Ofwat’s new Growth Duty – will it support sustainable growth? 

25 April 2024

In February the government announced the extension of the ‘growth duty’ to the water industry. This raised alarm bells that it could undermine Ofwat’s existing duties to protect the environment and water consumers. CIWEM’S Catherine Moncrieff investigates.

The growth duty is part of the 2015 Deregulation Act and requires regulators to ‘have regard to the desirability of promoting economic growth’ when exercising their regulatory functions. Following two consultations last year the Department for Business & Trade (DBT) confirmed that the growth duty will be extended to regulators Ofcom, Ofgem and Ofwat, subject to Parliamentary approval. Refreshed statutory guidance on how this Growth Duty should be applied has been published.

Why is the growth duty problematic?

At the heart of concerns is the statement in the statutory guidance which says that “Certain enforcement actions, and other activities of the regulator, can be particularly damaging to growth. These include, for example, enforcement actions that limit or prevent a business from operating; financial sanctions; and publicity, in relation to a compliance failure, that harms public confidence”.

The duty could potentially therefore undermine Ofwat’s existing duties to protect the environment through enforcement actions such as fines for sewage pollution incidences and capping bonuses for underperformance. As highlighted by campaign group Wildlife and Countryside Link, the duty would make it difficult for Ofwat to take such enforcement actions as they might be construed as hindering their growth.

It seems odd that the government would make such a move in the face of public uproar against sewage discharges. The environment and public have suffered from the effects of deregulation of the water industry over the last decade – including self-monitoring and lack of investment and maintenance in essential infrastructure. Meanwhile excessive bonuses and dividends have been paid out in some parts. The result has been sewage pouring into our rivers and coasts on a regular basis, and freshwater ecosystems pumped dry during periods of water scarcity.

The last thing that Ofwat needs is a growth duty that makes it hard to apply its existing powers.

Government dispelling concerns

The government has been at pains to dispel concerns that the growth duty will weaken environmental protection. The consultation response on the duty says that the government "has considered the issue and has concluded that it is not expected that the extension of the growth duty ... will cause environmental harm. The growth duty does not override the existing environmental protections to which these three regulators must conform." It refers to the environmental principles policy statement (EPPS) within the Environment Act which sets out how policymakers should apply five environmental principles to support environmental protection and enhancement.

Ofwat are toeing the government line, reporting to ENDS that the consultation response is clear that activity which underpins protections to the environment should be appropriately dealt with by regulators and that it will continue to hold water companies to account and drive better performance and outcomes for customers and the environment.

Flying in the face of growth?

This government is clearly very focused on driving economic growth and removing any ‘red tape’ that might hamper it, assuming that less regulation will automatically enable economic growth.

But is this really true of the water industry which operates as a regional monopoly, and that provides an essential public good based around necessary physical assets? Ofwat cannot encourage growth in the same way as other regulatory bodies can for competitive industries – including power and communications.

In fact, applying a growth duty risks perpetuating and exacerbating existing growth challenges. What is needed for economic growth is long-term resilience of water supplies, underpinned by restored natural resources, which will supply homes and businesses with clean water well into the future. It also requires an upgraded sewer and drainage system, able to cope with more wastewater and increasing climate extremes. This requires long-term investment in and maintenance of infrastructure – both grey and green. Ensuring sufficient capital and operating expenditure requires the checks and balances of Ofwat and (by extension) water users, who ultimately pay for the required infrastructure through bills.

If short-term savings and growth are prioritised then it will undermine the recovery and sustainable management of natural resources - what the water industry relies on for long-term and resilient growth.

Spooked investors

Part of the motivation for extending the duty is likely to be borne out of fears that UK infrastructure, and in particular the water sector, is no longer an attractive investment proposition.

Indeed, it was clear from investors speaking at a water industry ‘social contract’ summit in February, that investor confidence in the water sector is dwindling. Moodys reported that their UK water outlook is ‘negative’, reflecting rising social risk from affordability pressures and critical public sentiment, as well as sizeable investment requirements, high leverage and a growing risk of material fines. Barclays asked ‘why am I putting my money here?’ with the prospect of tough returns in the next business plan cycle, ‘dividend lock-ups’ and threats of prison for water company executives.

Tension between growth and environmental protection

There is a clearly a tension within the water industry and wider government between regulation and growth. You have parts of government desperate to demonstrate economic growth (The Treasury, DBT, and Department for Levelling Up & Community), and another part, led by the Department for Environment, Farming & Rural Affairs (Defra), that is ratchetting up the enforcement pressure on water companies in the face on public concerns over sewage pollution.

In February, Environment Secretary Steve Barclay announced that the government would get ‘much tougher’ on water companies, quadrupling the Environment Agency’s regulatory capacity for water company inspections. This followed announcements on the removal of the cap on civil penalties for water companies and plans to ban bonuses for water company bosses who oversee criminal pollution.

This tension has recently played out in the House of Lords. A ’regret amendment’ was tabled to recognise the new duty’s impact on Ofwat’s ability to enforce against polluting water companies. This was supported by several members, who called out the dichotomy between DBT’s imposition of a growth duty and Defra’s commitment to tighten the regulation of the same industry. But it wasn’t passed, with Lord Johnson of Lainston arguing that ‘nothing could be further from the truth’ in terms of the growth duty conflicting with environmental duties. He went on to explain that ‘the growth duty does not legitimise non-compliance with other duties or objectives, and its purpose is not to achieve or pursue economic growth at the expense of necessary protections’.

What about a new 'Sustainable Duty'?

We can draw some comfort from the fact that the refreshed statutory guidance recognises environmental sustainability as a driver of economic growth, setting out that ‘natural capital and the ecosystems in which we live are fundamental to economic growth, and therefore need to be safeguarded for economic growth to be sustained…’

But we’re not convinced that the guidance will ensure Ofwat can fully exercise its regulatory powers in the interest of the environment and water consumers.

We would like to see the imminent Statutory Instrument withdrawn, but this is looking increasingly unlikely. So we propose introducing an over-arching ‘sustainability duty’ to shore up the current imbalance, exacerbated by the new growth duty, between Ofwat’s economic regulatory focus and the need for more robust environmental enforcement. A sustainability duty does already exist in the Water Industry Act, but it’s only a secondary duty. This means the focus remains on economic regulation, rather that long-term sustainability and value.

As advocated by ‘A Fresh Water Future’, we’re also keen to see an altogether more positive regulatory regime for the water sector, one which encourages a more holistic, outcomes-based approach that delivers water supplies and sewage services resilient to climate change and fit for the future.

Catherine Moncrieff is Policy and Engagement Manager at CIWEM.