Water (Special Measures) Bill: what's next for the water industry in the UK?

The Water (Special Measures) Bill (the "Bill") was introduced into Parliament on 4 September 2024 and is currently at the Committee stage in the House of Lords ("HoL"). As part of its announcement introducing the Bill, the Department for Environment Food & Rural Affairs ("DEFRA") emphasised that the Bill is intended to significantly strengthen the power of water industry regulators in the UK – holding water companies to account "where they have failed to deliver for the environment and customers and begin to restore trust in the industry".

These are significant ambitions for a sector which has come under intense criticism in recent years. It certainly appears that the new Government is intent on taking a more interventionist approach than its predecessor by, in this case, encouraging greater scrutiny over remuneration packages and the imposition of more fines and other penalties. And it also seems to be in a hurry to do so. The Bill forms only part of the Government's plans for the sector, and just last week it also launched a wider independent review into the water sector and how it is regulated, which suggests further changes may be on the way. These plans – and how they approach juggling (often competing) policy desires to minimise costs to bill-payers and protect taxpayers, to manage impacts on the environment, and to continue to attract private investment – will be closely scrutinised by not only the water industry, but also operators and investors across networks and utilities more generally.

Now Reading

Background to the Bill

The challenges faced by the water industry – from aging assets and environmental impacts through to the linked liquidity issues faced by Thames Water - are well documented and publicised. Prior to the UK's last election in July 2024, Labour's manifesto contained a specific commitment "to put failing water companies under special measures to clean up" the UK's water, by providing "regulators new powers to block the payment of bonuses to executives who pollute our waterways and bring criminal charges against persistent law breakers". While strongly worded, in some ways the focus here is rather narrow and many in the industry for example welcomed the absence of a new promise to bring the water industry back into public ownership – which was a specific commitment under Labour's manifesto leading into the 2019 election. This position was publicly reaffirmed by DEFRA's Secretary of State, Steve Reed, in early September 2024, who emphasised the anticipated high cost and potentially lengthy implementation period of any (actual or quasi) nationalisation.

The Bill therefore represents the Government's proposals to tackle some of the perceived 'behavioural' concerns within the industry that have garnered attention in the UK press in recent years, rather than the more fundamental economic challenges facing the industry. This can be seen by the Government's spokesperson emphasising to the HoL when introducing the Bill that it will look "to drive rapid and meaningful improvements in the performance and culture of the water industry". However, that more fundamental economic question is being separately looked at by Government (as discussed at the end of the article), and this all sits apart from (albeit is linked to) the ongoing deliberations on the Environment Agency's regulatory enforcement positions in relation to sewerage discharges, and the various legal challenges relating to the same.

Remuneration and governance

A substantial part of the Bill is concerned with giving Ofwat (as the UK's Water Services Regulation Authority) new powers to establish rules relating to governance and remuneration – which will include provisions around performance related pay ("PRP") and the introduction of a fit and proper person test for senior officers. Ofwat will have the power to issue a compliance direction, where they identify that a company has failed to comply with the new requirements and, where a company remains in breach, will be able to issue fines.

As we are seeing across much of energy and infrastructure, the new administration is clearly keen to see that change effected quickly. Even though the Bill remains in the legislative process, Ofwat published its consultation on new rules on remuneration and governance on 22 October (the "Consultation"). The Consultation (which closes on 19 November) sets out Ofwat's views and proposals on the standards required under the Bill related to various governance and remuneration matters, including:

restricting PRP where company performance fails to meet specified standards;
requiring companies to test whether individuals in senior roles meet standards of ‘fitness and propriety’; and
ensuring companies have arrangements in place for involving consumers in company decision-making.

Who will the new remuneration and governance rules apply to?

The Consultation states that the obligations will apply to the "16 largest companies holding an appointment as a water and/or sewerage undertaker under the Water Industry Act 1991" in the UK, being the larger regional monopoly undertakers. Ofwat is separately considering as part of the Consultation whether the new requirements, either in full or part, should also apply to smaller appointees (known in the industry as 'NAVs'), given that it may not be appropriate for certain rules to apply to smaller businesses – which will not necessarily have, or at least need, as sophisticated governance systems and other management arrangements. Other changes (related to enforcement etc.) are expected to apply to the whole sector (including NAVs), although their enforcement risk profile is generally considered to be lower.

What are the expected timings?

The Bill is expected to make relatively rapid progress through Parliament, although exact timings for it to come into force are unknown. The obligations related to fitness and propriety, and ensuring consumer decision making input, are anticipated to start applying from the beginning of the new Ofwat price control period (commencing 1 April 2025), however, the requirement connected to PRP are due to apply to companies from the current financial year (depending on how soon the Bill makes it into law).

Performance related executive pay

The Consultation starts from the premise that it is unacceptable for executives to receive PRP where a company has "demonstrably failed to meet its core duties and responsibilities". This is not entirely new policy - Ofwat had already introduced a new price control cost recovery mechanism for executive pay that prevented certain payments being recovered from customer bills last year (which applies to 2023-2024 pay awards) – however new requirements imposed under the Bill (as and when it becomes legislation) will likely be far broader.

The new restrictions will apply to those in senior roles only (e.g. the chief executive and directors), including any executive director who is a member of the company board, and restrictions will be placed on annual bonuses and long-term incentive plans. Where there is a breach of certain core standards, no PRP can be issued – irrespective of whether there was any causal link between the acts or omissions of the person in question and that breach. As drafted in the Consultation, the core standards that must be achieved are relatively narrowly defined – but potentially could be triggered relatively easily. For larger water companies, operating at a significant scale, it may at times be difficult to achieve compliance and thus placing an almost de facto ban on any PRP.

The rules are also expected to set out an expectation that a company should undertake best efforts to recover the payment of PRP (when Ofwat has determined the rule has been breached) if the payment has already been made. However, learnings from other industries suggests that this can in practice be highly challenging.

Overview of Proposed Core Standards for PRP

PRP will be prohibited if the company has had a serious pollution incident in the preceding calendar year. Ofwat is consulting on whether this threshold should relate to category one and two incidents only – which means those incidents which either have a "serious, extensive or persistent impact on the environment, people or property" or "a lesser, yet significant impact on water quality". According to information collected by the Environment Agency, incidents of this scale are relatively common – with Southern Water recording a total of 5 category one/category two incidents in 2022, and Thames Water recording 17 in the same period.
(which includes maintaining a good credit rating, ensuring there are adequate financial resources and that these are appropriately ring-fenced). The Consultation suggests that the PRP prohibition will be tied to the existing minimum credit rating requirement (although exactly what that will look like has not yet been determined).
PRP will be prohibited if a company has been convicted of any criminal offence in the relevant financial year (to which the PRP relates). This is broad and could capture breaches relating to not only environment (overlapping slightly with the above, and very much in focus for water companies) but also broader areas such as safety, financial ethics and certain employment laws. Moreover, given the potential time lag between an offence taking place and an actual conviction, how this would work if an executive has already left an organisation, before it is convicted, remains to be seen – and the strength of clawback provisions will therefore be key.

Fitness and propriety

The Bill includes a mandatory obligation that Ofwat introduces a rule that requires water companies to only appoint (and keep in place) senior individuals (chief executive and/or directors) who meet certain fitness and propriety standards set by Ofwat. This is not without precedent - there are other examples of these requirements from other industry regulatory regimes in the UK (e.g. the Financial Conduct Authority's fit and proper test) – but, as Ofwat recognises in its Consultation, it will be important that any obligations that are imposed are proportionate and relevant for the water industry.

Overview of Proposed Fitness and Proprietary Standards

On current proposals, Ofwat appears to envisage a fit and proper senior individual would have:

no unspent convictions;
not been the subject of any adverse finding or settlement in civil proceedings;
not been the subject of a regulatory investigation or disciplinary proceedings;
not been involved in the management of a business that has gone into insolvent liquidation or administration whilst in connection with that organisation, or within one year of that connection; and
not been the subject of adverse findings of mismanagement in relation to a regulated activity.

Ofwat is also considering whether an additional limb should be added to the above – which would require the individual to have "adequate knowledge and understanding of the duties of the undertaker under the relevant laws and licence conditions", although it has not yet determined if that would be appropriate.

It is proposed that companies provide assurance to Ofwat through their annual performance reporting process that standards for fitness and propriety have been, and continue to, be met. However, there may also be an ongoing notification obligation if an individual no longer meets the requirement.

Consumer perspective in decision making

The Government intends that customers have greater representation in decision-making, which may include a requirement for water companies to establish consumer committees or similar panels where consumers can voice their opinions. The decisions in scope will likely be those which may have a material impact on consumer affairs (such as the development of long-term strategies, performance and following major incidents).

The consumer representations will need be accessible and gathered in a sufficiently independent way, and consumers will also need to be able to see how their views have been taken into account as part of decision making (along with appropriate feedback).

Criminal charges and increasing enforcement

Criminal Charges

The Bill proposes new, tougher, penalties for water executives when companies fail to co-operate, or obstruct, investigations. Whilst existing laws in the UK enable certain regulatory authorities (such as the Environment Agency and the Drinking Water Inspectorate) to bring criminal charges in such cases, there is a high bar that must be met and only five individuals in total have been prosecuted by the Environment Agency to date – two of whom successfully appealed their convictions. Therefore, the Bill introduces provisions that enable:

the courts to include imprisonment as a sanction in cases where an investigation has been obstructed; and
this offence to be heard in the Crown Court and for executives and directors to be prosecuted for this offence, where it is committed by the regulated entity with their consent or connivance, or is attributable to their neglect.

Fixed monetary penalties and lower standard of proof

The Bill enables fixed monetary penalties to be imposed by the Environment Agency and Natural Resources Wales for specific water industry offences relating to pollution, failure to comply with information requests and associated reporting obligations and where there has been a water resource incident (such as the abstraction of water without permission). The Bill will also allow regulations to be made to impose certain civil penalties based on the civil standard of proof (i.e. 'on the balance of probabilities') rather than on the criminal standard of 'beyond reasonable doubt' – mirroring reforms seen around a decade ago in environmental regulation that was intended to make it easier for enforcement action to be brought against alleged wrongdoers.

This is an area which the Government will further consult on, but fixed monetary penalty fines are currently in the region of £300 per offence for other environmental offences. The Government has said that the "value of the penalty must be such that it will act as a sufficient deterrent against future offending whilst remaining proportionate for minor to moderate offending", which suggests that the level of these fines may increase. However, these penalties are anticipated mainly to be used for smaller breaches – rather than significant incidents (which are expected to remain in the focus of the more significant, if complex from an enforcement perspective, criminal regime).

Sewage monitoring and pollution incident reduction plans

The monitoring of storm overflows has already been a focus within the industry and, as of December 2023, monitors were in place at 100% of storm overflows (c.15,000) in England. Back in 2023, Ofwat introduced a storm overflow action plan, and from 1 January 2025 (under existing requirements), water companies will be required to publish information derived from these storm overflow monitors (within an hour of a discharge), which will increase transparency in this area.

The Bill extends this existing obligation to 'emergency overflows', which are not currently fully monitored in England. These overflows are used in emergency circumstances (e.g. where there has been a mechanical breakdown etc.) and there are approximately 7,000 of them in England. The Government expects water companies to achieve monitor installation at 50% of these sites by 31 March 2030 and 100% coverage by 1 April 2035.

The Bill will also include a statutory requirement for water companies to publish a mandatory annual pollution incident reduction plan – which will need to be made publicly available. As part of these plans, there will need to be an assessment of proposed actions and also a requirement to report on progress from the previous year. Many large water companies already publish these plans on a voluntary basis.

Changes to special administration regime

The Bill also introduces a new power aimed at enabling the Government to recover a shortfall in its costs at the end of a Special Administration Regime ("SAR") intervention (i.e. those that are not recovered through a sale), which is more in line with existing requirements in relation to energy companies.

The way that the legislation is currently drafted provides the Government with significantly more flexibility, and the Government has stated that it "will be able to decide if they want to use this power and whether losses are recovered from a single company, some or all water companies" – although this will be subject to consultation with relevant stakeholders. The Bill enables the Secretary of State to seek "relevant financial assistance" from any other water company who holds an instrument of appointment – although the Secretary of State must set out their reasons for doing so and consider any representations that are made, before making any final decision.

This was reported in some quarters as effectively being a means to allow water bills to be raised to pay for a potential bailout of Thames Water (in the event the company was placed in a SAR). Last month, DEFRA took the unusual step of issuing a press release to specifically address this "misleading coverage", emphasising that these provisions are intended only to protect taxpayers and there were no plans to raise customer bills as a result of the 'unlikely' event of a SAR – although we note that the Bill does not specifically restrict water companies from doing so.

What other changes are in the pipeline?

In addition to the changes to the water industry outlined as part of the Bill, the Government separately launched an independent commission on the water sector regulatory system on 23 October 2024 (the "Commission").

The Commission will deliver a report to Government by Q2 2025, which will include its recommendations for reform. The Environment Secretary has confirmed to the press that the Commission's review will consider whether current regulators, such as Ofwat, remain fit for purpose and if they should be replaced by a different regulatory authority or significantly reformed. There has also been some commentary suggesting that the Commission will explore water companies being run on a not-for-profit basis, however we note that one of the primary objectives of the Commission is to ensure that the "water industry regulatory framework delivers long-term stability and enables the privatised water industry to attract investment, maintain resilient finances and contribute to economic growth", which suggests such a change is not necessarily at the centre of the Commission's review.

While we have our doubts as to whether any of the more far-reaching and fundamental changes to the water industry being discussed in the press are really on the agenda for the current administration, the outcomes of the Commission's recommendations (together with the Bill) will be important for the industry as a whole – and are likely to set the tone of wider water regulatory policy in the UK over the course of the longer term.

Read John Buttanshaw Profile