Ofwat has launched a new consultation seeking views on improving water companies’ licences by tightening up company ownership requirements to enhance protections for customers.

The wide-ranging consultation - part of the package of work that Ofwat’s Chief Executive Rachel Fletcher set out in her letter to water companies CEOs to help get the sector back in balance - focuses on the ring-fencing provisions in company licences. 

Rachel Fletcher commented:

“Ensuring that regulated water companies are autonomous regardless of who owns and controls the company is an important way in which Ofwat protects customers. The changes we are proposing will help strengthen those protections and drive water companies to focus on delivering for customers at all times.”

Under either the licence conditions or the Board Leadership, Transparency and Governance (BLTG)Principles, water companies are expected to operate the business as if:

• it is their sole business - which requires the Appointee’s management to manage the company’s affairs independently of the holding company; and
• it is a publicly listed company - which imposes reporting and transparency requirements equivalent to those of a publicly listed company.

The regulator is now reviewing its overall approach to assessing changes of control which takes into account specific issues identified as part of its assessment of the recent changes in the ownership and, as a consequence, control of Thames Water.

Ofwat is seeking views on its proposals to address a number of issues with regard to Thames Water licence as a result of recent changes in Thames Water shareholding structure. If taken forward, the modifications will align Thames’ licence with the most up to date of Ofwat’s current ring-fencing conditions.

Image: Source Ofwat

Need to clarify ring-fencing conditions arises from recent changes in Thames Water ownership

In March 2017 the sale of a 26.3 per cent stake by Macquarie managed funds in Kemble Water Holdings Ltd, the holding company of Thames Water, was announced. OMERS, a Canadian pension fund, and the Kuwait Investment Authority (KIA), a sovereign wealth fund, acquired 17.54% and 8.8% of these shareholdings respectively. The sale and purchase was completed on 31 May 2017.

Since the Macquarie sale, a number of smaller shareholders have either divested or reduced their shares in Kemble, allowing OMERS to acquire over time an additional circa 10% stake in Kemble and another new shareholder, the Universities Superannuation Scheme (USS) acquiring a circa 11% stake in Kemble.

As a result of various transactions OMERS became the largest shareholder in Kemble – and Ofwat understands that OMERS is now in the process of acquiring an additional 4.36% stake in Kemble.

Multiple ownership transactions left Thames without a lead investor for a time

According to the consultation paper, the multiple transactions left Thames Water (for a time) under the terms of the Kemble shareholders agreement without a lead investor, making it harder to determine who else is an Ultimate Controller in addition to Kemble.

Ofwat is seeking views on whether any of the shareholders, in addition to OMERS, are individually or jointly, Ultimate Controllers of Thames Water and thus should also be providing undertakings. In the case of Thames Water, Ofwat said it sees multiple parties potentially qualifying as Ultimate Controllers of the Appointee.

The consultation is also seeking views on Ofwat’s assessment of the incoming investors of ThamesWater, including views on the ability of the new investors of Thames Water to run a regulated water utility.

The set of ring fencing provisions proposed for Thames Water represents the most up to date provisions that Ofwat would seek for all companies.

Ofwat expects to introduce similar modifications to all companies’ licences later in the year.

Ultimate Controller of a company - consultation sets out principles Ofwat will adhere to

The consultation sets out the principles the regulator intends to adhere to when there is a change to the Ultimate Controller of a water company.

Ofwat intends to introduce a new licence condition in all licences that requires the Appointee to inform it when it becomes aware of a change, or an upcoming likely change, that could be a change of control.

In broad terms, the information Ofwat will request includes:

• General background - corporate and organisational structures
• Actual or perceived conflicts of interests
• Economic and financial standing
• Technical and professional capacity to run a regulated water utility
• Understanding of the regulatory environment and how they will comply with their statutory and regulatory requirements.
• Any legal or financial claims an investor or member (as relevant) is subject to
• Any financial investigation by an accredited UK (or equivalent) regulator

Currently there is no direct requirement for an Appointee or its shareholders to provide this information when a change of control occurs or is proposed. To date, Ofwat said it has typically relied on the goodwill of Appointees and investors to provide this information.

Ofwat also intends to tighten up on the identification of the Ultimate Controllers – currently defined in the licence as “any person which, whether alone or jointly and whether directly or indirectly is….in a position to control or in a position to materially influence the policy or affairs of the Appointee or any Holding Company of the Appointee”.

The consultation says that in many cases identifying who the Ultimate Controller or Controllers are is straight forward as there is a clear controlling interest. However, where ownership is more dispersed, Ofwat’s aim is to capture any shareholder or another party who could materially influence the policy or affairs of the Appointee.

Appointees will be expected to regularly review the identity of its Ultimate Controllers, including the governance arrangements which might affect the identity and/or number of parties which wield material influence.

The existing licence also requires the Appointee to procure legally enforceable undertakings from its Ultimate Controller(s), but does not require the Appointee to enforce an undertaking. Ofwat is also proposing to insert an additional provision into the licence condition to require the Appointee to comply with any direction from Ofwat to enforce an undertaking.

Potential for minority cross shareholdings to create risk of conflicts of interest

The consultation paper also flags up the potential for minority cross shareholdings to create a risk for potential conflicts of interest if confidential information relating to one Appointee becomes available to another Appointee. Some investors have minority shareholdings in multiple water companies which to date have not been reviewed by any regulatory authority due to the size of their shareholdings and/or turnover falling below the prescribed thresholds affect customer interests. Ofwat now wants to ensure that companies take appropriate steps to manage potential conflicts.

Maintaining credit ratings

Most Appointees’ ring fencing conditions include a requirement to maintain an investment grade credit rating, including the triggering of a cash ‘lock up’ provision if a company is on the lowest investment grade rating and has been placed on a negative watch/outlook.

This means the company cannot release any funds to its holding company or other associated businesses, including paying dividends, without Ofwat’s consent. The regulator intends to make the provisions consistent as part of a wider drive to bring all company ring fencing conditions to the same standard.

Deadline to submit responses to the consultation is 8 June 2018 – Ofwat then currently expects to publish its decision in July 2018.

Click here to download the consultation paper