Making waves: regulatory developments in the water sector

There have been a number of notable regulatory developments in the UK water sector in the first quarter of 2025. This includes the Water (Special Measures) Act 2025 (the Act), which received Royal Assent on 24 February 2025.  

We explored key provisions in the Water (Special Measures) Bill 2024 (the Bill) in our recent blog post, which considered the key changes that the Bill was expected to introduce, including:

1. Measures related to performance related pay;
2. Lowering the standard of proof for certain offences to “the balance of probabilities” for fixed and variable monetary penalties;
3. The imposition of automatic penalties for certain offences; and
4. Requirements to publish near real-time data on discharges from emergency overflows.

This post builds on our earlier commentary exploring the substantive changes made to the Bill in the final stages of its passage through Parliament. We then look at next steps for implementation of the Act.

Finally, we touch on proposals for reform, including the Cunliffe review.

Key changes to the Act introduced at the last minute

Two new provisions on financial transparency and charging arrangements were introduced to the Bill during its third and final reading in the Commons, aimed at improving customer accessibility, support and engagement within the sector.  

Financial Transparency

The Act places an increased emphasis on water companies' financial position, introducing a separate provision on 'financial transparency'. Initially, the Bill required companies to report on their financial structuring/restructuring on an at least annual basis, providing information on debt levels, commercial strategies and risks, as well as long-term sustainability.

This provision was expanded in the final Act, imposing a broader obligation on Ofwat to secure that water companies publish an accessible overview of their financial position on an annual basis. The information which falls within this wider scope is still unclear, with Ofwat to decide the precise nature of the information to be included in the overview. However, the Act itself refers to the publication of details of the share capital and debt used to fund the company's operations, as well as significant changes which have or are expected to take place in the 12-month period prior to publication. In order to achieve this outcome, Ofwat must either modify conditions attached to water company appointments or issue new rules under the Act.

Charging Arrangements

The Act also includes a new provision on charging arrangements, supplementing existing powers under the Water Industry Act 1991 to provide special charging arrangements for customers in need. Regulators can now require water companies to auto-enrol eligible customers on future water support schemes. This is supplemented by amendments to the Digital Economy Act 2017, with provisions on information sharing between public authorities and water companies to assist those in water poverty now applying to those eligible for special provisions in charges schemes.

Costs associated with making special provisions can also be shared across water companies by way of direct payments or a managed fund, aimed at ensuring the costs of providing support are distributed more evenly across the sector. Companies can pass the net costs of complying with the requirements of any new schemes on to their customers. Any regulations brought forward under these provisions will require a consultation between the Secretary of State and relevant stakeholders, including Ofwat.

Next steps for implementation of the Act

The Act represents a significant shift in the power of water industry regulators to influence the governance of water and sewerage companies, with regulators now set to establish their own rules on an industry-wide basis.

Ofwat has already begun consulting on how it intends to use its new powers granted by the Act, publishing an initial consultation in October 2024. This included proposals on how Ofwat should introduce the three remuneration and governance-related rules required by the Act, namely:

1. A rule to prohibit performance related executive pay where company performance does not meet specified standards;
2. A rule requiring companies to test if individuals in senior roles meet standards of 'fitness and propriety'; and
3. A rule to ensure companies involve consumers in company decision-making.

Responses were published in March 2025, with Ofwat issuing a second consultation on 28 March 2025. This focuses on performance related executive pay (PRP), with the remaining two rules expected to be consulted on later this year.

Under Ofwat's new consultation, the PRP prohibition rule is explored further with an additional policy option (Option 2) being preferred. This will require companies to prohibit the payment of PRP where a water company has failed to meet the following key standards in any given year:

1. Consumer matters – where Ofwat makes a decision that a company has breached its statutory duty, warranting a financial penalty;
2. Environment – if a company receives a one-star rating in the Environmental Performance Assessment for the preceding year;
3. Financial resilience – if a company breaches its licence requirement to hold a sufficient credit rating; and
4. Criminal liability – if a company is convicted of any offences, with some exceptions.

Item 4 above (the criminal liability standard) is likely to be the standard of most concern, bearing in mind the inherent risk/likelihood of criminal liability arising from the company's activities. Criminal liability can arise from even minor non-compliance, given that most environmental offences are of strict liability. There is no threshold for the degree of severity or culpability of the offence, and the fact that prosecution may take place several years following commission of the offence may result in this standard applying in a financial year that has otherwise seen improvement.

Subject to responses received, Ofwat intends to implement the PRP prohibition rule for PRP paid from 1 April 2024 onwards, with the rule expected to come into force later this year.

Proposals for Reform

Select Committee Inquiry

Alongside these significant regulatory developments, Parliament's Environment, Food and Rural Affairs Committee launched a new "Reforming the Water Sector" inquiry in December 2024 (the SC Inquiry). So far, senior executives of nine water companies have given evidence in six sessions across January to May 2025. The Committee's questions have focused on the key themes of corporate governance, financial performance (including executive renumeration and dividend payments), environmental performance, customer satisfaction and asset resilience. Environmental performance has generally dominated discussion, demonstrating a clear link between Committee concerns on pollution incidents and the new powers granted to regulators under the Act.

A timeline for future evidence sessions and the publication of reports is yet to be published, with the Committee having described the Inquiry as "long-term" and indicated that it will call for evidence on a "regular basis", publishing "iterative and focused reports" throughout.

Cunliffe review

The SC Inquiry is in addition to the Independent Water Commission (IWC) on the Water Sector Regulatory System, chaired by Sir Jon Cunliffe and launched in October 2024 (the Cunliffe review). The Cunliffe review's scope is to review and strengthen the regulatory framework of the water sector in England and Wales, focusing on:

• The need for strategic co-ordination across sectors impacting or interacting with water;
• The need for clear, long-term planning on water;
• The complexity and volume of water industry regulation;
• Concerns about the regulatory oversight of the water industry;
• The need for fair and stable returns to investors; and
• The need for an improved infrastructure resilience framework.

The Cunliffe review's Call for Evidence closed on 23 April 2025. Industry experts, regulatory bodies (including Ofwat and the Information Commissioner's Office) and industry body Water UK were among those who responded to the Call for Evidence. The IWC's proposals for reform are expected to be published in mid-2025, after which the UK and Welsh Governments will respond and consult on any proposals that they intend to take forward.

The efforts of the SC Inquiry and the Cunliffe review are closely intertwined; the Cunliffe review is expected to take into account the evidence gathered to date in the SC Inquiry when formulating its proposals for reform, and the SC Inquiry will likely have regard to Cunliffe's proposals when determining the next steps in its longer-term examination of the issues affecting the water sector.

NAO report on "regulating for investment and outcomes in the water sector"

The SC Inquiry and the Cunliffe review take place in the context of a critical report on the water sector by the National Audit Office (NAO), published on 25 April 2025. The NAO report is not a reassuring read for any water sector regulator, but it is particularly critical of Ofwat. Key points include:

• A significant increase in investment is needed to enable the water sector to address current and future challenges, and this is changing the risk profile of the sector;
• The Environment Agency has duties to the water environment but is not required to balance them with cost (or net zero) considerations;
• Ofwat's approach to price controls is complex and difficult for investors to understand;
• The regulators do not have a shared understanding of the condition of water and wastewater assets, and the level of funding needed to maintain them;
• Ofwat's performance incentive regime has resulted in penalties for most companies in the 2020-25 control period, and most companies have overspent allowances;
• Water company performance has not been consistent or significantly improved in recent years;
• The financial resilience of the sector has weakened (at a time when significant further investment is required); and
• The downgrading of the stability and predictability of the regulatory environment has led directly to increased customer bills and contributed to worsening investor perception of the sector.

Comment

The Act has already introduced a number of significant changes to the regulation and governance of water companies. The SC Inquiry, the Cunliffe review and the NAO report all point in the direction of structural changes to the water sector regulatory environment in the short to medium term. This view is reinforced by the sustained public and political discourse to which water companies have become increasingly subject.