Water (Special Measures) Bill [HL]

Lord Remnant Excerpts

2nd reading
Wednesday 9th October 2024 Lords Chamber

[Lord Remnant (Con)]

My Lords, I declare an interest as having been a non-executive director of Severn Trent, the largest of the listed water companies, for eight years between 2014 and 2022, chairing the board’s remuneration committee for that time.

Last month, the Secretary of State said that the Government planned to carry out a full review of the way in which the water industry is regulated and that this would shape future legislation. It is a shame, then, that this piecemeal Bill cannot be assessed in the context of more fundamental reforms to the way in which the water industry operates. Worthy of debate would be the plethora of sector regulators and the frequency of Ofwat’s periodic price reviews. Successive Governments and regulatory price reviews have prioritised lower customer bills over the industry’s investment needs. Now, however, in addition to greater accountability, we should be focusing on the need for more innovation, the recruitment of new talent and, above all else, greater investment to raise standards. My concern is that there are aspects of the Bill that run contrary to these objectives and where scrutiny of the rules set by Ofwat under the Bill’s general provisions, and of the powers exercisable by statutory instruments, will be limited.

I turn to the specific provisions of the Bill. Although I would normally view the stiffening of penalties in the form of automatic penalties, lowering the standard of proof and imposing custodial sentences as less of an effective deterrent than the consequence of a failure of the underlying regulations themselves and/or their oversight, it will be underperforming companies which have the most to fear from this. Clarification on the scope of offences to be covered and the potential value and proportionality of fines will be required, and I leave it to others to comment on whether imprisonment for impeding regulatory investigations is really the most effective utilisation of our apparently scarce prison capacity.

My principal area of concern relates to the rules for remuneration and governance. Clause 1 contains provisions giving Ofwat the power to block the payment of bonuses to the chief executives and directors of water companies. While sensible in principle, the devil will be in the detail, which may lead to unintended consequences. How best to remunerate senior individuals is complex. It involves alignment with the business’s strategic goals, balancing short- and long-term considerations, fixed versus variable pay, and attracting and motivating talent. Decisions are best made by the boards of companies, which take account of the views of all stakeholders, particularly shareholders and regulators, in assessing matters requiring fine judgments. This is not within the core competence of an economic regulator.

It is perhaps overoptimistic of me to expect the Minister to excise Clause 1 from the Bill in its entirety. There may, however, be areas of common ground on which I would welcome her thoughts. The Bill is too widely drawn. It states that the rules will apply only to pay which is linked to

“the meeting of any targets or performance standards”

by the water company or the individual. There is no clarity on how the relevant standards will be measured, which will fall to Ofwat to determine, nor on when the relevant trigger occurs and which remuneration will be affected. For example, will the relevant remuneration be that payable in respect of the year in which the failure occurs or when the penalty is imposed? Where remuneration is based on multi-year performance and there is a failure in only one of the years, would the whole award be impacted or only a proportion?

The key elements will be the metrics which Ofwat applies to determine whether the standards have been met. A properly constructed system of metrics linked to objective measures, which seeks to eliminate reward for failure but which aligns with the company’s own key performance indicators and does not penalise those in the industry who are meeting or outperforming stringent targets, should be the aim. Should the rules, however, be punitive and have the effect of discouraging the best people from working in the industry and restrict water companies from rewarding performance when appropriate, the consequence will be damaging.

Do we really want companies to move away from bonuses and long-term incentive schemes linked to performance to compensating increases in fixed pay? There is a precedent within the financial services industry when mandatory bonus caps were imposed—since removed by the last Government, a move endorsed by the current Government. The experience was not a happy one because it removed incentivisation and increased fixed costs, to the detriment of consumers.

In terms of employees within the scope of these rules, they apply to the chief executive and other directors of the regulated water company. The Bill provides that Ofwat may extend the rules to

“such other description of role”

as it specifies. Not only would such an extension be wider in scope than the current disclosure requirements of the Water Industry Act 1991, but it would be difficult to implement in practice as different water companies will have individuals described differently by title and role. This additional power conferred on Ofwat by the Bill should surely be removed if we wish to attract and support the next generation of leaders in this vital industry from middle management. This will not be achieved by extending these restrictive remuneration practices to them.

Clause 1 also includes provisions intended to establish consumer involvement in corporate decision-making. Clause 1(6) provides that this may include a requirement for persons representing the views of consumers to be

“members of a board, committee or panel”

of the water company. While I support the principle of strengthening the voice of consumers, this should not be through a highly prescriptive, one-size-fits-all approach.

We do not have different categories of director in this country. Non-executive directors may have particular specialisations, but they are chosen for their wider skills and ability to make a comprehensive contribution. Those representing consumer interests may not wish, or be equipped, to sit on corporate boards, with all the responsibilities and liabilities that entails. It should not be for Ofwat to require that such people sit on the boards of the water companies; it should be left to the companies to decide which forum best suits their own requirements, whether it be board, committee or panel. Providing such flexibility was effective when companies enacted the workforce engagement mechanism for the purposes of the UK Corporate Governance Code.

Finally, I turn to the section on special administration orders, which relates to the insolvency of water companies. Clause 10 gives the Secretary of State the power to modify a water company licence in order to recover any shortfall in costs for the Government from its consumers, and new Section 12J(4) extends this recourse to all other companies in the sector. Forcing good companies and their blameless customers to bail out failed companies cannot be justified. This unquantifiable potential liability will serve only to deter much-needed external investment in the sector.

There are provisions of this Bill which will deter the investment that the industry so badly needs, and experienced executives from working in it. Let us not return to a pre-privatisation environment. In particular, the discretion given to Ofwat is too broad, but I look forward to the next stages of the Bill, which will give us opportunities to improve it.