Ofwat consults on dividend-blocking powers

Ofwat has given statutory notice of its intention to modify water company licences to strengthen financial resilience and bring consistency across the sector.

It is consulting until 29 September on the following proposals.

Raising the cash lock-up trigger to BBB/Baa2 with negative outlook, effective from 1 April 2025.

This would ensure companies maintain headroom “well within the investment grade” and take earlier corrective action where it is required. The paper explained: “We have become concerned about the general decline in credit quality in the sector over time. The present minimum standards in company licences allow companies' financial resilience to deteriorate too far before distributions outside of the regulatory ring-fence are restricted and they have to engage in meaningful corrective actions or in discussions with us on the mitigants being planned and executed.”

Requiring that dividend policies and dividends declared or paid should take account of service delivery for customers and the environment over time, current and future investment needs and financial resilience over the long term.

Ofwat said this would formalise existing expectations given shortfalls in the clarity with which some companies are currently explaining their dividend decisions, as well as ensuring consistency and removing ambiguity. The changes would give the regulator extra powers to stop water companies making dividend payments if the company's financial resilience is at risk, and enable it to take enforcement action against companies that don't link dividend payments to their performance, or those failing to be transparent about their dividend pay-outs.

Requiring companies to maintain investment grade issuer credit ratings with at least two credit rating agencies and to notify Ofwat of changes to credit ratings.

The paper also set out how Ofwat is pursuing improved transparency on swaps and pensions, outside the licence, and made provision to bring other ring-fencing provisions in Wessex Water's licence up to the current industry standard.

Chief executive, David Black, said: “It is vital that companies have sufficient financial strength to withstand shocks and surprises. Our proposals today will raise the bar on credit quality and give us new powers to block dividends if a company is putting their financial stability at risk in making them.

"These changes should also ensure that companies engage with us earlier when they do see any concerns with their financial resilience.

“In addition, our proposals will reinforce the link between performance and dividends. Customers are rightly concerned that companies pay out dividends even where the fall well short of their obligations to customers and the environment. The responsibility for determining dividends ultimately sits with companies and their boards. However, in a sector that provides an essential service, where customers cannot choose their supplier, it is important that customers and wider stakeholders can understand and have confidence in how decisions companies make about dividends relate to overall performance.”

The proposals were amongst those published for discussion in December 2021. Ofwat reasoned that weakened financial resilience can lead to reduced levels of operational performance and erode a company's capacity to cope with financial pressures or shocks without compromising service to customers.

It pointed out: “In some instances, companies have been slow to acknowledge that their financial position needs to be improved when we have raised concerns and have been unwilling to engage openly on these issues. In addition, we have seen recent cases of companies stepping back from public commitments to improve financial resilience. These experiences have indicated to us that backstop financial resilience protections across the sector need to be improved.”