Ofwat chairman Jonson Cox has made no secret of his belief that water company boards are too opaque, sometimes dominated by vested interests, and not adequately accountable. The regulator moved to change that this week with the publication of a consultation document outlining what it expects of water company boards if they are to escape new licence conditions to clean up corporate governance.
Cox is concerned about corporate governance because most water companies are no longer listed. With private owners, often from overseas and sometimes with complicated holding company and ownership structures, there is little consistency between how the companies run themselves. The pressure to deal with this has become more acute in a hostile media environment, with the national press picking up in several cases on finances and corporate behaviour among water companies.
As the consultation says, maintaining legitimacy in the eyes of customers is vital given the monopoly status of water companies when it comes to serving households. To this end, it also sounds a note of caution on director pay. “The remuneration and incentivisation of management plays an important part in ensuring that there is the right emphasis on customer outcomes as well as those of shareholders,” it says. “The legitimacy of a monopoly public service company will also be affected by how transparent this remuneration structure is.”
In a letter to company chairmen sent alongside the consultation, Cox said: “There is significant public pressure on companies to operate to high standards of governance and transparently demonstrate that they do so. We have seen unwelcome criticism, in the media, of some companies’ board leadership and governance arrangements…
“Our board considers that a self-regulatory approach is preferable, but this relies on companies responding promptly in the same vein. It remains open to us, however, in the public interest to pursue licence modifications to secure the principles in companies’ licences if we find that a significant number of companies do not accept the approach set out in our principles or are not indicating an intent and plan to meet our minimum expectations in the timescale.”
These expectations include:
• Transparency, with company reporting meeting or exceeding standards set out in the Disclosure and Transparency Rules.
• The regulated company acting as if it were a separate public listed company, with an effective board fully focused on the regulated company’s obligations. Board committees, including the audit and remuneration committees, to act at the regulated company level, and to consist of a majority of independent members. This is designed to limit the influence of holding companies and increase transparency.
• Significant independent representation on the board, with independent non-executive directors making up the largest single group (ie outnumbering investors or executives). This reflects a wide divergence among companies on how the boards are made up and is likely to prove challenging for some.
• An independent chair, rather than one drawn from investors or management.
• Group structure to be explained in a way that is clear and simple to understand.
Ofwat has been clear that it would prefer water companies to adopt these standards voluntarily, no doubt mindful of the damaging fight that arose from its last attempt to change licences. It has given “leading” companies until the end of the year to put in place a code that sets out how they currently apply the principles, and a timetable to full adoption of the principles. It has built in time for companies to change their shareholder agreements and other legal structures if necessary. The regulator will confirm the final principles in January 2014, and expects all companies to share their codes with Ofwat by April 2014, and to comply fully by April 2015.
The consultation closes on 31 October. Ofwat will publish further principles for holding companies later this year.