Labour calls it a “change election”. But how much difference might a Labour government make? In this five part series, Gwyn Bevan, Patrick Diamond, Kate Bayliss, Stewart Lansley, and Abby Innes, set out an agenda that could take the country in a fundamentally different direction. 

In this fourth instalment Kate Bayliss interrogates Labour’s plans to solve the crisis of the water and sewage system by introducing tougher regulation and argues that won’t be enough. Given the opaque corporate structures of the private utility companies, and the revolving door between Ofwat regulators and the water industry they used to regulate, public ownership seems to be the best option. 

The water and sewage system in England and Wales is in crisis. Since privatisation in 1989, companies have paid £78bn in shareholder dividends while cutting annual investment spending. Meanwhile debts have gone from zero to over £60bn. Yet the utilities companies have not spent enough on investment to prevent raw sewage spilling into rivers and seas, destroying ecosystems and posing a risk to public health. Meanwhile Thames Water, with its history of financial engineering, is at risk of financial collapse with debts of nearly £15bn and a track record of poor performance.  Price increases are planned but trust in the sector is at an all-time low.

Labour is talking tough on water, proposing criminal charges for bosses of water companies that repeatedly break the rules, introducing automatic and severe fines as well as  “forcing” all companies to monitor “every single water outlet”. But despite the forceful tone, the reality is more complicated. Tougher regulation will not be enough to resolve the problems of the sector for several reasons.

It’s not just sewage and debt – it’s about fairness and transparency

Many struggle to pay their water bill and yet, as they spend this money on meeting their essential human needs, they are also paying into the pockets of the world’s richest.

The water network is funded by water bills which pay for dividends, debt service, CEO bonuses as well as operational costs. Many struggle to pay their water bill and yet, as they spend this money on meeting their essential human needs, they are also paying into the pockets of the world’s richest. Some water companies are owned by offshore private equity funds. The largest shareholder of Southern Water, for example, is a private equity fund registered in Luxembourg managed by an Australian investment bank. Wessex Water and Northumbrian Water are owned by large Asian conglomerates controlled by wealthy families. The interests of such shareholders are at the heart of how the water companies are run.

Opaque corporate structures, which apply across the growing number of utility companies now in private equity ownership, contribute to a lack of transparency and accountability. And price increases raise the spectre of more money from struggling households disappearing into offshore bank accounts via payments that contribute to the service of debt and shareholder dividends, increasing inequality.

The limits of regulating a powerful, opaque corporate structure

A lot of time, energy and money has gone into designing and implementing water regulation over the decades. But important elements were overlooked. While experts were tweaking estimates of the cost of capital, investors were loading the utilities with debt and failing to invest in sewerage infrastructure.

The regulator cannot know what is going on inside companies until things become visible by which time the impact is huge and regulators have to catch up.

The regulator cannot know what is going on inside companies until things become visible by which time the impact is huge and regulators have to catch up. Furthermore, as state institutions, regulators need to follow government processes which takes time. Regulation is tightened in response to what is observed from the past, which means that regulators can be like generals fighting the last war.

The regulatory process is becoming incredibly dense and costly. For each price review there are hundreds of reports some running into hundreds of pages. Increased density in regulation can mean not seeing the wood for the trees. Adding more and stricter rules to the current system, in a process of regulatory whack-a-mole, will lead to even more detailed attention to some segments of the system in a way that risks obscuring the bigger picture.

According to a 2019 report by the National Infrastructure Commission, regulation of infrastructure, including in water, is biased towards investors. This is because of asymmetries of information and because companies have more resources than others in the system (such as consumers or environmental groups) to lobby regulators. After decades of academic and empirical effort in the field of regulation, the only advice the NIC can offer is simply for regulators to “aim off” in regulatory decisions in order to take account of this bias.

Aerial view of a sewage treatment plant in East London. The facility on the banks of the river Thames processes waste from the capital © Britain from Above on Shutterstock

The capacity to discipline capital is limited

More robust regulation may be a deterrent to major investors in infrastructure, at a time when the UK is looking to private investors to finance for the transition to green energy and other vital infrastructure. Macquarie that owns Southern Water also owns windfarms as well as National Grid gas. The owner of Northumbrian Water, CKI Infrastructure Holdings Ltd, also owns a large share of our gas networks and railway rolling stock. Tighter water regulation can have knock on effects for investment finance costs. In 2018, proposals introduced by the economic regulator for the water sector, Ofwat, intended to boost financial resilience, led Moody’s to downgrade the credit rating of some companies. These measures were considered to be a departure from normal regulatory practice.

The staff of the regulator, the water companies and the consultants they employ, are from the same camp. Analysis by The Observer Newspaper found 27 former Ofwat directors, managers and consultants now working in the water industry that they used to regulate.

The staff of the regulator, the water companies and the consultants they employ, are from the same camp. Analysis by The Observer Newspaper found 27 former Ofwat directors, managers and consultants now working in the water industry that they used to regulate. This results in shared understanding of how the water system ought to be managed, which prioritises finance over social equity, transparency and the environment.

These issues are not unique to water. Global private financial investors operate across our essential services in the UK, from care home chains to energy networks, and these face similar risks, especially when operating as monopolies. Regulation is not simply a case of setting rules and stepping back. Rather it is about mediating across a complex set of agents, rooted in contextual power relations.

Public ownership would not only lead to greater democratic accountability for management of this essential resource, but it will also likely be cheaper as debt can be raised through government organisations rather than using commercial borrowing.

There are underlying reasons why regulation has failed to be tough on water companies. After 35 years of privatisation things are getting worse rather than better. Rather than tweaking regulation, a more imaginative approach is needed to construct a transparent and fair water system. No other country has copied our way of providing water. Public ownership would not only lead to greater democratic accountability for management of this essential resource, but it will also likely be cheaper as debt can be raised through government organisations rather than using commercial borrowing. It would not be a step back to the 1970s but would bring us into step with the rest of the modern world.

All articles posted on this blog give the views of the author(s), and not the position of LSE British Politics and Policy, nor of the London School of Economics and Political Science.

Image credit: Yau Ming Low on Shutterstock.