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Ofwat in danger of repeating same mistakes say water investors

GIIA has responded to Ofwat's PR24 draft determinations highlighting investor concerns and the critical need for a balanced approach to securing future investments in the UK water sector

Statement 

Jon Phillips, chief executive of the Global Infrastructure Investor Association, said: “Ofwat’s draft determinations do not give water companies enough funding to make the necessary upgrades to clean up our waterways and prevent further issues. We cannot continue to kick the can down the road, and we know climate change will likely exacerbate the problem. 

“For too long, the regulator has prioritised low bills at the expense of investing in the resilience of the sector. The solution to this vicious circle sits with Ofwat – the regulator can’t continue to penalise water companies for not meeting expectations without equipping them with means to provide the solution. 

“Ofwat has a duty to make the sector investable but has created a situation where the opportunity to achieve reasonable levels of return are out of kilter with the associated risks.  Pension funds have a responsibility to deliver a return for the savers whose money they are investing, if the UK can't provide that opportunity they will look elsewhere.  

“The Chancellor has been clear that attracting investment is key to the country’s infrastructure renewal and growth plans, but regulators must set out the right framework. Water companies need proper funding to provide the level of service customers expect, and to run a sustainable business.” 

Notes on GIIA’s response

Ofwat’s inadequate investment plan in PR24

  • The PR24 draft determinations propose a 16% overall reduction in expenditure and a 25% cut in enhancement spending from what water companies had planned. This undercuts the sector's ability to address critical challenges such as sewage spill reduction and infrastructure resilience, further jeopardising the long-term viability of water services in England and Wales. 

  • A 7% reduction in day-to-day operational funding poses a serious risk to the maintenance and replacement of essential infrastructure, potentially leading to increased service failures and environmental breaches. 

  • The current draft determinations continue a troubling trend from PR19, Ofwat rejected where approximately £6.7 billion of additional investment. This historical underfunding has left the sector playing catch-up, leading to the current crisis in infrastructure resilience and service reliability. 

An unattractive investment proposition

  • The draft determinations propose a Weighted Average Cost of Capital (WACC) that offers returns only marginally above risk-free rates, which are significantly lower than returns available in other regulated sectors globally. This low return fails to justify the higher risks and operational challenges investors face in the UK water sector. 

  • Investors are increasingly concerned about the unstable regulatory environment, where new gearing restrictions, stricter performance targets, and an overall unfavourable risk-return profile have made the sector less attractive. The introduction of measures like capping dividends below market rates further diminishes investor confidence. 

  • The unattractive investment conditions are evident in the stagnant performance of listed water companies like United Utilities, highlighting the sector's struggle to secure the capital necessary for infrastructure improvements and environmental commitments. 

New strangling constraints on companies

  • Ofwat’s PR24 draft determinations impose new restrictions on executive compensation and dividend payments, particularly for companies with higher gearing levels. These measures constrain companies' ability to attract and retain talent, incentivise performance, and secure equity investment, which are critical for the sector’s long-term health. 

  • The introduction of tougher outcome delivery incentive (ODI) targets and new Price Control Deliverables (PCD) penalties heighten the operational risks for water companies, further reducing their capacity to meet ambitious targets with the limited funding provided. 

  • Ofwat's increasing involvement in strategic decisions such as gearing levels represents a shift towards a more interventionist regulatory approach, which may stifle innovation and hinder companies’ ability to respond flexibly to emerging challenges. 

Impact on public trust and investor confidence

  • The cumulative effect of inadequate returns, heightened operational risks, and regulatory instability has led many investors to declare the UK water sector "uninvestable." This perception not only jeopardises the flow of essential capital into the sector but also risks further deteriorating public trust as companies struggle to meet rising expectations with insufficient resources. 

  • With approximately 6.8 million UK public and private sector employees having a stake in water companies through their pension fund savings, the failure to create a sustainable and attractive investment environment has direct implications for millions of pension savers who depend on the sector’s success.