21
Examination of witnesses
Emma Reynolds and David Hill.
The Chair: Good afternoon. This is the Industry and Regulators Committee of the House of Lords. This afternoon, we have a public meeting on water regulation. Our witnesses are Emma Reynolds MP, who is the Secretary of State at Defra; and David Hill, who is the Director-General of Strategy and Water at Defra. Welcome to you both.
It is some time since the committee looked in detail at the water industry and Ofwat but we are concerned on several levels, which we will raise later. Of course, since then, we have had the Cunliffe report, which was very important for the department; you are going to follow up with a White Paper, I think.
Emma Reynolds: That is right.
Q1 The Chair: Can we start with what the themes of that White Paper might be; and how the department and the Government see the water sector going forward?
Emma Reynolds: Thank you very much for inviting us to give evidence to your committee. It is a great pleasure to be here. This is my first House of Lords committee since taking this post; I did one in my previous position, as Economic Secretary, but it is good to be with you down this end of the Committee Corridor.
By way of introduction, let me just say that reforming our water system is a huge priority for this Government, one of the reasons being that it is a big priority for the British public as well. I will come to your question, but I think that it is worth laying that out to start with. We were really pleased to commission Sir Jon Cunliffe and to receive his report in July. We have seen a whole-system failure here, in the regulatory system and in other parts. We can get into that, but there has been a failure on so many levels in terms of how we have got to where we are; therefore, we need fundamental reform.
The White Paper that we will set out shortly—in the coming weeks—will have a number of themes, but top of mind is always how we can deliver the best possible outcomes for consumers and the environment. We are also looking at better strategic planning, which has been completely—not completely but largely—missing up until now. We are looking at reforming the regulators and the regulation of water; improving water infrastructure; and, crucially, making sure that we are attracting good, long-term investors into our water industry, which I worked on in previous positions when I was the Pensions Minister and, then, the Economic Secretary.
The Chair: As you say, there is quite a lot there. We agree that there has been a whole-system failure in terms of regulation; committee members will want to draw out different aspects of that. Can you give any indication of exactly what “shortly” means, in terms of the publication?
Emma Reynolds: In the coming weeks.
The Chair: This year?
Emma Reynolds: Before Christmas, we hope.
The Chair: Okay; that is helpful to know.
Q2 Viscount Trenchard: It is very nice to receive you, Secretary of State, before our committee today. Probably first among the recommendations of the White Paper is likely to be, as you have already committed, to replace Ofwat with a new single regulator. However, as you know, when you restructure any government department, agency or regulator, there is a lot of disruption and distraction from doing the job in hand. What benefits do you expect the establishment of a new single regulator to bring? Will it be worth the potential disruption and distraction that it could cause?
Emma Reynolds: The short answer to your second question is yes, but let me come back to that in more detail. The overall question is: why do we need such a big structural reform? It is because we have seen this whole-system failure, but, more specifically, because we have seen fragmentation of the regulation. At the moment, we have an economic regulator sitting with Ofwat and environmental regulation of water sitting mostly with the EA. We have seen fragmentation but we have also seen duplication—for example, water companies sometimes having to supply the same information in slightly different formats to different regulators.
We have seen, as we said at the outset, this big whole-system failure, so we have had to come forward with something that is a fundamental reform in order to ensure that we make progress. Anything that looked piecemeal—I understand the spirit of your question—would not have done the job of making the progress we need to see. You are right that there is always a risk of disruption, but we are trying to minimise that risk as much as possible.
After the water White Paper, we will set out a transition plan in the new year. We want to see the most orderly transition possible. We are already working with the Environment Agency and Ofwat to see how they can better integrate the things they are doing, particularly on a local level. We are cognisant of the risks that you point out, Viscount Trenchard, but I think that we can minimise those risks. The benefits will be better outcomes for consumers and the environment because we will have a single integrated regulator, which will avoid the gaps in regulation that we have seen and the overlaps that have, frankly, cost money. At the end of the day, that money goes to the consumer, in essence; if the water company is having to comply with two regulators doing sometimes similar things, that duplication is bad for consumers.
Viscount Trenchard: Can I move on from that a little? You mentioned the two regulators.
Emma Reynolds: Sorry—there are four.
Viscount Trenchard: The Drinking Water Inspectorate is a third regulator, I think.
Emma Reynolds: Yes.
Viscount Trenchard: Together, these three regulators already have huge, broad responsibilities for wide-ranging issues, from customer services and metering to the delivery of large infrastructure projects and the deteriorating environmental performance of water companies. I am worried about how long it will be before the new regulator can focus on these issues and how quickly it will be able to improve the management of those issues, because, at the same time, as we know, a large organisational restructuring will take up a lot of management’s time.
Emma Reynolds: Let me just clarify. There are four regulators. We are talking about Ofwat and the DWI—the Drinking Water Inspectorate—as well as a part of the Environment Agency and a part of Natural England. We are bringing those four together to make an integrated, single and more powerful regulator. We are already boosting the capacity. The reason why I keep coming back to the EA and Ofwat is because they have such a big job to do but, obviously, the other two are also important.
You asked whether we can make improvements. We are already driving improvements because both the EA and Ofwat have had increased resources to do more inspections and enforcement. The EA has increased its number of inspections and Ofwat is holding water companies to account; in fact, Ofwat has tripled its enforcement capacity since May 2023. We are already driving and working with our regulators to do more to improve the performance of the water companies, while taking this reform forward alongside that. As you say, there are always risks when you make a new organisation, but we are trying to minimise those risks. We believe that we can drive improvements at the same time as taking the reform forward.
Q3 Baroness Nichols of Selby: Will the Government legislate to give the new regulator a clear set of statutory objectives, as we have heard in the past, whether they are small or bigger and wide-ranging? Following the recommendation of the Corry review, will you consolidate and clarify the objectives of the other regulators that are sponsored by your department?
Emma Reynolds: Let me take those in order. Sir Jon Cunliffe recommended that we set clearer strategic priorities for the water regulators. We accept this recommendation. We will set out in detail how we will approach that in the forthcoming White Paper, but it will include a simpler set of statutory objectives and some guidance on the trade-offs, because there are a number of trade-offs; we may get into those in the rest of our discussion. There is certainly a feeling that, previously, there were too many objectives, particularly in terms of wider duties on Ofwat, which sometimes gave the regulator conflicting priorities and a lack of clarity on how to judge the trade-offs. Clearer direction from government will help the regulator drive better outcomes.
You asked about the other regulators. We have other regulators in our department, obviously. This links to what we are talking about. The structural reform that we are pushing for in water is a big focus of the department and is taking up a lot of resource. That is our starting point: structural reform of the regulators. We are also taking forward some of the recommendations from Dan Corry’s review, which we received earlier this year, on how we can drive outcomes towards better growth and better nature restoration through the framework that we have.
Overall, Dan Corry’s conclusion, when he looked at this in detail, was that, within the current regulatory framework—putting water to one side—there is so much more than we can do to drive different performance and different culture in those regulators, in order to drive better outcomes for nature restoration and growth in the widest possible way. Do you want to add anything, David? I am doing a lot of the talking.
David Hill: As the Secretary of State said, in the Corry review, one of Dan’s main findings was that many of the current regulatory frameworks for which Defra and its agencies are responsible are not delivering particularly good outcomes for either the environment or broader government objectives such as growth. One thing he identified was that it is often difficult for the bodies we work with, including local partners and businesses, to interact with the decision-making of the regulators. A real thrust of what he recommended was about how we can simplify that body of regulation; we have a programme of work to simplify some of our most complex regulations.
How do we get our regulators working together better? Different environmental regulators each have a part to play in relation to a scheme. It is complicated for those bringing forward big infrastructure projects to navigate that so we are piloting innovations around a single lead regulator, with one of our group of regulators taking the lead on working with big infrastructure schemes. For example, we are piloting this with the lower Thames crossing, so that there is a single front door for the scheme promoters to engage with our regulators.
Also, crucially, where we see organisations that have the capacity and capability to deliver effectively for the environment or nature, can we give them more freedom and discretion to get on with their projects without jumping through so many regulatory hoops? For example, we are partnering a pilot with the National Trust where, in effect, we would give it trusted partner status; it would not need to go through so many of the licensing and permitting requirements to deliver better nature projects on its land. It is all part of a piece to try to make the body of our regulatory frameworks work in a more agile, flexible and proportionate way.
The Chair: Thank you; that is really interesting. You just mentioned trade-offs, so Baroness Drake might want to come in here.
Q4 Baroness Drake: Staying with statutory objectives, outcomes and trade-offs, currently, the water regulators find themselves making political and distributional trade-offs between the affordability of water bills and the need for UK investment in water supply and water environment. One of my questions is: will the Government give a clear steer to the new regulator on how it should prioritise when making these trade-offs, either through statutory objectives or statutory guidance?
Emma Reynolds: We will issue statutory guidance and give much clearer prioritisation and guidance on the trade-offs. Affordability will always be one of the key issues, but consumers are also concerned about the pollution of our waterways; about the supply of water and whether there is disruption to that; and about the crumbling water infrastructure that we have inherited. Affordability is key but, when I think of myself as a consumer, I am concerned about lots of other things. It is about how we help the regulator navigate some of these trade-offs and choices. We will certainly be doing that; the regulator has not had much guidance from government on this before.
Baroness Drake: Without putting words in your mouth, do you accept the principle that the Government need to give a sense of priority when doing those trade-offs, particularly between price to the consumer and investment?
Emma Reynolds: Yes. We are also saying that, frankly, if the infrastructure is left to crumble over time, it costs more money. My predecessor used to talk about a crack in the wall: the longer you leave it, the more pronounced and more developed it gets, and the more expensive it is to fix. We have to recognise that we are working with the regulator and the regulator is working with water companies because we must ensure that we get on top of improving the infrastructure. That is why the price review and securing the £104 billion of investment—it is not all capital expenditure, but quite a significant chunk of it is—is so important.
David Hill: Just to add to that, this point about government setting a clearer articulation of national strategic priorities for the sector was a central insight of Cunliffe’s findings. The Government agree with that.
This links to Viscount Trenchard’s question about structures. There should be a high bar for making structural changes to our regulators, for all the reasons he laid out. That is important in this instance because, currently, the trade-offs that you refer to are broadly reflected in the structures of our regulatory frameworks, in that we have environmental regulation and, often, a disconnect with our economic regulation, with questions around the affordability and feasibility of some of the environmental enhancements being placed on the sector. Part of the reform is that government should set clearer priorities up front for the sector and the water system as a whole, but we also think that bringing the regulators together will make it easier to weigh in the balance how those trade-offs will be put into effect.
Q5 Viscount Thurso: Can I follow up on a comment you made in your answer to a previous question, Secretary of State—we all agree on it, I think—about the need to catch up on the backlog of investment? Do the Government accept that that will necessarily mean that water bills will continue to rise for consumers? If not, is there a necessary trade-off required with the security of water supply or environmental goals?
Emma Reynolds: If you will forgive me, I cannot speculate on future bill rises, but, as I have said, affordability must be at the heart of those discussions and future investment plans. What we, as the Government, is have done work with Ofwat to introduce a ring-fence so that the vital infrastructure investment we have agreed with the water companies can be spent only on upgrades that benefit customers and the environment. In that section of the money, if that money is not spent on investment, they will have to refund consumers via lower water bills. We are making sure that the framework does not enable the siphoning off of investment money into other priorities. The investment that we ring-fence must be spent on the upgrades, which is ultimately what consumers want to see, I think.
Viscount Thurso: Logic would dictate that, if you are going to invest many billions in upgrading a water ring main in some part of the country, say, that must be funded from either existing operational cash flow or borrowing, which obviously brings a cost with it. That has to be paid for at some point by somebody. The current structure would require it to come from raised bills or, if not there, from savings somewhere else. I am trying to see where the Government’s thinking is. There is no criticism in any direction; it is just a piece of financial logic, as it were.
David Hill: The thrust of what the Independent Water Commission was getting at on this—the Government broadly accept the analysis here—is that, if you look at the profile of investment over successive price review periods, it is extremely lumpy. In the latest price review period, we have broadly seen a quadrupling of enhancement investment spending, yet, in the previous price review period, it was a much lower figure. What that means is that there is a bill consequence. In this price review period, the average bill increase is something like 36% by the end of the period. Cunliffe rightly described that as a suboptimal system, because what we want is a much more stable and smooth profile of investment over time.
That is why the Secretary of State was talking about bringing in much more effective long-term planning. Many of the infrastructure investments are made over five, 10 or 15-year periods, so we can smooth that investment profile over time and avoid what we saw at the beginning of this price review: significant spikes in bills. I do not think that that is in the interests of consumers, and it is not easy for long-term infrastructure planning. The reforms around long-term planning are partly designed to generate a smoother profile over time and avoid bill shocks in future.
Q6 Viscount Thurso: Can I ask a slightly different question, which is on social tariffs? At the moment, every company pretty much does its own thing. Do you think that it would be a good idea if either the Government or the regulator said, “Here is a social tariff for everybody everywhere”, rather than letting the water companies do whatever they feel like, as it were?
Emma Reynolds: I understand the question. Sir Jon Cunliffe recommended that the Government should consult on a national social tariff. We are considering that recommendation, but there have been some improvements here. We will say more about them in the White Paper, but I was pleased to see that, over the price review period, there was more provision to support the poorest and most vulnerable. From this year, about 4% of households are supported—that will rise to 9%—but I recognise what you said in your question. We are also consulting on the WaterSure scheme to try to improve protection for vulnerable customers.
David Hill: As the committee will be aware, WaterSure is a statutory scheme that caps bills for lower-income customers who have higher usage due to medical need, for example, or large households. We are consulting on reforms around whether we can further improve the way in which that scheme works. Around 260,000 households currently benefit from that scheme, and the average discount is around £325, so it makes quite a significant difference to some of the most vulnerable customers.
The Chair: We have Baroness Valentine online; I hope that the technology works and that we can bring her in now.
Q7 Baroness Valentine: I hope you can hear me. Are the Government confident that the water sector will continue to attract the private investment it needs, given the political debate and broader uncertainty around the sector? How do the Government plan to ensure the continued financial sustainability of the sector, particularly in the light of the situation at Thames Water?
Emma Reynolds: The technology and sound are excellent; I am very glad that you can be with us.
Let me answer your broader question. The intention of the White Paper and following legislation is to give more long-term certainty on what we want to see from the water industry and how we want the water sector more broadly to develop over the longer term. We hope that that will give greater confidence to investors. I am a former Pensions Minister; I am keen that we attract pension investment and other long-term investment into our water industry, while recognising some of the issues you just outlined. The intention is to give that longer-term vision and make sure that the regulator has better guidance from government on priorities and trade-offs. This will, I hope, give more confidence to investors and make sure that water companies across the board can borrow less expensively—more cheaply—because they have better credit ratings. That is the intention.
David Hill: The terms of reference that the Government gave to Sir Jon Cunliffe were very explicit that the long-term investability of the sector was a key criteria for his review. The appointment of Sir Jon, as a former deputy Governor of the Bank of England, was important in that regard; he brought a great deal of expertise to these matters. It is fair to say that the response from institutional investors to his findings and recommendations has been broadly positive. Obviously, the Government will say in the White Paper how they propose to take forward the thrust of his reforms.
I note that, since the final determinations for the price review were published in December 2024, water companies have raised around £2 billion of new equity, so there is clearly an appetite out there in markets to invest in the water sector. Everything that the Secretary of State has outlined is about how we reinforce that going forward in the longer term.
Emma Reynolds: Given my previous position as Economic Secretary and Sir Jon’s previous experience, I am interested in us looking at what happened in financial services to see what the read-across could be. For example, one of the things we hear from water companies is that the current set-up does not recognise the different contexts in which they operate. We are considering what Sir Jon Cunliffe said about adopting a supervisory approach that is much more tailored towards the individual circumstances of individual companies. That is what happens at both the PRA and the FCA; obviously, I am very familiar with those regulators. There are some interesting lessons to be learned from other sectors here.
David Hill: That supervisory approach could encompass not just financial sustainability, which will be an important aspect of it, but much deeper technical expertise on the part of regulators in terms of, for example, the technical or engineering challenges facing individual water companies. Ofwat had a chief engineer on its board until the early 2010s; that was lost. As we bring in supervisory regulation for the sector, we envisage a much stronger focus on engineering expertise in the single regulator going forward, in line with Cunliffe’s recommendations. It is about making sure that those regulating have a deeper technical understanding and appreciation of the particular issues and circumstances of each company.
Baroness Valentine: I have a follow-up question but, before I move on to it, do you want to say anything about Thames Water and the financial sustainability of the sector?
Emma Reynolds: Sure. Ofwat is considering the proposal from the consortium. We cannot say much more about that, I am afraid—given that it is a live and, obviously, sensitive issue—but top of my mind is always, “What can we do to ensure that we deliver better outcomes for customers and the environment, given the situation we are in?”
Q8 Baroness Valentine: My follow-up question is about the balance between dividends and consumer costs. What is the Government’s view of the balance between ensuring that the sector continues to attract investment through the payment of dividends and the need to ensure that customers’ money is spent on vital improvements to water infrastructure?
David Hill: Shall I comment on that? Again, thinking back to my earlier answer, one of the things we asked Sir Jon to make recommendations on was how to create the climate for sustainable long-term investment in the sector. It is right that investors should be able to secure a fair return on their capital, and it is absolutely the case that the sector has a significant infrastructure investment requirement, as Viscount Thurso alluded to. The way in which the sector funds big infrastructure is to attract equity and raise debt to fund up-front investment then, over time, to recover that through customer bills—but with a smoothing effect by phasing those bills over the lifetime of the projects they are funding.
What we want to achieve is an environment in which the sector is attractive to investors and where those investors are in it for the long term, so that their planning horizons are consistent with investing in public infrastructure and utility infrastructure and they are committed—by the nature of these investments—to a long-term plan for the infrastructure they are supporting and the services over which they have stewardship. In the White Paper, we will say about more about how we will create the conditions to attract that kind of investment into the industry.
Emma Reynolds: Something I care deeply about is that I do not want to see financial engineering. I want our system to better protect against it. The regulator has some powers in this regard, but we are considering further measures to protect the consumer against value being taken out of the companies.
Q9 Viscount Chandos: It is a question of cost of capital. The shock to the system of Thames and the problems generally—all other things being equal—will make investors look for a higher return to balance what they risk, whatever improvements are introduced. If you take that to a relative extreme, what is the Government’s ultimate position if the cost of capital is too high and that leads to years or decades of higher consumer bills than are desirable or fair?
Emma Reynolds: Ideally, we want the cost of capital to be not as high. I understand why people want to talk about Thames Water, but it is worth pointing out that we have very different circumstances in different parts of the sector. Ideally, all water companies would not have high costs of capital because, as you say, they are not good for consumers; they certainly do not allow the water companies to borrow in order to invest in some of the infrastructure that we are talking about.
David Hill: There is no single answer to your question because a number of things need to be put in place to address how we create a more stable, sustainable and predictable long-term investment climate in the sector. If you look at some of the problems we have seen in the past 10 to 15 years, we have seen complex financial engineering, which has left some companies in a much less financially resilient position. We need to address that. We have also seen excessively high levels of gearing in some companies and a regulatory regime that has not always driven the outcomes we would wish to see in terms of environmental performance.
Building on what Cunliffe is recommending, we need to address all of those elements together: stable, predictable regulation with better join-up between the environmental and economic regulation; and clearer, simpler regulation. We also need to see some measures to ensure responsible stewardship of water companies, in terms of some of their financial governance and financial practices. Each of those elements contribute to the outcome you are reaching for.
Viscount Chandos: Absolutely. I hope that those reforms lead to the ideal position or something very close to it. If not, whatever those efforts are, what is the Government’s plan B or fallback position?
David Hill: It is difficult to comment on a plan B because what I hope we are conveying is that the Government are committed to a significant programme of reform for the sector, precisely because we recognise some of the risks you are highlighting. That is why, building on probably the most important review of the sector since privatisation, the legislation flowing from that review will be brought forward later in the Parliament. The changes already announced to the regulators are about ensuring that the right things are being done to address these systemic failings in the sector. It is difficult to comment on the counterfactual to that because so much effort is going into what the Government have accepted and concluded is a necessary set of changes to reform the sector. Absent those changes, many of the problems you have identified persist.
Viscount Chandos: The rate of return that investors might demand for equity investment in the water industry would be judged against the equivalent in other areas of infrastructure.
David Hill: That is a live question on which the Government have not yet reached a view. Cunliffe made some recommendations on whether there should be a common approach to setting the cost of capital across regulated utility infrastructure; we have not set out our public position on that yet, but we intend to address a range of things that Cunliffe made findings on in the White Paper.
Q10 Viscount Thurso: Very quickly, as a follow-up to that, it strikes me that utilities should not be in the growth sector of an investment portfolio. They should be in the protection sector as a solid and good but not exceptional return and, therefore, a cost of capital that is affordable. That almost certainly relies on a level of equity investment that gives the strength—a bit like tier 1 capital in the banks—where the money is, therefore, raised through bonds. That is what you would typically find. Is that a direction of travel at which the Government are looking?
Emma Reynolds: We want investors to be able to make a long-term investment that gives them a stable but, as you say, not excessive rate of return. When I was in Canada recently, I met most of the “Maple Eight”. There is already Canadian pension money and other pension investment in some of our water companies. Ideally, we want that sort of investment to ensure long-term sustainable financing for the sector over time.
Viscount Thurso: It relies on a minimum equity in the company to give the strength for the bonds that you are putting out to undertake the investment, in order to make it—I was about to say “unsexy”. I should declare an interest: I am a trustee of the Parliamentary Contributory Pension Fund; we invest in infrastructure.
Emma Reynolds: I wish you every success. I have an interest, too.
Viscount Thurso: We are doing quite well; we are in surplus. The point is that our infrastructure investments are typically things that give a nice solid return, where you are not looking to do anything other than protect. That is where utilities should be. Is that where the Government are aiming to get water to?
Emma Reynolds: Yes.
Viscount Thurso: Lovely—thank you.
Q11 Lord Teverson: Welcome, Secretary of State; it is good to see you here. I want to move on to special administration and look at it generically; we may move on to Thames Water after that. I am trying to understand how the Government view special administration. It seems to me, from looking at the recent history, that they want to lock it away, not look at it and ignore it, to a degree. On the other hand, it is an absolutely fundamental part of the original legislation on privatisation; it is the ultimate resolution of a problem. Are there any circumstances in the water industry—I am not concentrating on Thames at the minute—where the Government would ever consider using it, or is it always going to be a no-no?
Emma Reynolds: I would reject the characterisation in your question.
Lord Teverson: Surely not.
Emma Reynolds: I do not see it like that. Coming back to financial services, there is a process in financial services as well. It is always good to have contingency planning to make sure that we are prepared for different eventualities. Obviously, the criteria for entering a SAR are set out in law; two different SARs are possible with regard to water. David can come in on the detail of those.
David Hill: I would be happy to. You are absolutely right to ask: why do we have special administration in the water sector at all? It is precisely to ensure that, in the event of a water company going into administration, the safe, secure provision of services continues. That is the founding rationale for it in the legislation.
I do not recognise the characterisation that we have not paid it any attention. In the past 18 months, we have brought up to date and modernised the original legislation in the Water Industry Act; we have also passed a range of secondary legislation to bring it in line with modern insolvency law, and so on. The special administration regime for water is now up to date and available as a tool to be deployed.
Uniquely—these two grounds do not appear in other regulated sectors—there are two grounds in water on which special administration could take place under Section 24 of the 1991 Act: insolvency, which is whether a company can cover its financial obligations; and a performance special administration, which is the ground that does not exist in other regulated sectors. The evidential bar for a performance administration would be high. It has never been tested in court before. Ultimately, it is a matter for the judge, but one would expect it to be a company that was in serious breach of one of its principal statutory duties—for example, the duty to provide safe, clean drinking water—or in serious breach of an enforcement order, such that it was no longer appropriate for the company to hold its licence.
Would the Government contemplate a special administration? The Government’s actions would always be guided by what is in the best interests of the customer, the public and the continuity of services. The Government would have to make a well-evidenced case to the court, taking account of the circumstances of a water company at that particular point in time, to lay before the judge an evidenced case for an administration on performance grounds.
Q12 Lord Teverson: That is clear and useful; thank you. Coming back to Thames Water, it seems to me that this company is repeating the problems of the financial crisis, in effect, in that we almost have a “too big to fail” situation and a moral hazard: “You can do all the financial engineering you like and you’ll still be all right”. Why not go for special administration on Thames Water? In a way, if you do not do that, with all the issues that have gone on there, you are selling out the taxpayer and the consumer, because this company has got itself into this situation. We are finding every way we can to help it out, if I can put it in colloquial terms.
Emma Reynolds: I do not think that we would accept that characterisation, but—
Lord Teverson: There is a moral hazard, is there not? Surely you must accept that.
Emma Reynolds: We are working carefully with Ofwat to consider the consortium’s proposals. We are well aware of all of the different risks and we are prepared for different eventualities, including if we need a SAR, which is why we have nominated an advisory firm—FTI Consulting; that is in the public domain—to help with SAR contingency planning. We are working closely with Ofwat, and Ofwat is carefully considering the consortium’s proposals, but I do not accept some of the characterisation of the question, with the greatest possible respect.
Lord Teverson: Which bits do you not accept?
Emma Reynolds: The suggestion that we do not want to consider these things. We are, as I said, prepared for different eventualities. What we always have top of mind is: “How do we deliver the best outcome for the consumer? How might this apply in other circumstances?” We have to take the risks that you touched on into account.
Q13 Lord Teverson: Following on from that, one of the things that bill payers, taxpayers and citizens find difficult is that you have water companies—Thames is one of them, I think—asking for leniency on fines and all the bad stuff that the environmental regulators have found they have done. That is very politically difficult, is it not?
Emma Reynolds: We are clear that, if a water company breaks the law, it will be held to account by the regulators. That applies to every water company, and we expect every water company to meet its statutory obligations.
Lord Teverson: If they do not, they should take the consequences and that should not be affected in any way.
David Hill: It is worth noting as an example that, in May, Ofwat imposed a penalty of £104 million on Thames for breaches of its obligations under the wastewater treatment regulations. Even companies in distress are subject to the law; if they breach the law, the regulators will enforce accordingly.
Lord Teverson: I ask these things because I think that these are really important issues in terms of not just the environment but the feeling of justice that all of us—government and ourselves as parliamentarians—would like to see. Having been seen to be taken for a ride by the water industry because of the lax work on financial engineering by Ofwat in the past, there is a concern about the lack of justice, at the end of the day.
Emma Reynolds: I completely appreciate that. I am not a client of Thames Water but my constituents are, so I am well aware of the feeling you articulate. We inherited this problem. It is not an easy one to deal with. Top of mind is what is best for the consumer, but it is not an easy issue.
Q14 Lord Best: Secretary of State, my question may encroach on the White Paper, which is coming out in less than a month; that is good news. It is about water supplies. We see projections that there will be a huge gap between the supply we need and the demand for water. We have not built a reservoir for more than 30 years. Do you believe that steps are in train to achieve the bridging of that gap?
Emma Reynolds: Yes, but you are right to say this is a significant challenge and that we have not built a reservoir for 30 years. We are doing a number of things; I will hand over to David in a minute. My colleague, Emma Hardy—the Water Minister—chairs the Water Delivery Taskforce, which we established when we came into government to make sure that water companies and others are sitting around the table to plan their investments; and that we are able, as much as possible, to speed up the delivery of the vital infrastructure we need. We are acutely aware of some of the supply issues, particularly in some parts of the country.
David Hill: You are absolutely right, Lord Best, in terms of your description of the challenge. Our estimate is a water resource gap of around 5 billion litres per day by 2050 if no action is taken to address that gap. Broadly speaking, we have plans to address around two-thirds of that gap through demand interventions; that is, for example, action on leakage. There are plans over the next five-year period to reduce leakage by 17%, but we would expect that investment to be sustained in future price reviews.
There is significant action on smart metering as well, which all the evidence suggests has an impact on water consumption. In the current price review, there is funding available to support a rollout of more than 10 million smart meters. There are measures around water efficiency. We have plans to legislate on the mandatory labelling of white goods that use significant amounts of water. We estimate that that could address up to 20% of the supply/demand gap. It is also beneficial for consumers because it offers not only savings on water bills but significant savings on energy bills, because those goods often heat water and are quite energy-intensive—so it is important from a cost of living perspective.
On the supply side of the equation, as I discussed earlier, in this price review, we are seeing a quadrupling of enhancement spending, broadly speaking. That includes around £8 billion of investment in the five years to 2030 on water supply infrastructure. That is progressing nine new reservoirs, as well as water recycling schemes and water transfer schemes—in effect, moving water from wetter western parts of the country to drier, more water-stressed eastern parts of the country. All of those things, taken together, are about addressing the gap that you identify.
Q15 Lord Best: Have you factored in the growth in the number of data centres? How greedy are they? We hear about their supply demands.
Emma Reynolds: Yes, we have. It is a good question. I am very interested in looking at what other countries are doing on this. When I was at the G7 in Canada recently, I was talking to one of my American counterparts—they have been building data centres more quickly than we have—to see what they do, particularly in recycling water. It is definitely a factor that we are considering.
David Hill: Absolutely. The Government designated data centres as critical national infrastructure in 2024. Part of the answer to your question are the Government’s wider reforms to the planning system so that we have better join-up between future infrastructure, housing coming through the planning system and what the water supply needs for that infrastructure are likely to be, so that we can plan more effectively for all of that. We recognise that data centres are an emergent class of infrastructure that we will need to factor into future plans. Some of the work we are doing with our colleagues in the Ministry of Housing, Communities and Local Government is precisely to ensure that, as new infrastructure is brought forward through the planning system, our water sector and water supply infrastructure can cope with and accommodate it, as well as ensuring that water companies can plan their investments to accommodate it.
Lord Best: That is very important.
Q16 The Chair: Can we move on to some of the concerns that the committee had when we looked at the water industry, Ofwat and the Environment Agency? One of the things that shocked us was the fact that there was much less monitoring than we would have expected, in terms of the water environment; in particular, the Environment Agency was relying on self-reporting from water companies, which seemed not to be an ideal situation. That is partly a question of resources for agencies. Taking that into account, with your new structures, will there be sufficient resources?
There was also the problem of skills in the agencies. It is often quite difficult to attract people to work there, partly because of Civil Service pay scales—at least, that is what we were told on occasion. There is a general skills shortage that seems to hang over everything the Government want to do at the moment, but this is one particular thing that was brought to our attention. Is it taken into consideration when you are thinking about the new structures that you are implementing?
Emma Reynolds: Let me take the first question, then I will ask David to come in.
I absolutely agree that self-monitoring is not a good idea. It seems pretty self-evident to me. I want to give you a keen sense that we are not waiting for a new, more powerful, integrated regulator to move on this. This has been a key focus of our Government from day one. We have already seen £189 million—the highest amount ever—go to the Environment Agency’s water regulation and enforcement unit this year. We have seen huge increases in inspections. We need to shine a light on what is happening and the regulator needs a much more accurate picture of what is happening, rather than leaving companies basically to mark their own homework. That is what we inherited and what we are moving away from as rapidly as we possibly can. The short answer is that, yes, it will be in the new set-up, but it is already happening; it is key to driving better performance from the water companies starting now, not starting from when we have the new regulator. David, can I turn to you on the skills issue? Is there anything else you want to add?
David Hill: I want to add a couple of points on monitoring; the Government have seen the committee’s previous work on this area and accept the committee’s findings. In the period since the committee last reported on this, Environment Agency funding relating to water quality regulation enforcement has increased by 64% since 2023-24. Water company inspections, which are direct inspections by the Environment Agency, now stand at around 4,700 a year—five years ago, it was 300 to 400 a year—but there is funding available to increase that further, to 10,000 a year, which would be a really significant increase in inspections.
On monitoring, a number of things are under way. From 2024, importantly, we have had 100% monitoring of storm overflows in place. We also legislated in the Water (Special Measures) Act to bring in additional requirements for the monitoring of emergency overflows—typically, overflows at wastewater treatment centres and so on—and are working towards 50% coverage by 2030 and 100% by 2035. Additionally, we are bringing in continuous water quality monitoring, which looks at the upstream and downstream environmental impacts of discharges into rivers and watercourses. That work will be progressively rolling out from this year. We absolutely agree that we need to strengthen monitoring across the board and see it be carried forward into the new regulator.
On the point about skills, this is a challenge across many aspects of the sector.
The Chair: Indeed.
David Hill: Certainly, many of our regulators need access to specialist skills but are often at a disadvantage because those skills command a high tariff in the private sector. We have some flexibility, even in the current arrangements—the EA made some use of this last year to make a pay flex case—where we can seek to agree with the Treasury to pay a targeted uplift for certain specific skills. We are obviously open to exploring that with our colleagues at the Environment Agency for, for example, specialist engineering skills. Looking ahead, Sir Jon made some recommendations on the terms and conditions of any new regulator. No firm decisions have been made on that; it is one of the issues that we need to address when we come to the full response to Sir Jon’s recommendations.
The Chair: Thank you for citing the committee’s previous reports; we always appreciate that.
Q17 Viscount Chandos: In our previous inquiries, we heard pretty compelling evidence that nature-based and catchment-based solutions could do a lot to improve the water environment but that regulators had been cautious in allowing them, preferring concrete and steel. What are the Government going to do to open up the use of these solutions?
Emma Reynolds: We are considering the recommendations made by Sir Jon around constrained discretion. I agree with the tenor of your question, which is that we want to see more nature-based solutions. They are good for nature and biodiversity, but they are often very effective and preferable to some of the other solutions that you talked about. Obviously, it depends, case by case—you cannot make generalisations about these things—but we would like to find a way to empower the regulators to use more discretion to approve projects that focus on the delivery of the best possible outcomes for people and the environment. We think that there needs to be more emphasis on nature-based and catchment-based solutions.
David Hill: We have seen some steps towards those in the latest price review. Broadly speaking, we estimate around £3 billion-worth of schemes, including supporting nature-based solutions, being supported. Ofwat took a decision when considering funding for schemes to apply what it calls a lower-cost challenge—in effect, an efficiency challenge to these schemes and a lower percentage cost for nature-based compared to traditional infrastructure solutions. That is to try to recognise the regulatory support for more innovative approaches. We agree with the premise of your question. We do want to see environmental regulators be more innovative and creative in nature-based solutions.
This was one of the things Dan Corry made recommendations around. He made recommendations around, for example, more experimentation with regulatory sandboxes and creating a protected space for regulators to try new, different things. The Environment Agency is now running a series of pilots around nature-based solutions. We want to use those pilots to build up the evidence base, which will allow us to better score, from a cost-benefit perspective, some of these innovative solutions; we think that they have a lot of potential against some of the more traditional grey infrastructure, which is easy to score but is not necessarily delivering the best or optimal outcome.
Viscount Chandos: You have described the way in which the regulatory regime can nudge in that direction. Is it not true, though, that, ultimately, the consumer will be paying for that? What can be done, if that is the case, to sell that increase in cost to consumers?
David Hill: It is not necessarily the case that, if we had a broader evidence base for nature-based solutions, they would be intrinsically more costly. Some of the schemes that are supported are relatively low-cost, such as reed beds or so on. It is simply about establishing an equivalent body of evidence to a long-established analysis of the cost benefits of grey, traditional infrastructure. I would not have thought that it is necessarily the case that, in rolling out nature-based solutions, you must prepare consumers to pay more. It is more that we need to create the space to try some new and different things; that will enable us to make better-informed judgments about how to do those things at scale.
Viscount Chandos: It is easy, in a sense, if the cost is no higher. I suppose the question is about where it might be.
David Hill: Yes. It is about building up the evidence so that we can make broader judgments based on the facts.
Q18 Viscount Chandos: I have one granular follow-up question. Where there are prescriptive legislative targets, such as the phosphorus target in the Environment Act 2021, and those are found to be barriers to these solutions, are the Government prepared to move to amend them?
David Hill: Having the target in and of itself is important because of the impacts of phosphorus and other nutrient pollution on the environment. Our focus is less on resiling from the target; it is about the incentives that regulators offer, in terms of how that target is best achieved. We agree with the premise of your question: the regulatory system needs to be better equipped to support new and different innovative techniques to achieve the target. I do not think that we would envisage resiling from having the target itself, because there was a strong evidence base that led us to set a target for phosphorus because of its negative impacts on the environment.
Q19 Viscount Trenchard: Following on from Lord Chandos’s question, the Corry review recommended, as you know, a more proportionate, outcomes-based approach to environmental regulation, with greater discretion for firms to meet their obligations in different ways. Do you think that regulators can change sufficiently to adapt to these new approaches? Would this not require better-resourced, more expert regulators that can use judgment rather than relying on detailed rules?
I should add the second part of my question, which is about the risk that a more outcomes-based approach with less detailed rules would reduce clarity and predictability. How do you think this can be managed to ensure that it is clear that those being regulated know what their obligations are and are able to meet them?
Emma Reynolds: Let me take the first question first. We are already discussing with our regulators how they can use constrained discretion; this pertinent to the second part of your question. It is about constrained discretion; it is not about absolute discretion without any guardrails. We think that the status quo is not good for some of the growth objectives of the Government or nature restoration. We hear from some third-sector organisations that, when they try to do nature restoration projects, they have to jump through so many different hoops and it takes quite a long time. As a Government, we want them to get on and do these nature restoration projects because they are absolutely vital to us meeting our environmental targets.
We are already working with the regulators. There is a pilot in place, which David may be able to talk to in more detail, around how the regulator uses constrained discretion with trusted partners so that they can get on and do some of these things that the Government and the regulator want them to do. We are pushing ahead with that already.
David Hill: Perhaps I could just offer an example to illustrate what we are trying to get at here.
Over the summer, I visited a catchment partnership in Hampshire, working along a tributary of the River Dart. It had done some work on bringing a chalk stream back into good environmental condition. Over the course of a couple of years, it had seen a huge increase in local biodiversity and nature; it had worked in partnership with the water company, the local farmer and Natural England on the ground. It said that, had it been a bit further downstream, in what was a designated protected site, it would have struggled to have done some of the things it did. With the way the current regulations work, it would have struggled to get the regulatory permissions to modify the direction of the stream and would have been unduly constrained because the regulators would have been locked into a rules-based approach to what was and was not allowed on that site.
What we are trying to get at is a regime where, if you have local expertise in your environmental regulator, we can enable it to make informed, evidence-based judgments about what is the right thing to do for nature recovery in a place. That does not mean dispensing with the rules or environmental standards at all; it is about how you better empower it to exercise those judgments.
Forgive me—I realise that, in my opening remarks, I said the River Dart. I meant the River Test.
Emma Reynolds: I wondered where you were.
Viscount Trenchard: Which river?
David Hill: The Test.
Viscount Trenchard: The Test? Oh yes; I thought the Dart was in Devon.
David Hill: I realise I said the Dart; I meant the Test. You are quite right. I have been to the Dart as well but, to correct the record, I was talking about the Test and the projects near the Test. This is what we are trying to get at when we look at this concept of constrained discretion: how can we better empower regulators to make evidence-based judgments that do not let overly rigid rules get in their way?
The Chair: There have been similar things in the Calder Valley, which have not been quite as successful.
David Hill: Yes.
Q20 The Chair: You just mentioned constrained discretion. You talked earlier about trusted partnership schemes with the National Trust and a new approach, with a single front door for infrastructure. There is clearly quite a lot that you can do without changing regulations or without legislation, but you mentioned right at the beginning that the White Paper will look at the need for future regulation and future legislation. You have lots that is changing at the same time. You have the different attitude to investment that you are trying to get, and you have the Government’s growth agenda to consider as well. This will be quite challenging, and you will need whole-of-government buy-in from the Treasury and whatever. How much of what you want to do will depend on new legislation?
Emma Reynolds: Quite a lot but not all; that would be my summary. We will need new legislation to have a new, single, integrated regulator. We cannot do that without legislation, but what we can do is put a transition plan in place and discuss—we are doing this already—with our colleagues at the Environment Agency and Ofwat what they can do on the ground to integrate the way they work. They are already doing this and are very open to doing it better. Whereas, in future, some of those people will be in the same organisation, what we are driving at is getting them to work more closely now before putting them in the same organisation.
We are already doing things, as we have talked about, which can help improve the system, clean up the waterways and deliver better outcomes for the consumer and the environment. However, because this has been such a big failure of both regulation and the way in which the system works, we have to have legislation to underpin some of the more fundamental regulatory changes that we need to make.
The Chair: There is always a lot of competition for legislative slots; I speak as a former business manager.
Emma Reynolds: Indeed.
The Chair: One of the ways to make that easier is to offer pre-legislative scrutiny as a means of making sure, when you do get such significant changes going through. I do not expect you to commit to that instantly, but it is something that the department might take on board.
Emma Reynolds: I understand the question. We have had the Independent Water Commission, with its significant analysis of where we are now and the recommendations that it set out; it also consulted and talked to different stakeholders. We have the Water White Paper, which will involve a period of consultation. I feel that we are doing a significant amount of consultation anyway.
In terms of whether this is a priority for the Government and the business managers, I used to work for a Chief Whip after you were the Chief Whip, a few years later, in the previous Labour Government. This is a priority for the Government, partly because we promised to sort this out in our manifesto but also because, if you look at the polling, this is in the top five issues for the public pretty consistently. That was not the case previously—I stood in 2019, 2015 and 2010—because I do not think that the scale of the challenge and the awful outcomes that we have seen were appreciated as much by all of us.
However, as the committee has made clear in some of the questions that were asked about the situation we find ourselves in, the public are very concerned about the water industry and the water sector. We have to rise to that challenge. We promised that we would do so in the manifesto, but it is consistently a top five issue. It is something of which the whole of government is aware, so I am confident that we can have a discussion with colleagues about those decisions, in terms of timing and legislation, when we get to them.
The Chair: It was exactly those concerns that made this committee decide to have its inquiry into the water industry. We wish you well in trying to change the whole structure and outlook, in terms of what will be happening; it is challenging, so we wish you well. Thank you for your evidence this afternoon.
