Regulation takes the hit as Government pledges a rapid water reset

The Government has immediately backed two major structural changes recommended by the Independent Water Commission (IWC) that will fundamentally reshape the water sector as we know it: the abolition of Ofwat, and movement to a catchment-based model for water system planning.

Super-regulator

Ofwat will pay the ultimate price for what environment secretary Steve Reed described as obvious failures by the water industry. His list of indictments included record levels of sewage pollution, multiple hosepipe bans, infrastructure in disrepair, company profiteering at customers’ expense and steeply rising bills – albeit pollution and water resources fall under the Environment Agency’s remit rather than Ofwat’s. “Ofwat has failed to protect customers from water companies’ mismanagement of their hard-earned money and failed to protect our waterways from record levels of pollution,” he told Parliament as he announced the formation in England of “a single powerful super-regulator responsible for the entire water sector… [that] will stand firmly on the side of customers, investors and the environment and... prevent the abuses of the past.” In Wales: “We will work closely with the Welsh government to devolve economic regulation of water to Wales.”

Ofwat will remain in place during the transition and “I will ensure they provide the right leadership to oversee the current price review and investment plan during that time. To provide clarity during this period, I will issue an interim Strategic Policy Statement to Ofwat and give ministerial directions to the Environment Agency, setting out our expectations and requirements.”

Existing regulation was sidelined as Reed pledged to establish “a new partnership based on effective regulation where water companies, investors, communities and the Government will work together to clean up our rivers, lakes and seas for good”.

Timing

The Government backed two further IWC recommendations immediately: the creation of a new statutory water ombudsman with legal powers to resolve customer complaints; and the end to operator self-monitoring. This will be replaced by open monitoring across the wastewater system, the data from which will be made publicly available online.

Ministers said a White Paper will be published in Autumn giving the Government’s full response to the IWC recommendations (see below), together with a consultation on the proposed changes and a transition plan for regulation. This will be followed up by a new Water Reform Bill “early during the lifetime of this Parliament” – which suggests prompt action, perhaps next year.

The IWC made it clear in its final report that many of its recommendations could be implemented ahead of or without primary legislation – putting the pressure on ministers not to delay. 

Reaction

Few have disagreed with the Commission’s conclusion that the water system needs fundamental change. Most stakeholders in and around the industry have welcomed the thrust of the recommendations. But many of the clean water activists that helped get the sector on the political agenda in the first place have been critical. River Action, for instance, said the report “fails to propose the bold reform urgently needed to fix the UK’s crumbling water system. While the report acknowledges the depth of the crisis, it ultimately offers the illusion of change – not real change.”

A key theme of much of the criticism – including from some politicians, press, trade unions and campaigners – has been that public ownership was taken off the table before the Commission even began its work. This could prove a sticking point for effectively rebuilding trust in the reformed system.

Other key issues are exactly which IWC recommendations will be adopted and how they will be implemented. The resourcing of the new super-regulator has emerged as a key concern, not least because of reports last week that thousands of water tests to identify potential harmful pollution in English waterways were cancelled in the last three months due to staff shortages.

• The Office for Environmental Protection has closed its investigation into the regulation of combined sewer overflows. This found failures to comply with environmental law by Defra, the Environment Agency and Ofwat. However, the OEP said the Government’s response to the IWC showed “significant reforms are on the way” and that many actions to remedy the problems have already been taken. 

• Reed’s comparison of water quality in England and Scotland in media interviews about the merits of public ownership have sparked a spat between the UK and Scottish Governments. Scotland’s Cabinet secretary for climate action and energy Gillian Martin has written to Reed asking him to “retract inaccurate and misleading comments regarding the quality of water in Scotland” and criticising him for his words to “dismiss out of hand the value of public ownership of a key asset like water”.

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The IWC’s key recommendations – a quick reference guide

Strategic direction

• The UK and Welsh governments should each bring forward a new, long-term, cross-sectoral and systems-focused National Water Strategy for England and Wales respectively. 

• Strategic Policy Statements should be replaced by a new Ministerial Statement of Water Industry Priorities (MSWIP), directing all water industry regulatory and systems planner functions. 

Planning

• Integrated and holistic water system planning should be introduced via ‘regional water authorities’ (with a national coordinator) in England and a national authority in Wales. Responsibility for ensuring consistency in scenarios, assumptions and metrics to sit at the national level. Options development and cost benefit analysis to sit at system planner level.

• Nine current plans should be reduced to two core frameworks: water supply and water environment. 

• Five-year price reviews should be retained for bill/revenue setting but investment planning should stretch to 25 years (high level) with indicative plans for years five to ten.

Legislative framework

• The UK and Welsh governments should review the current water legislative framework and amend it accordingly. Areas of focus to include: driving pre-pipe solutions to stop pollution and rainwater entering the system; establishing chief medical officer-led taskforces in England and Wales to work out how to incorporate public health outcomes into the legislative framework; and introducing more flexibility within tramlines for regulators and system planners (“constrained discretion”).

• Specific legislation-derived regulations recommended for reform were:

  • Urban Wastewater Treatment Regulations 1994, including to report on whether an Extended Producer Responsibility scheme is needed for the water sector to fund necessary improvements. 

  • Water Framework Directive regulations, including to cover public health outcomes.

Regulators

• The UK Government should establish a new integrated regulator in England. This should combine the functions of Ofwat, DWI and water functions from the Environment Agency and Natural England.

• The Welsh Government should create a new economic regulatory function, either embedded in Natural Resources Wales (preferred) or via a small freestanding body like Scotland’s WICS.

• These regulators must have the ability to recruit and retain high-quality technical staff and sit outside of public sector pay controls.

Economic regulation 

• Regulators in England and Wales should adopt a more ‘supervisory approach’ to regulating individual companies.

• Base capital maintenance, base operational expenditure and enhancement capital expenditure allowances should be clearly defined and ring-fenced.

• RCV run-off could be more closely linked the depreciation of assets. 

• Ofwat’s Quality and Ambition Assessment for water company business plans should be withdrawn.

• Performance Commitments should be rationalised and their corresponding rewards, penalties and returns at risk clarified.

• Strategic guidance should include a target relating to the stability of the regulatory model.

• The assurance and Price Control Deliverables frameworks should be reviewed and improved.

  
  

Competition and Markets Authority (CMA) 

• Governments should consider giving the CMA responsibility to set a common weighted average cost of capital methodology for all UK regulated sectors.

• The water sector should move from full redeterminations to appeals, as in energy.

Environmental regulation

• Operator self-monitoring should be reformed; a stronger approach to monitoring, using greater digitisation, automation, public transparency, third-party assurance and intelligence-led inspection should be taken.

• Plans for continuous water quality monitoring should be reviewed; technology could be used to improve cost efficiency.

• Move the treatment, storage and use of sludge into the Environmental Permitting Regulations.

• Implement the civil sanctions provisions in the Water (Special Measures) Act 2025 to expand the regulator’s toolkit to enable swifter enforcement.

• Accelerate the resolution of long-running enforcement cases.

• Ensure full cost recovery for regulation in line with the polluter pays principle.

• Bring abstraction under the Environmental Permitting Regime. 

Drinking water regulation

• Drinking water quality standards should be regularly reviewed and updated.

• Regulation should be beefed up to cover all third party operators, and to have the ability to directly impose financial penalties. 

• The regulator, water industry and governments should secure and expand Regulation 31 testing services for drinking water products.

Consumer representation

• Consider converting CCW into a new mandatory water ombudsman.

• Transfer CCW’s advocacy functions to Citizens Advice. 

Water efficiency

• Introduce compulsory smart metering for a wider range of circumstances.

• Ensure there are smart meter standards for the non-household market.

• Introduce water efficiency tariffs, potentially including removing falling block tariffs for business customers.

• Policy should drive the adoption of water re-use infrastructure in the domestic and commercial markets.

Affordability

• The UK Government should consult on the introduction of a national social tariffs with consistent eligibility criteria and levels of support. 

• The Welsh Government should review existing social tariff schemes provided by the two companies in Wales and consider reforms to ensure they are providing equitable outcomes. 

Company control

• Regulators should adopt an evidence-based process to consider, on a case-by-case basis, whether it would be appropriate for a water company to transition to an alternative ownership model where they request to do so or following special administration (SAR).

• Regulators should have the power to block material changes in control of water companies and to direct parent companies and ultimate controllers.

• Governments should establish a new regime for senior accountability.

Finance

• Regulators should create a financial supervision framework, publishing a range of risk factors that inform their judgement of a company’s financial risk profile, and should set minimum capital levels for water companies.

• A formal turnaround regime should be created for poor performers, and a framework set out to ensure companies are prepared for SAR. 

• Environmental bonds should be promoted.

Competitive markets 

• A post-implementation review of the business retail market should be conducted, and short-term measures to improve its functioning pursued.

• Streamline New Appointment and Variation applications and obligations.

• Alternative procurement models (DPC and SIPR) should be evaluated after five years.

Resilience and asset health

• Statutory resilience standards, covering system, infrastructure and supply chains, should be developed and adopted. 

• Companies should map and assess the health of their assets, and the regulator should ensure metrics for asset health are sufficiently forward-looking. 

• A chief engineer should sit on the regulatory boards.

• Legislation on security should be strengthened and regulators given stronger security enforcement powers.

Supply chain

• The regulator should conduct a sector-wide risk assessment of critical supply chain dependencies and assess infrastructure delivery needs assessment against supply chain capacity and workforce availability.

• Water companies, through Water UK, should share best practice on supplier contracts and procurement strategies to help improve water company relationships with the supply chain.

  
  

Innovation

• Introduce structured regulatory sandboxes to support innovation.

• Review innovation funding mechanisms.

• Companies via Water UK should disseminate innovation learnings across the industry. 

Development and growth

• Review the ‘right to connect’ and strengthen companies’ roll in the planning process.

• Planning processes in England should be updated to support the timely delivery of water industry infrastructure. 

• RAPID should be expanded and strengthened to support strategic infrastructure delivery and NISTA should consider how the water industry could move towards standardised practices. 

Public narrative

• Governments should reset its approach to strategic communications regarding the water industry. This should include setting justifiable criticism within the context of reform to show support for the industry as performance improves, and setting the sector’s environmental performance in the broader context of the contributions of other sectors to achieving environmental objectives, especially where remedial action for past failures is underway. 

  
  

Implementation

• Governments should outline regulatory transition plans and establish an implementation advisory group for England and Wales to drive collaboration.

• An independent review of the follow up to the Commission’s report should be carried out in two years’ time.