New Clause 19 - Ofwat responsibility for the financial stability of water companies

Water (Special Measures) Bill [Lords] – in a Public Bill Committee at 3:30 pm on 14 January 2025.

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“In section 2 of the Water Industry Act 1991, after subsection (2D) insert—

‘(2DZA) For the purposes of ensuring that relevant undertakers are able to finance the proper carrying out of their functions under subsection (2A)(c), the Authority must establish rules for the purposes of ensuring the financial stability of water or sewerage undertakers.

(2DZB) Rules produced under subsection (2DZA) must include—

(a) a prohibition on water or sewerage undertakers having offshore holding companies;

(b) a requirement that the Regulated Capital Value for each undertaker is annually reconciled against the market values of the undertaker’s equity and debt.’”—(Charlie Maynard.)

Brought up, and read the First time.

Photo of Charlie Maynard Charlie Maynard Liberal Democrat, Witney

I beg to move, That the clause be read a Second time.

Photo of Rupa Huq Rupa Huq Labour, Ealing Central and Acton

With this it will be convenient to discuss new clause 23—Ofwat to publish guidance on debt levels after administration—

“In section 2 of the Water Industry Act 1991, after subsection (2D) insert—

‘(2DZA) For the purposes of ensuring that relevant undertakers are able to finance the proper carrying out of their functions under subsection (2A)(c), the Authority must establish guidelines to be followed by relevant undertakers who have been in special administration.

(2DZB) Guidelines produced under subsection (2DZA) must—

(a) set out a maximum level of debt which can be accrued by the undertaker;

(b) set out a process for agreeing capital expenditure necessary for service improvements, bill increases, and changes to operating costs while the undertaker is subject to the Special Administration Regime;

(c) state the penalties which will be imposed for breaches of such guidelines, which may include –

(i) financial penalties;

(ii) prohibitions on the payment of dividends or other bonuses; or

(iii) such other special measures as the Authority deems appropriate.’”

Photo of Charlie Maynard Charlie Maynard Liberal Democrat, Witney

I will speak first to new clause 19, which has three parts. Proposed new section (2DZA), which I will cover very quickly, essentially ensures the financial stability of water or sewerage undertakers. I think we discussed that at length in the debate on new clause 4, which I will not rehash, as I think we all know each other’s views.

Proposed new section (2DZB) has two subsections, (a) and (b). Subsection (a) is

“a prohibition on water or sewerage undertakers having offshore holding companies”.

Why would a UK-regulated water company need an offshore holding company? Maybe to dodge some tax? Maybe to make it as untransparent as possible? I would like a straight answer as to why we are not going to kill this possibility off today. Do we really need to push this out another six, maybe 12 or maybe 24 months—until maybe never—with the water commission? I do not know. I think each of us could just find our way to saying that offshore holding companies are not good for our rivers, our citizens or our country. I really hope we get there.

It is getting a bit late, but there is something I would really like Members to engage their brains on. It is a difficult and complicated subject, but it is the key to understanding what is going wrong with our water companies. It is called regulated capital value. What is in proposed new section (2DZB)(b)? It would introduce

“a requirement that the Regulated Capital Value for each undertaker is annually reconciled against the market values of the undertaker’s equity and debt.”

What on earth is regulated capital value? The key thing to remember is that it decides how much money the water companies make, so a higher regulated capital value is good for water companies.

The bizarre thing is that regulated capital value has not really been a proxy for enterprise value, which basically means the equity value of the company—what the shareholders’ value of the company is worth—plus the net debt. That was set up—this is really one of the original sins—back in the mists of time, around 1989 and beyond, when the companies were originally privatised. It has been carried forward every year: “Take last year’s, and add a bit for inflation and a bit for capex. Never, never, never reconcile it with reality.” That is what has gone on for decades.

Now we have this thing called regulated capital value, which is the critical thing the water utility companies are focused on: “This is how we make money, so we want this number as big as possible.” What we are advocating here is taking that apart, because of the reality on the ground. I will take Thames Water as my usual guinea pig. Many, many of Thames Water’s equity shareholders have declared that their holding in Thames Water has no value. That includes OMERS—the Ontario Municipal Employees Retirement System—and the UK’s Universities Superannuation Scheme, and I think the Abu Dhabi Investment Authority may have done it as well. They have said, “Our equity is toast. It’s written off.”

The debt is not that hard to calculate either, because people can just look at what Thames Water is trading at; these are bonds, and people can see what discounts they are trading at. People can add that up, and they have a number that is much, much smaller than the regulated capital value of Thames Water today. But if it is a water company or Ofwat, they say, “Let’s just put a big pair of mufflers on and ignore that fact,” because it is safer to be in fantasyland.

This matters because, if that is the case, it is unreasonable to expect consumers to be paying prices that are artificially inflated purely to compensate investors, whether they are debt or equity investors, for the cost of their poor historical decisions. I believe that what Ofwat has just done by sticking a 35% price rise to all the customers in the Thames Water catchment is basically bail out, or attempt to bail out, the existing shareholders and particularly the lenders to Thames Water. That is wrong, and we should be doing everything in our power to stop it.

It is ridiculous that we are relying on the concept of RCV, which is found on calculations done more than 30 years ago, bears no relation to reality and is never reconciled against the company’s balance sheets. That is one thing. Secondly, the continued use of an inflated RCV works to the advantage of investors and lenders at the expense of consumers—bill payers—and enables lenders to avoid the economic consequences of their poor lending decisions. In crude terms, consumers are bailing out the banks. I sincerely doubt the balance sheet strength of the water companies, as the asset lives are entirely unrealistic, but they have enabled water companies to claim sufficient financial strength to be able to pay excessive dividends and management bonuses.

I am really keen to highlight another thing. Again, I feel a little sorry to bring this on the Minister, but I am going to do it. If we look at the asset depreciation rates of these water companies, they are the biggest I have ever seen in 25 years in finance. Let us say that someone has a waste water network asset—people might immediately think of Bazalgette’s great big pipe, which he built 150 years ago. They might think, “Well, that is pretty good for purpose,” and perhaps they do not need to depreciate it over more than 150 years. But let us think about places in my patch, such as Aston and Standlake, where pipes were put in 30, 50 or 70 years ago and are leaking hand over fist. We have half a million hours of sewage dumping, but do you know what the depreciation rate on that asset is, Dr Huq? It is not 20 years, 30 years, 40 years or 50 years. It is 150 years.

Photo of Jerome Mayhew Jerome Mayhew Shadow Minister (Transport), Opposition Whip (Commons) 3:45, 14 January 2025

This is a genuinely interesting point. I know it is late, but I would be grateful if the hon. Member could expand in further detail. While he is referencing regulated capital value and the difference between what is on the sheet and what is reality, could he explain in a bit more detail, for the benefit of the Committee, what that means in reality? If there were to be a rebase of regulated capital value, what would be the practical impact of that?

Photo of Charlie Maynard Charlie Maynard Liberal Democrat, Witney

I question what value regulated capital value, given how completely out of whack it is with reality, is bringing to the table. I do not have all the answers, but I question whether this has any utility to the conversation. What is happening here is that a business is generating £1.2 billion of cash flows, and it has this enormous balance sheet and this enormous regulated capital value. Because of those essentially false premises—I believe that we do not actually have assets of that value—regulated capital value is essentially a figment. We are grappling with things that have no basis, and we would do well to reconcile and to look at the facts—at what these assets are actually worth—and then to build out from there.

Photo of Jerome Mayhew Jerome Mayhew Shadow Minister (Transport), Opposition Whip (Commons)

One possible reason why regulated capital value is important is that the assessment of whether bills are reasonable or not relates—in part, at least—to what is considered to be a reasonable return on capital. Does the hon. Member agree that if one’s regulated capital value has depreciated to zero, there might be an adverse knock-on impact on what is considered a reasonable bill, to take account of the debt and the capital investment? Does he think that that might be something to do with it?

Photo of Charlie Maynard Charlie Maynard Liberal Democrat, Witney

The whole thing is reverse engineered—I am completely in agreement on that—and that is not necessary or useful in terms of where we are getting to, and that is causing a lot of the trouble. I would like to find a way out of that, and I would really recommend that the water commission digs into this to find a way out. I am on the Business and Trade Committee and I will be asking the Financial Reporting Council, which oversees the accounting body, to ask these accounting firms whether they actually think those numbers—those incredibly slow depreciation periods of 150 years—are valid and, if so, why.

Photo of Jerome Mayhew Jerome Mayhew Shadow Minister (Transport), Opposition Whip (Commons)

I am grateful to the hon. Member for allowing me another intervention, this time on proposed new subsection (2DZB)(a), which refers to

“a prohibition on water or sewerage undertakers having offshore holding companies”.

He referenced some of the international investors who have holdings in Thames Water, and perhaps in the majority of the other water companies. Access to international markets is very important for raising investment into our water utilities. Does he accept that using offshore holding companies might be a mechanism that allows for easier transfer of funds, easier investment and easier access to international finance, and may therefore have a benign rationale? We always assume that offshore holding companies are somehow suspicious, or that their motivation is tax avoidance, and I believe that the hon. Member referenced that earlier. That might be the case—in which case, they should not be encouraged—but with his 25 years’ experience in finance, which he referenced, does he think that there is an argument for saying that offshore holding companies make it easier to access international investment?

Photo of Charlie Maynard Charlie Maynard Liberal Democrat, Witney

I have the name of one here: Thames Water Utilities Cayman Finance Holdings Ltd. Why Cayman? If I say “Cayman”, people say “tax haven”. That is why it is there. We should be doing our best to stop that. Last I looked, London was still a financial capital, and equity and debt could still be raised in this country, and I sincerely hope that remains the case. So I do not see a good reason to have holding companies offshore. Hon. Members might be happy to hear that that was all I wanted to say on new clause 19.

New clause 23 is also being considered in this tranche, and I will highlight proposed new subsection (2DZB)(b), which refers to

“a process for agreeing capital expenditure necessary for service improvements, bill increases, and changes to operating costs while the undertaker is subject to the Special Administration Regime”.

We have to spend a huge amount of money on our water utility companies, because they have not been spending enough over the last decade or two. When a special administrator is appointed in such instances, the goal is to ensure that the special administrator takes that future spend into account in considering how much debt needs to be cut. We do not want to come out of special administration with debt that is still high, which will prevent the investments from being made that will be required over the next. That is the goal of the new clause.

Photo of Emma Hardy Emma Hardy The Parliamentary Under-Secretary of State for Environment, Food and Rural Affairs

I thank the hon. Member for Westmorland and Lonsdale for the intent behind new clause 19. As highlighted, it seems in parts to contradict new clause 18, which was also tabled in his name.

It is important to highlight that Ofwat already has a core duty under section 2 of the Water Industry Act 1991 to ensure that water companies are able to finance the proper carrying out of their statutory obligations. Ofwat already monitors information it receives about companies and their financial positions on an ongoing basis. That includes carrying out a detailed review of the financial information published by companies in annual performance reports, statutory accounts, interim accounts, investor reports and other sources. Ofwat also directly engages with companies where it sees an increased level of risk. Additionally, Ofwat has recently updated water company licences to require companies to take account of service delivery for customers and the environment, as well as financial resilience when deciding whether to pay a dividend.

More broadly, the independent commission into the water industry will look at long-term, wider reform of the water sector, as I have mentioned. Company financial structures are one of a number of areas that could be explored under the commission, and we do not want to pre-empt the outcome of the commission through this new clause. The former deputy governor of the Bank of England, Sir Jon Cunliffe, chairs the commission. As mentioned, he has decades of financial, investor and regulatory experience. His appointment demonstrates the Government’s ambition to fix the foundations of the industry. As I have mentioned previously, there will be a call for evidence, and the hon. Member will be able to make his points to Sir Jon Cunliffe and the commission. Given the existing monitoring of the financial resilience of the sector and the forthcoming recommendations of the independent commission, we do not believe that the new clause is appropriate, and I ask the hon. Member to withdraw it.

Turning to new clause 23, which was also tabled by the hon. Member for Westmorland and Lonsdale, a special administration regime enables a company that provides vital public services—water, energy or rail—to be put into administration in certain circumstances to ensure that the public service will continue to be provided pending rescue, via a means such as debt restructuring or transfer, via a sale, to new owners. There is no need for a company exiting a SAR to be placed under an enhanced regime regarding its debt levels. Water companies are allowed to raise debt to fund the delivery of their services, and it is for companies to decide their financial structures. I will resist the urge to repeat my previous comments about the water commission looking at the financial structures of all the water companies, and I hope the hon. Member will take what I outlined previously as read.

In relation to capital expenditure during a SAR, it is not necessary to establish a statutory process for agreeing that expenditure, as that would be agreed under a court-appointed special administrator in the lead-up to a SAR. The Government can provide funding support to a special administrator. Any company under a SAR will still be subjected to the same regulatory regime and expected to meet its statutory obligations.

I hope the hon. Member understands why we cannot accept his new clauses, but I repeat the offer made: he will be able to talk to Sir Jon Cunliffe and present to him the evidence he has just presented to the Committee, so that he can consider it as part of the wider evidence gathering. I therefore ask the hon. Member not to press his new clauses.

Photo of Charlie Maynard Charlie Maynard Liberal Democrat, Witney

It is very kind of the Minister to have so much faith in, and be so charitable towards, Ofwat, given its record over the last decade or two, particularly with regard to its management of water companies’ financials. We will not press new clause 23, but would like to call a vote on new clause 19.

Question put, That the clause be read a Second time.

Division number 18 Water (Special Measures) Bill [Lords] — New Clause 19 - Ofwat responsibility for the financial stability of water companies

Aye: 3 MPs

No: 11 MPs

Aye: A-Z by last name

No: A-Z by last name

The Committee divided: Ayes 3, Noes 11.

Question accordingly negatived.