Oral evidence: Thames Water Finances, HC 402

Oral evidence, 12 December 2023.

Witnesses

Alastair Cochran, Sir Adrian Montague CBE and Cathryn Ross.

Chair

Welcome to this special session of the Environment, Food and Rural Affairs Select Committee. We are very pleased that the senior management at Thames Water have come in to talk to us and to hopefully clarify the situation on some of the items that have been reported in the press, which seem to be at some odds with what we were led to believe the last time you arrived, but no doubt that will all become clear. The second part of this session will be with Ofwat, the regulator. Could I ask our witnesses to introduce themselves briefly, starting with Sir Adrian?

Sir Adrian Montague

I am the Chair of Thames Water and of Kemble as well. I took up those positions on about 10 July.

Cathryn Ross

I am one of the interim Co-Chief Executives of Thames Water.

Alastair Cochran

Good afternoon. I am Co-Chief Executive and Chief Financial Officer.

Chair

Yes, so it is probably a good idea to start with you. You published your annual accounts recently. When you appeared before the Committee in July, you said that you were brought in with a whole new executive team to turn around Thames Water. How is that going?

Sir Adrian Montague

Sir Robert, would you mind if I just started with an apology? An apology is in order. As you said, when we were here in July we described the shareholders’ contribution of £500 million as equity. That is a description that has been fiercely challenged.

Chair

Yes. We are going to come on to that on question 3, but you can make a brief statement to start.

Sir Adrian Montague

We stand by what we said, and I will explain why when we get to question 3. However, we were not clear enough in unpacking the different elements of the shareholders’ contribution, so I am sorry if we caused any confusion.

Chair

Yes. No doubt we will explore that in a little bit more depth when we come on to Mr Gardiner’s questions. Alastair, how is the turnaround going? I know that the previous management resigned two years into an eight-year plan, and you guys came in to, would it be right to day, pick up the pieces or continue the great work?

Alastair Cochran

It is a combination of both, I suspect. How is it going? When we were last here, we explained that we were pivoting away from an eight-year turnaround plan. We were refocusing that plan. On the back of that, we have over the course of the autumn defined a three-year turnaround plan to deliver an improvement in both operational and financial performance. At the same time, we have submitted our business plan for the next regulatory review to the Committee, so it has been a very busy six months. You certainly have seen our results from last week, the first six months of this year. As part of that turnaround plan, we are now focusing on six core operational priorities. They are aligned to what our customers care about the most. In three of those we have demonstrated and delivered improvement over the first six months of this year, albeit I would stress that this turnaround will take some time. We will not complete the job in three years. It will take both this—

Chair

Is your three-year turnaround just basically the first three years of the eight-year plan or are there some fundamental changes that you have made?

Alastair Cochran

It will deliver substantial improvements in those six key priorities. For example, in water quality, which is the most important measure for our customers, that they get safe, clean drinking water, we are targeting an 80% reduction in what is called the compliance risk, the risk of not having safe water. In fact, we delivered that in the first six months, so good progress on the most important measure for our customers. However, we are cognisant that we still have to do a better job on a number of other measures where we are falling short. For example—

Chair

Leaks, for example?

Alastair Cochran

—on pollutions, our performance is not good enough. We reported 257 pollutions in the first half, so that was an increase of 40 on the prior period. Our complaints from customers increased to just over 38,000 after two very good years of reducing that. Our health and safety performance, measured by lost time, injury and frequency rate, also increased a fraction. There is a lot to do, but we do believe we have a comprehensive plan in place that over three years will deliver material improvements in performance for our customers.

Chair

You are planning to do in three years what might have taken five under the old plan? Has carbon neutrality become less important compared with sewage discharges? What are the decisions that were made at board level that this plan will be a better and more effective plan and a plan that is more financially viable for the company?

Alastair Cochran

There are two things to highlight in particular. First of all, the reflection that we as a board and an executive management team came to over the course of the spring and summer last year was that we simply could not deliver everything at once. It was not feasible, nor was it sustainable. Therefore, we did have to prioritise and hence why we focus on those six core operational priorities. We have also made a large number of changes to how we are prosecuting that plan. It is now a data-driven plan. It focuses on the root causes of underperformance and discrete and direct interventions to change and improve those root causes. We are dedicating resources to it. Instead of asking our people to not only deliver their day job but to also deliver turnaround, we have dedicated resource focused exclusively on the turnaround while other individuals, other colleagues, focus on delivering business as usual. There are a large number of changes. We are also simplifying our processes and our systems, and we continue to invest in improving services. One of the highlights of the last six months was a record £1 billion of investment into our assets to improve performance for our customers and the environment.

Chair

In terms of the financial performance of the company, your pre-tax profits fell 54% in the six months to September, while your revenues climbed 12%. Is this the impact of interest rates on a very highly geared company or are there other factors that have come into play?

Alastair Cochran

It is not that at all. Our underlying profitability improved. The cash measure of profit, EBITDA, is up 22%. We hedge through derivative instruments, so swaps, exposure to interest rates, foreign exchange changes and inflation. Those swaps are designed to protect customers so we can plan ahead and invest. The consequence of putting those swaps in place is that every six months we have to review the balance sheet value of those swaps. Accounting rules require us to reflect the change in that balance sheet value through the P&L. It does introduce some volatility into our reported profit. The true test is if you look at our cash profit it was up and, indeed, our operating cash flow was up. It is that operating cash flow that is so important that underpins the increased investment.

Chair

We are going to go into the debt situation in more detail with Mr Byrne later on. The shares are not traded, as many companies are, openly on the stock market, but we did notice that the Ontario Municipal Employees Retirement System, OMERS, had written down its stake in Thames Water by 30%. Is that a reflection of the core value of the company, so if it had been a quoted company your shares would have fallen 30%? For what reason has it done that, just to take into account some of these debt issues and the expectations of the pensions it will be paying out?

Alastair Cochran

It is its view of the valuation of the company. You are right; we do not have publicly quoted shares, so we do not have a transparent, liquid share price to measure the value of the company. Each of our investors will periodically review what they think the value of the investment is. If it declines, they are required under their rules to write that down. It reflects the value of the business as they see it at a particular point in time.

Chair

If you have a company that is 80% geared and its value falls by 30%, does that mean you are, in effect, in negative equity or is that not something that concerns you?

Alastair Cochran

No, there is certainly equity value. It did not write it off completely, to the best of my knowledge. There still is some equity value. Clearly, the value—

Chair

You see the point I am making. If I have a house with an 80% mortgage and the value of the house falls by 30%, I owe more than I own. Does that parallel work or am I very naive in my understanding of the finances of big companies like yours?

Alastair Cochran

You are right; there is a thinner equity buffer, if you like. The valuation of the equity is much more sensitive to the overall enterprise value. It is the value of the equity and the debt added up. If the debt was worth more than the company value that is when you would get negative equity value, as you can do in a house. In our scenario, OMERS has not written it down to zero, to the best of my knowledge and, therefore, it still believes there is some equity value in this company.

Chair

Will that impact the level of risk for your credit rating and the levels of interest you might need to pay on borrowings or is it because a lot of the borrowing is from your owners, in effect, that they take a slightly different view than an external bank that would be looking at risk much more seriously?

Alastair Cochran

Lenders will take a different perspective. They will typically look at the credit rating of a company. We have a strong triple B credit rating that allows us to borrow money at reasonably attractive rates of return. Of course, those interest rates have risen as interest rates have increased over the last 18 months. The question for an equity provider ultimately—like OMERS and USS and others that we have—is whether the return they will get from putting more money into a company will deliver an adequate return for the risk they are taking on board. That is a judgment they will take from time to time as and when they are asked to provide additional equity.

Chair

Thank you. Apologies for making you answer all the questions, but as Finance Director they were particularly important. Barry Gardiner, I will turn to you.

Barry Gardiner

Mr Cochran, when you appeared before this Committee in July you will recall that I asked you about the way in which a clause had been included in a previous debt issue that would have required the immediate payback of £560 million of outstanding debt in the event of nationalisation. You claimed not to recognise either the figure or the clause. I think there were four senior secured notes that contained the nationalisation clause. They were in 2018 and 2019. I was surprised, given that you had been and still are the Chief Financial Officer, that you were unaware of that, but you kindly agreed to investigate and write to us. Why did you not do so?

Alastair Cochran

We did write to you after the Committee. If you have not seen that letter, I will quite happily—

Barry Gardiner

I checked with the Committee Clerk earlier today and no such letter was received by them.

Alastair Cochran

I can just reiterate that we did.

Barry Gardiner

Thank you for that. The purpose of the four senior secured notes that were issued privately in 2018 and 2019 by Kemble Water Finance was to insulate the structurally senior bits of the company—that is those bits in the holding group outside what the public would recognise as Thames Water—from the potential financial losses that they would incur if Thames Water were to collapse to such a point it had to be nationalised. Is that correct?

Alastair Cochran

There is no obligation for those loans to be repaid in the event of nationalisation.

Barry Gardiner

There is not?

Alastair Cochran

No.

Barry Gardiner

What were those clauses doing?

Alastair Cochran

It was explained to me that they were designed to provide some protection to creditors, but they—

Barry Gardiner

Against nationalisation.

Alastair Cochran

As I say, they—

Barry Gardiner

Are you saying that those clauses were poorly written and did not provide the protection they were supposed to?

Alastair Cochran

That is correct.

Barry Gardiner

Sir Adrian, does Kemble Water generate any income aside from that drawn from Thames Water?

Sir Adrian Montague

Not materially.

Barry Gardiner

Just so that we are absolutely clear, Kemble Water Holdings Limited’s annual report says there is a separately managed property business through which you sell land and other property that is no longer required by the appointed business. Can I take it that the “appointed business” is Thames Water? Is that correct?

Sir Adrian Montague

Yes.

Barry Gardiner

Fine. Everything that comes to Kemble is from Thames. That is what I wanted to establish. You are the Chairman of Thames Water?

Sir Adrian Montague

I am the Chairman of Thames Water.

Barry Gardiner

You are also the Executive Chairman of Kemble Water, all the other directors being non-executive. Is that correct?

Sir Adrian Montague

I don’t recognise “Executive Chairman”. I am certainly the Chairman of that company.

Barry Gardiner

Okay, but all the other directors are non-executive?

Sir Adrian Montague

As I think I am as well.

Barry Gardiner

The accounts of both companies are filed from the same address and by the same company secretary. Is that correct?

Sir Adrian Montague

Yes.

Barry Gardiner

From the point of view of a lay member of the public, they might struggle to see how Kemble Water is not the same thing as Thames Water, but you and I will accept that legally, in company law, they are separate. When we last met in July we discussed the way in which Macquarie, a previous owner of Thames Water, had piled the company with debt and extracted huge dividends, weakening the company financially such that it struggled to carry out some of its vital public-facing obligations. You were kind enough to reassure me that this could not happen now. Indeed, you said it was ancient history if I recall. Is that your recollection as well? Sir Adrian Montague indicated assent.

Barry Gardiner

Yes. It is important to understand why it is that the £500 million of what you insist in your letter to this Committee is new equity is, in fact, new equity and not debt that Kemble Water could use to extract excessive payments from Thames Water, just as Macquarie did. I take it that we are agreed that that is the essential purpose of this session.

Sir Adrian Montague

Exactly right.

Barry Gardiner

Because, of course, that is what you have been accused in the media of doing, the same thing as Macquarie. We are agreed that originally the £500 million was not provided directly to Thames Water Utilities Limited but to Kemble Water Holdings as what we technically refer to as a convertible note with 8% interest attached. The debt is held by Kemble Water Holdings, is that correct? Sir Adrian Montague indicated assent.

Barry Gardiner

Okay. The money when it was cascaded down to Thames Water Utilities Limited became equity.

Chair

Nods do not work on Hansard. If you would like to just say—

Sir Adrian Montague

Yes, that is correct. All those propositions are correct.

Chair

We can all see you nodding, Sir Adrian.

Barry Gardiner

The transcript will record that Sir Adrian Montague nodded his assent, yes. Of course, when you take an equity stake in a company, you normally get shares in return. However, when Kemble Water Finance gave the money to Thames Water it could not take shares because it was already 100% owner of the company so it would have been a bit odd, wouldn’t it? That is why it might have looked odd. Let’s focus on this convertible note.

Sir Adrian Montague

Willingly.

Barry Gardiner

That was the one that was provided to Kemble Water. If I may quote Julia Roberts in “Pretty Woman”, “Slippery little suckers”, aren’t they, those convertible notes? One of the main distinctions between equity and debt for a convertible note is, first and foremost, whether the conversion is mandatory. Do you agree? If the holder can decide not to convert, it is not really regarded as equity from the ratings point of view. It looks like debt. Would you agree?

Sir Adrian Montague

It may help if I say that I agree that that note is debt.

Barry Gardiner

The £500 million convertible note with 8% interest that Kemble Water received, is the conversion mandatory?

Sir Adrian Montague

I don’t believe so. I think it can be repaid, but the expectation is that it will not be repaid, and it will be converted.

Barry Gardiner

If the holder can decide not to convert, it is not regarded as equity?

Sir Adrian Montague

I don’t think it is equity. To be clear, I do not think it is equity. It is not our proposition that that note constituted equity.

Barry Gardiner

The second distinction between equity and debt for a convertible note is whether the coupon is required to be paid in cash according to a schedule or can be compounded and paid at a later date. If it is a cash payment, it looks like debt. If it can be compounded and paid later, it is regarded as equity. You agree. Does the £500 million convertible note require cash settlement?

Sir Adrian Montague

No.

Barry Gardiner

It doesn’t?

Sir Adrian Montague

The provision is that outstanding payments, interest payments, are satisfied by further notes, so the interest is rolled up and carried forward to a future date.

Barry Gardiner

That makes it look more like equity, doesn’t it? Would you agree?

Sir Adrian Montague

It could be.

Barry Gardiner

From a ratings point of view, you and I know that it would be regarded more as equity because it can be compounded and paid at a later date.

Sir Adrian Montague

I think it is properly categorised in the accounts as debt. It is not our proposition that it is actually equity. It looks a bit like equity, but it is correctly categorised as debt.

Barry Gardiner

The other important thing about convertible notes is their tax treatment. If the coupon is tax deductible, it clearly indicates that the convertible is debt, and the issuer has told the tax authorities it is a debt. Please tell us how the coupon is treated for tax purposes.

Sir Adrian Montague

I do not think I can answer that question. Mr Cochran may be able to help.

Barry Gardiner

You would not wish this Committee to think that you had structured this £500 million in such a way that you could claim to us it is equity but then claim to the tax authorities that it is debt, would you?

Sir Adrian Montague

I am not claiming to you that it is equity.

Barry Gardiner

No, but I am asking you to claim something, Sir Adrian.

Sir Adrian Montague

I am claiming—

Barry Gardiner

I want to know what the tax treatment is.

Sir Adrian Montague

I am telling you that it is in our accounts we believe accurately categorised as debt. I am afraid I cannot answer the question about tax deductibility. We can certainly write to you on that subject immediately afterwards, Mr Gardiner.

Barry Gardiner

This matters because, of course, you have told us that Kemble Water generates its income exclusively from dividends received from Thames Water. If Kemble Water needs to service its debt or faces some other financial difficulty, where would it look to get the money from except from Thames Water and its bill payers?

Sir Adrian Montague

The practice is that it draws the revenue it needs to pay interest and eventually repay the debt from distributions from Thames Water.

Barry Gardiner

That is just what I said, isn’t it?

Sir Adrian Montague

Yes, I am agreeing with you.

Barry Gardiner

In other words, ultimately it would be Thames Water and the bill payers that ended up paying for whatever trouble the holding company got itself into. You have structured it differently, I will grant you that, but this is exactly what Macquarie did and what you denied could happen under your chairmanship to this Committee only five months ago.

Sir Adrian Montague

There is a very important difference. Thames Water pays those dividends if it seems in the best interests of Thames Water to do so. It is not obligatory for Thames Water to pay those dividends. The Kemble lenders—

Barry Gardiner

You have told us it is not obligatory either for Kemble Water to pay in a scheduled way the interest that is due on the note.

Sir Adrian Montague

Forgive me. I think it is important to separate different debt instruments at the level of Kemble.

Barry Gardiner

Slippery little suckers, aren’t they?

Sir Adrian Montague

No, because there is this convertible note, which we say is debt and I think you are agreeing with me, and there are separately some borrowings that Kemble Finance has taken on in the past that will need to be serviced in the usual way. It is those borrowings for which in the past Thames Water has paid dividends to put Kemble in the position where it can service that debt. We are under no obligations to do so, and we do so if it is considered in the interests of Thames Water. Perhaps if I can—

Barry Gardiner

In October you paid £37.5 million dividend to your parent company. We understand that Ofwat may be deciding whether or not to investigate that payment as a potential breach of your licensing conditions. You would agree with that?

Sir Adrian Montague

It is seeking clarification. It is not at this stage investigating.

Barry Gardiner

No, I said it is considering. Is it appropriate to be paying dividends at the same time as failing to meet key environmental and performance targets? You said that you would only pay those dividends in the situation that it was in Thames Water’s best interests to do so. It seems to me that it may well have been in Kemble Holdings’ best interests to do so.

Sir Adrian Montague

Well, I think it is true that it was in Kemble’s interest to receive the payments from Thames. That is clearly right, because otherwise it would not have had the means to discharge those interest payments. Can I turn to the position of the Thames board because I do think this is very important and the crux of the issue?

Barry Gardiner

Please.

Sir Adrian Montague

I think we are agreed that Thames is under no obligation to pay dividends to Kemble. It is a dividend. It is a discretionary payment within the control of the Thames board.

Barry Gardiner

It is not a debt. We are agreed.

Sir Adrian Montague

These payments to Kemble are not new. Thames has been making those dividend payments consistently since 2017. I think we are also agreed that Kemble’s solvency is reliant on those dividends. That is my proposition; I guess you would agree with it. If Kemble was allowed to go into default, our concern from the Thames board perspective is that that would curtail or at least derail the possibility of receiving further equity from our shareholders. Without that equity, we are going to have to curtail expenditure and that would be unfortunate for our customers.

Barry Gardiner

Absolutely. Look, I understand what you are saying, and I agree. It would be extremely unfortunate. That is why I would question the £37.5 million dividend payment that you did make. You are aware that, given the situation with Ofwat and its potential to investigate that and the controls that it has taken to itself, Ofwat could potentially fine you 10% of your revenues for the breach of your environmental and performance targets. That would blow a hole in the capacity of the holding company to be in the position that you want it to be in and why you say you paid the £37.5 million in the first place.

Sir Adrian Montague

Long story short, we paid that £37 million to keep Kemble secure. We need to keep Kemble secure because a failure to do so will prejudice our new equity, and our new equity is needed to sustain the provision of services to our customers in the long term. We said in our business plan—and we have said consistently—that to some Thames is faced with a pretty unappetising series of choices on the way forward. We took that decision in October because we wanted to preserve the corporate structure of interest to Thames because it allows us to access new equity. That is the key thing here. We must have new equity as the shareholders have conditionally agreed to subscribe for.

Barry Gardiner

To what extent does Ofwat’s controls of dividend payments threaten the business model that you have established, though? It is clamping down on your ability to make dividend payments to the holding company. Without those dividend payments, you have just admitted to this Committee that the prospects of you securing additional investment from shareholders recede. I will not say it reduces to zero, but I will be charitable and say it recedes. How are the controls and constraints that Ofwat can put on you, which are for the public benefit—maybe not for the company’s benefit, but for the public benefit—going to impact on your ability to secure that investment? Previously, you told this Committee that your investors wanted to see Ofwat relaxing its controls and not imposing fines.

Sir Adrian Montague

Not quite the same thing. Perhaps I will ask Cathryn to elaborate on that in a few minutes. Ofwat’s new provisions regarding dividend came into effect, from memory, in March or May this year. We had submitted our dividend policy to Ofwat ahead of that time and it had given it a green light. Our discussion and the areas where Ofwat is seeking clarification are to understand how the dividend we declared sits in relation to that dividend policy. If you like, perhaps Cathryn can pick up the other point that you mentioned.

Barry Gardiner

We will move on to that shortly then. In your discussion with the Chairman—or perhaps it was Mr Cochran, sorry—you said if the debt amounted to more than the company value, then it would be written down to zero, but OMERS had not done that, to the best of your knowledge. However, it is only looking at Thames Water, isn’t it? That is why you have had to put debt into the holding company. If anybody looked at all this together, you have what the market describes habitually as a byzantine structure with Kemble Holdings, Kemble Finance—

Sir Adrian Montague

We can certainly agree it is complex.

Barry Gardiner

If anybody looks at that whole structure, the game is up. Last time, when you were assuring us that this was new equity finance coming in, you did not explain just what a slippery trick you were using with those notes and that was the point, I think, of your apology to the Chair at the beginning.

Sir Adrian Montague

No. To be fair, we have missed an element, Mr Gardiner. I think that I do need to mention this for completeness. I think it is common ground between us that the moneys came into Kemble as debt in this slightly strange convertible note that we have already discussed once.

Barry Gardiner

Well, it faces both ways, for the reasons that we outlined, and I know each convertible note is very carefully structured to do what you want it to do in this byzantine world. However, I do still want your written response about how it is treated for tax purposes.

Sir Adrian Montague

We will certainly provide you with that.

Barry Gardiner

I think that is key.

Sir Adrian Montague

We are very happy to provide you with that. However, once the money was received by Kemble Holdings it was successively passed down through this byzantine, to use your word, complex chain, to use my words, of companies. When it got to what we describe as the ringfenced group, which is the operating group of the three companies at the foot of the chain—

Barry Gardiner

What people would recognise as Thames Water.

Sir Adrian Montague

At that stage it was applied in the purchase of new shares. I think that is the key point. Once you have new ordinary shares, as it happens, no bells and whistles, just ordinary shares, they were subscribed by Thames Water Utilities Holdings, the immediate parent company, and the proceeds of that application were passed down to Thames Water. That is the reason why we believe the transactions are correctly described as equity to Thames Water.

Barry Gardiner

I understand that. You will understand why anyone looking at this says they have taken on debt as a group. They have translated it into equity when it comes into the regulated asset. That regulated asset does not have to pay a dividend and, therefore, it can be regarded as not being a debt. The trouble is when that debt is called in and the holding group has no money to pay it, the only place it can get it from is from Thames Water, and that means the bill payers.

Sir Adrian Montague

Don’t forget that we have two classes of debt at the level of Kemble. We have the convertible debt to the shareholders, which as we have said is not like an ordinary, straightforward instrument. It is not like a straightforward instrument because they are shareholders, and this is a loan with special characteristics because they are shareholders.

Barry Gardiner

But it is at 8% interest.

Sir Adrian Montague

This was settled in the light of market conditions at the time. In our capital raising in October, from memory we paid 8.25%, so it was in the realm. That interest is always satisfied in notes. It is rolled up. It is no cash drain to the company on account of interest. If we agree that that is in one pocket, the other pocket contains all the market borrowings of Kemble. It too depends on a flow of dividends from Thames Water. I do not think there is any suggestion that that is not the case. There is an instalment that will fall due early next year, in April, as has been reported in the press.

Barry Gardiner

That is £2.6 billion.

Sir Adrian Montague

No, £190 million.

Barry Gardiner

Sorry, that is the £190 million, yes.

Sir Adrian Montague

We will talk to the lenders about that maturity early in the new year. Our proposition to the lenders is going to be please will you extend the maturity, because everything about Thames Water will be much clearer from a financial perspective after we have received Ofwat’s determination, preliminary in June and final in December. Then it will be much easier to see Thames’s future and to decide how to restructure that debt.

Barry Gardiner

That determination from Ofwat could go against you, couldn’t it?

Sir Adrian Montague

It could, certainly.

Barry Gardiner

Given the changes that were made at the beginning of the year that you referred to earlier in Ofwat’s capacity for enforcement, it is more likely to go against you than it would have been at the beginning of the year.

Sir Adrian Montague

I do not think that is a conclusion you should be drawing. It has enhanced controls over dividend payments, but this is a core feature of many groups’ financing plans. I am sure you will ask Ofwat this yourself, but many companies in the utilities sector have this structure.

Barry Gardiner

The £2.6 billion that I was referring to of debt in the parent company, when does that have to be repaid?

Sir Adrian Montague

I must ask Mr Cochran to help here.

Alastair Cochran

There is £1.35 billion of external debt that is owed by the holding company. The maturities range from April 2024 through to 2028.

Barry Gardiner

Sorry, just remind me. The first payment is due in April. What amount is due to be paid in April?

Alastair Cochran

It is £190 million, one, nine, zero.

Barry Gardiner

Does the holding company have that money?

Alastair Cochran

Not currently, no.

Barry Gardiner

Where does it propose to get it from?

Alastair Cochran

That is exactly why Sir Adrian said the shareholders are proposing to discuss with lenders the options for extending that facility until such time as we have clarity on PR24 and, indeed, the equity subscriptions by shareholders. Typically what would happen is if there was that clarity, particularly around future equity flow, which is so important to increase investment for our customers and the environment, if you have that clarity, lenders are then willing to refinance that facility in the normal way that many companies and, indeed, Kemble have done in the past.

Barry Gardiner

Ms Ross, you were going to come in and elaborate on what Sir Adrian had said.

Cathryn Ross

I do just want to clarify one of the things that Sir Adrian was saying. I think you referred to Ofwat taking new powers. Sir Adrian was right, Ofwat did reach the end of its consultation and make a formal decision to amend company licences earlier this year, but I do not believe that those provisions actually enter into force until April 2025, at the start of the new control period. What those provisions do is they give Ofwat the ability—and I am emphasising the word “ability” because this is rather important—to place the regulated business in what it calls cash lock-up, so no cash must leave the regulated business, if the credit rating of that regulated company drops to one notch above investment grade. The reason I am emphasising the fact that the new provisions in the licence give Ofwat the ability is that—and you will need to explore this with Ofwat, of course—I do not think Ofwat would regard that as an automatic thing that it would do. I think that it would want to look at the circumstances of the case and decide whether that cash lock-up was in the round in the best interests of the regulated business. If we were to be in that situation, that is the conversation we would have with Ofwat at that point, but I do not think it is automatic.

Barry Gardiner

Thank you for that clarification. When we last met, I asked you and Mr Cochran about the redundancies that the company was proposing to make. Mr Cochran, I think you said that you did not recognise any redundancies. Since then, how many redundancies have there been?

Cathryn Ross

We are currently consulting on 172 redundancies.

Barry Gardiner

Yes, and a further 90 for the end of the year, is that right?

Cathryn Ross

I am currently aware that we are consulting on 172, of which 56 are voluntary and 116 we currently envisage as compulsory.

Barry Gardiner

Those redundancies you are aware are preventing you currently from performing some of your statutory duties?

Cathryn Ross

I would not accept that.

Barry Gardiner

You would not accept that. If we look at the review of leak allowances, what percentage of leak allowances are you able to review at the moment?

Cathryn Ross

In terms of our leakage performance?

Barry Gardiner

No, your leak allowance. You know what a leak allowance is just as well as I do.

Cathryn Ross

I am not sure I do. I know what leakage target we—

Barry Gardiner

Goodness me. A leak allowance is when somebody says there is a leak from their supply and that they are paying too much for their water as a result of that and you then make an allowance because of the leak.

Cathryn Ross

I understand.

Barry Gardiner

You are obliged to conduct a review of the leak and the leak allowance. You are not doing that, though, at the moment in many cases, are you?

Cathryn Ross

We have changed our policy, and our policy is switching to asking customers to pay to fix their own leaks. As far as I was aware, we are still reviewing the leak allowance that we give to the customer. I do not think we have stopped doing that activity.

Barry Gardiner

That is not what has been reported to Ofwat from other sources.

Cathryn Ross

I have not heard what has been reported to Ofwat.

Barry Gardiner

Up to 40% of leak reviews are not taking place.

Cathryn Ross

I can look into that and come back to you. I haven’t got the statistics.

Barry Gardiner

How is it appropriate to be sacking, making redundant, 171 posts when you are not able to perform your key environmental and performance targets? You are reducing your capacity to deliver on your essential functions.

Cathryn Ross

I would not accept that. What we are doing, and it is the same as any business in any environment does, is looking at the resources that we have available to us in terms of people and money, and we are trying to make sure that we are aligning those resources with the priorities of our customers.

Barry Gardiner

The reason that you are not able to perform those tasks has nothing to do with the staffing levels that you have in place to complete those tasks?

Cathryn Ross

I certainly do not believe that the redundancies that we are currently consulting on, and I stress that we are consulting on those redundancies, are related to our reduction in looking into leak investigations and leak allowances for customers.

Barry Gardiner

Or any other key performance targets.

Cathryn Ross

The majority of those redundancies that we are proposing are in the retail area. A significant proportion is in our digital team, so looking at our systems that support the business. None of those redundancies is frontline. We are prioritising allocating the resources that we do have on being frontline in terms of fixing leaks, tackling pollutions and driving down customer complaints in line with the priorities that we have set out in the turnaround plan.

Derek Thomas

Sir Adrian, given that we ultimately care about our customers, the clean water they drink and that they have enough of it, and that everything that goes through our drainage system goes in the right place and is treated correctly, how does this complex arrangement of companies, as you have described it—I will not quote Barry’s description—help the customer?

Sir Adrian Montague

I must beg Mr Gardiner’s pardon for saying what I am about to say. This is a structure that has been put together over the years. A lot of it is very long standing. The companies in the group have their individual functions in terms of raising the borrowed money that we need to carry on our activities. That is the way we present it. They are part of the overall structure designed to allow us to finance this business efficiently because efficient financing of the business is in the interests of customers. We need to keep the cost of the borrowed money as low as we can, so efficiency in financing is a fundamental requirement.

Derek Thomas

As Ofwat has sought to tighten up legislation, the Environment Act and other bits and pieces, and has sought to shed some light on what is going on within water operating companies, does that present a real problem for you or is it acceptable that Ofwat can only manage or scrutinise Thames Water but none of the layers of companies above?

Sir Adrian Montague

That is the way that the legislation has been set up. Ofwat’s function is to regulate the water and waste water companies. In our case it is Thames. There are other companies involved in the structure, of course, but that is the focus of its regulation. I strive, we all strive, to have the right constructive relationship with Ofwat. I said last time, I think, that we try to do this on an open-book basis. I have regular conversations with the Chairman just to tell him what is happening.

Derek Thomas

As you have helpfully described, this has developed over time, this complex arrangement and nature of companies. With you as Chairman now, do you see your task as trying to sort that out, resolve it, simplify it, or is it not possible to do that? Does it make everything too vulnerable?

Sir Adrian Montague

I would love to do that, and I have asked the question. I think I probably need to ask it several times more before we make any progress.

Derek Thomas

Okay. I suspect that is all I had to ask.

Ian Byrne

Thanks for the evidence so far, Sir Adrian. I note what you had to say there, Sir Adrian. I am just listening to what you are saying. I think that 69% of the nation wants water nationalisation. After listening to this, I think that it will be nearer 100%. It has certainly strengthened my view and I think it will be strengthened even more, but listening to the whole financial structure is very worrying. Going on to the debt issue, you have identified that your shareholders, including China Investment Corporation and the Abu Dhabi sovereign wealth fund, would individually have the power to veto this injection of the £750 million and the further £2.5 billion by 2030. How much risk does this veto pose to the future of Thames Water and the supply of water to millions of people in this country?

Sir Adrian Montague

I have one very small precision and then I will answer. They act individually in relation to new investments. All these institutions are accountable to their own investment committees, so they will take decisions one by one. That is just a small precision. We have made no bones about the fact that to finance all the improvements in service we want to create for customers and our business plan for the next five-year period is something like a 40% increase in spending. It is a huge amount of money we are trying to raise and spend. We need the support of the customers because they likely will be paying their bills. We need the support of the equity investors because we must arrange for them to support the borrowing by the company. That is broadly how the water industry has been structured. You mentioned nationalisation. It is important to be clear that if nationalisation were to occur, then the burden of financing all these things will fall on the Treasury, not on private capital. The emphasis over the last 25 or 30 years has been to involve private capital, debt and equity, in financing the activities of the utilities. It is just how it works.

Ian Byrne

Just touching on that, Professor David Hall of the University of Greenwich said that if the Government were forced to take over the running of Thames Water, which might happen looking at the complexity of where we are in the financial structures and the absolute mess it is in, the cost to the taxpayer would not necessarily be high. If you go through special administration, the shareholders take the hit if the company is not viable, and that is what the shareholders are for. Then the process needs to not be nationalisation but to set up regional local authority bodies to take over. You transfer the company as a going concern to those regional local authorities. There are other avenues without scaring people by saying it is the Treasury that takes the hit.

Sir Adrian Montague

I am not trying to scare people. I am just trying to project what I think is likely to happen. The goal of trying to enhance regional participation is a very worthy goal, but those regional bodies that would inherit the stakes in the water companies have to finance themselves somehow.

Ian Byrne

You have come to this late and I understand that, I really do. Worryingly, what you said before was lots of the other water companies are structured in the same way. Looking at it from the outside with a little bit of honesty, I know you are inside now, but if you looked at it before you were appointed to this role, would you say that the entire structure is an absolute shambles and needs ripping up and starting again?

Sir Adrian Montague

It is difficult, Mr Byrne—and I accept that this is not an answer to your question, but it is a factor to be taken into account—because this complex financial structure is a structure that people who lend money to the companies are familiar with, and they would say it works. Viewed from the outside, I think this debate we are having now has focused attention on capital structures in a way that it has not previously been focused on. As I said, I have sympathy with the fact that this appears to be and is a complex structure, but it is there for a purpose, which is to allow us to raise money.

Ian Byrne

It is the purpose that we are scrutinising, isn’t it? We just touched before on the potential £3.25 billion that will be required by 2030. If this money does come through this structure, will it be in the same way as the £500 million that you have just had the discussion with Barry about?

Sir Adrian Montague

To be honest, I don’t think we have got to that stage yet. It could be. It might be in a different way.

Ian Byrne

Cathryn, would you like to add anything to that?

Cathryn Ross

No. We just do not know at the moment.

Sir Adrian Montague

Shall I just talk for a moment about where I think the shareholders are? The shareholders have not had a dividend for six years. It has not been a great investment for them. I think they are saying, “We want to know that this is an investable company. We want to know at least what the general lines are of the outcome of the determination that Ofwat is making. We need to understand whether sufficient cash is going to come into the company to support further investment by the shareholders”. I speak to them two or three times a week because I think it is important that we help them along, jolly them along, until we get to a point of decision. We are not yet at a point of decision. We will be as soon as the white smoke emerges from Ofwat.

Chair

I am sure they are watching this session. I would be if I were them.

Ian Byrne

I am sure they will have an interest. Alastair, can I touch on capitalisation of interest payments? Page 143 of the annual accounts states that £215.2 million worth of borrowing costs were capitalised in the period, this year, 2023. It was worrying because I have spoken to people about Carillion, and Carillion utilised the same capitalisation of interest. Ofwat called it imprudent, but you are carrying on with that same practice. Can you outline why you are utilising the same practice? What are the advantages and why are you doing it if Carillion utilised that practice as well? We all know what happened to Carillion, with millions lost, jobs lost, livelihoods lost.

Alastair Cochran

I think that Thames Water is in a very different position to Carillion.

Ian Byrne

Explain then.

Alastair Cochran

As you know, we reported we had £3.5 billion of liquidity. That is more than sufficient without raising any more money to see the business through and continue its investment programme through to essentially the next regulatory period. Once we have clarity on that period, you would expect to continue, and we expect to continue to raise money through this period as well. We are a liquid company. We also have a strong credit rating. We have continued to borrow money, even since we last met this Committee. Last month we raised £625 million either through new facilities or extending old facilities. Lenders still want to lend to this company because they see it as a viable business. The equity is very important to this business. We have increased investment significantly over the last four years to the benefit of the customers and the environment. We are proposing to invest another essentially £4 billion these next two years and beyond that we—

Ian Byrne

What is the idea behind the capitalisation of interest?

Alastair Cochran

Typically, for Thames Water—Thames Water, to be absolutely clear—most of that interest is cash interest, but on our swaps some interest is capitalised and then added to the principal that gets repaid on maturity.

Sir Adrian Montague

Can I help with one point regarding Carillion?

Ian Byrne

Yes.

Sir Adrian Montague

The nature of the business is very different. Carillion was a contracting company. It is sometimes quite difficult in long- term contracts to work out how much profit you are making from them. We have in that respect a simpler business. We provide services to customers. They pay us. It is real cash. I think it is a more stable business.

Ian Byrne

Yes, but you also have the potential of being told no; you cannot increase the bills to the extent that you want to increase them.

Sir Adrian Montague

I think that we would say that some of the problems that we are now encountering were because our bills were kept deliberately very low over the last period. Perhaps it is the case that we would say that, wouldn’t we—

Ian Byrne

Absolutely, yes.

Sir Adrian Montague

—but there is some substance to that view.

Ian Byrne

Thames Water customers would not say the same thing.

Sir Adrian Montague

There is some substance to that view.

Dr Neil Hudson

I want to explore some of the environmental issues. We have touched on this in some of the backdrop to the financial discussions that we have had. Your latest results show that the number of pollution incidents has increased during the six months to September, and you have admitted that your performance has deteriorated. To people watching this and to your customers, what assurances can you give this Committee that you are fully taking the steps necessary to address these environmental issues, including these very important pollution incidents?

Cathryn Ross

I can pick that up. You are right to point out that pollutions are going in the wrong direction. We are very disappointed with that. As you know, one of our priorities for our turnaround plan is to drive down the number of pollutions. One of the things we have been doing, and it is part of our turnaround plan to do this, is that we are thinking differently about how we understand the root cause of pollutions. This is something that Thames has not been particularly good at over a number of years, getting to the root cause of why something is wrong and what is really going on here. In that regard, what we have been doing with pollutions is trying to understand when we have a pollution incident which part of our asset base, if you like, caused that pollution incident. What we found is there is a very different picture if you look at sewage treatment works and if you look at our network, so the pipes. Sometimes, for example, we get a pollution incident that is caused by a fault in a pipe: you get a burst sewer, or you get a burst rising main or, indeed, you get a burst clean water main that discharges chlorinated water into a river. We are not doing badly on those, and those pollutions are coming down because we are managing our network better and we are improving some of the aspects of network quality. However, on sewage treatment works we are doing worse. What that is telling us is that we need to invest much more in improving the quality of the effluent that is coming out of the sewage treatment works; improving sewage treatment works capacity and things like that. That is what we are investing in. If you look at our plan for PR24, for example, we have I think nearly £900 million-worth of investment there to improve our performance on storm overflows, which is one source of pollution. We are investing heavily to improve the sewage treatment work estate in terms of the quality of the assets but also to provide better for population increase and climate change. That understanding now of what is actually driving those pollution numbers is helping us to get on top of it and target the investment in the right way.

Dr Neil Hudson

Targeting that investment—coming back to some of the financial discussions—are you confident that you have the financial capability backing resources to invest so that these unacceptable sewage outflows are stopped? Are you confident that you can say that to people?

Cathryn Ross

We would like to do more and in the current control period we would certainly have liked to have done more. You may be familiar with the fact that although we are delivering something like 91% of the environment schemes that we are supposed to deliver in this control period, there are a number that are slipping into the very beginning of the next control period. That is mostly to do with the fact that we had a dreadfully slow start in our capex programme at the beginning of this control period. That was entirely down to us. There is nobody to blame for that but us. We simply find ourselves unable to make up the run rate that we lost at the beginning of the control period, so we are delivering some of this investment later than we would have liked. I told you about the big plans we have in the next control period. Whether we are able to do all that obviously depends on Ofwat’s decision on funding and efficiency challenge and things like that.

Dr Neil Hudson

You mentioned Ofwat. I guess you are limited in what you can say. There is an ongoing investigation by Ofwat. It has just announced today that it is asking water companies such as yourselves for further clarification, and you will be able to provide information on that. I guess you are limited what you can say, but there is an ongoing investigation then for the regulator looking at your performance and what you are doing. Do you acknowledge that?

Cathryn Ross

Yes. That investigation has been ongoing for, I think, two years now. We have been completely fully co-operative—as Adrian says, open book—with Ofwat about what is happening across our estate and what our performance is in respect of the areas that it is investigating. This morning it has issued a statement on that, which we will consider, and we will continue to interact and co-operate with it.

Dr Neil Hudson

It has given its provisional findings to you and is asking you for additional information. It will then make decisions as to where it goes from there.

Cathryn Ross

Yes. It is very much an ongoing process.

Dr Neil Hudson

Okay. You recently told an online meeting held with Thames customers that you potentially had left yourselves with too much to do in too little time to reach your 2025 improvement targets. How did that happen?

Cathryn Ross

It is a good question. That was the point that I was referring to earlier on. We had a very slow start to the beginning of this control period, for a number of reasons. We submitted a poor quality plan to Ofwat in the last price review. From memory, that plan asked for something like £14 billion of cash from our customers and, I think, again from memory, we ended up getting about £9.5 billion comparatively, like for like. The plan was very poor quality. There is no doubt about it, it took the business some time to get its head around the determination that Ofwat had given it and to work out what it was then going to do. We had a bit of turbulence in senior management at the time. We lost the then chief exec. We had our Chairman coming in as an Executive Chair for a while. We simply had a very slow start to the beginning of the control period. When I came in to Thames three years ago, we had something like £100 million of our capex programme on contract with the supply chain, which is woeful. This year we have something like £800 million on contract, which is much more like it. It is all very well doing that in years 4 and 5 but you cannot make up what you did not do in years 1, 2 and 3. That is why we are ending up just having to tip over from the end of AMP7 into the beginning of AMP8 to deliver some of these schemes.

Dr Neil Hudson

There is more to do, and you want to do things more quickly, but in December you have now said that you are getting rid of your pledge to try to become net zero by 2030 because you need to prioritise improving performance on sewage. Why does one have to be ditched to achieve the other?

Cathryn Ross

Let me just explain a little bit about what we are doing. You are right, and Al said this earlier on. One of the things that is different about our three-year turnaround plan from our previous turnaround plan is that we need to prioritise. We just cannot make progress on everything. We really cannot do that, and we have learned that more than we ever knew it in the last 12 months. One of the things we have prioritised is leakage, pollutions, health and safety, supply interruptions, complaints and things like that, all the things that matter most to our customers. Our customers do care about net zero and they do care about wider impact on the environment, but it is way down the list compared to those things that they care most about. We are trying to focus on those things that they do care most about.

Dr Neil Hudson

Do you have a revised target from 2030 to a later date then?

Cathryn Ross

Yes. We are still aiming for net zero operational carbon by 2035, but what we are doing, and this is important, is we will achieve progress on the road to net zero because we do desperately need to become more efficient in our use of energy. Of course, a big thing for us is whether we can use less energy. Another big thing is whether we can generate more of the energy that we use from our own renewable sources. As we are doing that and delivering efficiencies for the business that then result in lower bills for customers, we will also be on the road to that net zero operational carbon by 2035.

Dr Neil Hudson

Do you have targets on improving your performance in sewage outflows? Do you have set targets or is it just broadly, “We will try to do better and hope we do not have too many outflows”?

Cathryn Ross

No, we do. We are targeting by the end of 2030, so that is the end of the next control period, a 28% reduction in storm overflows.

Dr Neil Hudson

I am aware I have mentioned that there is this ongoing investigation, but I think we can talk about previous investigations and court rulings. Back in July, Thames Water was fined £3.3 million for discharging millions of litres of sewage into two rivers, killing more than 1,400 fish near Gatwick airport. I think that was in 2017. Thames Water admitted four charges in an Environment Agency prosecution, but the judge in that case, Justice Christine Laing KC, said she believed that Thames Water had shown a deliberate attempt to mislead the Environment Agency by omitting water readings and submitting a report to the regulator denying responsibility. What is your response to that?

Sir Adrian Montague

Can I step into this?

Dr Neil Hudson

Yes. What is your response to that?

Sir Adrian Montague

From inside Thames, we do not consider that finding to be soundly based, but it is the finding.

Dr Neil Hudson

Why don’t you believe it is soundly based?

Sir Adrian Montague

To be honest, I am not sure. For the business, it is the finding of deceit that is so dangerous, so damaging to us. That suggests—

Dr Neil Hudson

You do not believe you misled the Environment Agency then?

Sir Adrian Montague

I don’t think it matters what we believe. What matters is the judge’s finding.

Dr Neil Hudson

Forgive me, I think it does matter what you believe. If the judge has said that perhaps there was a deliberate attempt to mislead the Environment Agency, were there attempts at all or not? You are denying them, are you?

Cathryn Ross

Perhaps I can come in. I did sit in the court to hear the judge’s sentence on the Crawley prosecution, and I have read the file. There is no doubt about it. We did not handle that incident well. There is no doubt about it. We did not handle the provision of information to the Environment Agency well either. In particular, there were different parts of Thames Water that were looking at the same thing and coming up with different conclusions, and some of those found their way to the Environment Agency quicker than others. It was a complete screw-up. The incident should not have happened. It was a dreadful incident. I completely apologise to everybody who was impacted by that incident. We also did not handle the reporting to the Environment Agency well. Personally, I did not form the view that it was deliberately done, but I can see why the judge did and we completely accept the finding.

Dr Neil Hudson

Not deliberately done but accidentally done is what you are saying?

Cathryn Ross

We screwed it up.

Dr Neil Hudson

So inaccurate water reports were sent in, or the wrong water reports were sent in?

Cathryn Ross

There were different views within the team about what had happened. Some of those views were passed to the Environment Agency. Those views were more favourable to Thames Water. There were other views from different parts of the team, and they did not find their way to the Environment Agency, I believe, until the Environment Agency specifically asked for more information and then they did.

Dr Neil Hudson

As a Committee, we now have a court of law that has questioned some of the things that you have done and said. We have had two sessions with you now. Sir Adrian, in your introductory comments you apologised and said perhaps you had not unpacked some of the information that you had given us back in July. To people watching this, is there a culture of not unpacking the information properly or giving wrong information? Should we have confidence in what you are doing at Thames Water?

Sir Adrian Montague

I will say that that was six years in the past. It does not reflect well on Thames. We are quite clear that it does not reflect well on Thames. The finding that the judge came to is deeply concerning because we want to be sure that there is not a cultural weakness inside Thames. We have to address that and one of the ways of addressing it is through our turnaround plan. We have talked about the previous turnaround plan. I would say that this one, which is the product of the new management, is exhaustive—300 pages’ worth of plan. It is properly resourced because we have some external managers helping us devise this plan. It has the full support of the board, and it will have to look at two things. It is first, as Al was saying earlier on, going to look at our processes in relation to the major types of water and waste water management action. We will look at our process minutely and that is where a lot of the efficiencies will come. It also has to look into the deeper culture of the organisation. It has to look at accountability. It needs to look at the way we set objectives and the way we manage performance. It is going to be root and branch. It has to be root and branch because we must turn Thames into what it, I think, has a right to claim. It is a long way from it. It is the biggest water company in the country. We serve 15 million people. It needs to be up there with the best. It is not there. That is the ambition.

Dr Neil Hudson

I take your point and you said you will be looking at the culture of your organisation. You have said that some of this is ancient history, it is a few years ago, but today my colleague Mr Gardiner has been talking about modern history. We have been talking about how you have provided us evidence just a few months ago and then we have asked you to come back to clarify it. Is there this culture that needs to be looked at about how you present information?

Sir Adrian Montague

No. If we go back to July, we described this £500 million of equity. I hope we have satisfied you that it is equity. There was no misdescription about it. I agree with Mr Gardiner that it is a complex financial structure, but it is equity. We stand by what we said in July. There is only one way to approach these problems and that is with frankness and openness, and that is what we are trying to do here today. I have said that we are trying to address cultural issues within Thames Water.

Dr Neil Hudson

This is my final question. Are you confident that we are not going to be asking you to come back in three or four months’ time to clarify things further?

Sir Adrian Montague

Yes.

Dr Neil Hudson

Are you confident of that?

Sir Adrian Montague

Yes. External events may impact on this, but we are dedicated to trying to sort this culture out once and for all.

Chair

There is one question from me. Cathryn, having been a regulator yourself, do you think Ofwat could do its job better if it has an overview of Kemble and the various bits of Kemble and Thames? Would that give it a little bit more perspective on what is happening?

Cathryn Ross

I don’t know. I think you would have to ask Ofwat. I think that it does pretty well. The information, for example, that it has asked us for to clarify why the Thames Water board decided to pay the dividend is comprehensive and thorough. We will provide that information. We will provide it under condition M. I feel it has a lot of information to look at and it is up to Ofwat to decide what it chooses to do with it.

Cat Smith

On the customer satisfaction scores for water companies, Thames Water is bottom. Why do your customers think you are so rubbish?

Cathryn Ross

Yes, we do not do well, I completely accept, on the Ofwat measure of customer experience. We have been 17th out of 17 for some time. A lot of the issues come up through complaints. The biggest single category of complaints relates to billing, so we have a lot of dissatisfaction with billing. We have also been undertaking quite an extensive metering programme in this control period. In fact, we will continue it into the next control period. We get a lot of complaints about that metering process as well. Sometimes it is as simple as, “Somebody said they were going to turn up to my house and they didn’t show up”, which is a good reason for somebody to complain. Sometimes people are not happy to have a meter. Sometimes they are not happy with the bill they get, when they get the first bill after their meter reading. Billing and metering are probably the two biggest areas of complaints for us.

Cat Smith

When it comes to billing, do you think your customers will be more or less satisfied if Ofwat is to allow you to have the 40% increase in water bills?

Cathryn Ross

Well, I think customers will certainly see a significant improvement in service on some of the things that they care about and that is why we are targeting what we are targeting. To give you some examples, the plan that we are proposing for the next control period, we have already talked about 28% reduction in storm overflows. We are targeting a 30% reduction in pollutions. We are targeting a 17% reduction in sewer flooding. We are targeting a 22% reduction in leakage. Those are all the things that our customers tell us they care most about.

Cat Smith

If a customer was to have a complaint about a bill and was to telephone your customer service centre, would they have a positive or a negative experience? What things do you think would influence that?

Cathryn Ross

That is a good question. I think they would have a more positive experience now than they would have done a couple of years ago. One of the things we have done over the past 18 months or so has been that we have brought back our customer telephone agents. They were outsourced to a different company based in Durban in South Africa. We have now brought them—

Cat Smith

Where are they based now?

Cathryn Ross

Swindon. We are basically employing 175 more people in Swindon to deal with customer contacts over the telephone than we were a couple of years ago.

Cat Smith

There are some customers who are particularly unhappy, I believe, in Camberley. I know that yesterday you issued an apology to the residents there for leaving 200 tankers of sewage through the hottest months of the year. Councillors in Surrey are requesting a reduction of bills. Why is it that when customers are faced with having sewage in the middle of a heatwave making their town stink that they should not be entitled to some level of compensation?

Cathryn Ross

Let me just recap on Camberley. I will completely accept that the residents of Camberley have not had a great summer and we have apologised to the residents of Camberley for that. What happened was that we had a problem with one of our large digesters at one of our sludge treatment centres in Hogsmill. We found ourselves having more sludge than we could treat and the only place that had capacity to store that sludge was at the sludge treatment centre in Camberley, so that is what we did. Unfortunately, that did lead to a large volume of sludge being stored in Camberley during the summer, with potentially predictable impacts on the local residents. I completely understand why they are not happy. We have been down there; we have talked to them. Our operations director for Thames Valley and Home Counties has explained this. We have had discussions with the local MP as well. The fact of the matter is that if you look at the regulatory regime, odour from sewage treatment works and sludge treatment centres is not something that we are required to compensate customers for. We did address the issue as quickly as we possibly could. We did address the issue as quickly as we possibly could. We cleaned the sludge treatment tanks down in August and the odour was mitigated properly in September, so we did do what we said we would do when we said that we would do it. However, I do recognise that it has left the residents of Camberley feeling rather dissatisfied.

Cat Smith

You must spend a lot of time saying sorry to people when you work for Thames Water, mustn’t you? If Ofwat does not grant you the increase, what would the implications be for shareholders to support Thames Water and what is the financial viability of the company if Ofwat was to not grant that?

Alastair Cochran

Perhaps I can pick that up. In practice we would revisit our business plan and reduce our expenditure to fit the available funds. To the extent that we needed equity, we would seek that equity from our existing shareholders. If they determined that it was not an attractive enough return to invest in it, we would have to go to other investors to seek equity from them.

Cat Smith

For any of your customers who have been watching this afternoon’s exchange, do you think that they are going to be more or less satisfied with Thames Water, given your responses to the Committee today?

Sir Adrian Montague

As I said, we understand that our performance has not been good enough; it has not been good enough for several years. We do have a turnaround plan to try to address these deficiencies. It will require us not only to look at each step in the process but to think about the culture of the organisation. The commitment that we have made is that it will become better. This is a seminal moment for Thames. We were very fragile in July. The chief executive resigned, without notice, 10 days before a change of chairman and the financial markets took fright. We have stabilised the business and we have finalised our business plan. We have raised more money, and we have a turnaround plan. There is a process under way to try to identify a new chief executive. That will happen when it happens, but we will have new leadership and we need to make a fresh start. I know that management always says this, but it is true in this case, because this is a fresh team.

Chair

On that point, when are the interim chief executive officers going to be normalised, or replaced?

Sir Adrian Montague

Relieved from duty, I think is what you are looking for. When the new chief executive arrives. I cannot tell you when that is going to be. I am too long in this game to give promises that are difficult to establish. Then they will go back into the line positions. They have done magnificently. We could not have got through this period without them.

Chair

Thank you very much indeed for coming along at the first opportunity following our getting in touch with you. I appreciate the candour—at times, at least—that you have shown to the Committee. Thank you very much indeed. Examination of witnesses

Witnesses

David Black and Iain Coucher.

Chair

Welcome back to the second session of this investigation into the goings on at Thames Water. We are very pleased to have Ofwat, the industry regulator, to see us. Would you introduce yourselves for the record, please?

Iain Coucher

Good afternoon, I am the Chair at Ofwat.

David Black

Chief Executive, Ofwat.

Chair

Thank you. You and I were together at the Department for Transport for a while, were we not, when you were running trains?

Iain Coucher

We were.

Chair

You have been listening to the first session, so you will be well aware of some of the concerns that we have. In July, you expressed confidence in Thames Water’s financial position and resilience. Do you still hold that view?

David Black

In July we set out that we had two concerns about Thames. One was its operational performance and the second was its financial resilience. We were clear at the time that there was a lot of discussion about Thames having cash-flow issues, or short-term financial issues. We thought that those were overstated but we remained concerned about the operational performance—you have just heard more about that—and the overall financial resilience. We identified in 2022 our concerns about its lack of financial resilience: its levels of debt, its financial structures.

Chair

I think that 60% is your recommended level and this has reached 80%, which is way above.

David Black

Yes, it is the most highly geared company in the sector. There are a number of measures that we look at companies on every year and we produced a report in September. Not surprisingly, this year and the previous year we have identified—with a group of other companies—where action is required for the company to improve its financial position.

Chair

How did Ofwat allow this situation to develop where the borrowings at Thames were way ahead of recommended safe levels?

David Black

As a regulator, up until relatively recently, we have not had the powers to control the financial structures of a company. Provisions were put in its licence some time ago, when it was increasing its level of debt, requiring it to have a minimum investment-grade credit rating. That was designed to ensure that companies had adequate financial resilience. We have taken a number of steps since that time to require companies to have improved financial resilience. We have talked about the dividend controls that we have recently introduced. Back in the 2019 price review we introduced a financial incentive for it to de-gear the business. We have been using the tools that we have had at our disposal as a regulator to encourage companies to have more prudent financial structures. None the less, a principal regulation has been that it has been that it is up to companies to make the choices as to the level of debt and equity that they choose to finance at, subject to the provisions in their licence about minimum grade credit rating. It is a choice for management and the shareholders as to how it raises that balance of debt and equity. Our view is that it should have and does need more equity in its structure.

Chair

The turnaround plan, its investment plans, its plans to improve customer service, to reduce sewage and leaks and everything else, we heard in the first session how it has gone from an eight-year long-term plan to a three-year plan. Were you fully involved in those changes and were you content that those changes were still going to deliver for customers?

David Black

It has been presenting its revised turnaround plan to us and seeking to provide assurance to us about that plan. We had another session with the company this morning to talk about its turnaround plan. We are examining that plan, and it is too early to say whether we are satisfied that that plan will succeed and turn around the business.

Chair

Thank you very much indeed. What assessment have you made of the chances of Thames successfully delivering these improved services and reduction in pollution incidents? If I was sat on the board of Thames, the financial stability is the thing that would keep me awake at night. I would worry about sewage bills, but I would lie awake at night worried about the debt.

David Black

It does face an extremely challenging situation. It has its financial position, which there are a number of concerns about, and it needs to address those concerns. Related to that there is the operational performance. It needs to turn around that business. We can point to other companies in the sector that have faced challenging operational turnarounds and have succeeding in improving their performance. It runs a monopoly business, and the challenges of that business are known. It ought to able to institute a turnaround plan and ought to be able to address those issues. It has been very open that it has not had the information and it has not had the management processes to drive the performance that it should have done in that business. It is setting about remedying those, and we are confident that it can make the improvements. The question is whether it will make those improvements. That will require backing from shareholders, which you have been talking to them about.

Barry Gardiner

I went back and checked the record of our conversation when you were here before the Committee in July; perhaps you did as well. I asked you, “Are you confident that, going forward, no part of the ownership of the company will be able to receive the level of returns that Macquarie was extracting from Thames Water?” You replied, “We have changed the licence to give us the power to do that but, furthermore, we now have more flexibility with the licence. If we think further changes are required, we will introduce them”. When you appeared before the Committee in July you welcomed the £500 million of equity secured by Thames Water from its shareholders. You did not mention anything about the structure of that funding, the additional debt that it loaded on to the ownership of the company, the holding company, Kemble Water. Did it blindside you or did you blindside us?

David Black

No, I do not think that either of those two points is right. From our perspective we look at Thames Water, which is the regulated business. As Thames has explained, there has been £500 million of equity injected into the business. We welcome that and still do. It needs more equity.

Barry Gardiner

You know very well that if holding companies have to pay off the £190 million that they are due to pay in April and they have to pay off the debt that it has now incurred, the £500 million debt with the note of 8% interest, that the only place that they can get that from is Thames.

David Black

Yes, that is exactly right.

Barry Gardiner

Why did you not tell us about that? Why did you not expose that structure? Did you not know it, or did you know it and simply think that this Committee might not be interested?

David Black

We regulate Thames Water, the regulated business. The £500 million is equity into that. You are absolutely right that the risk is that it then makes dividend payments to support debt at the holding company structure, which is why we are asking further questions around it.

Barry Gardiner

The £37.5 million?

David Black

Yes, that is right, and we are asking it to explain that to us. If we are not satisfied with that explanation, we have the ability to open enforcement action and take enforcement action against Thames Water. That position remains.

Barry Gardiner

You have not answered my question. My question was: were you aware of the structure of that equity injection and the debt that it left with the holding companies at the time when you appeared before this Committee? If you were, why didn’t you tell this Committee about your concerns, your proper concerns, that ultimately that could rebound on bill payers?

David Black

The question at the time of the hearing was about the ability to protect customers with the controls over dividends. In terms of what we knew, every year it provides its financial returns to us. It did that on 15 July, which was about the same time as I appeared at the Committee. At that time, I had not been through that information, so I was not aware of the source of that financing.

Barry Gardiner

Thames blindsided you?

David Black

No, it informed us as part of its financial statements, but at the time that we had the Committee hearing we had not been through that information in that detail.

Barry Gardiner

Was it just unfortunate timing?

David Black

The key question from an Ofwat perspective is: do we have the controls to protect customers’ interests against dividends being paid to support the holding company debt? The answer is that we have now brought those controls in. That is the point that I was making to you.

Barry Gardiner

You know very well—and we have just heard it, as you have, you have been watching it, from the chairman, from the acting chief executives—that if you do exercise those controls, the shit really does hit the river.

David Black

That is a question for Kemble Water.

Barry Gardiner

No, it is not. It is a question for you because you have an obligation to the bill payer. Ultimately, it is the bill payer who is going to be the one who suffers here. It is the customer, isn’t it?

Iain Coucher

Can I say a few words? I am not sure if this is going to address your point. We were satisfied, when we spoke about the injection of equity, much-needed equity into Thames in the summer; it needed those funds to continue to support its business. We saw equity coming in and we gave you an assurance that that was happening. We have controls—subject to the point that I know you are going to raise immediately after this—about whether funds can be released from the operating company to pay dividends. We will only allow dividends to be paid if it is in the best interest of consumers and it meets other obligations. You can get money in, and we look after consumers’ interests by only allowing dividends to be repaid to support their businesses as and when the business can afford to do it. That is the assurance that we can give you.

Barry Gardiner

Mr Coucher, they have got you be the short and curlies, haven’t they?

Iain Coucher

No.

Barry Gardiner

They have absolutely got you because you know that you are in a Catch-22 situation. If you do what your job is, to protect the environmental quality, to make sure that you protect the bill payer, and you impose those fines on them for dispersing that £37.5 million, the result of that, that 10% that you can levy against it, the fine that you can levy against it, that sends a direct message to its shareholders, “Don’t put any more money into this company, it’s going down the pan”. That is why you are impotent in this, isn’t it?

Iain Coucher

No, I do not accept that characterisation; no, I don’t.

Barry Gardiner

Why is it that the chairman did? Why is it that the chairman was very clear that what you can do is a threat to the holding company and, therefore, a threat to the whole operation?

Iain Coucher

Because the way that it works is that they have to demonstrate to us that the payment of dividends—because the whole construct, whether it is debts and equity payments, relies on institution investors putting up billions of pounds to fund the business going forward so we need to allow dividend streams to go to companies. We will do so as long as we are satisfied that the company can afford to make those payments and that it is in the best interest of customers. That is the protection that we have. We have to allow dividends otherwise you will not get money in the first place.

Barry Gardiner

That is right, you have to allow it. You have no option because you know that in this situation if you put the screws on them, if you come back and say, “Hang on, you haven’t met your environmental targets. You haven’t met your key performance indicators. The people of Camberwell are not terribly happy with you either”, what is going to happen is that you are going to choke off the investment that this company needs if it is able to turn itself around.

David Black

I do not think that that is correct, because you also heard the chair of Thames saying that it has £190 million due at Kemble in March/April next year and it is going to extend.

Barry Gardiner

It is going to extend. How long can it go on doing that?

David Black

That is a question for Kemble Water.