Ofwat has today announced that new rules on executive bonuses and on dividends are beginning to bite in their first full year of operation, in 2023-24 financial year - the regulator says that 73% of exec bonus payments will not be paid for by water customers in a new report Protecting customer interests on performance-related executive pay: 2023-24 assessment.

The rules require water companies to demonstrate that executive bonuses are sufficiently linked to company performance. 

Nine companies will not be able to use customer money to fund bonuses. This means that in the first year in which Ofwat's new rule on exec pay has been applied, bonuses amounting to £6.8 million (73% of the overall total) will now be impacted in this way. 

Of the £6.8 million, Ofwat will use its new powers to step in and directly block three water companies from allowing customers to pay £1.5 million of bonuses, which apply to: Thames Water, Yorkshire Water, and Dŵr Cymru Welsh Water. 

The intervening action Ofwat took against the three companies was as follows:

• Thames Water CEO and CFO payments: £770,000
• Yorkshire Water CEO and CFO payments: £616,000
• Dŵr Cymru Welsh Water CEO and CFO payments: £163,000

Ofwat has determined that these companies have not adequately reflected overall company performance issues in their bonus payments. In these cases, Ofwat will adjust costs for the companies in question so they cannot recover it from customers.

For the further £5.2 million of the remuneration payments, water companies have voluntarily decided not to push this cost on to their customers. Instead, shareholders at the six companies will pay. Ofwat commented: “Had this not been the case we would have acted to ensure these were not funded by customers.” 

The Water (Special Measures) Bill that is being brought by the Government further extends Ofwat’s current powers. Rather than preventing company directors' bonuses being funded by customers, it would allow Ofwat to prohibit performance-related pay entirely in certain circumstances.

David Black, Chief Executive of Ofwat, said: 

"In stopping customers from paying for undeserved bonuses that do not properly reflect performance, we are looking to sharpen executive mindsets and push companies to improve their performance and culture of accountability. While we are starting to see companies take some positive steps, they need to do more to rebuild public trust.

"Our new rules on exec pay and dividends link both to company performance. Through these new rules, our enforcement action and our incentive regime, which has imposed £430 million in performance penalties since 2020, we are challenging companies to deliver improvements for both customers and the environment. 

"We will take forward further action under powers to regulate exec pay proposed in the government's Water (Special Measures) Bill." 

Ofwat set to support companies through unprecedented investment period

Ofwat has today also published its latest annual Monitoring Financial Resilience (MFR) report, covering the 2023-24 financial year.

The regulator says the findings show Ofwat has been making progress to ensure that any dividends paid by water companies reflect company performance and do not threaten their financial resilience.

This has included introducing a change to water company's licences which came into effect in May 2023.

Year-on-year, companies have paid out £400 million less in dividends, a reduction of almost a third (£1billion vs £1.4billion). Ofwat said this is due to a range of reasons, with a much clearer link now between dividends and performance. Thames Water, South East Water and Southern Water are also subject to cash lock-up measures which prohibits them from paying dividends without consent.

Noting that £4.6 billion of new equity has been invested into the sector since 2020, with more committed in the next asset management period which starts next year, the MFR report places the 16 regulated companies into one of three categories. 

In total, six companies are categorised as Standard (the routine level of monitoring), seven are classified in the Elevated Concern category, with three companies in the Action Required category. The categorisations set out the level of monitoring and engagement that Ofwat will carry out in the year ahead.

“Overall, the position is reflective of many factors, including their historical financing choice"

Ofwat commented:

“Overall, the position is reflective of many factors, including their historical financing choice and where companies are in the current investment cycle, the scale and nature of their programmes of proposed work in the upcoming asset management period - and the resulting financing requirements that these place upon water companies.

“The sector is on the cusp of a significant challenge and opportunity in the form of an unprecedented £88 billion package of investment proposed at PR24. This means it is increasingly important all companies maintain robust and steady financial health as this enables them to invest for the future and bounce back from any short-term difficulties that may arise.” 

Monitoring Financial Resilience report

 Ofwat explained that he MFR report is part of its ongoing monitoring and review of companies (and increased company reporting requirements) which better enables engagement with them – crucially, at an earlier point where there is potential risk.

This engagement is wide-ranging and allows Ofwat to input views, encourage appropriate actions and decision making, increase company accountability and request additional specific information. It also allows Ofwat to seek commitments, review for licence compliance, provide guidance, and more widely strengthen regulatory protections and expectations if appropriate.

 Commenting on the company categorisation, Ofwat said:

"Thames Water is shown distinctly in the Action Required category reflecting the extensive level of our engagement with the company on its financial matters, and the unprecedented level of oversight, including through our appointment of an Independent Monitor following downgrades to the company’s credit ratings to below investment grade."

Commenting on Performance Related Pay (PRP), Ofwat concludes in the report:

“The application of our recovery mechanism for 2023-24 PRP has primarily been necessary because companies have not adequately taken into account overall performance. In particular they have not met the high evidential bar for making any PRP payments where there are clear indicators of poor performance. While companies often recognised this poor performance, which is welcome, in all cases there was some element of PRP payment for which sufficient justification was not provided.

“It is not enough for companies to just acknowledge events which clearly indicate poor performance, they need to be clear how any payment at all is justified in the light of these events. We look to companies to recognise this when considering what PRP payments to make in future years and to make sure that PRP payments are only made when they can be clearly justified. We will engage with companies on the specific areas for improvement identified in this report.”

Click here to download Ofwat's Monitoring Financial Resilience Report

Click here to download Protecting customer interests on performance-related executive pay: 2023-24 assessment