Just last month, an influential group of global infrastructure investors declared the UK to be, in effect, a no-go zone, citing concerns about tougher water regulation and threats from the Labour opposition to renationalise the water sector after three decades in private hands.
It was the latest shock to an industry that has been wrestling with growing public antipathy to its business model. Opinion polls have shown a large majority in favour of reversing privatisation, while ministers, including environment secretary Michael Gove, have become increasingly vocal in their criticism of water companies, lambasting excessive pay and the sector’s tendency to take on high levels of debt to fund large dividends to its shareholders and minimise tax.
At the heart of this storm is Jonson Cox, the regulator charged with returning the sector to public favour without alienating the private capital that backs its finances. The 62-year-old chairman of Ofwat, who became head in 2013, is not fazed by the rancour. Indeed he is confident that his plans are beginning to pay off.
“We are close to peak intrusion,” he said, arguing that a period of more intense oversight is needed to get the industry back on an even keel. Once companies have adjusted, he believes Ofwat will be able to move back into “lighter touch” mode.
Mr Cox plans to take up an offer Mr Gove made last year of greater powers to control the sector’s behaviour, and will seek more freedom to alter the terms of company licences. Currently Ofwat must seek the companies’ consent or get parliament to change legislation in order to make these changes, a system he described as excessively “clunky”.
But so far Mr Cox and Ofwat’s new chief executive Rachel Fletcher have relied on artfully using the powers he already has. They have sought to shore up fraying public support by pushing water companies to be more mindful of their social obligations, restraining bills that have risen 40 per cent in real terms since privatisation and fixing more leaks while restraining them from loading up with debt and paying huge dividends.
Some see this as a belated attempt to atone for Ofwat’s previous light touch — the regulator was criticised by MPs last year for putting companies’ interests ahead of those of consumers.
The latest test of Mr Cox’s new, more proactive approach came in January, when Ofwat for the first time issued grades for the business plans submitted by the 17 English and Welsh water companies as part of the process for setting prices in the five-year period from 2020. Under this scheme, companies compete for more favourable terms by outdoing each other on cost efficiency and leakage. Mr Cox set them the task of cutting leaks by 15 per cent by 2025.
The results were mixed. Three companies got gold stars, meaning their regulatory settlement will be both more generous and fixed faster, thus giving certainty to investors. All three offered real terms cuts in prices over the next regulatory period. But 10 companies were told their plans needed improvement. And four were sent back to redo their work; the regulator’s equivalent of detention or the dunce’s cap.
“It would have been nice if it were five companies getting fast-tracked with really good plans,” said Mr Cox, who regarded the overall experiment as a success. “But frankly if we had too many in the fast track, you might be saying ‘shouldn’t you actually be giving scrutiny to more’.”
The companies that failed or did poorly were those that struggled to hit Mr Cox’s financial challenges. They included highly indebted businesses that have attracted controversy such as Thames Water and Southern Water.
Thames Water has complained about Ofwat’s new approach, claiming that it is unrealistic of the regulator to demand increased investment while squeezing prices. Mr Cox dismissed the criticism. “What we have said to Thames is that we have looked at the efficiency standards set by other companies and they could deliver this programme for significantly less.”
The highly indebted companies are already under pressure because of the regulatory threat to squeeze returns while their gearing — levels of debt relative to assets — remains elevated. Several companies including Thames and Yorkshire Water have had to risk the ire of their investors by reducing dividends to repay borrowings. Two big investors in Yorkshire — Deutsche Bank and Corsair Capital — recently failed to sell their stakes in the business because they did not find buyers at acceptable prices.
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The war on leverage illustrates the tightrope Ofwat is walking. Critics of the sector point out that despite the dividend cuts and the regulatory nudges, leverage levels have barely fallen. Yorkshire, for instance, had debts worth 75.6 per cent of its regulated asset base in the last financial year, down from 76 per cent the previous year, according to Moody’s. Thames’s debt/RAB ratio remains about 80 per cent. Meanwhile investors fret that owners will become stranded and discouraged.
Mr Cox dismissed their concerns: “If we have driven fair value for customers, frankly what premium [an owner sells] the asset for is [their] problem.”
Financial targets are only part of the regulator’s plan. To entrench better social attitudes Mr Cox wants companies to engage more with customers and to have more independent non-executives on their board. Among the seven unlisted big water companies, most have boards dominated by non-executive representatives of the owners.
The move is controversial, however. Critics, such as the economist Dieter Helm, have accused the regulator of weakening the link between ownership and control, which they say risks entrenching management and diluting the very efficiencies that are needed to pay the elevated returns that private capital expects. Mr Cox disagrees. Boards with more independent directors “take better decisions”, he said.
The policy has yet to yield many perceptible results, however, despite the appointment of independent directors in some companies. One of its aims, reining in high pay, for example, has yet to change remuneration across the sector.
Some see the regulator’s plan as a last chance to stave off the threat of renationalisation. When asked whether much of what he wants to achieve could be done more simply by the state taking direct control, Mr Cox acknowledged that theoretically the cost of capital could be lower in a state-owned water industry, but claimed it is not something he worries too much about.
“While the industry is structured as it is, with a combination of different ownerships, my job is to make sure we do the best we can,” he said. “I’m not going to go anywhere near a decision about whether its state or privately financed. That’s not my remit.”
Jonson Cox has been criticised for not practising what he preaches. When he ran Anglian Water a decade ago, he received a pay-off of more than £9m for turning round the company. As an adviser to I Squared, an international infrastructure investment group, he is a director of Viridian, an electricity company with a regulated supply business in Northern Ireland. According to its last annual report, all the non-executives were representatives of I Squared.
Mr Cox said Viridian was largely an unregulated business, and suggested there was a value in his keeping a toehold in “commercial infrastructure”. He rejected that his role was a conflict of interest. “I don’t think anyone is in doubt that I am completely committed and first in my mind is doing a great job at Ofwat. I don’t think you could find a single example where I have been held back from doing the right thing in this job,” he said.