barry Gardiner: It was a Government Minister, actually, as well.

Cathryn Ross: The regulatory settlements are done on a CPIH plus debt basis.

Q82            Barry Gardiner: Indeed, we all know that your interest payments are going to go up. This is what has precipitated the problem. The question is: how much are they going to go up? What do you actually foresee is the rise that your customers are going to have to pay as a result of your company’s failure?

Cathryn Ross: Our customers are paying less than they otherwise would as a result of the poor operational performance of the business, because we are in penalty territory in terms of Ofwat’s incentive regime. That means that the penalties we pay actually translate into lower bills than would otherwise be the case for customers, because we are not delivering the service.

Q83            Barry Gardiner: So we want companies to fail in order that bill payers do not pay as much. Is that what you are saying?

Cathryn Ross: No, but the view is that customers should pay for the service they receive. We have not been providing the level of service that customers expect, and therefore we should not charge them at the prices that we would otherwise have charged them.

Q84            Barry Gardiner: But we are talking about the interest payments on your debt bleeding through to a rise in the bills that your customers will pay. Is that the case?

Cathryn Ross: No, there is no mechanism within the current price control to enable us to put up bills to reflect higher interest payments.

Barry Gardiner: So your bill payers can rest assured on the assurance of the co-chief executive of the company that the financial difficulties you have got yourselves into will not result in their bills rising. Thank you very much.

Chair: Thank you very much for coming and giving us evidence. We will now move on to our second panel. Thank you very much indeed to our witnesses.

Examination of witnesses

Witnesses: David Black and Iain Coucher.

Q85            Chair: Welcome to our second panel from Ofwet—Ofwat; actually, Ofwet as well, probably. Can I ask the witnesses to introduce themselves? I know Iain from my time at the Department for Transport, of course. Welcome—it is nice to see you again. Can you introduce yourselves briefly?

Iain Coucher: Of course. I am Iain Coucher, the chair of Ofwat. I have been there since this time last year, so 12 months.

David Black: I am David Black, chief executive at Ofwat.

Q86            Robbie Moore: If I said that Ofwat is the economic regulator of water and waste water sectors in England and Wales, would I be correct?

David Black: Yes, that is right.

Q87            Robbie Moore: How can I, any members of the Committee or, indeed, my constituents have any confidence in Ofwat when on 29 June, you expressed confidence in Thames Water’s financial situation, yet Thames Water’s debt burden is 20% above your recommended level?

David Black: As the economic regulator, we set an amount of debt level, in terms of when we set price controls, as what a reasonable, prudent company should have. However, companies have discretion to manage their own financial affairs, so companies make decisions about the choices they make in terms of debt levels.

What we do as a regulator is protect customers’ interests by ensuring that they do not bear the consequences of companies’ decision making. What we have done in the last two years is to very much strengthen the provisions around companies having adequate financial resilience. Our concern is making sure that companies have sufficient buffer to deal with uncertainty and with events that may materialise. That is exactly what we have done. We have protected customers’ interests. Customers are protected in terms of the bills they pay and the services they receive, and they will remain so.

Q88            Robbie Moore: Do you think that you have acted reasonably, responsibly and quickly enough within the situation we are seeing with Thames Water at the moment?

David Black: Thames Water are responsible—and the shareholders are responsible—for their level of debt. We are holding them to account on behalf of customers.

Q89            Robbie Moore: How are you holding them to account if we are in the situation that we are in at the moment? What action have you taken so far?

Iain Coucher: Can I say a few words? The situation in which Thames finds itself is a consequence of its underperformance. It has got high levels of gearing. We would like to see the gearing levels down, because it does provide, as David says, a greater buffer when things go wrong.

Thames’ problems at the moment are being crystallised because they have underperformance—they are not getting the revenue they expect, because they are delivering poor service to customers—so revenues are down, and their costs are higher, so the shareholders are now bearing the extra cost. Because of the lack of resilience in the company, which we are concerned about, it now needs an injection of shareholder funds.

Our concern is performance. They are in this situation because performance is not where it needs to be. We have got similar issues in other companies, but at Thames, their performance is bad. We have been all over them, addressing their issues with turnaround, improvement, customer services and costs.

Q90            Robbie Moore: When you say that you have been “all over them”, why, on 29 June, did you express confidence in their financial position? We are in July now; that was only last month.

Iain Coucher: We are confident, from the conversations we have had, that Thames have sufficient equity commitment coming from the shareholders to address their shortfall. In the short term, we believe that the right course of action at this point in time, because they haven’t got financial resilience, is for the shareholders to inject equity to support the business as it stands today.

Q91            Robbie Moore: Ofwat expressed confidence in Thames Water’s financial position on 29 June. We are now in July. You are here recognising that they have challenges now with their financial position. Thames Water has raised £750 million of the £1 billion it requires. You mentioned the short term. What is the impact going to be on customers—on my constituents and the constituents of Members sat around the table here?

David Black: Before I respond to that, I think I should make it very clear that in December last year, we published a report saying that we were unhappy with Thames’ financial resilience and that action was required. At that time, the company had committed to £1.5 billion of equity injections. That was the basis of our view at that time.

Q92            Robbie Moore: It has not raised that level of funding though, has it?

David Black: It is not that on 29 June we suddenly changed our position. We are very clear, and have been for some time, that Thames has inadequate financial resilience and that it needs to address that—just to be clear.

Q93            Robbie Moore: Over that timeframe, Thames has not raised that level of funding—is that correct?

David Black: They have injected the £500 million, as they committed to recently. It was the remaining £1 billion that they have now reached an agreement about with shareholders to support a £750 million injection into the company. That is the change. That was our concern, and why we were engaging with the company ahead of their financial reports about the shareholders’ commitment. Those are the discussions we have been having.

Q94            Robbie Moore: As a regulator, do you feel that you have taken sufficient action, despite having first raised the issue in December and not having given as stark a warning as I would have liked to have seen from a regulator on 29 June?

David Black: Our warning in December last year was unambiguous and clear that Thames had insufficient financial reserves.

Q95            Robbie Moore: Do you feel, as a regulator, that you have taken sufficient action since the warning that was put out in December last year?

David Black: Yes, but we were also engaged before that. We were having discussions. Shortly after I was appointed as acting chief executive, I was discussing with the then chief executive of Thames Water our concerns about their financial resilience. We have an annual process where we look at the company’s assurance around their adequacy of financial resources, and how the company was going to demonstrate that. The outcome of those conversations was the company’s commitment to inject the £1.5 billion into the business. We have been engaged with Thames on their financial resilience for some time and the shareholders are responding, but we remain concerned that there are significant issues to address, and, as Iain said, significant performance issues in terms of the turnaround of the company.

Q96            Robbie Moore: How are you, as a regulator, going to ensure that that challenge is addressed and that its debt burden is brought down? 

David Black: The first thing is for the company to get a plan that will secure its turnaround. It has obviously made a number of attempts to turn around its business. Those have not succeeded at this point, and we continue to hold the company to account on its performance to date; we have imposed financial penalties on the company for its failure to deliver for customers.

We have a number of licensed powers. We have powers in terms of the payments of dividends for example, which we have just brought into place. We will also examine its assurances around its financial resilience, which it has provided to us on this past Monday and we will work through that and engage with the company. We remain in discussion with the company about its ability to secure finance from shareholders.

Q97            Robbie Moore: One of my concerns is that, ultimately, customer bills will go up as a result of Thames’s poor management.

David Black: No, I can be unequivocal on that. We set companies’ allowed cost-to-capital returns on the basis of efficient, well-functioning companies. Thames shareholders are up for the additional costs associated with its poor performance, and that is evidenced by the fact that they have had to inject additional funding into the company and that they have had very little in the way of dividend payments over the last seven years.

Q98            Robbie Moore: You were very quick to come out with a no there, but what time period does that relate to?

David Black: We reset price reviews every five years, but the key point is that we are saying that we will allow Thames the efficient cost of running the business. That may vary and we will set that again as part of the 2024 price review. 

Q99            Robbie Moore: So you can only confidently say no until 2024—is that correct?

David Black: Not at all, because we have a policy position: whether bills go up or down will be determined by the needs of our customers and an environmental perspective. We will set bills on the basis of Thames’s efficient costs and the efficient cost of financing. That will be the basis for setting bills and it won’t be about Thames’s actual debt burden or actual costs of debt. Thames customers do not pay a penny more for Thames’s 80% gearing versus other companies’ 60% gearing.

Q100       Darren Jones: Last year, my Committee did a major inquiry into the collapse of the energy market and highlighted a number of failings at the energy regulator, Ofgem, which it is now dealing with. Have you been working with Ofgem to learn the lessons from the energy market as it relates to the water market?

David Black: Yes, we welcome your report and we have considered it. We have also engaged with Ofgem and the advisers it engaged with during that process. For example, we had the people from the consultancy it commissioned to do the independent review come in to speak to our senior leadership team and talk through their view about the lessons learned for Ofgem.

Q101       Darren Jones: Having considered my Committee’s report, what is the main takeaway? What do you now need to change at Ofwat to secure the future of the water industry? 

David Black: We think the key changes we have made are the bringing into being of new conditions in company licences around the payment of dividends and financial resilience. Under the Environment Act 2021, we received new powers to amend company licences. Until that point, we did not, in our view, have sufficient power to change company licences. We have now used those powers. The first target of our use of those powers was strengthening provisions on financial resilience. The second change we are making is about improving customer protection and customer service.

Q102       Darren Jones: In 2022, Ofwat started financial monitoring of water companies, according to the review of your 2014 price review that was published on your website. Were you not doing that before?

David Black: We have published a financial monitoring report since 2016. We have published a series of reports every year. They come out. We look at the financial statements companies provide us with. We do our analysis on a range of financing issues around companies, including their debt structures, dividend payments and their plans for equity. We have been doing that since 2016.

Q103       Darren Jones: Did you raise the issues about Thames Water in 2016? 

David Black: We identified that it had high levels of gearing and that it had financial ratios that raised concerns.

Q104       Darren Jones: Why has nothing happened about that?

David Black: Thames has been able to finance its activities. We have been engaging with the company and we have raised concerns about it, but frankly our concerns at the time were more focused on Southern Water—we have secured injections of equity into that company—and Yorkshire Water. We have also secured equity injections into that company. We are now more focused on Thames in recognition of the issues that it is facing, but at the time those issues were less severe than those faced by the companies that I have just named.

Q105       Darren Jones: Shouldn’t you be focusing on all the companies you regulate, not just one, at any given time?

David Black: We do, but the point I was making is that we were engaged with the shareholders of Southern at that time in terms of securing their exit from the business and the entry into the business of new shareholders who were able to inject £1 billion into Southern Water.

Q106       Darren Jones: During the previous panel, the new chairman of Thames Water said that we need to enter a period of transparency in which the water companies are transparent with the regulator. The implication of that is that they have not been in the past. Is that right?

David Black: They have provided information to us on their financing. I would say that they were not sufficiently transparent with the public. Obviously, company financing issues are complex, and we have criticised them for being opaque. We have introduced licensing conditions to require companies to provide more adequate financial information. But I think there is a huge challenge for companies in explaining, in plain English, what is going on with their financing structures, where the money is coming from and where it is going to.

Q107       Darren Jones: I think you said that from 2025, you are going to reduce the debt target from 60% to 55%. Is that right?

David Black: As part of price review, yes, we use a notional gearing target, and that is to signal that we think there should be prudent headroom in financing structures. We are using that to signal to investors and companies that we think their equity buffer needs to increase as they face the challenges of the future. They are going to be making large investment programmes, they are facing the challenges of climate change and we are also increasing the level of financial penalties on companies, so we want them to have adequate financial structures to bear that.

Q108       Darren Jones: Only three of the 11 companies that you regulate have debt below 60% today. What is the consequence if they do not hit your debt target from 2025?

David Black: What we are concerned about is the adequacy of financial resilience. That does not rest on gearing alone, so I think we need to be quite clear that the gearing number is useful—

Q109       Darren Jones: Sorry, could you try that in plain English for me? Forgive me. What happens if they do not hit your debt target? What is the consequence for the company?

David Black: We are not setting a target in terms of companies—

Q110       Darren Jones: Why do you call it a debt target if it is not a target?

David Black: Because that is the basis for setting the price review, which is about making sure we are protecting customers’ interests. Customers are paying a bill based on a 55% gearing target rather than the actual gearing the company has, which relates to the question earlier about how we protect customers’ interests. We are saying that we are going to set customer bills on this basis and that, if companies have different financing structures, they bear those consequences. It is really important that shareholders and companies are responsible for their financial structures. We are here to protect customers’ interests, and that is what we are doing.

Q111       Darren Jones: My last question is on consequences. You have made the point repeatedly that you protect customers, and you have talked about customer bills. Do you recognise that there is a scenario in which the taxpayer would have to pick up the cost of a failed water company, because it is too important to fail? Do you ever think about the risk to taxpayers of bankrupt water companies when you are looking at protecting consumer interests?

David Black: I think you are referring to the special administration regimes. The situation in water, as with other regulated industries, is that a special administrator will be appointed if a company is in danger of insolvency. It is the special administrator’s job to then deliver services to customers and protect customers’ interests, but also to secure new owners for the company.

In contrast, perhaps, to the energy companies you looked at, water companies have very large asset bases, so in the first instance we think costs around special administration will be borne by investors. We accept that there is a risk for taxpayers, and that is one of the reasons why we have been working to drive increased financial resilience into companies and why we have used the new powers we have received under the Environment Act to change licensing conditions to tighten up on financial resilience.

Q112       Darren Jones: The public will look at what is being reported as happening in the water industry, having just gone through what happened in the energy industry last year. The risk here is that the Government—taxpayers—have to borrow enormous amounts of money to underwrite the risks that companies have been allowed to take. The public will see, once again, companies like Macquarie cashing out and walking away with their money, and they will see that the previous year the regulator refused to apologise for the fact that we are in this position in the first place. The public will say, “What are the consequences? Who is responsible for exposing taxpayers in this way?” Do you, albeit as the new chief executive of the water regulator, want to apologise on behalf of your predecessors for ending up in this position in the first place?

David Black: I think we have to be careful about the parallel with the energy sector. As I have explained, the energy companies that failed had very little in the way of assets. In Thames’s case, we are talking about a £19 billion company, and so the question is whether the equity holders—or, if needs must, debt holders—bear the consequences of that.

Q113       Darren Jones: Mr Black, a taxpayer and a customer are the same person. It is still a person paying out money either to the Government or to a company. My question was whether you recognise the failure of the water regulator over these many years, which has got us into this position in the first place, and whether as the chief executive of the water regulator, you want to apologise to the public for the position we are in today, much like the chief executive of the energy regulator did last year.

David Black: We continue to protect customers’ interests. We are not in a position of either Thames being in special administration or—

Q114       Darren Jones: You think everything’s okay right now—is that what you are saying?

David Black: No. I think there are some very serious issues that Thames Water needs to address, but my point is that customers’ interests remain protected by the regime. I have been very clear that we are not at the point that customers are having to pay any more for Thames’s financial issues or for its poor performance, and that remains so. As I have explained, the situation in energy is different from that in water: water companies’ shareholders have much greater capacity to absorb the consequences.

Darren Jones: I understand; you have made the point, Mr Black. This is my last question, because otherwise I am going to test the patience of the Chair.

Chair: I am a very patient person.

Q115       Darren Jones: Thank you; I will keep going, in that case.

Do you not have a request of the Government to enhance or extend your powers? It seems to me that both you, Mr Black, and your predecessor, Ms Ross, who was on the previous panel, have said to us, “It’s up to the companies how they run their businesses. Don’t worry, because if it goes wrong, the Government probably aren’t going to have to nationalise it anyway.” That is not what it looks like from where I am sitting. I want you and the other regulators to be in a position where, when you are regulating a company that is too important to fail, you actually know what is going on at that business and you have the power to make sure they do not end up in the position they are in now. Do you need additional powers from the Government to do that job properly?

David Black: I agree that the issues you are raising are very serious, and I agree that up until 2021, we did not feel we had sufficient powers to address those issues. The crucial change for us in 2021 was our ability to amend company licences. The licence is the instrument that we use to regulate companies.

We now think we have sufficient flexibility in terms of amending licences, both in terms of the changes we have already made and, if we think further changes are required, to go ahead and make those changes. We think the Government have now given us the additional powers. We have also received additional funding or the ability to raise additional funding, so we can resource up to exercise those new powers.

Darren Jones: Thank you.

Q116       Cat Smith: Mr Black, in response to an earlier question from Mr Jones, you said that the water companies were being transparent with you as the regulator but not necessarily with their customers. I am left wondering what on earth the point of a regulator is if you are not then communicating that with the public.

David Black: We think companies have a responsibility to communicate clearly with their customers; that was the question I was responding to. We are able to get information from companies. We require them to provide annual information to us of considerable detail. We also have a five-yearly business plan where they set out their five-yearly projections—

Q117       Cat Smith: Mr Black, I am sorry, but if you know that companies are not being transparent with their customers and you know what is going on, why is Ofwat not communicating that with them?

David Black: We want companies to take responsibility for communicating to their customers. We have changed company licences to require them to do that. We think that they are now taking steps to do that, but the point I would make is that it is challenging to explain these issues to customers, and quite clearly, customers do not feel they have sufficient information.

Q118       Cat Smith: What is “taking steps” in that situation?

David Black: We can set guidelines in terms of what companies ought to be doing and what they publish—

Q119       Cat Smith: Guidelines are optional, yes?

David Black: We also have requirements of what companies publish.

Q120       Cat Smith: What are the requirements?

David Black: The companies publish annual financial statements. The question is not so much whether they set out the information; it is about communicating that in an understandable form to their customers. We think the information is—

Q121       Cat Smith: Can you understand why the public are questioning what the point of your organisation is when it appears that you have done absolutely nothing to inform them about some of the risks that these companies are taking? I am left wondering whether or not the model of water ownership we have in this country, which is completely out of step with the international norm, is working. In 2017, the FT reported in a 10-year review of company accounts that on profits of £20.7 billion, water companies paid an average tax rate of 8%. Who benefits from water privatisation?

David Black: Since privatisation, £190 billion has been invested, and that has driven significant improvements in service, improvements in water quality, reductions in the levels of pollution, improvements in customer service and reductions in water supply interruption. Capital investment in the sector is about double the rate pre-privatisation. Clearly, the question about the ownership of companies is a matter for Government, not for Ofwat, but you can point to tangible investments under the regulated model of more investment and better service.

That said, we are under no illusions that there are real problems for the sector to address. The situation on sewage spills and storm overflows is unacceptable. Now that we have the information about those discharges, action has been taken, but I should point out that these are issues that exist in other jurisdictions as well—they are a problem in Scotland and in other countries. It requires a concerted effort to address. It will require more investment, and we are part of that process.

Q122       Cat Smith: We have had 34 years of water privatisation. Why are we still talking about this desperate need for investment if privatisation was meant to be the answer to the investment question 34 years ago? Why are we still in this situation today? Is it because of the regulator, or is it because of the water companies?

David Black: In terms of areas where companies have fallen short on performance, we have been very clear with the Committee that we think the performance of Thames Water is poor and needs to improve, and there are other companies that we have concerns about. We think there are sector-wide issues to address, but again other countries and jurisdictions are facing the same challenges—issues relating to climate change, high-density urban areas and older infrastructure, in getting better performance in line with what the public would expect. We can point to significant investment and improvements since privatisation, but there is clearly—

Q123       Cat Smith: So why is privatisation so unpopular? Whenever we see public polling, the idea of renationalisation of water companies is incredibly popular with the public. Why do you think that is?

David Black: I don’t think that is a question for me to answer. You as an MP are much better placed than me to address that question.

Q124       Cat Smith: Is it because of the absolute, utter failure of the water companies in England right now?

David Black: As I say, we can point to huge improvements and huge levels of investment. We accept that the public is clearly dissatisfied with the companies. We have done some research that suggests that trust in the companies has fallen over the past three years, and we think it is really important that the sector addresses those issues. Iain and I called our companies’ chairs and chief executives in to make the point that they need to improve performance. We are seeing signs of change in the water sector, but much more change is needed. This is not about who owns the companies; it is about the companies adopting much more forward-looking management practices. It is about investing in smart networks and smart metering, using nature-based solutions at scale, and modernising the way they work. We will continue to push the sector to do just that.

Iain Coucher: Can I just say a couple of words, Cat? That is a really good question about the privatised water model. It has been privatised for 30-odd years, and £190 billion of investment has gone into the sector. That is £4 billion, £5 billion or £6 billion a year. I would worry that, in a nationalised situation, if there were a call on that kind of investment, it wouldn’t be there; the money wouldn’t be available. It is going in.

We are facing such an investment crisis now because the nature of the investment is changing. We have to address things like water resilience, and we now need more water to cope with population growth, urbanisation and climate change. There are changing standards on levels of water abstraction that the Environment Agency is pushing through, the drive towards net zero and the need to address the storm water overflow. That is a very significant step-up of investment that we have not seen in the past, and that is causing some concerns about the future.

Q125       Cat Smith: My final question is about Thames Water. What plans have been put in place to prepare Thames Water for potential failure? What might that look like?

David Black: We have what we call contingency planning for the failure of a water company. We keep that under review. In terms of our concerns about Thames Water, we have been looking very closely at the arrangements that need to be taken, and we are confident that we can rise to the contingencies that may occur. We think it is prudent planning to be ready for special administration, but as the company said this morning, they have sufficient liquidity to meet the challenges of the immediate future and a shareholder commitment for additional funding. Should that materialise, obviously the planning won’t be needed, but we think it is prudent as a regulator that we prepare for these outcomes, and we have been working on that.

Q126       Cat Smith: Would you say you are confident that the special administration regime will not be needed in the case of Thames Water?

David Black: I think we need be ready to employ that—

Q127       Cat Smith: Do you think you will be deploying it?

David Black: At this point in time, the company is saying that they have secured commitments from their shareholders, so it won’t be needed.

Q128       Cat Smith: Do you believe them?

David Black: Obviously, I think it is great that the company have secured that commitment from the shareholders, but clearly the money has not yet arrived with the company. At that point, we will feel more confident.

Iain Coucher: Can I just add a tiny bit? One of the reasons we are doing a lot of contingency planning is to learn the lessons from Bulb, and what that would mean. That is the most recent example of administration. We are working with our colleagues across Government to say, “In the unlikely circumstances that it happens, are we ready? Have we got everything in place?” We don’t think it is likely at the moment for the reasons that David set out, but it would be sensible for everybody to think about the possible implications.

Q129       Cat Smith: So you do not think it is likely?

Iain Coucher: At this point in time, we are confident that the shareholders will inject some cash, but the problems at Thames are deep rooted. I repeat what I said before: the problems at Thames are a function of cost overruns and poor performance, and they need to fix them as quickly as possible; otherwise, they will have the same problems in the future.

Q130       Cat Smith: Have you been asleep at the wheel as the regulator?

Iain Coucher: No.

Q131       Darren Jones: I have a very quick follow-up. It is great to hear that you are trying to learn the lessons from the Bulb failure. One of the issues with the energy companies that collapsed last year was the capital that the Treasury had to provide to keep them running as going concerns. Bulb was huge for the energy market, but it is actually quite small compared with Thames Water. What has been the assessment for the Treasury of the amount of capital it needs to put aside should Thames Water fail?

David Black: We have been working on those issues. I am not going to name a number in terms of where we are in the process, but as I have noted, there were quite big differences between Bulb, which was a relatively asset-light company exposed to energy market fluctuations, and Thames, which is a large capital-intensive business with a larger asset base and ability to raise funding.

Q132       Darren Jones: When the energy market failure was happening, both the regulator and the Government wrote to my Committee confidentially to tell us those numbers. Will you commit to doing that for this Committee?

Iain Coucher: I think we will probably refer that to Treasury. It is a question for them, really.

Q133       Chair: Could you give taxpayers an assurance that if there were to be a special administration, it would not be the taxpayer bailing out the shareholders? They would have already lost their shirts and it would be a case of picking up the pieces—more like the banks, I suspect, than the energy companies. And, who knows, if the company performed well, it could well be sold back into the private sector, as we have seen with some of the bank shares.

David Black: The company would remain an attractive interest for other potential investors. As I say, it has a £19 billion asset base and a secure revenue stream. The question will be around the interests of existing shareholders—they are the first, in terms of their equity being at risk, and they are well aware of that—and then there is a question about the debtholders in the company.

Q134       Chair: That might be the same people, so we heard in the first session.

David Black: I do not think, in the main, that that is the case.

Q135       Barry Gardiner: First of all, let me make it absolutely clear that I understand, Iain, that you came into the business only in July of last year and, Mr Black, you came in in April, just before that. You are left responding to things that happened broadly before your tenure, and I just want to say that we appreciate that.

Let us go back to 2003 and South East Water. You will remember that Macquarie purchased South East Water then, sold it three years later for almost double what it purchased it for and had, by that time, increased the debt more than fourfold. In effect, it repeated that with Thames Water, only it was a much bigger prospect, and increased the debt threefold. Instead of it being the case that companies raising debt in that way would use it to increase the infrastructure for the benefit of the public good, they actually took £2.7 billion out of it, and £2.2 billion of that was in loans.

You have rightly said, and you have reiterated it to this Committee, that you were very concerned about the gearing, not only of this company but of others in the sector. The higher debt—that gearing—gives a notional lower cost of capital, of financing, doesn’t it? And that means that lower charges result in the short term.

My accusation against Ofwat is that you have basically encouraged overleveraging. I have to say that the two of you are not entirely innocent of that because, of course, in August of last year, after both of you came into post, you encouraged the purchase by Macquarie of Southern Water. You knew its track record. You know what this company does. You know it overleverages. You know that in the short term that can get charges down, but when it goes wrong and financing costs increase, we see the debacle that we have had with Thames Water.

It seems to me that Ofwat, over a long period of time, has been guilty of encouraging overleveraging, and the immediate charge that I would lay at your two doors is that you did exactly the same thing, just after you came into post, with Southern Water.

David Black: Just to contextualise, I will go back to the early 2000s—actually, if we go right back to the start of privatisation, the sector asset base was £9 billion and it was fully financed by equity at that point. Today, the sector asset base is around £85 billion and debt levels are around £57 billion. Of that growth in the asset base of £77 billion since privatisation, £57 billion has been financed by debt and about £20 billion from equity. So when we look at the picture across the sector, debt has been a key source of finance—not the only source of finance—and that was intended at privatisation; debt levels would increase to fund the growth of the asset base.

Q136       Barry Gardiner: I don’t want to go over ground where we agree; I want to go over ground where we disagree.

David Black: Yes, so I will now move on to the cases that you have talked through—it’s a very knowledgeable question—in terms of South East Water and Macquarie’s ownership of Thames. I would agree, on Macquarie’s ownership of Thames, that they did gear up the company to very high levels. They extracted that in the form of dividends. And that is the reason why we changed the licences once we had the power to do so. We have been very clear about the new basis and our new expectations of investors. And to come to the specifics of Southern Water, Macquarie have injected £1 billion into the Southern Water group. They are now standing by to inject a further £500 million. They have had very little in the way of dividends out of that company—

Q137       Barry Gardiner: To date.

David Black: And we have new controls on dividends now, so they cannot get the money out of the business and we have the ability to intervene. I take some satisfaction from the fact that Macquarie as an investor are injecting money into the sector, rather than taking it out of it, and we have the arrangements in place to protect customers’ interests.

Q138       Barry Gardiner: This goes back to your response to my colleague Darren Jones, doesn’t it? Actually, what is this target about the gearing that you want if you can’t enforce it? What gives you the assurance that Macquarie are not going to do with Southern Water exactly what they did with Thames and exactly what they did with South East?

Iain Coucher: The difference is the new financial resilience measures we have put in place, which prevent companies from taking dividends out of the company when they are poorly performing or when dividends are not justified. We did not have that power before.

Q139       Barry Gardiner: I don’t know the answer to this question—that is rare when I ask a question.

Chair: That’s the whole point of questions, Barry!

Barry Gardiner: No, it’s not—I assure you it is not, Chair. Usually I know the answer to the question that I am asking.

Mr Coucher, are you saying that in a highly complicated debt structure like WBS in Thames Water, you have the power to stop dividends going to each of those debt payers and not only to what everybody would normally understand as being the shareholders, the equity shareholders?

Iain Coucher: We have the powers to stop dividends being released from the operating company. Where they go beyond that is a matter for the company, but the financial powers that we have retain the dividends that would have been paid inside the company if we are not satisfied that they are performing and they have not satisfied us that they have sufficient financial resilience. We did not have that power before; we do now. And the Southern one is a good case in point of it working. Macquarie have gone in there with a group of investors. They have looked at the business. They realise they now need to inject further equity, because of the base, and that is precisely what they are doing now. We are confident that the situation that happened a decade or so ago is now protected against.

Q140       Barry Gardiner: Thank you. So you are saying that had these new arrangements been in place when our previous witness was the CEO of your organisation and subsequently, what happened with Thames Water could not have happened.

David Black: We would have had the ability to block the dividends going out of the company, yes.

Q141       Barry Gardiner: In response to another question from, I think, my colleague Darren Jones, she denied that they had failed in any way or that they lacked any powers. That is one way in which the debacle could have been prevented.

David Black: Yes.

Q142       Barry Gardiner: So are you confident that, going forward, no part of the ownership of the company will be able to receive the level of returns that Macquarie was extracting from Thames Water, of between 15.9% and 19%, which is over double the normal return?

David Black: We have changed the licence to give us the power to do that but, furthermore, we now have more flexibility with the licence. If we think further changes are required, we will introduce them.

Barry Gardiner: Thank you very much.

Chair: I think Rosie wants to come in with a supplementary question on that.

Q143       Rosie Duffield: I am going over some ground covered by Darren Jones and Cat Smith, I’m afraid, but my constituents would really like to know this. Do you understand why people in the coastal town of Whitstable, for example, do not have a lot of faith in Ofwat, the Environment Agency or anyone else that is supposed to be imposing fines? We know that you imposed record fines against Southern Water, but nothing has practically or physically changed. Every time we get a thimbleful of rain, there is sewage released into the sea, which affects every aspect of daily life in a town like Whitstable. Can I give you the chance to briefly explain to them why they should have faith in you and what you can do? You have talked about improving customer service, revoking licences and stopping shareholders getting dividends, and you have said that customers’ interests remain protected. Can you convince my constituents that you are doing your job?

Iain Coucher: The issue of storm water overflows is appalling. I have said to the Committee before that the overreliance on the use of storm water overflows to deal with rainfall, as you suggest, is unacceptable. We have been very clear to everybody that if a company is in breach of its legal obligations, the Environment Agency will take action and force compliance, and the company will be responsible for rectifying the problems.

We have got ourselves into a situation where some of these storm water overflows are allowed, under permit, to release sewage into water systems, so we need to tighten up all those permits and say to people, “That is no longer acceptable. You might have a permit today, but we need to see that tightened over the course of time.” But we will ensure that companies comply with the law, their environmental obligations and their permitting requirements, and the cost of doing so is for the companies themselves. We have six concurrent large-scale investigations into the companies that have been doing this, to satisfy ourselves that they are complying with their legal obligations and complying with the environmental permits. They are complicated—I do not wish to trivialise it—but we are working through that, and we know our colleagues at the EA are doing exactly the same.

Q144       Rosie Duffield: If they are still within those legal limits, though, and sewage is still spilling out every time it rains, who is responsible for changing that or imposing different legal limits? Is that us? Are you saying we need to come back and change that, or does DEFRA need to step in?

David Black: That is for the Environment Agency. It is the Environment Agency that permits each and every storm discharge—that is the arrangement. 

Iain Coucher: DEFRA’s plan for water sets much lower targets for the use of storm water overflows, but it is going to take time.

David Black: The Government has set out a £56 billion plan to address this issue. I have been on site at Whitstable. There is scope to make quick improvements, which the company is in the process of making, but there are some quite significant issues, which will require investment to address. 

Q145       Dr Hudson: I just want to follow up quickly before I get on to my main question. Mr Coucher, you have been before us before and I have asked you about the teeth you have in terms of putting pressure on the water companies. We have talked about fines and not allowing dividends to go out. We have talked about financial performance today, and Rosie has been touching on sewage overflows as well. If water companies are having these unacceptable and immoral sewage discharges into our watercourses, do you feel that you have the necessary teeth, and what are those teeth? Would they be with the fines, or can you potentially stop dividends going out if companies are breaching the sewage outflows? Or is it more about financial performance and using that particular tooth?     

Iain Coucher: I’ll ask David to add something, but I will just say that yes, we have the power to enforce compliance to address any aspect of underperformance, either through fines or withholding dividend payments, if we think they are in breach of their obligations.

Q146       Dr Hudson: But if it is the underperformance, it could be about sewage rather than financial underperformance?

Iain Coucher: Yes.

David Black: Yes. We have a set of performance—we also have obligations that we enforce on companies in terms of the operation of their sewage systems. That is what we are investigating with our six cases. We have the ability to impose financial penalties; we have imposed £250 million of penalties on companies in the last five years. We won’t hesitate to use those powers.

Q147       Dr Hudson: Can you reassure the Committee and the public watching this that you will use those teeth to hold those water companies to account?

Iain Coucher: Can I just add one extra thing? When I appeared here before, you were asking very similar questions. In the last 12 months, we have secured additional funding from Treasury and through DEFRA to allow us to ramp up our investigation capabilities. We are empowering our people to be much more intrusive on companies’ performance, so it is a more muscular approach. When we see companies not performing—performing below what we are expecting—we have had them in and we have said, “We would like a rectification plan from you. Your performance is not acceptable. Please give us a turnaround plan to rectify.” That is new; we didn’t do that before. And in the first part of this year, we had five companies in to say, “We are not satisfied. Please give us an improvement programme.” And that’s the result of the extra powers and extra funds that we have secured. Sorry, David; I cut across.

David Black: We think we do have the powers. As noted, there is the role of the Environment Agency in setting permits at sites, but we have the powers and the ability to impose large financial penalties of up to 10% of turnover.

Q148       Dr Hudson: You have got the powers, but can you just reassure us and the public that you will use those powers?

David Black: Yes. We are taking enforcement action against six large waste water companies at present. I know that these investigations take time and people are impatient to see results—I am, as well—but we are making good progress and we will have announcements to come on that. 

Q149       Dr Hudson: I want to move back on to the topic that we touched on earlier today, in terms of staffing and leadership and the relationship between the regulator and the sector. One of our previous witnesses, the new interim joint chief executive of Thames Water, is one of your predecessors, Mr Black, at Ofwat. Are there high numbers of senior Ofwat staff moving to potentially higher-paid positions in private water companies? If so, do you feel that is problematic at all for your ability to maintain trust in Ofwat’s role and motives?

David Black: First, just to reassure, all departures from Ofwat are covered by civil service business appointment rules, which allow us to impose conditions on staff for up to two years after they leave, in terms of the work they undertake. That’s important.

The other point that I would make is in terms of contextualising this. There have been lots of media reports on this issue, but they are talking about numbers which amount to two or three staff members per year leaving Ofwat. We are an organisation of over 300 people. And a number of those staff members didn’t go from Ofwat to a water company; they went from Ofwat to another employer and then to a water company.

Q150       Dr Hudson: You mentioned these media reports. Do you recognise the figures of about 27 former Ofwat directors, managers and consultants who are now working with private water companies?

David Black: I recognise those figures, but the point I would make is that a number of those people left Ofwat to go to work either in another sector or not for a water company, and then later on—some years later—they have gone to work for a water company. I think it does need to be seen in that context. We have strict rules about what people do upon leaving Ofwat. I think these numbers do not support the contention that has been made.

Q151       Dr Hudson: We recognise and understand that in the public sector there are finite resources in terms of the salaries that can be paid. Professor Sir Dieter Helm of Oxford University has said, “There is a merry-go-round between the core regulators and the regulated utilities. Regulators are not paid very well, and if there is the potential of future jobs in the firms they regulate, it creates potential conflicts of interest.” Do you concur with that statement at all?

David Black: I don’t accept—I work with an incredible bunch of very dedicated people, most of whom, as I say, do not go to work for water companies. I think they do a fantastic job. They are very dedicated to the public interest and to protecting customers’ interests. And it is probably worth noting that Professor Helm also works for these water companies and is engaged by them.

Q152       Dr Hudson: That is a fair point. I very much take on board what you say, namely that the people who work for your organisation work so hard to try to do the best to improve the water quality for our country. For you, as two leaders of that regulator, does it concern you—that potential pull and drag into the private sector, and that it is draining you of the vital resource you need to do the best job you can?

David Black: Again, to contextualise that, I think only one member of Ofwat’s senior leadership team, which was Cathryn Ross, whom you saw earlier, has left Ofwat. She did not go to a water company. She went to BT, but has ultimately ended up in a water company. So—

Q153       Dr Hudson: So it doesn’t worry you, then?

David Black: No. I think people—

Q154       Dr Hudson: Mr Coucher, what do you think?

Iain Coucher: It doesn’t look good—I accept that—but I would like to assure the Committee and everybody that we have processes and governance regimes to make sure that decisions are syndicated and are taken thoughtfully, and no one individual really has the powers to make decisions that may be biased, or whatever it may be. I am reasonably reassured that the decision-making process we have got protects that, but I do accept that, on the face of it, people could ask questions. But for David’s reasons, it is not really an issue. There is a small number of people. They tend to be more junior people, and they tend to end up in the regulatory departments of these big organisations, which tends to be a bit of a specialist skill. Understandably, they have skills, knowledge and capabilities about the process, which is valuable to companies, but I do accept your observation.

Dr Hudson: Thank you.

Q155       Philip Dunne: Let me follow up that point. For the avoidance of doubt, for clarity and to reassure the public, can you confirm that you, Iain, have no financial interest in a water company or a company that is a major supplier to a water company?

Iain Coucher: I have no interests at all in any water company or any supplier to the water industry.

Q156       Philip Dunne: Thank you. David, can you give us the same reassurance?

David Black: Yes, that is right. I have no interest in any water company.

Q157       Philip Dunne: For anybody you bring into Ofwat, whether executive or non-executive, you can receive a similar assurance?

David Black: Yes. It is very clear upon entering employment at Ofwat you are not allowed to own shares in a water company.

Q158       Chair: David, you talked about this—obviously, you produce a financial monitoring report, which delves into some of the ways these companies are funded—but you also said that sometimes there were fairly opaque mechanisms. Do you think having more powers to delve into some of those opaque funding streams would help you, or do you feel you have enough powers at the moment?

David Black: I think we have adequate powers to require information from companies. There is a question about the level of resources and expertise required, so we are looking to beef up our resources in that space. I guess my key question is, do we have the resources in that space? That is why I am pleased we have the additional funding to strengthen our capabilities, but it is a complex area. It is an area of specialist expertise, and it is not just about having the information. It is about having the expertise to understand what is going on and to ask the right questions of companies.

Q159       Chair: To follow on from Neil’s point, you said only one person has moved from Ofwat. I think the figure we saw was 27.

David Black: I said one member of the senior leadership team, which was Cathryn Ross, so the 27 people referred to over the period of time means about two or three employees a year.

Chair: I thought we had had that figure before.

Q160       Barry Gardiner: Sorry, Chair. I don’t think that’s accurate either: “Six of the nine…companies in England have hired directors of corporate strategy or heads of regulation who previously worked at Ofwat… Andrew Beaver…Northumbrian Water…former director of strategy and planning Iain McGuffog, now at South West Water…Ross at Thames Water, Jonathan Read, director of regulatory policy”.

David Black: None of those was a member of Ofwat’s senior leadership team, just to be clear.

Iain Coucher: You have senior leadership positions—

Q161       Barry Gardiner: They have gone on to senior positions within the companies they have joined. Half of the 27 have gone on to senior leadership positions in the companies they have joined.

Iain Coucher: While at Ofwat, they were not members of the leadership team. They were lower down the hierarchy.

Chair: Perfect, we are bang on the time I had in the back of my mind for moving on to the final evidence session. Thank you very much indeed, Iain, and thank you, David, for coming in and giving us such useful evidence. Thank you.

Examination of witnesses

Witnesses: Rebecca Pow and David Hill.

Q162       Chair: Welcome to our panel for this session. Will you introduce yourselves, starting with the Minister?

Rebecca Pow: Thank you, Chair. I am Rebecca Pow, Environment Minister—water comes under my portfolio.

David Hill: I am David Hill, director-general for the environment in DEFRA.

Q163       Chair: Minister, we heard how, in the worst scenario, if there was a failure—we have also been looking at some energy companies and the banks—water companies might have to go into special administration. How concerned are you about potential failure at Thames Water and other providers in the sector? Is that on your radar?

Rebecca Pow: As the water Minister, obviously I look at all the water companies and work closely to make sure that Ofwat is doing its job as the regulator. It would be highlighting things to us constantly, of course, and we are very mindful of its resilience report from earlier in the year.

On the special administration order you refer to, should a water company no longer be able to fulfil its financial obligations, the Secretary of State and Ofwat have powers to apply for that on insolvency grounds. However, I have been made fully aware—in fact, the new chairman, Sir Adrian, came in to see the Secretary of State just yesterday, and he gave absolute assurances—that we are nowhere near that situation. But a Government always have to have the measures in place should they ever be required.

Q164       Chair: Do you agree that Thames Water has been skating on dangerously thin ice with 80% gearing and half its debt linked to inflation when inflation rates are rising? Alarm bells are ringing all around, as it is not just Thames Water; other water companies are highly geared and exposed to debt repayments.

Rebecca Pow: Obviously, we look closely at this whole issue of debt and gearing, and at how the whole system works in attracting outside funding in equity or raising debt, because obviously the water companies have to pay for all the investment—the huge investment—in infrastructure. Let us not forget that since privatisation, investment has doubled, compared with what it was before privatisation. The industry has attracted in £190 billion—

Chair: That is two HS2s.

Rebecca Pow: Money, one might say, that we would have struggled to have attracted had we not gone through this process of privatisation. When I talk to people—we might call it “back in the old days”, Robert, which I think you and I remember—and I have talked to a lot of people who were involved pre-privatisation, saw the system through and are now in privatisation, I ask for their reflections and thoughts. The water system was in a terrible state: we had terrible leakage and masses of interruption to supply. We have since cut leakage by a third and supply outages by a fifth, so there has been huge improvement. I honestly think that we must not forget to tell that story. That is not to say that there is not an awful lot that we have to keep our eye on. We have to make sure that our water companies are delivering.

As for what we need now, in a changing world—I think the chair of Ofwat referred to this—we have huge demands on us, with climate change and so forth. You asked about the gearing, but Ofwat indicated in its financial resilience report that it had some concerns about Thames. That is why Ofwat is working with it very closely.

I draw the Committee’s attention to the statements we had from Ofwat and Thames Water. On 29 June, we had the statement that emphasised that Thames Water had a strong liquidity position, which included £4.4 billion of cash and committed funding. This week, we have just had the Thames Water announcement via the annual report that, after some money had been committed earlier in the year, it had secured a further £750 million of equity investment.

Q165       Chair: That was a shortfall on the £1 billion that it was suggested needed to be injected though, wasn’t it?

              Rebecca Pow: Yes, but I think they gave some adequate answers. I have been listening to—you know, this is the money that needs to be spent soon, and they need to know that they have got it, and the company knows, or the shareholders know, that they will be seeking another £2.5 billion, and they have given a statement of intent of that. You asked about the gearing; with this injection of funds, it has just dropped to 77.4%, so it is coming down.

I have to just get this in there, Chair, but it was actually under the Labour party, in the mid-2000s, that this debt—if you looked at a graph—started to rise steeply among the water companies, and it stabilised under this Government.

Q166       Chair: I think that what we have been talking about today is the difference between raising debt to pay dividends and raising debt to invest in infrastructure, which are two completely different things.

Rebecca Pow: Yes, well, I think you have had a lot of discussion and answers about that, and about where the money goes, but, equally, Thames have not paid what they call dividends for six years, but they completely admit, and it is in their accounts, that—

Barry Gardiner: To the shareholders, they didn’t.

Rebecca Pow: The shareholders haven’t been paid the dividends but the money—

Barry Gardiner: They paid it to investors.

Rebecca Pow: But the money has gone to that service holding committee, and I will bring David in here if you want more detail on that.

Q167       Chair: The question that I was going to ask—maybe David could come in if necessary—was, are you prepared for a potential failure? If so, could you reassure the Committee, and indeed the taxpayers, that this would not be about bailing out the shareholders but about ensuring that service continues to be supplied?

Rebecca Pow: Absolutely. I think that that is a really clear message that we have to give customers. This will not affect customers. The whole point, if it was ever needed, would be that it is not a form of renationalisation—just to get that absolutely on the record—but it is a tool that is used to ensure that the services can continue and that new owners can be found.

Bulb has been referred to a number of times, and the work with DESNZ, so lessons can be learned from that. Obviously, water companies are different in the way that they are structured, but we can give absolute assurances that, if necessary, the system is there. But, I would also like to assure the Committee that we will keep the Committee informed as and when, and if necessary. However, as I said, in speaking to the chairman yesterday, we would be—it is not on the cards. We are a long way from that. There is a lot of work under way already with Thames to sort the gearing out and to ensure that the company can continue to deliver the services that customers need.

David Hill: I would just add a little to that, Chair. As the Minister said, should a special administration order ever be needed for a water company, the statutory purpose of the order would be to ensure that customers continue to receive their water and waste water services. That public-interest test is really the reason that we have a special administration regime in the statute book, in the Water Industry Act 1991. As I think David Black was saying earlier, in terms of taxpayer liabilities, it is important to note that, in the case of Thames, it is a company with £19 billion-worth of assets. Therefore, in the first instance, the task of the administrator, if appointed, would be to work with debt holders and the company to protect the interests of the taxpayer.

On your question about preparedness, obviously we need to keep all of our preparations for a whole range of scenarios up to date, and that is what we will do. However, as I think Sir Adrian indicated earlier, the liquidity statement from the company was important. I think that that is the company very clearly signalling that, with £4.4 billion of liquidity, we are some way off some of these scenarios.

Q168       Julian Sturdy: I just want to touch on worst-case scenarios, Minister. You have already mentioned that we are some way off that, which is good news, but if it was a worst-case scenario, how advanced are plans to potentially nationalise Thames Water, and have you estimated any costs of doing that?

Rebecca Pow: I reiterate that we are nowhere near that. What we do not want to do is scare people. This is being closely monitored by Thames. They are working incredibly closely with Ofwat to steer through this. Also, it is not nationalisation—I think you said that—and Government have the process and the powers, if they are needed, and will not hesitate to use them, of course. I need to give assurances that that is what would happen. The Government, the Secretary of State and Ofwat have the powers to place a company in special administration, effectively, and the point of that would be so that it could be transferred as a going concern to new owners. That would happen either on insolvency grounds, because they were unable to pay their debt, or on enforcement grounds if they were in serious breach of one of their duties.

Q169       Julian Sturdy: I understand all that, and I understand that I am talking about the worst case scenario here, but what planning has been done if that scenario does come up? What ability would there be to pass it on to another buyer? Have you looked at those options going forward? What conversations have you had with the Treasury about this?

Rebecca Pow: I will bring David in here.

David Hill: As I say, we keep all our preparations up to date for a range of scenarios, up to and including special administration, should that ever be required. It does not look imminent at this point in time, as I think both the company and the regulator said earlier. We would do all that work jointly with the Treasury and, indeed, with UKGI. Should it be required, we would be prepared for that. That said, the company has just signed off its accounts, and it has returned its various statements to Ofwat giving assurance, in the judgment of the directors, that it is a going concern—independently validated by the auditors. The focus now is on the company’s business plan.

The critical thing that the regulators need to see is the company bringing forward its business plan. I think you heard Sir Adrian Montague talking about this earlier. The company does need to prioritise as part of its business plan. There are performance issues that the company needs to address, and that is the thing that our principal focus is on for the foreseeable.

Q170       Julian Sturdy: But you still have not given me the confidence that, in this worst case scenario, those plans are there in the background ready to go. Can you confirm that?

David Hill: We keep all our preparations up to date, up to and including preparations for a special administration order, should we ever need to apply to the court for one.

Q171       Julian Sturdy: Some of the previous discussion was about Thames Water having an immediate pay-off of around £560 million of its debt in case of nationalisation. They say they do not recognise that clause. Could you shed any light on that at all?

David Hill: We saw that earlier exchange. I am afraid that we did not recognise the figure either. We will check in with the regulator and, indeed, with the company after this Committee. I think the company committed to write on that point.

Q172       Chair: Could you share that information with us if and when you get it?

David Hill: Of course.

Q173       Ian Byrne: Minister, England and Wales are international outliers on the level of water industry privatisation since 1989. Privatisation since 1989 has seen £72 billion going to shareholders, water companies building up a debt mountain of £60 billion used to finance dividends to shareholders, and our bills going up 40% in real terms. The Environment Agency has said that by 2050 some rivers will see 50% to 80% less water during the summer months because of the climate disaster. Water companies are now actually leaking away 2.4 billion litres of water every day. Every day, the water companies discharge raw sewage into our rivers and seas—over 9 million hours since 2016, and we know the consequences of that.

Catastrophically, 14% of English rivers are considered to have good ecological status. Not one reservoir has been built since 1989, and nearly 70% of the British public want water back into public ownership. Would you agree with the vast majority of the British public that the experiment of privatisation has certainly not served the best interests of this country at large?

              Rebecca Pow: Thank you for your list, sir. I want to put something on the record, Chair: if you take inflation into account, since 2020 our water bills have been pretty static.

Q174       Barry Gardiner: 2020?

              Rebecca Pow: Sorry, 2010. In 2010-11 it was £427 on average; in 2020-21, it was £426. We have to look at that in perspective and take inflation into account.

I think your main question was about privatisation, though. I reiterate that actually, England is relatively unusual in terms of its privatisation model compared with other countries, but the UK invests more per inhabitant than most of our comparable countries. That includes Germany and France. We have had increased levels of investment since privatisation, as I said at the beginning, which has resulted in a lot of benefits to—

Q175       Ian Byrne: Why do 70% of the country—this is not ideological; a lot of Conservative voters are of the same mindset. Why are they so unhappy with the current system? Why do they want to bring it back into public ownership?

              Rebecca Pow: In terms of any errors that water companies have made, I have made it absolutely clear many, many times standing at the Dispatch Box that they need to be held to account—for example, on the use of their storm sewage overflows way above what their permits allow. That is why we brought in the storm sewage overflow reduction plan, and that is why we have asked every single company to produce a plan for all their relevant storm sewage overflows. They are now with our Department; they have already come in. But it has to be said that since privatisation, we have attracted £190 billion, or about £5 billion a year, which arguably would have been very hard to—

Q176       Ian Byrne: So why have they got such record levels of dissatisfaction? Why are so many people so angry about what is happening in their communities?

              Rebecca Pow: Well, we want satisfaction as well, don’t we? I would be the first to say that water companies have to get their house in order, and that is why we are coming down so hard on them, but also why we have put so much in the Environment Act, why we have our integrated plan for water, why we had our storm sewage overflow reduction plan and why we have all our targets that they will have to deliver on.

But we also have to say that we have had some successes under privatisation. Leakage has been cut by a third; outages have been cut. I am not defending any of the recent outages we have had from some water companies—they have to get their house in order, and they are. That is what Ofwat has to do and that is what we have to oversee. We have to demonstrate to the public that a lot of good is being done for water and that water is the most critical thing going forward. That is why we brought out our integrated plan for water and why as a Government we are backing it all up with legislation and, indeed, enforcement, higher penalties and so forth.

Q177       Ian Byrne: Maybe we have to take the ideological straitjacket off and look at alternative models of ownership, because many would say that it has been a catastrophic decision to leave a public good at the mercy of the market—something that actually sustains life. Have you looked at alternative models of ownership in Government, such as those in the Welsh, Scottish and Northern Irish Waters?

              Rebecca Pow: Obviously, it is sensible to learn from other people, but I will say this in terms of Scotland, and I think David will back me up here. In England, we are now monitoring—and it is this Government who have brought in all the monitoring; that is why we really know what is happening. This happened under the Conservative Government, not the previous Labour Government. I think it was 4% of storm sewage overflows monitoring when we took over; now it is 93%, and it will be 100% by the end of the year. In Scotland, they only monitor 4% of their storm sewage overflows, and in Wales—I believe I am right, and we can send you the stats, Chair—their illegal use, basically, of storm sewage overflows is much higher than it is in England. David, you might be able to back me up on that.

Chair: We are in danger of straying into an ideological debate, when we are meant to be looking at the problems that Thames Water faces at the moment. I understand it, but the next general election will be a good opportunity to exercise these issues, Ian. 

Q178       Derek Thomas: You are right about the monitoring. The reason people might be dissatisfied is that we have provided some very transparent information about what is going on and then how we fix it. I completely get that we have engaged with the customers and told them what is expected, and that is why they are much more aware of what is going on.

My concern is that much of the water industry is owned by overseas financial investors. Do you think, with that responsibility in your portfolio, that that is acceptable for the UK customer? Should there be stricter ownership criteria?

              Rebecca Pow: Thank you for that. Yes, we do have a lot of overseas investment, but in a way, that is one of the strengths of the system. Despite all the conversations that have been going on, we have still continued to attract a great deal of overseas investment. We need to attract in overseas investment, so that we have the funding we require. Obviously, a strict eye needs to be kept on that and where it is coming from. To give reassurance, we do have a power to intervene in investments through the National Security and Investment Act 2021. Indeed, we would have the power to block an investment if it was deemed necessary. David might want to add to that.

David Hill: That is certainly true on national security grounds under the Act, which will be familiar to Mr Jones.

The other point to make about foreign investment is that there is no differentiation in terms of Ofwat’s ability to regulate and take enforcement action between whether the investor is a domestic or overseas investor. Ofwat will regulate, as it were, blind to the provenance of the investment and will go through a process of testing, in dialogue with prospective investors, any acquisitions.

Q179       Derek Thomas: We heard a lot earlier on in the session—I do not know how much you caught—about the role of Macquarie. Given the issues caused by Macquarie’s ownership of Thames Water, should we have concerns about its ownership of Southern Water and other essential infrastructure, such as the gas distribution infrastructure in the UK?

              Rebecca Pow: I overheard a bit of it; we were waiting outside the door at that point. I would reiterate that we are still continuing to attract this overseas capital, which we really need. We do have the powers to intervene if necessary, and there has been very close oversight of Macquarie and its involvement with Southern. Southern is doing the self-monitoring it needs to do. It has just put a stop on paying out any dividends as a result of one of the recent credit ratings. That did not come from Ofwat, and it did not come from us. Its board did that themselves.

If there are concerns, this is why Ofwat has very clear oversight and why it has ramped up its monitoring and its assessment of financial resilience. It is also why we put new powers in the Environment Act, which Ofwat wanted, so that it can change licences. With the changeover at Southern, there was an opportunity, with a new company coming in, to change the licence, so that it could get these resilience measures firmly embedded. For example, dividends now cannot be paid if there is any issue about the credit rating or environmental performance. That all backs up what we said to Ofwat in our strategic policy statement, which we give to Ofwat and it has to act in accordance with.

David Hill: If I may build on that answer, the important change that the Environment Act brought in is that, while previously Ofwat could vary licence conditions, it had to be done with the agreement of the company. The Act strengthens it so that Ofwat can now impose licence conditions on a company. Two of the first uses of those powers are: one, as Ofwat explained earlier, preventing money flowing out of the regulated company, in circumstances where the credit rating of the regulated company is reduced; and, two, much more explicit enforcement of a linkage between dividend payment, input and performance. That is a distinct shift, with more legal backing for Ofwat, compared with when Macquarie first entered the sector.

Rebecca Pow: Also, Treasury have just agreed that Ofwat has another £11.3 million for enforcement. That is going to go on more monitoring, more reporting and much more forensic oversight.

Derek Thomas: Thank you. I will leave it there, as I am conscious of time.

Q180       Chair: I think your office indicated that you need to be away by half-past 12 but, if you are not catching a train, could we prevail upon you for a bit longer?

Rebecca Pow: That would mean another hour.

Q181       Chair: Sorry—half-past 11. Can we prevail upon you?

Rebecca Pow: We will do our best, Chair.

Chair: Short answers would probably help in that regard, as well.

Q182       Darren Jones: This is a short question from me, on that basis. The UK is about to join the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, where companies from those member countries can sue the British Government, in a private inter-state dispute settlement scheme, for loss of expected earnings because of the actions of the British Government.

Canada and Australia are both members of CPTPP. If we end up in an environment where the Government have to take action on Thames Water, for example, and the Canadian shareholder loses out, could they bring action against the British Government to recover that amount? Has that legal risk assessment been done as part of your planning?

David Hill: I think I should take that away and give you a fuller response. Of course, the decision to enter an administration rests with the court. The Government, Secretary of State or Ofwat, with the consent of the Secretary of State, would apply to the court. In those circumstances, it would be the court making an administration order. I will talk to my lawyers but, in effect, they would be seeking to bring action against a court order.

Q183       Darren Jones: If you could write to us with your assessment, that would be helpful.

David Hill: I am happy to.

Darren Jones: I do not know the answer, which is why I am asking.

Chair: I think some lawyers could get quite rich on that. Barry has a quick point.

Q184       Barry Gardiner: Following up on the issue of foreign investors, yesterday, the Deputy Prime Minister identified China as the top security concern. You have said today that it is a good thing that we have foreign investors in Thames Water, but the Chinese Investment Corporation owns 8.7% of that. Do you think that that is a good thing, or is it something that the Deputy Prime Minister should be concerned about?

Rebecca Pow: I will refer you back to my previous answer. If there were any concerns, there are powers to intervene to block investment. We have the National Security and Investment Act, and could act accordingly with that. Unless David wants to say any more, I will leave it at that.

David Hill: I do not think there is any more we can say here about that.

Rebecca Pow: No.

Q185       Dr Hudson: Today, we have been looking at the example of Thames Water, and also at the broader implications for the resilience of the water sector across the country. The Government have said, through what is going on with Thames Water, that there is no risk of water bills going up. Given that huge infrastructure investment is required, do you feel that that position can hold? Can you reassure the public that bills will not be affected?

Rebecca Pow: As you will know, bills are capped until 2025 anyway. There is no expectation that bills will rise in the short term. They are subject to inflation—that is completely separate from what is happening to the water companies.

In terms of any potential rises to bills, that will all come out in the wash once Ofwat have gone through all the business plans for the water companies. You know how they work. They look at what water companies are required to deliver, what expectations the Government have put on them through targets, and the public’s expectations, in fairness, for the huge investment that will have to happen in future. Decisions will then be made, but I would add that we are always mindful of the effect on consumers. We have a sound system for looking after the vulnerable. Through our WaterSure scheme, 1.3 million people have already been helped. Our social tariffs, payment holidays and so forth are always there, and will continue to be. Considerations will be made about whether there might be some impact on customer bills, but we cannot say what that will be yet.

Q186       Dr Hudson: So broadly you feel that, hopefully, in terms of the five-yearly water bill review, these events should not buffet them too significantly.

Rebecca Pow: The whole reason why we have the debt and the equity is to get the big cash injection in to build the infrastructure as fast as we can, within the limits of whether we have the people and materials available to build the stuff, and so you don’t get sudden impacts on bill payers. It has always got to be smoothed out. It would not be wrong to say that the Thames tideway tunnel has been factored into bills. That was all completely understood by the people of London, and it is due to open next year. That is the way that has worked, and it is a completely separate private-public partnership.

Q187       Dr Hudson: Separate to that, the Government have made the welcome announcement that there will potentially be unlimited fines on water companies that do not play according to the rules and are not fulfilling their capabilities. Can you give reassurances to the public that if those fines are enacted—and we welcome that teeth are now being given to the regulators and enforcement agencies—it will not have any effect on water bills?

Rebecca Pow: The fines have got to come out from shareholders. No money should ever come from customers to pay for these fines.

Q188       Dr Hudson: So they should have no effect on customers’ bills.

Rebecca Pow: No. We have also set up our water restoration fund so that money from fines goes into that. That money will go back into the environment. I think you are referring to the announcement that we have just made about the variable monetary penalties. Should I talk about that now, Chair?

Q189       Chair: Do you want to briefly give that a plug?

Rebecca Pow: It is very exciting, and it is new.

Q190       Chair: Is it coincidental that it was announced just before this session?

Rebecca Pow: You know, Chair, that we have been working on this. Indeed, the right hon. Philip Dunne has worked very hard on this particular issue, as have many others. The current limit on the cap for civil penalties is £250,000. Today, we have announced that the amount will be unlimited—that is for people contravening their permits. It will be used, as and when appropriate. Obviously, there will still be the opportunity to go to the criminal court, but if appropriate, these civil penalties can be used.

Chair: Thank you. I think Alan wanted to come in briefly on the back of that question.

Q191       Alan Brown: I should put on the record that I worked for Scottish Water. The Minister referred to Scottish Water and private investment being the way forward. But it has got to the point now that Scottish Water has invested 35% more per head on average since privatisation compared with England, and the bills are lower—so investment can be done through the public body. I ask the Minister: do you believe in the “polluter pays” principle?

Rebecca Pow: The “polluter pays” principle? I would take issue, potentially, with some of the Scottish stats. I think we would need to look at those, because—

Q192       Alan Brown: I am pretty confident on those. If we move on to the “polluter pays” principle, in England and Wales, there is still a right to connect for housing developers. Last year, something like 200,000 houses were built in England and Wales connected to the sewer system. If they cause any overloading of the sewer system or additional overflow discharges, it falls on the water company and the bill payers to upgrade the sewers. In effect, that is the opposite of the “polluter pays” principle. Water bill payers in England and Wales are paying a subsidy to housing developers, because normal practice would be that the housing developers have to pay to upgrade the sewer before the houses are constructed. Why are the Government not changing that?

Rebecca Pow: I refer the hon. Gentleman to our integrated plan for water, where we cover that point specifically. All new houses have to have separate connections. I also refer him to the work we are doing with DLUHC and the housing industry to separate out those systems.

Q193       Alan Brown: That is not law yet. Is that correct? It has not been put into practice yet.

              Rebecca Pow: Many new developments already do it, but going forward, this will be what will happen. 

Q194       Alan Brown: It is not mandatory. A new housing developer can come along and connect 5,000 houses to the sewer. It is not mandatory to do sustainable drainage, and it is not mandatory for them to do a sewer upgrade. 

              Rebecca Pow: Well, it will be.

Q195       Alan Brown: When?

              Rebecca Pow: We will give you chapter and verse on the details, Chair—you did ask me for short answers.

Q196       Alan Brown: Until then, bill payers are subsidising housing developers. Isn’t that the case?

              Rebecca Pow: I have answered the question. This is being addressed. We have hundreds of thousands of Victorian houses in this country, and that is one of the problems. We have storm sewage overflows because of this system, and they had to be an extra emergency failsafe measure. We are addressing all this now, and it will be solved.

Alan Brown: We are likely to be overloaded by new houses being connected without—

Q197       Chair: I think we probably need to move on. Of course, it is the existing housing stock that causes the problem with storm water outflows. New housing has separate top water.

              Rebecca Pow: Yes, exactly.

Q198       Chair: It produces sewage, but it does not inundate the system.

              Rebecca Pow: We are also putting in sustainable urban drainage, which will also address the problem you are addressing.

Q199       Philip Dunne: Just to follow up on Neil Hudson’s comments about the regulator and the licensing regime, we heard from Ofwat earlier that they are investigating Thames Water permit breaches alongside the Environment Agency. There were 2,000 of them. That was initiated in response to a report from the Environmental Audit Committee and the new Office for Environmental Protection, which was focused on water issues; it was not stimulated by their own action and recognition of problems. Do you believe that the powers and the extra resource that they now have, which you have just been referring to, will allow the Environment Agency and Ofwat to do their job properly and investigate permit breaches as a matter of routine, rather than being prompted to do so by parliamentary and other interaction?

              Rebecca Pow: Obviously, we want them to be fully functioning and enforcing. We want clean water. I have said all the way along the line that sewage in rivers is unacceptable and that some of the stats we have had for water companies are unacceptable, which is why we have been tightening, step by step, the regulator’s powers, and why we brought forward those measures in the Environment Act, which will enable licences to be altered so that dividends cannot be paid out if there is any environmental damage or a financial issue with the credit rating. But it is also why Ofwat now have an extra £11.3 million for enforcement, and it is why we have introduced these variable monetary penalties that are uncapped.

In fairness, it is because of the monitoring we are doing as a Government that all of this has come to light. I know that the EAC and this Committee did a lot of really useful work in helping gather the evidence for lots of these things, but it is the monitoring that is bringing it all to light. It was actually our monitoring that showed that lots of these water companies were breaching their permits, and some of them did put their hands up and say, “We admit that we are using our storm sewage overflows too much.” We have this huge investigation that has been under way, and we are wading through all of this. People will be held to account if they are responsible.

Q200       Philip Dunne: So the outcomes of those investigations will be subject to the new, uncapped fining regime. Is that right?

              Rebecca Pow: People with permits—that comes under the permitting regime. There are two recourses: there are civil penalties, which are quicker to operate, but there is still the recourse to go to court.

David Hill: The EA investigation into potential permit breaches at waste water treatment works is a criminal investigation, so it would not be subject to today’s announcement, which is essentially giving them more tools in relation to civil sanctions. But for the most egregious cases, there is still the criminal route, and that is the route they have gone down for this one.

Q201       Philip Dunne: So a civil sanction can be applied for by the Environment Agency and Ofwat—or is it just the Environment Agency?

David Hill: These are Environment Agency and Natural England powers, so they are powers for the environmental regulators.

Q202       Philip Dunne: So that would apply where a campaign group identified a problem and drew it to the attention of either Natural England or the Environment Agency. Instead of being treated as a routine expense for doing business, which is how water companies have been operating, there will be a scale of fines. Are you providing advice on the level of fine for the level of severity of the problem, or is that going to be up to the EA?

              Rebecca Pow: You have highlighted a very good point, in that the system was slow before if you had to go to court. Obviously, it is all based on evidence, whichever method you use, but this could be more flexible and quicker, providing that you have the evidence to hold someone to account so that the polluter does pay. Obviously, there will be guidance on these tools.

David Hill: I will make just two points, if I may, to supplement that. One is that there are Sentencing Council guidelines as a reference point for the Environment Agency or, indeed, any other environmental regulator. And on a point of clarification, the cap that was lifted today does not just relate to water companies. It relates to any operator in scope of the environmental permitting regulations, so waste and other potential malpractice could be caught by that.

Q203       Philip Dunne: I have one final question, if I may, Chair. The water restoration fund, which I welcome without reservation, is an excellent way of ensuring that, as Alan said, the funds raised from fines go into resolving the issues—not necessarily the immediate issue, but improving water quality in the area. Can you give us any more indication of how that will work? That presumably applies only in relation to fines arising out of water pollution.

              Rebecca Pow: Yes. The criteria are being worked on now for exactly what would be most helpful for this fund to go into, but obviously it is going into improving the environment. We now have a big emphasis on catchments in everything we are doing through the integrated plan for water, because we need to work at a catchment level if we are going to have the cleanest, most wonderful water and ecologically healthy rivers. We need to work right the way up the catchment, so there will be a focus on it going into things like catchment restoration. There are already some great projects, but there will be many more of those. This would be a good use for the money.

Q204       Philip Dunne: Determined by DEFRA.

              Rebecca Pow: But there will be other categories that are being looked at right now, to make sure that the money is channelled to the most useful place and can have the quickest impact as well—potentially to be used in the area where the money came from.

Q205       Philip Dunne: Sorry, I said that was the last question, but this is supplementary to the last question. Will there be some guidance coming out of DEFRA as to how these will be deployed?

              Rebecca Pow: There will, yes. We have actually sought lots of views on this, so we have been talking to lots of different organisations and groups about where they think the best use of the money would be. 

Philip Dunne: Thank you very much.

Chair: Thank you very much. I think we will draw stumps now. I thank Mr Hill and the Minister for their time. I also thank our colleagues from the Business and Trade Committee and the Environmental Audit Committee for their cameo roles this morning.