Welcome to the second panel in today’s hearing. We will be looking at the role of utility regulation, in particular electricity and water regulation. David, Jo and Jonathan, thank you so much for joining us.

When we compare ourselves to other countries, the biggest differentiator for us is this country’s dependence on gas. The driver for high industrial prices is the underlying cost base within the industry. For both households and businesses, that is the primary driver of cost. There is a secondary driver, which is the way we allocate network charges. Some countries choose, for large industrial users, to basically reduce those costs quite substantially. Prior to the industrial strategy, we offered a discount to those charges, but not as much as our competitors. That has been adjusted as part of the industrial strategy.

That is in 2027 onwards, I think.

Yes.

In terms of the macro picture, those are the costs that I described. Focusing on small business users particularly, during the crisis we saw a set of unacceptable behaviours by some suppliers and brokers.

When did you see that, Jonathan?

We saw that during the energy crisis, so in 2022‑23.

To lay out the things we have done to address that—these are new measures, so we will see whether they have the impact that we hope for—as you have already mentioned, we have recommended to Government that we are regulating brokers. We are expecting that as part of the energy independence Bill, we will get powers to do that. That is critical, by the way, because many of the stories that I have heard have been of people who signed up to five-year-long contracts at the height of the crisis and are still paying those contracts today at those prices.

I will come to that. Secondly, we introduced a set of standards of conduct that include transparency about pricing and commissioning, as well as regulations about how you apply the deemed rate. We do expect the deemed rate to be a reasonable reflection of costs. The third thing, which is critical, is that when I spoke to people who were affected incredibly badly by that behaviour, one of their problems was that they have nowhere to go. The only place that you can go to try to resolve your problem is court. On our recommendation, the Government have extended the powers of the ombudsman at the end of this year to make sure that we have a dispute resolution service. Coming back to your comment on deemed rates and what are offered, people now have a place to go to say, “What I have been charged is too high.” Before, you would be expected to get your own lawyer and take that to court, which is too difficult to do. Finally, particularly for small businesses, we have extended the role of Citizens Advice, so that it can provide people with the sort of advice that you get as a domestic customer to make sure that you can address these issues with your company and take complaints to the ombudsman. We have put in a package of reforms that we expect to change the business market that we see. If they do not succeed, we will have to come in with harder-edged regulation, but this is always a trade-off.

We have set these rules up now, and we are monitoring them. It is happening as far as we can see, but we will continue to monitor them against retailers.

I cannot comment on individual cases. Part of it is about the credit rating of people who are on the other end of that contract.

Yes, that contract was. I cannot comment on individual cases, as you will understand, but for example, we have already taken action against Maxen Power, where we did find breaches against these regulations. We will continue to do so. We are changing this market. Without a doubt, what I saw a year and a half or two years ago is not acceptable, and that is why we put that set of measures in place.

How did we end up in this position?

In a sense, when we look back at the history of the business market, there was a dramatic change in the underlying pricing that we saw in the crisis, and we saw different parts of the market take advantage. My principal concern—I have sat with shopkeepers who have lost shops because of this—is the role of some of the brokers. That is an unregulated market. We have bid before to be able to regulate it, and we are going to be regulating it in the future.

How did we end up in a situation where people were just able to behave in this way?

In my mind, there is a wider question in energy. We are moving from the system 20 years ago, when we had a small number of companies running big power stations to supply customers, to a much more fragmented market now. The kind of regulation that we want to introduce for brokers is something that we are going to need in other parts of the market as well. It is simply that lack of regulation that led to that point.

Basically, it was a free-for-all in which a small number of predators—maybe it was a large number of predators—could just milk small business in a way that was uncontrolled.

On the brokers’ market, I am not sitting here saying that every broker is a predator, but without a doubt there were some people who pressured customers into taking contracts that were against their interest. That is why we want to have it regulated.

They were allowed to get away with it.

There were no rules or legal powers in place to stop them.

You are now telling us today that the rules that are coming into force will end that behaviour.

There are two sets. There are the standards of conduct for the retailers, but there is also this regulation of brokers, and the ombudsman. When I think about regulation, it is not just about the rule setter and the rule enforcer; it is about where you go when you have a problem. It is much better for any customer, unless you are of a large enough scale to have your own energy and legal teams, to be able to go to the ombudsman and get a resolution for your problem.

So the misbehaviour that we saw in the past, which you very eloquently described today, will no longer be possible under the new rules that are coming into force.

That is what I expect. If these rules do not work, for any reason, we will come back and we will be firmer and tougher, but that always has a trade-off, because that gets more complex and more interventionist. As you know, we have to keep a balance.

We have enforced against Maxen Power for wider licence breaches, so we will keep monitoring it. We started by trying to regulate this through suppliers. The truth is that it is just too long and too abstract. You need to go directly to the behaviour, and that is going directly to brokers.

Let’s move on to water. Why are bills rising so quickly? In my constituency, Southern Water raised bills by 53%. What is Ofwat doing about it?

Bills are rising, driven by the scale of investment programmes in the most recent price review, which was in 2024. There has been around a fourfold increase in investment, from about £11 billion over the price review period to £44 billion, which has resulted in bills increasing. In the case of Southern Water, it has a very large investment programme relative to what it has invested before, because it is upgrading a lot of its key water treatment works as well as significant upgrades on the wastewater sites. These partly reflect action taken to reduce storm overflows, but more generally to improve environmental performance and bring forward new water resources that are much needed for the future.

Why have you not pushed that in the previous five-year cycle? Why is it coming now? What could you have done to have prevented this huge hike?

That is an excellent question. It is something that we have thought about, and that is why there is also a review of sector regulation. My colleagues at the Environment Agency are responsible for leading on environmental investment planning. That scales up what they call the water industry national environment programme. For example, at the 2019 price review it was around £5 billion for the price review period. In the most recent review, it is around £24 billion. We reflect those environmental investment requirements in the price review, but there are questions about how we get that balance of investment planning right and make sure that we are looking out over not just five to 10 years, but 15 to 25 or 30 years.

The obvious next question is to Jo Nettleton of the EA: what was going on five years ago? Why were you not looking ahead to ensure that we managed our investment in infrastructure appropriately?

The way we inform the price review is by carrying out assessments through the water industry environment plan. It is fair to say that over the last three or four years, we have really stepped up our game in terms of water regulation and the input into that review. Previous price reviews have resulted in significant investment, but we have stepped that up to the next level now, in the same way that we have stepped up our regulation of the water industry.

What happened two or three years ago to cause that step change?

The general expectations of society around water increased—

I should not interrupt, but why did it take getting measures put in place that enabled consumers to be able to see what was happening? Why could the industry and the regulators not have managed that themselves without consumers having to monitor it for them?

My colleague Helen Wakeham, who is the director of water, would be able to answer that, and we can write to you. What I can say is that we have significantly improved how we regulate water over the last few years. We have increased our investment, we are bringing in more people, and we are carrying out more inspections. At the same time, in terms of our assessment of what needs to feed into the price review, this year’s price review has identified 20,000 actions that need to be taken to improve or prevent deterioration across the sector.

Why should consumers have confidence that all this new investment, all these new people and this nice gravy train will necessarily provide cost-effectiveness and an increase in productivity? What are the measures in place to ensure that that happens?

In terms of the financial and commercial side of things, I will refer back to David. In terms of what we regulate, which is the environmental impact of the water industry, we have increased our number of inspections. We carried out 4,600 inspections last year and 10,000 this year. We are bringing in a lot more inspectors. What is really at the heart of our approach now is a very outcome‑focused basis for our regulation of industry. All our regulation of the water industry is aimed at improving performance in a really intelligence-led way. We have a strategy that features right through from how we carry out our permissions, how we undertake our compliance work and the enforcement that we take, with measures around how well we are doing that, but also—to your question—how effective that is and whether we need to review that strategy. We are absolutely on it.

How do you feel that Ofwat, the EA and the water companies are working together now? The thing that struck me when I first was elected was that there is no strategic overview of how water is used and produced in this country. Do you feel that we are moving to create that, or was my judgment incorrect in the first place?

All I will say on that is that this is an area in which there is a lot of scrutiny, quite rightly. The Cunliffe review is very much looking at that and making recommendations around that very point of how the system of regulation works across water.

I am just going to go back slightly to the previous question. What we need to see is innovation and new ways of working in the sector. We have established innovation from the last price review. We have doubled that in scale at this price review, so that ought to provide a pipeline of really quite exciting new technologies in the sector. We have also been encouraging the sector to adopt smart networks. Effectively, a lot of the technology in the water sector has traditionally been quite old, so what we are looking to see is much more use of monitoring technology on networks, which then allows companies to design and deliver better services. Another area is nature-based solutions and approaches, so we have been also encouraging the sector to adopt those. As Jo mentioned, as part of the WINEP process, we have trialled what we call advanced WINEP, which is about getting to more outcomes-based approaches and encouraging partnership working by companies and their communities and councils. I was up in Manchester recently, looking at integrated water management there and what they are doing between the councils, the Environment Agency and the water company to make sure that we are making much better use of water and how it is captured and stored.

David, you have managed to go through all your answers today without once referring to the level of dividends paid out by water companies to their shareholders. Do you want to just remind the Committee of how much has been paid out to shareholders in dividends since privatisation?

About £52 billion has been paid out in dividends over the last 34 years, based on Ofwat’s records. If you look at the last seven years, there has been a marked reduction in the level of dividends. In most recent years, they are averaging around 3% returns. I would quite agree that in earlier periods, they were too high. When we look at the reasons that drove the high dividends, we saw that there were higher returns from financing outperformance, which was something that was talked about at the Public Accounts Committee in 2016, looking back at earlier review periods. We also recognise that financing costs were much higher in the period immediately following privatisation, so returns were just inherently higher. We are also very aware of companies taking on debt to pay dividends, particularly in the case of one or two companies in the sector. In terms of actions that we have taken as a regulator, up until 2021 we lacked powers to change company licences to properly police this area. We have been given those powers in the Environment Act 2021. We have imposed new licence conditions on companies to regulate their level of dividends and ensure that they are linked to performance. I should say that dividends are an important part of the sector, in terms of a privately funded sector.

Are you inviting us to believe today that the balance between dividends to shareholders and the amount invested is correct?

As I say, dividends are around 3% a year. There has been about £5 billion of new equity raised over the last five years. In fact, there is more equity being raised by companies than dividends being paid out in recent years, so the balance has changed. The question is whether we can keep that balance right in the years to come as well.

In your judgment, is the balance now right between dividends paid out to shareholders and the amount of money that is being invested?

At a sector level, it looks much like it is in balance and back to where it ought to be. There are still questions about individual companies. For example, we took action to fine Thames Water when we believed that it had paid a dividend inappropriately a year or two back. There are still cases where we have concerns, but if we look broadly across the sector, we are seeing much lower dividends.

What you have collectively described to us this afternoon is, basically, a breakdown in regulation for which consumers and small businesses have paid a price, while billions of pounds has been routed out to shareholders. What we really want to get into now is whether there is a fix to this regulatory regime which is about to arrive, but let me first bring in Charlie Maynard.

Hi, David. It is good to see you. Who is the ultimate controller of Thames Water?

This is a question that we have under review. In our view, it is still the existing shareholders in Thames Water.

OMERS is the largest shareholder in Thames Water. Last May, 14 months ago, it removed its director from the board and wrote off its shareholding. How can you tell us seriously that it is the ultimate controller of this company?

That is a question that we have considered and continue to consider, but the ultimate controller test is not just about whether they are exercising control, but whether they have the ability to exercise control. At the moment, they still do have that ability to exercise control.

The concept is broader than legal ownership, as you know. It includes anyone who can exert significant influence over strategic decisions. As per the High Court ruling and that judgment, it is very clear that class A bondholders are meeting that level. Do you agree?

That is something that we have considered and, as I say, it remains under consideration. We may change our position, but at this point in time, we do not think that that test has been met.

Can you explain why you think that the class A creditors do not exert significant influence over strategic decisions for Thames Water?

One example is that they are not formally co-ordinating together. The creditors have informal collective mechanisms, but still retain the ability to act alone. That is one of the issues that we are looking at in terms of the test. As I say, it is a matter that I am not going to go into further details on, because it is something that we do keep under review.

What it looks like to me, and perhaps to other members of the Committee, is that you are flouting your own regulations on purpose, because making them ultimate controller would mean they have legal obligations that they no longer have. We have shareholders who have publicly walked away and said, “Our equity is valueless and we have no board representation any more,” and, as per the letter that you wrote to me on 11 March, you are saying that they are still in control of this company. Then we have class A creditors that a High Court justice is saying have significant control of this business, and you are saying, “No, they don’t.” It just feels very convenient for the class A creditors particularly, and possibly Ofwat too.

It is not a matter of convenience. It is a matter of our view about how we apply the law in this case.

When are you going to come to a decision?

As I said, it is a matter that we have taken a view on, but we do keep it under review. We have inquired of the company. We have information. We have made investigations of the issue. It is not a matter that we are taking lightly. It is a matter that we have considered and will continue to consider. If we think it is appropriate, we will set out that view.

My next question is on the special administration regime. Steve Reed wrote to Alistair Carmichael on 25 June and said, “However, we expect that any Government funding required during a SAR would be recouped after the conclusion of the administration.” Do you agree with that?

Yes, that would be the intent of the Government. Whether that transpires will depend on the facts of the case, which may depend on how long the special administration goes on for and what the exit process is.

Running with that, what you are also agreeing with is that the net cost to the Government is likely to be zero, because what Steve Reed stated is that they are likely to recoup their money at the conclusion of the administration.

There is a question for the Government as to what their view on that is.

I am asking for your view.

Again, this is a matter of conjecture and speculation. There are different ways in which a special administration can be financed, but we expect that the Government may be required to provide money for Thames Water in terms of cash flow purposes over the special administration period. That number could amount to billions of pounds. Again, it depends on the choices made by the Government, and that is a question for the Government, not for us as a regulator.

Do you agree with the Government’s assertion that they would expect to recoup their funding at the conclusion of the administration?

That is a reasonable proposition for the Government.

In that reasonable proposition, the net cost to the Government of putting Thames Water into special administration would be zero. Just sticking with what we have stated here, are you in agreement with what Steve Reed said?

That would be the ambition of the Government in this process. There are lots of uncertainties in terms of how the special administration process might work and what the exit might be. For example, it depends on what value the company attracts at exit and what cost the Government have incurred.

They are the super senior lender, so they are at the top of the tree.

Yes.

The next question is about investment grade. A year ago, last July, Thames Water breached its operating licence, whereby it has to have two investment-grade credit ratings. It has not had that since last July. We are 12 months on. As per May this year, Moody’s is now unable to state a credit rating, because it does not have sufficient information. That is what it called it. For how long is that okay? What moral hazard does it send to the rest of the water industry and to other regulated industries that companies are allowed to breach their operating licences conditions with effective impunity, carry on and never mind? Why can everybody else not do it?

That is not the case. We have reached a set of undertakings with Thames, which we are in the process of implementing. Part of that is about reinstating investment-grade credit ratings. It is also true to say that that is going to take a number of steps, one of which is likely to be the restructuring of the business itself. It will have to secure new equity and restructure debt in order to get to that position. That is the process that it is working through now. It has run a process. As you know, there have been two bidders in that process. They are now down to one. It is that process that it is looking to resolve, and that needs to happen as soon as possible. In terms of moral hazard, it is costing the creditors hundreds of millions of pounds—billions of pounds, in fact—to keep this company going, so it is certainly not without its cost. The ultimate cost to creditors could well be quite substantial.

With the Chair’s permission: would you mind writing to the Committee to set out what your reasoning is with regard to the ultimate controller?

Yes, I will endeavour to do so.

Just stepping back and looking at how we have approached customer service, we have been very interventionist in the last two years to improve customer service. In 2022-23, we saw a significant dip in the standards that customers should expect. As a result, in the latest customer satisfaction survey that we have run since pre-2020, we are now at satisfaction levels that are higher than they have ever been in our history, although we have been measuring it for only a smallish number of years. That has been because Ofgem has been very direct about the sorts of changes that we need to see. If I take you back to one company—and it is all public—E.ON was failing to answer the phone during the height of the crisis, so half its customers were leaving before they even got an answer to their phone call. We have now driven down response rates to around two minutes; they were taking an extremely long time to answer. We have also spent a great deal of time across the board on trying to set standards that bring them up to a different place. We do not have direct control over executive remuneration within our suite of powers. I know that my colleagues in Ofwat are getting legislative powers that we do not have. That is a consideration that Ministers will be thinking about when they think about the Ofgem review. Our focus really is on the incentives that we put around companies to make sure that we drive up standards, and we will continue to do so.

Can I just check: drive up standards rather than drive down price?

It is both. The four outcomes that we seek are fair prices, decent standards, resilience and getting to a cost-effective net zero system.

You will appreciate that your judgment about fair prices is pretty different from that of my constituents.

I need to be clear what we mean by that. We cannot change underlying costs, so we cannot change where the energy comes from. Right now, this country is very dependent on an international gas market that none of us in this room, in this Parliament, in Government or in the regulator controls. That is why we are really supportive of the Government’s drive to get to net zero, not just because it delivers on climate change, which is my background, but because that is the way that you get away from a set of prices that, frankly, are being controlled by geopolitical events.

The level of bonuses in the sector is unacceptable, and that has driven a reduction in trust. It is not just about performance of the sector, but about the perception of customers that there have been rewards for failure. Prior to receiving the new powers that Jonathan referred to, we introduced provisions requiring companies to recover the costs of bonuses from customers only where they could demonstrate that bonuses had been linked to performance, and, in many cases, we were successful in stopping customers paying for company bonuses. The Government have passed the Water (Special Measures) Act, which now gives us new powers to stop bonuses in specific circumstances. We have just received those powers, but we will use them to stop bonuses where they have not been justified. In particular, there are criteria around the level of environmental performance and customer service, and we will act using those new powers.

We are, and the review that we carried out in 2023 gives us the foundation to do that. I have listed the things that we are introducing to try to make sure that businesses are better protected. We have wrestled with the question of whether we have a price cap in the business sector. Ultimately, that is not a question for us; it is a question that Ministers will have to answer, because ultimately it will require a change in the law. There are real pros and cons, though. Businesses are very different and quite heterogeneous, and it is harder to introduce pricing regulation in the same way as for households. What we really want is the behaviour of suppliers, and indeed of brokers, to change, which is why we introduced the measures that we did.

The Chancellor has asked you to regulate for growth. Lots of Governments have sought smarter regulation, good regulation and so on. What specifically has the Chancellor asked you to do, and what have you done so far?

We have highlighted two measures on the level of investment going into the sector. That is important for growth—not just the £104 billion in the price review, but particularly the £50 billion of major projects that we have coming along, which will be really important for future water resources to make sure that we have the water to power the economy in the future. We are also looking at innovation. I have already referred to doubling the scale of the innovation fund to drive more innovation. There is then innovation across the water sector, which is about new ways of using micro-satellites to detect leaks, for example, and promoting nature-based solutions, which are giving us a pipeline of technology to allow the sector to respond to the future. Those are the two areas that have been set out in the Government’s regulatory action plan, but we are also looking at what we can do to regulate smarter and faster, particularly in areas around developer services, which are services to new home builders, and how we can make that process more agile. In particular, we have highlighted the requirements to consult on each new site as a potential barrier. That is something that we would like the Government to address. On major projects, we have talked about different forms of financing vehicles, and getting the type of approach used for the Thames Tideway used more widely. There is lots of scope and lots that we can do.

We have committed to improving our response to planning consultations, to consistently hitting our 21-day KPI and to improving our environmental permitting service. We have put in place a number of measures around a digital portal, so that we are easier to do business with, and a priority tracked service, so that we can track the most complex permits through the system to support people who are working in innovation, particularly in hydrogen and carbon capture, utilisation and storage. We have committed to increasing our transparency, which is really important. People want to see us regulating. That is massively important. From spring this year, we have begun to put online our assessment reports from inspections of water companies, and we will be increasing that across other sectors. We have committed to providing specific advice to industrial clusters around environmental capacity and potential work with developers around potential solutions.

The way we put this to the Chancellor was that there are two things that we need to do. One is maximising the economic opportunities of all the investment that we are putting in place, getting the investment that we need for 2030 at pace and making sure that it delivers for customers. The second thing is working with Government and making sure that we not only create jobs through the building that is happening, but get factories and manufacturing located here, so that we can begin to export those services abroad. We are working with the national wealth fund and the Department for Business and Trade to make sure that that happens. It is also about making sure that the sector works for business. We talked about small business customers previously. The other part of this is really about making sure that our retail sector is innovative. We have companies that have gone global from the UK market, so we need to make sure that there is room for new entrants to come in and offer different services. It is public that Tesla has been looking at the UK market for a while, for example. That is a way in which we can both support customers and drive growth. It is then around the system that is there and whether that is configured for industrial and manufacturing customers. That is about working on cost—I was really pleased that in the industrial strategy we had the supercharger plus the British industrial competitiveness intervention—but it is also about allowing people to connect quickly. We are working to clear out the connections queue so that we have a system that works for business as well as for customers.

We know that the ombudsman’s caseload is increasing, so they are becoming increasingly active on this. We will work closely with them. We do monitor what they do and are happy to look at their resolutions. If you have concerns, I would be really keen to hear them, and we will feed them back in.

I am very happy to check in and see if they have the resources that they need. They have not flagged that as an issue for us. They charge per complaint, so their funding model reflects the number of complaints that come to them. There is a job alongside—I mentioned the Ofgem review—thinking about how the role of the ombudsman can be made more effective. What I am in favour of is seeing a much quicker referral to the ombudsman. In the domestic market, for example, we are beginning to trial not a system where you wait eight weeks and then reapply to an ombudsman to get your complaint resolved, but one where it automatically goes to the ombudsman and they resolve it. As long as you give permission, they resolve it quickly. That is the sort of thing that I would like to see for businesses as well as for customers.

This has been an extremely useful opening to our exchanges. We will invite you back soon, after we have had some exchanges of correspondence. The agendas that you are policing are of fundamental concern to the businesses of our country. You have described a pretty serious and significant set of regulatory breakdowns that have involved enormous costs that were unfair to the business community. You have told us a story about some regulatory changes that are coming in. We will want to remain absolutely on top of whether those regulatory changes are delivering for British business. Thank you for your time.