Water (Special Measures) Bill [HL]

Committee (1st Day) (Continued)

20:36:00

Amendment 10

Moved by

10: Clause 1, page 2, line 3, at end insert— “(d) requiring a relevant undertaker to assess and report regularly to the Authority on actual or planned financial structuring of the undertaker, including debt levels, coverage of the associated commercial strategy and any associated risks.” Member’s explanatory statement The amendment requires that financial engineering becomes a regular focus area for timely reporting in order to assist in regulators’ understanding and alert them in good time to risks or distortions.

Amendment 10 in my name and Amendment 13, which we discussed earlier, seek to address the problem that lies at the heart of what went wrong with our water industry; the regulators were simply outsmarted by PE financial engineering, either because they were not paying sufficient attention to what was going on or because they just did not understand it. Regulators have either lacked or failed to deploy the skills needed to assess the impact and purposes of financial engineering introduced by corporate investors. Amendment 10 addresses that shortcoming directly by requiring water companies to report regularly, not only on any financial restructuring or structuring but on the strategy lying behind it and any associated risks. This will ensure that such activities have to be made overt rather than, as hitherto, taking place under the regulators’ noses but apparently below their radar. I beg to move.

My Lords, I am delighted that Clause 10 does not appear to envisage a role for Ofwat. The amendments in this group are not really related to each other. As such, I shall confine my remarks to Amendment 86 in my name and I shall be brief. Under the “Special administration orders” section of the Bill relating 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. New subsection (4) extends this recourse to all other companies in the sector. I hope the Minister will tell me that I am mistaken in my interpretation of what this new subsection is designed to achieve. Does it not force good companies and their blameless customers to bail out failed companies? Can this possibly be justified? It has been a recurring theme of this debate, supported by the comments of many noble Lords, that the sector is in critical need of substantial investment to raise standards across the board and deliver the service that consumers and the general public so rightly expect. Any suggestion of collective punishment for the financial woes of others is to be resisted. The consequence of imposing an unquantified and unquantifiable potential liability on the sector will at best push up the returns required by investors to inject capital into the water companies, inevitably increasing costs to consumers. At worst, it risks making the sector uninvestable. That is surely not the intention of new subsection (4), but it may be the consequence. My amendment would remove that risk, and I hope the Minister will support it.

My Lords, I will address my comments to the amendment in the name of the noble Lord, Lord Cromwell. I agree with him that financial restructuring of companies has led us to where we are now, with Thames Water potentially on the brink of collapse—who knows who is going to have to fund the huge injection of capital that has apparently now been agreed. Other water companies are heavily indebted. Ofwat, which is after all the economic regulator, did not query, question or challenge those decisions made in the early years of water company privatisation. The consequence is that anything the Government now attempt to do is basically closing the stable door after the horse has bolted—and raced to the other side of the world—because the companies are where they are. Although I agree with the noble Lord, Lord Cromwell, that any future restructuring ought to be put under the microscope of the economic regulator, the current situation is leading us to a potentially very grave position, which the Government are trying to address with the other financial clauses in the Bill. I read the clause referenced by the noble Lord, Lord Remnant, as being directed pointedly at a particular water company. I support the amendment moved by the noble Lord, Lord Cromwell. I suppose it is better to change the situation now than leave it as it is, but what has happened already is unfortunate.

My Lords, Amendment 92 is very simple. Had it been in place when the water companies were privatised, it would have prevented the aggressive financial engineering that has led to the financial distress we see regularly reported in the press, which has provoked much anger in this House and elsewhere over the years. Before I address Amendment 92, I will briefly comment on Amendment 10 moved by the noble Lord, Lord Cromwell. It coexists neatly with my amendment, allowing regulators to be better informed on issues with the financial structures of the companies they regulate, and to be aware of future problems. I am pleased that the noble Lord has moved this amendment, and I broadly agree that the regulator should have better information about the financial structuring of water companies in the interests of protecting their viability and preventing circumstances in which they become overleveraged. I will speak to the dangers of overleveraging and the problems we have as a result of the weakness of the regulator, but we on this side of the Committee are interested in the amendment moved by the noble Lord, Lord Cromwell, which takes a fairly moderate step towards having a better-informed regulator. That said, it may be possible to go further, either by reforming the way the regulator works in the water sector or, as I propose in Amendment 92, by implementing statutory rules on borrowing for water companies and taking effective steps to prevent capital being taken out of companies that are overleveraged. We need to make the water sector attractive to investors so that they bring more capital into it to fund investment in cleaner and better water infrastructure. I add my whole-hearted support to the amendment proposed by my noble friend Lord Remnant. It seems grossly unfair that a company that has behaved responsibly should be penalised by the actions of another in the sector. I am aware of precedent in the financial services sector, but that is to protect the integrity of the financial system, which is in all participants’ interests. In this case, each water company is a unique entity whose actions have little or no impact on others. Without this amendment, one bad actor could contaminate the industry. I add my concerns about the wording that my noble friend Lord Remnant seeks to remove from the Bill. This new subsection as drafted applies the duty to render “relevant financial assistance” to any other company that holds, or held, an appointment under this chapter. This seems to me yet another example of retroactive effects that are littered throughout the Bill and which we will discuss in later groups. Could the Minister explain to the Committee what the Government’s intention is with this retroactive element in the Bill? Will there be a maximum period of time since the relevant company held an appointment for this duty to apply to it? This seems to us to be a concerning power, and we would seek clarifications from the Minister on both the unfairness at the core of this subsection and its retroactive element. I thank my noble friend Lord Remnant for introducing his amendment, and hope that he continues to make progress on this unfairness which exists in the Bill as drafted.

20:45:00

I turn to my own amendment in this group: Amendment 92. Its overriding purpose is to protect the Government as a stakeholder in this industry. The special administration order regime should never have to be implemented. As noble Lords are aware, this industry provides one of the necessities of life and has local monopolies. If the survival of that company and service to the consumer is to be guaranteed, as it must, the Government become, in effect, the owner of last resort. Why should the Government accept this obligation?

The amendment is intentionally simple and easy to implement. The financial services industry, where I spent my career before arriving in this House, thrives on complexity and creating ingenious structures based on that complexity. I hope to avoid that with this amendment. In this case, as I hope the Committee will agree, simplicity is best. I have set a ceiling on acceptable borrowing of 60% of the regulated assets in this amendment. I will not argue that 60% is the right figure, nor that the calculation of total borrowings to regulated assets is the right measure of that percentage. Ofwat uses 60% for its notional gearing. However, as a restrictive level, it may be necessary to go higher; that is, less demanding. Ofwat also uses net debt rather than total debt. I prefer to exclude cash balances, given that they may be necessary for working capital needs and not available to service debt, but I am not wedded to my definition.

I am aware that many of the companies in this industry are beyond this level currently and the impact of my amendment would be to force them to reduce their leverage beneath this level. That would be achieved by requiring all profits to be retained in the company, with no returns to shareholders or debt holders outside the operating company, until that leverage ratio is beneath this 60% cap. I am also aware that many of the water companies have holding companies above them that have debt serviced by the water company operating profits via dividends or other means and potentially debt guarantees. This amendment would sever those debt guarantees and significantly reduce the security of holding company debt holders and shareholders over the operating companies. In debt market terms, they would have been primed; other interests have been given priority over the cash flows of the operating companies without their consent. It is an aggressive move, but one with plenty of precedent in debt markets.

This amendment would make it impossible for an operating company to increase borrowing to fund a capital return or special dividend to a parent company or shareholders, if it took borrowing through 60%. It would also make ordinary dividends unpayable if it took borrowing through 60%. This amendment would help to protect our water companies from excessive levels of borrowing. If capital markets have been unable to set rules and standards for these companies to comply with their responsibility towards customers, employees and government, government must step in and do so.

The water companies have an investment plan of £88 billion, and I read that this is intended to be financed by only £10 billion of equity. Using the 60% rule, this is unlikely to be enough to protect the dividend-paying status of those companies through this investment plan. More equity may be required, or substantially more retained earnings. Ofwat already uses a 60% notional gearing ratio when assessing the industry, so there is acceptance that this is a reasonable number. However, the notional gearing ratio has no teeth. In its own words:

“Ofwat’s decision on the notional gearing level acts as an important signalling mechanism to companies considering their own choice of capital structure”.

It does not appear that much attention is paid to this signal. My amendment creates fangs and a barrier rather than a signal.

Other noble Lords have given cumulative numbers for debt, dividends and capital investment since the initial public offer and the flotation of these companies. The noble Lord, Lord Sikka, discussed the normal capitalisation of interest incurred in the case of construction, as well as repairs and maintenance, as if it is some kind of crime. In my mind, these discussions fail to see the wood for the trees. Financial gearing is the key metric of financial health for this industry, and the target that should be aimed at in the Bill.

I hope I have set out a clear case in favour of this amendment, but, if I may pre-empt the Government, Ministers may argue that this is too aggressive and abrupt a reform. If they argue that my amendment is too abrupt for those companies that may need time to reduce the level of debt they are currently operating with, we on these Benches are open to discussion. That said, we are keen to strengthen the rules on borrowing by water companies to protect their long-term future and prioritise investment in infrastructure and environmental improvements. It cannot be right that water companies’ decisions to take on excessive debt, to the benefit of parent companies or other bodies, is threatening outcomes for both consumers and the environment. I hope the Minister will listen to our concerns and put consumers and the environment first.

The Government have chosen not to include borrowing rules for water companies in the Bill. I anticipate that the Minister will suggest that this could be dealt with in a future water Bill. However, I ask her what the public’s response will be if a company falls into an SAO in the meantime that would not have done had this amendment been accepted into the Bill.

My Lords, I thank all noble Lords who have put forward amendments relating to the financial management of water companies. I will start with Amendment 10, tabled by the noble Lord, Lord Cromwell. Ofwat has a core duty under Section 2 of the Water Industry Act 1991 to ensure that companies can finance the proper carrying out of their statutory obligations. Ofwat already monitors the financial position of water companies and can take action when companies need to strengthen their long-term financial resilience. However, we recognise that some companies will need to take further steps to strengthen that financial resilience. Ofwat has required further assurance from these companies about their financial resilience into 2025 to 2030 and beyond, and the annual monitoring financial resilience report is due to be published this autumn and will provide a publicly available assessment of the financial resilience of each water company. I say to the noble Lord, Lord Cromwell, that we met and discussed these concerns previously. Clearly, the commission that we have talked about a lot today will look at performance and resilience, but I am very happy to discuss this with him further as we move forward through the Bill. Turning to Amendment 86, tabled by the noble Lord, Lord Remnant, I emphasise that there is a high bar for the introduction of a special administration regime and the Government do not expect to have to use this power. A special administration regime will be required only when there is evidence that a company is insolvent or in serious breach of its statutory duties. The noble Lord’s amendment is to Clause 10, and Clauses 10 and 11 are designed to introduce new powers for the Secretary of State and Welsh Ministers to modify water company licences to cover any shortfall that results from a SAR. Government funding may of course be required to cover the costs of a special administration, and these clauses mean that the Government will be able to recoup any taxpayer money spent during a SAR that cannot be covered upon exit from the SAR, either by rescue or by transfer. I wanted to make that clear. Of course, in the unlikely event that the power in the Bill is used, it allows the Secretary of State or Welsh Ministers to decide, subject to consultation, the rate at which the shortfall is recovered. I hope the noble Lord is therefore reassured that any intervention would be considered very seriously and as a last resort. I turn now to Amendment 92, tabled by the noble Lord, Lord Roborough. Water companies are allowed to raise debt to fund the delivery of their services and it is for companies to decide their financial structure. At sensible levels—that is the key point—debt can be an appropriate way to fund essential investment. Sustained investment in the water industry will continue only if the shareholders of companies can expect a fair return. This amendment may therefore threaten the ability of companies to attract investment if limits on borrowing are imposed. I reassure the noble Lord that Ofwat already has appropriate powers to prevent dividends where they would threaten financial resilience. I appreciate that the noble Lord has extensive experience in this area, but I hope he understands why we cannot accept this amendment, because it is vital that we ensure companies are able to finance their functions. If he would like to send in more information about this, I would be very happy to receive it and have a look. Finally, I once again highlight that the new independent water commission, led by Sir Jon Cunliffe, the former Deputy Governor of the Bank of England, will review the current water industry regulatory framework to ensure that it attracts investment and supports financial resilience for water companies. I once again thank noble Lords for their suggestions and input into this discussion on the financial management of water companies.

I thank everyone who has participated in this. I think we are all concerned about financial engineering of one sort or another. It is not only borrowing, but that is clearly an important part of it. I am sorry that the amendments have not passed muster, but I look forward very much to further discussions with the Minister, as she offered. I beg leave to withdraw the amendment.

Amendment 10 withdrawn.

Amendment 11

Moved by

11: Clause 1, page 2, line 8, at end insert— “(iia) meeting relevant standards issued under Schedule 3 of the Flood and Water Management Act 2010 (Sustainable Drainage),”

My Lords, I welcome the opportunity to debate Amendments 11 and 12 in my name in this group, on flood and water management. The amendments relate to Clause 1 and, in particular, tie the environmental standards which the department has set out in the Bill to those specifically meeting relevant standards issued under Schedule 3 to the Flood and Water Management Act. So it is the same provision to come in two separate places. I am very grateful to the Minister and members of the Bill team for meeting me prior to Committee to discuss this. I invite the noble Baroness to accept that this amendment and the provisions in Schedule 3 to the Flood and Water Management Act 2010 are Defra legislation, so I would like her department to take ownership of this. She is aware of my desire and passion that we implement the provisions of Schedule 3 to the 2010 Act as a matter of urgency. Defra itself has explained that Schedule 3 provides a framework for the approval and adoption of drainage systems, a sustainable drainage system approving body within unitary and county councils and national standards on the design, construction, operation and maintenance of sustainable drainage systems for the lifetime of the development. Schedule 3 also makes the right to connect surface water run-off to public sewers conditional on the drainage system being approved before any construction work can start. That goes to the point of ending the automatic right to connect that we discussed in a previous group. Wales has already applied Schedule 3 and has done a report on how it has been implemented. It is not entirely perfect and there are ways in which it could be improved, but we have been yo-yoing on this under successive Governments and it now falls to her Government and her department to really run with this.

21:00:00

In January 2023, under the previous Government, the department announced that it had accepted the recommendation of a sustainable drainage systems review to implement Schedule 3

“subject to final decisions on scope, threshold and process once a full regulatory impact assessment has been completed”.

In November 2022, the National Infrastructure Commission published the report Reducing the Risk of Surface Water Flooding, which made a number of recommendations along the lines that the technical standards set out therein should be immediately adopted. The then Prime Minister said that he desired to do so:

“We expect to consult on these matters by spring 2024 and aim to have finalised the implementation pathway by the end of 2024”.

Early on in taking up her role—it was a bit mean of me to ask this so early on—the noble Baroness responded to a Question from me on 30 July. My question was:

“To ask His Majesty’s Government when they will implement Schedule 3 of the Flood and Water Management Act 2010”.

The answer came back:

“The government is considering how best to implement its ambitions on sustainable drainage”.

My plea echoes a Question that the Minister’s honourable friend Emma Hardy asked of the previous Administration. She is now the Minister for Flooding. This runs through both main parties and other opposition parties. I do not think there is any dissent in the Committee that we would like to see this.

I press the Minister to make a commitment this evening to implement Schedule 3 to the Flood and Water Management Act without delay and perhaps set out a timetable. This legislation is the right place to do so, because it relates entirely to the environmental standards that the Bill sets out. It is one of the key environmental standards set out in new Section 35B, so I make a plea to the Minister to use her good offices to implement it as part of the Bill. I beg to move.

My Lords, I do not know whether the noble Baroness, Lady McIntosh, is right to try to urge the adoption of Schedule 3 to the Flood and Water Management Act through this Bill, but she is right that there was an expectation that it would be implemented this year. Given the new Government’s determination to expand the construction of housing as quickly as possible across the country, this schedule is pertinent and relates to the water services Act. We ought to try to address it, through this Act or not. The Minister’s heart is in the right place on this one, so now she has the levers of power I am sure that she will pull the right one.

My Lords, I thank my noble friend Lady McIntosh of Pickering for tabling these amendments, which rightly seek to tackle the issues of flooding and drainage. The Flood and Water Management Act 2010 set out standards for water companies regarding the reduction of flood risks and created more power for local authorities to be able to take action to protect their local areas. When in government, we tightened restrictions on water companies to protect our countryside, and we are pleased that this work is being continued. Since 2010, under the Conservatives, government investment has better protected more than 600,000 properties from flooding and coastal erosion. Since 2015, Conservative investment has protected over 900,000 acres of farmland, rightly putting the needs of rural communities first. In 2020, we built on this further and announced a doubling of capital funding into flood defences in England, to a record £5.6 billion from 2021 to 2027. As the Committee will understand from these steps, we had a strong record of investment in flood defences and water management. It would be helpful to hear from the Minister what plans the Government have to improve on those Conservative measures to protect communities across the UK from the harms of flooding. Much of our debate on the Bill has so far focused on the corporate structures and financial management of companies in our water industry. It is right that we consider these issues in depth and seek to put the right incentives in place to deliver better outcomes for the key groups and interests that we should be aiming to protect under the Bill; namely, consumers, employees of water companies and the protection of our environment. While the majority of the public debate around our water sector focuses on the damage that sewage overflows do to our waterways, my noble friend Lady McIntosh is absolutely right to take this opportunity to consider the dangers of flooding and to seek to ensure that water companies put this issue front and centre. We on these Benches certainly understand the issues of sewage contamination in our rivers across the country and would like to solve this issue to preserve the nature and wildlife that this has serious impacts on. We also recognise the horrendous impact that floods have on many communities because those water companies have not done enough in terms of flood management. The first impact most people experience when water management is poor is flooding on roads and on other key transport links. However, in serious cases—such as the 2007 summer floods and the floods of 2015-16—this can result in threats to lives and livelihoods, enormous costs to the economy and massive devastation for the people affected. I am not sure if the Minister is politically old enough to remember the terrible Carlisle floods a few years ago, but it was horrendous to drive through Carlisle and see thousands of homes with abandoned furniture outside, which was soaked through. In my own constituency, just south of Penrith, at Eamont Bridge, houses had been flooded to a depth of about three inches, but with osmosis, the water had been sucked right up the walls and everything had been destroyed. So, flooding seriously impacts people’s lives. Reporting on those two exceptional examples together, the Office for Budget Responsibility estimated that the 2007 summer floods cost the UK economy £3.2 billion, while the 2015-16 winter floods cost the economy roughly half of that, at £1.6 billion. These examples alone demonstrate the importance of improving water management to protect our communities from flooding. That said, it is not only the extreme examples that demonstrate the importance of managing flood risks. As anyone who is involved in farming or other rural affairs will tell you, 2024 has been a very wet year, with many communities facing difficult challenges with flooding. In April 2024, England as a whole received 150% of the long-term average rainfall for the time of year and the north-west was particularly wet—as the noble Baroness and I will testify—with, as my notes say, the wettest April since records began in 1871. I can also tell noble Lords that it was also the wettest August, with one dry day this year. This is a good opportunity to remind ourselves that it is not just people’s homes that rely on a good water system but our food supply—people’s livelihoods rely on it too. That is why my noble friend Lady McIntosh of Pickering is right to bring this point forward for debate as the Bill makes progress. When flooding and poor water management affect our rural communities, invariably this has a knock-on effect on agriculture and, in turn, consumer costs. Earlier this month, the Guardian reported that fresh food inflation increased to 1.5% from 1% just in August as the wet weather affected British production of salads and soft fruits, while storms in the Atlantic delayed imports of more exotic fruits, driving up prices. No Government can control the weather—thank goodness; farmers would like to control it of course, but each would want to control it differently—and no water company can entirely mitigate the impacts of wet periods on our agricultural output. However, good water management is very important when we are faced with unusually poor conditions. I am grateful to my noble friend Lady McIntosh of Pickering for tabling these amendments to the Bill. I know many farmers will be pleased to hear their concerns about the impacts of poor water management are being discussed in your Lordships’ House tonight. While the Government may not be inclined to accept these amendments, we on this side of the House see this as an important opportunity to ask the Government to please keep the issue of flooding and water management high on the agenda, in light of the very serious impacts it has on people across the country, in both direct damage to their homes and communities and the secondary impact it can have on food prices for all of us. I would therefore be interested to hear whether the Minister might consider bringing tougher flood mitigation duties for water companies into the Bill. As we have heard constantly, the Government intend to bring forward much wider reforms in the coming year, but, as we approach winter, many families up and down the country will have concerns in the backs of their minds about the risks of flood, in light of the continued failures in our water sector. Will the Minister take this forward and look at possible improvements that can be made to the Bill now? I hope the Government will listen to the important points raised by my noble friend tonight and consider these carefully before Report.

My Lords, I thank the noble Baroness, Lady McIntosh of Pickering, for her amendments relating to Ofwat’s duties. I will take Amendments 11 and 12 together. As I have previously noted, public trust in the water sector has been severely damaged, and the number of serious pollution incidents is increasing, yet companies are still paying out millions in bonuses. To rebuild public trust, we are creating a new framework to support accountability, including the new rules relating to remuneration and governance. As the independent economic regulator of the water industry, Ofwat will be responsible for developing these rules. However, the Government are clear that environmental standards are a vital component of performance. As such, the Bill requires the forthcoming rules to include standards that relate to the environment. The noble Lord, Lord Blencathra, has mentioned the devastation that flooding can bring; I reassure him and other noble Lords that I completely understand why it is so important for us to tackle flooding. I live in a house that has been flooded—living in Cumbria, you are always aware of these issues. With regard to the Flood and Water Management Act 2010 specifically, while the Act includes provisions relating to sustainable drainage, it does not prescribe or define any environmental standards capable of being applied in this context. It would therefore not be appropriate to include reference to standards in this legislation within Ofwat’s rules, as Ofwat does not have any functions or expertise in relation to the technical requirements prescribed under the Flood and Water Management Act 2010. The noble Baroness, Lady McIntosh, suggested that Defra should take ownership of delivering this. The issue we have is that it also impacts directly on development and developers, which is why the Government are currently working with the Ministry of Housing, Communities and Local Government to assess how best to implement their ambitions on sustainable drainage, while also being mindful of the cumulative impact of the new regulatory burdens on the development sector. At this stage, I do not want to pre-empt the outcome of that process. On this basis, the Government do not accept either of the amendments from the noble Baroness. However, I would like to say that the noble Baroness knows that I am very sympathetic to her concerns. As she said, we have discussed this previously. If she is willing, I suggest that we look to arrange a meeting between herself, myself and MHCLG, in order to discuss this further, where she can clearly explain her concerns to both departments—Defra and MHCLG—that have responsibility for moving forward on this.

My Lords, I am most grateful to all who have spoken, and in particular for the support of the noble Baroness, Lady Pinnock, and, from a sedentary position, the noble Baroness, Lady Parminter, as well as my noble friend Lord Blencathra. He referred to the flooding. I was actually a candidate—at a very early age—for Workington in 1987. I went back and visited as a shadow Minister during the severe floods of 2007 and 2009, so I am well acquainted with the pressures faced by Carlisle, Keswick and Cockermouth. It was very sad to see that many of the residents felt that they could not afford to take out insurance in those floods. I will add that it is not just flooding that concerns me; it is the surface water going into the combined sewers taking the sewage from the new developments that do not have mandatory SUDS that is causing the problem. I would like to take up the Minister’s offer. It would be good to have the meeting before Report, because I would be prepared to come back with these amendments then. Alternatively, if the department wish to come forward with even better amendments that achieve the same end, that would be very welcome.

21:15:00

I could not quite follow her argument as to why Ofwat would not be in position to implement this, because the Bill sets out in Clause 1(3):

“Rules made for the purposes of imposing the prohibition mentioned in subsection (2)(a) (‘the pay prohibition’)”,

include standards that relate specifically to the environment. So the Government are setting out, in the Bill, standards for the environment that those working in water companies must follow—so I think the Minister is arguing in favour of what I am proposing. On that basis, I would like to revert at a later stage—having, I hope, had that meeting—and find that this is the place in the Bill that my amendment should go. For the moment, I beg leave to withdraw my amendment.

Amendment 11 withdrawn.

Amendments 12 and 13 not moved.

Amendment 14

Moved by

14: Clause 1, page 2, leave out lines 17 to 19 Member’s explanatory statement This amendment prevents the new rules from overriding existing employment contracts.

My Lords, in moving Amendment 14, I will speak also to my Amendment 15. As I mentioned in an earlier debate this evening, there are a number of areas in this Bill where its effects are retroactive on existing agreements, but the Bill fails to set out the exact limits of these powers. On these Benches, we have been clear at every stage in the passage of the Bill that we want to see tougher measures to hold water companies to account and to ensure that we have better outcomes for consumers and our environment. However, it would not be right for us to approve this Bill because it has a worthy goal, without scrutinising those areas where it is deficient. We have already spoken about Ofwat’s failures, and noble Lords across the Committee will surely admit that there are improvements to be made to the way that Ofwat itself works. Giving unclear levels of retroactive powers to the regulator is not something that should be accepted by Parliament, and we will scrutinise the Bill very closely on its retroactive impacts. My Amendment 14 seeks to remove the lines from Clause 1 that seek to empower Ofwat to void existing agreements, including employment contracts. The Bill gives Ofwat the power to issue these rules without proper scrutiny, and in this part of the Bill we see how powerful those rules can be. Retroactively overriding employment contracts may be necessary for the Government’s objective to implement a blanket set of rules on remuneration for senior officers of water companies, but it is surely not an acceptable way to go about regulating the sector. I ask the Minister: what message does it send to a talented person working in the water sector today, as they build their career, to see measures such as this retroactively changing the rules of the game? We on these Benches fear that many talented people may choose to pursue a career outside the sector, for fear that the Government may yet again move the goalposts retrospectively. I have intentionally tabled my related Amendment 15 separately, to probe whether the Government are willing to move at all on the retroactive impacts of the Bill. Amendment 15 seeks to remove the part of Clause 1 that enables the retroactive deprivation of performance-related pay under the rules. It is surely not right to implement rules now that have effect from the beginning of the year. Our concern is that the lines in the Bill that we seek to remove allow the Government to renegotiate unilaterally an employment contract that has been freely entered into between a third-party employer and a third-party employee. While it is customary that employment legislation often does just such a thing, there is very limited precedent for picking on one class of employees in one particular sector. This is a very unfortunate precedent to set, which opens the door to a Government inserting themselves into employment contracts across other sectors to achieve the outcomes they want. That smacks of overreach. Should we seek to remove performance-related pay from software company managers if their software crashes; from insurance industry executives if we do not like their handling of claims; or from airline executives if their flights are late? I am sure that there may be some noble Lords across the Chamber nodding their heads that the Government should be doing just that; however, that is completely against the Government’s claims of being business-friendly. No competent executive would ever want to work for a UK-based company were these kinds of rules to be brought in. Our amendment does not suggest a better alternative but simply suggests that the current method is unacceptable, and that the employed and the employer also need to be cognisant of the law and agree that these contracts be amended or replaced with agreement to reflect the intent of the Bill. There is also the issue, which my noble friend Lord Remnant may address in greater detail in his comments, of interference in multiyear contracts, where portions of that payment may already have been earned and yet could potentially be prohibited under the Bill. I draw the Committee’s attention to the Explanatory Notes provided to the House by the Department for Environment, Food and Rural Affairs. Paragraph 79, under “Compatibility with the European Convention on Human Rights”, says: “Provision relating to remuneration of water company executives is also not considered to result in ‘deprivation’ within the meaning of Article 1 of Protocol 1 to the Convention, as the provision relates to future income. Such income will only constitute a possession once it has been earned”. I suggest that income in prior years in multiyear contracts has already been earned, just not yet paid. Therefore, I question the Minister on how compliance with the ECHR can be guaranteed in this case. My amendments are, by their nature, probing. Given that they address an election manifesto commitment, they are designed to produce convincing answers from the Government on how these issues can be addressed. I look forward to the Minister’s reply. I beg to move.

My Lords, I am delighted that Amendment 26 in my name falls into the same grouping as those in the name of my noble friends Lord Roborough and Lord Blencathra. Although I very much regret that your Lordships’ time is having to be spent on potentially amending proposed legislation that has retrospective effect, it gives me the opportunity very much to support the arguments advanced by my noble friend Lord Roborough in support of Amendments 14 and 15. It cannot be right retrospectively to override contract law with respect to employment contracts freely entered into by company and individual in line with relevant legislation and regulations in force at the time. Similarly, to the extent that, today, pay can be recovered from senior individuals under malus and clawback provisions in listed companies’ remuneration policies, such a draconian power can rightly be exercised only in extremely limited circumstances known in advance by the individual. The proposed exercise of the pay prohibition in the Bill retroactively goes way beyond accepted remuneration practice, and unacceptably so. On my own amendment, I will not repeat the general arguments made by my noble friend against the principle of retroactive or retrospective legislation. I am no lawyer, so I hope that your Lordships will forgive me if I perhaps erroneously use the terms interchangeably. The offending principle, though, remains the same. The general rule in this country, and indeed in most modern legal systems, is that legislative changes apply prospectively. If we do something today, we feel that the law applying to it should be the law in force today, not tomorrow’s backward adjustment of it. The Bill proposes that the provisions about performance-related pay apply from the financial year beginning 1 April 2024. We are currently some seven months into that financial year, and the Bill will not be enacted for some months hence. In effect we are talking about backdating the provisions for the best part of a year. The remuneration arrangements entered into between senior individuals and their employer will have been agreed under remuneration policies agreed by shareholders well before April for them to take effect from 1 April 2024. It surely cannot be right, whatever the merits of the Bill, for its provisions subsequently to alter those arrangements and the remuneration paid, or to be paid, under them. Few things concern investors more than retrospective legislation, and listed companies will need to consult with and seek approval from shareholders on changes to remuneration policies at their AGM. Requiring retrospective changes risks companies breaching shareholder-approved remuneration policies. More fundamentally, it will undermine investor confidence at a time when they are being asked to fund a record investment programme. My amendment would simply change the date from which the performance-related pay provisions come into effect from a historic 1 April 2024 to a mildly prospective 1 April 2025. Is that really too much to ask, to avoid breaching a fundamental legal principle? I do not think so and I hope that the Minister will agree with me.

My Lords, I thank all noble Lords who have stuck with us this evening and carried on the debate. We know that the public have been clear that they want to see change and that where performance is poor, executives should not receive large salaries or bonuses. I will start with Amendments 14 and 15, tabled by the noble Lord, Lord Roborough. The conditions of existing employment contracts may not align with Ofwat’s new rules. Our concern is that Amendment 14 may prevent Ofwat being able to apply its rules even when performance has not met the required standards. On Amendment 15, it is also right that where companies breach Ofwat’s rules on performance-related pay, Ofwat should be able, if it considers it appropriate, to require the company to recover any payment made in breach of the rules. Linking pay to performance should incentivise decision-making, resulting in improved outcomes for customers in the environment. I reiterate what I said earlier: should companies meet their performance expectations, executives can still be rewarded. So I hope that the noble Lord will understand why we will not accept his amendments. I turn to Amendment 26, tabled by the noble Lord, Lord Remnant. This legislation will ensure that Ofwat is able to implement rules on performance-related pay in the current financial year. However, I listened really carefully to the speech that the noble Lord just made introducing his amendment. I would really like to understand his concerns better, so I wonder whether he would welcome further discussion on this matter so that we can look at it in more detail. I would very much appreciate it if the noble Lord was prepared to do that. But currently we are not going to accept the amendments as we feel that they would prevent meaningful implementation of the rules.

My Lords, I am grateful for the Minister’s reply. We respect that this is an election manifesto commitment and therefore needs to be in the Bill in some form, but my noble friend Lord Remnant and I would both like to discuss further with the Minister, if possible, how we can help to improve this part of the Bill. In the meantime, I beg leave to withdraw my amendment.

Amendment 14 withdrawn.

Amendments 15 to 18 not moved.

Amendment 19

Moved by

19: Clause 1, page 2, line 39, at end insert— “(5A) Rules made for the purposes of determining standards of fitness and propriety mentioned in subsection (2)(b) must include criteria that help the undertaker to assess—(a) whether persons have the knowledge, skills and experience to perform the specific role that they are intended to perform;(b) whether, in assessing a candidate for a position within the management body of the undertaker, the management body as a collective possesses adequate knowledge, skills and experience to understand the undertaker’s activities;(c) how relevant and important any matters which suggest a person might not be fit and proper are;(d) whether appointed persons on temporary absence continue to meet the standards of fitness and propriety.(5B) The criteria in subsection (5A) are to be treated as guidance and may be applied in general terms when the undertaker is determining a person’s fitness and propriety.”

My Lords, I will attempt to be brief, in view of the hour. Amendment 19 provides a clear definition of the criteria that will be used in determining whether someone is fit and proper to hold a responsible role in the water industry. As currently drafted, there is no definition and, as such, it is likely that everyone consulted would have their own different definition of what “fit and proper” might look like. There is precedent in another industry for such a test, which was undoubtedly in the back of the drafter of the Bill’s mind, in the financial services industry. My amendment is an edited version of the Financial Conduct Authority’s definition of a “fit and proper person”. As I was previously a senior manager in an investment management business under the FCA’s senior manager regime, I have first-hand experience of this test. Even as laid out by the FCA, there was considerable debate about the application of the tests. I also question whether Ofwat is really the right place for such an assessment to be made. In the financial services sector, it is for the member firm to make its own determination and express its view to the FCA when seeking to register a new employee. The FCA could then query that view and potentially overturn it. Should Ofwat be required to do this, it is likely to use less professional help and real-world experience in forming that view and will require dedicated infrastructure to process applications. If the undertakers are responsible, overseeing those applications becomes relatively straightforward. This may not be a long debate, with only one amendment, but it is an important amendment to consider when giving effect to the Government’s intentions in this Bill. In providing clarity to the undertakers, what is intended by this provision? I am most interested in the Minister’s response and hope that, if she is not happy with my amendment, she might set out who she considers a fit and proper person and how that will be communicated to Ofwat and the industry. I am also most interested to hear why the Bill’s proposal for how to implement this is different from the financial services industry, despite a reasonably long and moderately successful record within that industry. I beg to move.

21:30:00

My Lords, how nice to have a quick last group. I thank the noble Lord, Lord Roborough, for introducing the last group of today with his Amendment 19, which seeks to specify the criteria to be covered by the rules on fitness and propriety, ensuring that senior leaders meet the public’s expectations. I have mentioned Ofwat’s consultation on remuneration and governance before, and I would just like to confirm to the noble Lord that this consultation references similar criteria to those proposed by his amendment. Ofwat’s consultation seeks views on whether it would be appropriate to include a concept of “ability” in the new test, defined as an individual having adequate knowledge and understanding of the duties of the undertaker. Ofwat has stated its intention to design a fit and proper person test with criteria that will improve public trust and company culture in the water sector, having considered how other sectors are regulated around these same principles. I hope this captures the noble Lord’s concern that standards of fitness and propriety will need to be relevant and encompass concepts of knowledge and understanding. Of course, we feel that Ofwat’s independence is an important part of the trust that companies have in the regulatory regime. The noble Lord asked why we felt Ofwat should be setting these criteria. We think it is right that Ofwat has the opportunity to consult on these criteria and that companies then have the opportunity to respond and perhaps propose different criteria. It needs to be a situation where Ofwat can then tailor these fitness and propriety standards to the water industry, rather than having prescriptive standards set out within the primary legislation. It is important that Ofwat’s independence is clearly upheld, because it will support its ability to hold senior officials to account for their actions. Ofwat also notes in its consultation that the 16 largest water companies have a licence condition that requires them to meet the four objectives of its board, which are leadership, transparency and the governance principles. These objectives include the requirement for boards and board committees to have the appropriate balance of skills, experience, independence and knowledge. I hope the noble Lord is content that this is already being looked at; I hope that he will look at the consultation and therefore see that his amendment is no longer necessary.

My Lords, I am grateful for the Minister’s reply, and it is certainly very helpful. Perhaps something I could have brought out more in my initial comments were the concerns over accountability. When I look at the FCA’s senior manager regime, and the fit and proper tests, none of that is here—nowhere is there any accountability to Parliament. We will take the Minister’s comments away and give this further thought. I beg leave to withdraw the amendment.

Amendment 19 withdrawn.

Amendments 20 to 27 not moved.

Clause 1 agreed.

Amendment 28 not moved.

House resumed.

House adjourned at 9.34 pm.