Oral evidence: Thames Water, HC 1704
Oral evidence, 12 July 2023.
Witnesses
Alastair Cochran, Sir Adrian Montague and Cathryn Ross.
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.
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—
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?
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.
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.
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.
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.
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.
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—
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.
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.
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.
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—
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.
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.
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.
Alan Brown
And do Thames investors get any returns from Thames Tideway?
Alastair Cochran
Not directly.
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.
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.
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.
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.
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.
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.
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.
Philip Dunne
This is a culture change that we can look to for the future.
Cathryn Ross
It is.
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.
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—
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.
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.
Barry Gardiner
That is £14.5 billion, isn’t it?
Alastair Cochran
it is £14.7 billion.
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—
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—
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.
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.
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.
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—
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?
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—
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.
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.
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.
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—
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—
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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—
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.
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.
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.
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?
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.
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—
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.
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—
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.
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.
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.
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.
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.
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—
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.
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.
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.
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.
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.
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.
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—
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.
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.
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—
Barry Gardiner
It was a Government Minister, actually, as well.
Cathryn Ross
The regulatory settlements are done on a CPIH plus debt basis.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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—
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—
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.
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.
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.
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—
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.
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.
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—
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.
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—
Cat Smith
Guidelines are optional, yes?
David Black
We also have requirements of what companies publish.
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—
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.
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—
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.
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.
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.
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—
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.