On 22 February 2024, the House of Lords will consider the following question for short debate:

Lord Sikka (Labour) to ask His Majesty’s Government what plans they have for reforming remuneration of the directors of water and sewage companies operating in England.

This briefing provides a summary of the issue of executive remuneration by water and sewage companies. For a wider examination of the questions of water pollution and the regulation of private water companies, see the recent House of Lords Library briefing ‘River pollution and the regulation of private water companies, published on 19 February 2024.

1. Why is action being taken on executive remuneration in the water sector?

The water industry in England and Wales was privatised in 1989. Most water and sewerage companies are regional monopolies, with dedicated pipe networks and water supplies in each company area. This means that household customers cannot choose or switch their supplier and competition is limited.[1]

Several issues including environmental concerns, levels of customer service, and concern over wider financial resilience have prompted Ofwat and the government to announce new measures, including restrictions on executive pay and reward, to ensure that water companies are taking action to address these challenges.

Before examining these new measures, these areas of concern are explored briefly below.

1.1 Environmental concerns

The amount of pollution in the UK’s water bodies, including rivers, streams, and the sea around the British coast, is of growing concern. Such pollution comes from various sources, including agriculture and wastewater.

The water industry collects and treats domestic and trade wastewater and sewage, including whatever is flushed down toilets, and water from baths, showers and sinks.[2] The water industry also collects rainfall, sometimes separately from wastewater and sometimes mixed with it. Generally, the network of sewers takes wastewater to a sewage treatment works where it is treated and returned to inland waters and the sea. However, in certain circumstances, water companies are allowed to release untreated sewage. These are called storm overflow discharges.

Storm overflows are used to spill excess wastewater and rainwater into inland waters and the sea.[3] They are “safety valves” used in combined sewer systems to protect properties from overloaded sewers causing flooding and sewage backing up into streets and homes during heavy storm events.[4] Storm overflow discharges can also occur at wastewater treatment facilities. There are around 15,000 storm overflows in England.[5]

Concerns have emerged in recent years about the frequency of storm overflow discharges. Reporting in 2022, the House of Commons Environmental Audit Committee found that:

Overflows are intended to be used infrequently and under exceptional conditions: this is reflected in the permit conditions stipulated by the Environment Agency. Their use nevertheless appears to be increasingly routine, as pressures on the sewerage network grow. Monitoring data seems to show instances where overflows are being triggered at times of low or no rainfall.[6]

The economic regulator of the water industry, Ofwat, published its ‘Water company performance report’ for 2022–23 in September 2023.[7] Ofwat said that five companies had achieved their performance commitment on compliance with permit conditions for discharges from wastewater and water treatment works. This was two more than in the previous year, but just under half of all companies (including some in Wales).

Although there had been a small reduction in certain categories of pollution incidents since 2019, Ofwat said that only five companies (four in England) had achieved their performance commitment level for pollution incidents in 2022, which it said was “unacceptable”.[8] The issue has resulted in calls for more to be done to compel water companies to tackle the issue, including restricting executive reward, as explored below.

1.2 Poor customer service, leakages, and financial resilience

In its September 2023 report, Ofwat also said that customer satisfaction in water companies continued to fall. It noted that “in 2022–23, customer satisfaction fell for most companies, and it is now worse than it was in 2020–21”.[9] It said that “companies should be taking steps to improve immediately, learning from other sectors to resolve customer issues quickly and accurately”.

Ofwat also said that water companies needed to do more to reduce leakages (whilst recognising that improvements had been made) and it said that the sector had not delivered the improvements in water supply interruptions anticipated three years into the five-year reporting period and “must take action to address this”. Ofwat also said that it remained concerned about the progress from a number of companies in delivering their water resources management plans.

Ofwat has also expressed concern over water companies paying dividends to investors without taking sufficient account of their financial resilience and the need to invest in infrastructure and service improvement.[10] CEO of Ofwat David Black said:

When deciding on dividend payments to investors, water companies need to take stock of their performance for customers, the environment, and the company’s overall financial health. Too often, this has not been the case.

2. What new measures have been proposed?

In March 2023, Ofwat outlined new plans to ensure customers do not fund executive bonus payments where they have not been sufficiently earned through the company’s performance for customers and the environment.[11] The regulator said it would regularly review all executive director bonus payments and “where the regulator’s expectations have not been met, customers will no longer pick up the bill”.

In proposed guidance, Ofwat said that it expected water company remuneration committees to take full account of performance for customers and the environment, and performance overall, when deciding whether to award bonuses to senior executives. It said that company policies and decisions on bonus payments would need to align to the expectations set out in the guidance.

Ofwat added:

Water companies will remain responsible for setting performance related pay but in their role as a monopoly provider of essential public services, they need to demonstrate greater accountability. This recovery mechanism will apply new regulatory scrutiny to board room and remuneration committee decision-making.

Ofwat’s review of company decisions on pay awards will be based on a wide range of criteria, including environmental performance, delivery for customers, overall financial health, and compliance issues—all factors which Ofwat expect companies to consider themselves. The proposals are the latest step in Ofwat’s programme of work to link board-level financial decision making to company performance.[12]

Also in March 2023, Ofwat announced new powers to enable it to stop a water company paying dividends to its shareholders if it would risk a water company’s financial resilience.[13] These powers would also enable it to take enforcement actions against water companies that do not link dividend payments to the company’s overall performance.

In addition, Ofwat said that it had written to companies to ask them to provide detailed updates on their progress towards meeting their commitments on improving river quality, reducing storm overflows and eliminating reasons for not achieving good ecological status. It said it was “concerned with the limited levels of detail some companies were able to provide on how they are making progress”. It said it was taking the matter forward with companies that would need to present comprehensive updates, and would make the updates accessible to stakeholders by the end of April 2024.

Ofwat’s plans on executive remuneration were confirmed in June 2023.[14] It published its final guidance on the issue,[15] after a consultation period which saw 25,000 responses—the most Ofwat has ever received. Speaking in June, Ofwat CEO David Black said:

Customer trust is damaged when executive bonuses are not aligned to water company performance. We are pleased that a number of companies and chief executives have already responded to our concerns with respect to last year. Going forward we will review all executive directors’ bonus payments and where our expectations have not been met, we will use this tool to secure protection for customers in the future.[16]

Ofwat does not have an explicit power to ban or curb executive bonuses, and it can only do so if this would contribute to its duties as set out in the Water Industry Act 1991.[17] These duties include ensuring that water companies are financially resilient.

The government has declared its support for restricting the ability of water companies to pay dividends to shareholders when required,[18] and to restrict executive remuneration.[19] On the latter issue, during a debate in the House of Commons, Robbie Moore, parliamentary under secretary of state at the Department for Environment, Food and Rural Affairs, said:

[…] in June Ofwat confirmed new plans that will ensure customers no longer fund executive directors’ bonus payments where they have not been sufficiently justified. Ofwat will regularly review all executive bonus payments, and where companies do not meet expectations, it will step in to ensure that customers do not pick up the bill, which is incredibly important to this government. These new rules have already placed pressure on water companies to take action.[20]

During the same debate in December 2023, Steve Reed, shadow secretary of state for environment, food and rural affairs, said that Labour supported these proposals but that it would also give Ofwat powers to ban the payment of bonuses to executives of water companies which discharge sewage.[21] Mr Reed said “rogue water bosses who [oversaw] repeated, severe and illegal sewage discharges will face personal criminal liability”.

On 11 February 2024, the government announced that Ofwat would be taking forward a consultation that would see water company executives banned from receiving bonuses if a company has committed “serious criminal breaches”.[22] The government said that Ofwat will use the consultation to define the criteria for a ban. This could include successful prosecution for a category 1 or 2 pollution incident—such as causing significant pollution at a bathing site or conservation area—or where a company has been found guilty of serious management failings.

The government said that the ban would apply to all executive board members and chief executives and would be expected to come into effect later this year, subject to the consultation. It also said that, if taken forward, Ofwat would implement the measures by changing the conditions of water company licences. (For water companies in England this would be done using the powers given to the regulator through the Environment Act 2021.) The policy would be expected to apply to 2024/25 financial year bonuses, but the government said it would expect companies to follow the proposed new criteria for 2023/24 bonuses on a voluntary basis.

3. What has the response been from the water industry?

In May 2023, water and sewerage companies in England apologised for not acting quickly enough on sewage spills.[23] Water UK, a membership body representing the water industry, said water companies were ready to invest £10bn in a new national overflows plan over the next decade, aiming to modernise the sewage system and treat overflow spills so they would have less impact on rivers. In response to the Environment Agency’s annual environmental performance assessment report published in July 2023,[24] Water UK said the results “demonstrate the need to further accelerate improvements in environmental performance”, to which the industry was “strongly committed”.[25]

Water companies published their draft business plans in October 2023 setting out their proposed spending on infrastructure and improvements to the water system from 2025 to 2030.[26] These are due to be scrutinised by Ofwat to ensure they meet legal requirements and government targets. This takes place as part of Ofwat’s five-yearly price review, through which it sets price controls for water and sewerage companies.[27] The final business plans and price controls will be agreed by Ofwat in December 2024, with changes to bills taking effect from April 2025. Water UK said that its proposed plans would see £96bn invested in water and sewage infrastructure between 2025 and 2030, including an £11bn investment to reduce overflow spills and the installation of advanced technology at sewage works to remove over a million tonnes of phosphorus from rivers.[28] It proposed these investments would be funded by “incremental increases to bills over a five-year period”, with the average bill in England increasing by £7 by 2025, rising to an additional £13 per month in 2030.

In response to the 11 February announcement on banning bonus payment for criminal breaches, a spokesperson for Water UK said water companies were providing record levels of help for customers, including financial support with their bills for 2 million households.[29] The spokesperson added it was “right that regulators have all the powers they feel they need to hold water companies to account”.

4. Read more


Cover image by Matthew Feeney on Unsplash.

Links to a House of Lords Library briefing were added on 19 February 2024.

References

  1. House of Commons Library, ‘Economic regulation of the water industry in England and Wales’, 4 June 2020. Return to text
  2. Environment Agency, ‘Pollution from water industry wastewater: Challenges for the water environment’, 22 October 2021, p 3. Return to text
  3. Stantec, ‘Storm overflow evidence project: Final report’, November 2021. Return to text
  4. Department for Environment, Food and Rural Affairs, ‘Consultation on the government’s storm overflows discharge reduction plan’, 31 March 2022. Return to text
  5. Stantec, ‘Storm overflow evidence project: Final report’, November 2021. Return to text
  6. House of Commons Environmental Audit Committee, ‘Water quality in rivers’, 13 January 2022, HC 74 of session 2021–22, p 49. Return to text
  7. Ofwat, ‘Water company performance report 2022–23’, September 2023. Return to text
  8. As above. Return to text
  9. As above. Return to text
  10. Ofwat, ‘Ofwat announces new powers on water company dividends’, 20 March 2023. Return to text
  11. Ofwat, ‘Ofwat plans tighter measures on water company executive bonuses’, 30 March 2023. Return to text
  12. As above. Return to text
  13. Ofwat, ‘Ofwat announces new powers on water company dividends’, 20 March 2023. Return to text
  14. Ofwat, ‘Ofwat delivers decision on executive pay’, 29 June 2023. Return to text
  15. Ofwat, ‘Protecting customer interest on performance related executive pay: Recovery mechanism guidance’, June 2023. Return to text
  16. Ofwat, ‘Ofwat delivers decision on executive pay’, 29 June 2023. Return to text
  17. House of Commons Library, ‘Opposition day debate: Bonuses for water company executives’, 5 December 2023. Return to text
  18. Department for Food, Environment and Rural Affairs, ‘Government supports new Ofwat powers to tackle water company dividends’, 20 March 2023. Return to text
  19. HC Hansard, 5 December 2023, cols 309–13. Return to text
  20. HC Hansard, 5 December 2023, col 312. Return to text
  21. HC Hansard, 5 December 2023, cols 276–80. Return to text
  22. Department for Environment, Food and Rural Affairs, ‘Government cracks down on bonuses for water company bosses’, 11 February 2024. Return to text
  23. Water UK, ‘Water and sewage companies in England apologise for sewage spills and launch massive transformation programme’, 18 May 2023. Return to text
  24. Environment Agency, ‘Water and sewerage companies in England: Environmental performance report 2022’, 12 July 2023. Return to text
  25. Water UK, ‘Response to the Environment Agency’s annual report on environmental performance’, 12 July 2023. Return to text
  26. Department for Environment, Food and Rural Affairs, ‘Water company draft business plans published’, 2 October 2023. Return to text
  27. Ofwat, ‘2024 price review’, accessed 13 February 2024. Return to text
  28. Water UK, ‘Water companies propose largest ever investment’, 2 October 2023. Return to text
  29. BBC News, ‘Ban water bosses’ bonuses now over sewage spills, say campaigners’, 13 February 2024. Return to text