Ofwat has launched a new consultation on its proposals for the financial monitoring framework under which it will monitor the financial stability of the water and wastewater sector in England and Wales.

The regulator said the purpose of the framework is to enhance visibility and transparency of company financing and capital structures to help ensure that all stakeholders can maintain trust and confidence in the sector.

Introducing the consultation, Ofwat said it was putting the financial monitoring framework in place to enable it to identify whether there is an appropriate level of corporate and financial resilience within regulated water companies and that service to customers is not being put at risk by companies’ choice of capital structure or financing arrangements.

It also aims to enable Ofwat to:

• monitor the financial stability of the businesses that it regulates;
• identify financial or structural risks that may impact on the companies’ ability to deliver for customers; and
• determine when it  needs to intervene to protect the interests of customers.

Ofwat intends to publish financial information on the sector and to provide a high-level review of that information which identifies key trends and significant changes and reports on an exceptions basis.

“We are not seeking to place an unnecessary burden on companies to provide additional information to us unless it adds value to customers and other stakeholders.”

Where possible Ofwat plans to use information that companies are already providing in the regulatory accounts, and from 2016 in the annual performance report, or which is already publicly available. However, if it has concerns about a company’s financial stability the regulator said it would seek to obtain additional information and collect it more frequently.

Framework will include all retailers when market opens for competition in 2017

Ofwat also expects the financial monitoring framework to apply to all regulated companies, including retailers - following the opening of the non-household retail market in 2017.

Ofwat will publish an initial pilot report once the 2015 regulatory accounts have been reviewed. Initially, this will comprise all the companies for which Ofwat set full price controls at PR14 (ten water and sewerage companies, eight water only companies). The as-yet-to be appointed licenced Infrastructure Provider for the Thames Tideway Tunnel  (or any similar project in the future) will also be included in the framework. The consultation is also seeking stakeholders’ views on the form and contents of the report, including the metrics stakeholders’ would find most useful and how it should be developed in the future.

If the results of the analysis lead Ofwat to conclude that it needs to look beyond the regulatory ring fence at the financial stability, financing arrangements, tax structuring and other arrangements entered into by holding companies or shareholders, it will consider how to obtain this information and whether it needs to change company licences.

Companies should stress test their financial plans from 2016 onwards

The regulator has also proposed that from 2016 companies should stress test their financial plans by carrying out sensitivity analysis and require them to publish the results of that analysis. Ofwat said that the type of analysis proposed will not be new to companies – it is the type of analysis that they are likely to have had to provide to their investors, funders and to the credit rating agencies. However, it will be the first time they are being asked to publish information of this type.

Ofwat has identified an initial set of 28 separate financial metrics that it intends to monitor, including:

• Revenue – actual vs final determination
• Profit after taxation - actual vs final determination
• Net debt
• Credit rating
• Dividend yield
• Profile of debt repayments

Ofwat is seeking comment on trhe follwing questions:

Q1 Do you think that the financial metrics we are proposing to include in our pilot financial monitoring report are appropriate measures?

Q2 Are there any other financial metrics that you consider should be included in the pilot financial monitoring report or that should be considered for future reports?

Q3 Do you agree that the financial metric definitions are appropriate? Are there alternative definitions that we should be considering? If so, why?

Q4 Do you agree that the financial monitoring report should be published each year with additional information being requested from companies only when required, or should we be asking all companies to provide financial information to us on a more frequent basis?

Q5 The financial monitoring report will focus on the regulated companies and their holding companies, including retailers. Are there any other companies that we should be including within the financial monitoring framework?

Q6 How far outside the regulatory ring fence do you think that we should be looking? Should the scope of the financial monitoring framework include more information in respect of principal holding companies, the ultimate controlling parties of the regulated companies or other key shareholders?

Q7 Do you agree that we should be asking companies to carry out stress testing by way of sensitivities on their business plans, based on their actual capital structures and expenditure plans, and to publish the results?

Q8 Are the sensitivities proposed appropriate, or should be we be asking companies to apply a different set of sensitivities?

Ofwat will publish an initial pilot financial monitoring report by the end of September 2015 that will be based on the 2015 regulatory accounts and other financial information which is publicly available at that time. The first full financial monitoring report will follow the publication of the first annual performance reports including the 2016 regulatory accounts after the first year of the 2015-20 control period. From then on full financial monitoring reports will be published on a yearly basis.

Deadline for submission of responses to the consultation is 3rd August 2015. Click here to download the consultation document.