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Water Industry (Special Administration) Regulations 2024

Volume 836: debated on Monday 19 February 2024

Considered in Grand Committee

Moved by

That the Grand Committee do consider the Water Industry (Special Administration) Regulations 2024.

My Lords, these regulations and the Water Industry Act 1991 (Amendment) Order are part of a package that updates the water industry special administration regime legislation. The package is made up of two commencement orders and three statutory instruments. The first commencement order was made on 11 January and the two affirmative statutory instruments being debated today were laid in draft on 15 January. The second commencement order and the negative resolution statutory instrument will follow shortly after the affirmatives are debated.

The purpose of these statutory instruments is to enable the Government to facilitate a more effective water industry special administration regime. They apply to England and Wales, and ministerial consent has been secured where necessary. The Government already have powers in the Water Industry Act 1991 to apply to the High Court for a special administration order. However, updates are required as the current legislative regime is outdated and modelled largely on the Insolvency Act 1986, which has since been modernised. The most notable legislative updates were the Enterprise Act 2002; the Small Business, Enterprise and Employment Act 2015; and the Insolvency (England and Wales) Rules 2016. These updates to insolvency legislation are not automatically applied to the legislative framework of the water industry special administration regime. Instead, the Government must assess how to adapt these insolvency law changes to each industry’s specific special administration regime. Legislation relating to special administration regimes is laid periodically; recent examples of this are the Payment and Electronic Money Institution Insolvency (England and Wales) Rules 2021 and the Energy Act 2023.

It is vital that the Government are prepared for a range of scenarios, particularly regarding the continued provision of public services. This is why an updated water industry special administration regime is so important. I want to make it clear that the two main grounds on which a water company can enter special administration are unchanged by this legislation. They are insolvency, where a company may be unable to pay its debts or its liabilities are greater than its assets; and performance, where the company has failed to carry out its statutory functions or licensed activities to such an extent that it is inappropriate for the company to continue to hold its appointment or licence. During a special administration regime, customers’ water and wastewater services will continue to be provided.

The first statutory instrument for noble Lords’ consideration is the draft Water Industry Act 1991 (Amendment) Order 2024. This order implements hive down provisions through amending Schedule 2 to the Water Industry Act, which makes provision about transfer schemes upon the termination of an appointment or the transfer of a licence for a water industry company and is amended by this order to include provisions about transfer schemes in cases where there is a transfer by hive down. This amendment is necessary to ensure that the hive down provisions commenced last month by the Flood and Water Industry Act 2010 (Commencement Order 10) Order 2024 are fully operable. Hive down is a common commercial restructuring practice to ring-fence value and attract potential buyers. This amendment allows the administrator to hive down the regulated business to a subsidiary in order to protect its business and facilitate a sale process that may be more attractive to a potential buyer.

The second statutory instrument that I ask the Committee to consider today is the Water Industry (Special Administration) Regulations 2024. This instrument will apply, disapply and modify general insolvency provisions as they apply in relation to water companies, including licensed infrastructure providers, and special administration orders made in respect of those water companies under the Water Industry Act 1991.

These regulations make general modifications to the Insolvency Act 1986 and other enactments about insolvency provisions, alongside specific modifications to Schedule B1 to that Act. The amendments adapt Parts 26 and 26A of the Companies Act 2006 via specific modifications for the purpose of the water industry special administration regime and amend Section 26 of the Water Industry Act, and Schedule 1 to the Water Industry (Specified Infrastructure Projects) (English Undertakers) Regulations 2013. In addition, this set of regulations will give government the power to lay a negative statutory instrument in the coming weeks, which will revoke the Water Industry (Special Administration) Rules 2009, replacing them with updated special administration rules for water companies, based on the 2016 general insolvency rules.

These statutory instruments update the water industry special administration regime legislation to ensure that, should a water company ever be required to go into special administration, a modern, efficient water industry special administration can be implemented. I am grateful for the support of the Committee and am happy to take questions, which I will endeavour to answer in my closing speech.

My Lords, I am most grateful to my noble friend Lord Douglas-Miller for setting out the content of the SIs before us. I am in great support of them and have just a couple of questions to press my noble friend on.

When my noble friend set out the circumstances behind these instruments, he seemed to indicate that we are just putting into effect existing legislation here and updating it. I would just query the timing of this, which was also queried in the House of Commons when these measures were debated there. At the moment, there are additional investments that we are, rightly, asking water companies to make and which are of a very high order: £60 billion of capital investment over 25 years for storm overflows and other investments such as the self-monitoring programme, which was embarked on under the Labour Government and which we vigorously and enthusiastically pursued. Might these additional responsibilities on water companies be causing the Government some concern, or is it literally about putting in and updating the background, as my noble friend set out? Obviously, we all want to ensure that the water companies are fulfilling the legitimate investment that we have asked them to make.

I have a rather cheeky question. My noble friend knows of my interest in Schedule 3 to the 2010 water Act. Why has Schedule 5 been preferred to be implemented before us in these instruments, and when might we get the orders implementing Schedule 3 to the same 2010 Act? That would put into place the sustainable drainage systems and end the automatic right to connect, which has been called for since the Pitt review and surface water flooding of 2007. That is my rather cheeky interjection, which my noble friend might either want to respond to today or write to me on.

Parallels have been drawn in the report before us with energy companies. When energy companies have failed over the last two or three years, the existing customers of a company which was asked to take on the customers of a failed energy company have found, regrettably, that their tariffs and charges have gone up. This is obviously a matter for Ofwat, but can the Government give any undertaking to customers in the event of a water company failing—which, heaven forfend, we would not wish to see—so that, essentially, what happens in the water sector will not be what we saw happen in the energy sector?

Finally, in what specific circumstances does my noble friend the Minister imagine the special administrator might be applied for? Paragraph 7.6 of the Explanatory Memorandum to the Water Industry (Special Administration) Regulations 2024 talks about, in essence, going into special administration—that is, being allowed to

“restructure its debts and then exit the SAR as a going concern”.

Is there a parallel to that in the UK or is chapter 11 in the US the nearest one? I cannot think of any other scenario where a company is allowed to divest itself of its responsibilities and restructure. I am not saying that it is a bad thing but is there a parallel in another area?

With those few remarks, I support the instruments before us this afternoon.

My Lords, I thank the Minister for his introduction to these two SIs, which make provision for the continuation of water supply to households should a water company be teetering on the verge of insolvency. I welcome this move to protect householders and businesses if that happens.

A special administration regime—SAR—allows the Government to prepare for all eventualities to ensure uninterrupted provision of this vital public sector service. Each service SAR is unique. Those governing the water industry—the WISAR—are distinct and come into play when a water industry company becomes insolvent. This is obviously a serious matter. I ask the Minister: how many of the country’s water companies are on the verge of bankruptcy? Is it a couple or is the prediction in double figures? Is the number of water companies struggling confined to England or are there similar threats of insolvency in Wales, Scotland, and Northern Ireland?

Paragraph 7.5 of the Explanatory Memorandum indicates that the High Court will appoint a person to manage the affected water company and that this will be on the recommendation of Ofwat or a Defra Minister. I would like an assurance from the Minister that this person will not be someone who has previously been involved in the running of the water company under consideration, nor someone who has been involved in the running of another insolvent water company. This must be someone who is completely independent in every sense of the word.

Apparently, the Flood and Water Management Act 2010 (Commencement No. 10) Order 2024 covers the arrangements for hive down provisions, which the Minister referred to. The Explanatory Memorandum states:

“This will allow otherwise viable water industry companies to enter a special administration, restructure its debts and then exit the SAR as a going concern”.

Not being a legal expert, I searched for the meaning of a hive down. I found this:

“A hive down is the transfer of all or part of the assets or business of a company to a subsidiary—usually a new subsidiary”.

Paragraph 7.6 of the Explanatory Memorandum indicates that this would allow the new subsidiary

“to benefit from potential tax savings”.

The process allows new owners to acquire a “clean” water industry company that has no existing liabilities. This is exactly what the current water companies inherited at the point of acquisition in the 1980s.

I sometimes despair at the way in which we as a country conduct ourselves. It seems to me that a water company facing insolvency would welcome the chance to create a subsidiary company, get rid of its debts—or restructure them, as the Explanatory Memorandum euphemistically calls it—and start again, delivering the same lack of investment and poor repair service. Unless I have missed it, there is nothing in the Explanatory Memorandum that prevents previous CEOs or directors carrying on their inefficient ways from the insolvent water company into the new subsidiary. Can the Minister comment on the likelihood of this happening under the proposals for a hive down?

I understand that the SAR rescue purpose applies only where the special administration was based on economic insolvency grounds, not performance grounds, but I am not sure that that is what the Minister said. Can he give more information on poor performance and not meeting the government-set vital environmental targets and say whether this is also a consideration? Will violation of environmental law constitute a failure to fulfil statutory duty, under the terms of Chapter II of the Water Industry Act? Do the Government commit to applying for a special administration order where a company shows consistent and flagrant breaches of its environmental duties?

Paragraph 7.12 gives a lot of detail about the process with a list of modification orders. These modifications indicate that only the Secretary of State or a Welsh Minister can make an application for a water industry company to go into administration. It further states that the interests of the customer should always be considered. I would have assumed it would be a given that the customer would always be the first to be considered.

There is also a section in the EM, at Paragraph 7.18, indicating that the appointed special administrator’s conduct may be challenged by the relevant Minister or Ofwat. Can the Minister give an example of what kind of conduct might qualify for a challenge by the Minister or Ofwat?

There is reference in paragraph 7.21 of the EM to paragraph 91 and the power of the sponsors to apply to the court for the replacement of the special administrator. Since it is necessary to put this information in the EM, this would indicate that it is not a one-off occurrence and is something that has happened in the past. Would the Minister care to comment?

The changes that the Government are proposing will also enhance the ability of special administrators to dispose of fixed-charge property without the consent of the charge holder. In this case, the fixed-charge holder receives only “appropriate value” rather than the standard test of “market value”. Can the Minister say whether this will lead to an increase in valuation disputes in challenges to the administration of sales of water company fixed-charge assets?

There has, as usual, been no guidance to accompany this instrument and no impact assessment. The reason given for no impact assessment is that the impact is alleged to be minimal, with the net present value of the SI over a 10-year evaluation period likely to be less than £55,000. Is this £55,000 a one-off or annually? If the latter, that is more than half a million pounds. Can the Minister say whether this figure includes the bankruptcy costs? If the debt is to be restructured so that the new water company can continue debt free, there will surely be some impact on the creditors of the water company at the point of insolvency. Can the Minister comment?

I understand that if a water company is about to be insolvent, something has to be done to allow water and sewage services to be provided on a continual basis to domestic householders and businesses, some of whom use vast quantities of water every day. However, I remain concerned about this process. It seems to me that those who had been running the previous, now insolvent, water company can simply transfer to running the wholly-owned subsidiary which will be set up under the WISAR. I also remain concerned that the SI makes no reference to the sewage crisis. The noble Baroness, Lady McIntosh, referred to that. Can the Minister confirm that the special administrator will be able to discharge environmental duties as well as financial duties?

I realise that I have asked a number of questions, but I hope that the Minister will be able to answer them. The Liberal Democrat policy is to reform water companies into public benefit companies. While this may not solve all the problems of the ailing water industry, it would certainly bring a great deal more transparency to the issues. I am looking forward to the Minister giving considerable reassurance on this extraordinarily complex matter.

My Lords, I start by thanking the Minister for his thorough introduction to these two SIs. As he said, the first one updates the special administration regime for water industry companies, looking at general insolvency issues. We welcome that; it needs to be looked at and sorted out.

The second SI is pretty technical. It allows part or all of a water company’s undertaking to be transferred to a wholly owned subsidiary, as we have heard, and for securities to be passed over to another water company. The noble Baroness, Lady Bakewell of Hardington Mandeville, talked about this to some extent, so I will not go into detail, but I stress the importance of minimising costs to the taxpayer if and when the companies need extra support, even if that is temporary.

We support these regulations because they give more security to people’s water provision. Clearly, it is essential that customers have a continuous provision of water services, irrespective of how the water company is performing. Water is needed for life, so this is important. However, I am sure that the Minister is extremely aware that further challenges face the water sector at present. Some pretty fundamental issues need to be tackled that clearly go beyond the SIs in front of us.

The fact that these legislative changes are necessary reflects the serious situation in which many water companies are not just failing to protect the environment but struggling financially. The noble Baroness, Lady Bakewell of Hardington Mandeville, asked about the number of water companies that are facing such problems. Of course, Thames Water is the one that has been in the media recently and there have been serious concerns about its solvency, but I also understand that Thames Water, Southern Water and South East Water have been using up to 25% of customer bills to service the huge debts that they have built up. Clearly, the customer should not be picking them up.

The noble Baroness, Lady McIntosh of Pickering, talked about the impact on consumers, picking up on paragraph 7.6 of the Explanatory Memorandum. I underlined the bit that she referred to specifically to ask the same questions that she did, so I would be grateful for a clear answer about that and the impact on consumers in this area, for example.

It is important that we have a radical rethink of how the water sector, regulators and Government all work together to ensure stability. I am sure the Minister would agree with me on this, but it would be good to get confirmation that the Government are looking more broadly at stability issues for water companies.

We know that the special administration order is intended to ensure that water services are not interrupted when a water company becomes unviable. The noble Baroness, Lady Bakewell of Hardington Mandeville, talked about environmental duties and impacts which could be interrupted when a company becomes insolvent. I am particularly concerned about that. When this was discussed in the other place, the Minister was asked whether

“the new regulations … guarantee that any special administrator will continue to discharge a company’s environmental obligations, including investment commitments under the water industry national environment programme, catchment plans and infrastructure upgrades”.

I remind the noble Lord of the Minister’s response during that debate. He said:

“Every water company is specifically regulated by the Environment Agency, as well as Ofwat. The Environment Agency will have powers if water companies are owned and operating under the regime they operate under now, or should they enter special administration”.—[Official Report, Commons, Fourth Delegated Legislation Committee, 6/2/24; cols. 5-9.]

I am not sure whether that answers the question, particularly asked by the noble Baroness, Lady Bakewell, about what those environmental obligations and duties would be if it is interrupted. You may potentially have a gap; how can we ensure that it is managed smoothly if it has been transferred across and who, outside the Environment Agency, is responsible for that? Someone has to report that to the Environment Agency and it has to go through that due process, but where does that environmental obligation sit during an insolvency, potentially with a move to a subsidiary? It may well be that the Environment Agency takes it away and manages that separately, but these things are normally done with Ofwat and all the water companies together. I just want clarity around that. In talking about clarity, I hope that I have made myself clear.

On that note, I support the questions from the noble Baroness, Lady Bakewell, on whether a breach of environmental law constitutes a failure to fulfil the statutory duty under the terms of Chapter II of the 1991 Act. That is an important point to pin down.

Having said all that, as I mentioned earlier, we support these SIs. We think they are important, but we need to ensure that there is proper consideration of how water companies manage their environmental responsibilities.

I thank noble Lords for all their questions, which I will now endeavour to have a go at, and for their very welcome support for these instruments. As I mentioned in my opening speech, these statutory instruments will enable the Government to facilitate a more effective, efficient water industry special administration regime, ensuring that we are prepared for all eventualities to ensure the uninterrupted provision of vital services. A number of noble Baronesses touched on that today.

I will start with the several questions asked by the noble Baroness, Lady McIntosh of Pickering. I might have three out of four answers for her; the second one probably eluded us all.

Everyone will be aware that there has been some recent instability and speculation around the financial resilience of some of our companies in the water sector. This has led Defra to carry out due diligence work on our water industry special administration regime legislation. This exercise identified unmodernised provisions in the current legislative framework. These statutory instruments update water industry special administration regime legislation to ensure that it reflects modern insolvency practices, as is the case for special administration regime legislation for other public services. Ensuring that legislation on special administration takes account of modern insolvency and business practices is important, regardless of the financial resilience of the sector, to ensure proper preparedness.

The noble Baroness, Lady McIntosh, also asked whether customers will be paying for water companies’ failures. I think that was the gist of her question, which cropped up in a number of noble Lords’ concerns. I want to make it clear that we will always act to protect consumers as a priority. Any intervention that puts pressure on the public purse will be considered very seriously and only as a last resort. The purpose of being able to utilise a more efficient insolvency practice is to protect consumers and ensure not only that they do not pay for those mistakes but, more importantly in the short term—a point raised by the noble Baroness, Lady Hayman—that we can provide that service. We can have an argument later about who paid for what and whether somebody needs some money back, but it is crucial that that service—water and wastewater—is delivered for everybody. That would be critical if we had to go through an insolvency, so I reassure the Committee on that front.

The final question that I can answer from the noble Baroness, Lady McIntosh, is whether the public would end up paying to bail out a company in special administration. I again make it clear that we will always act to protect consumers as a priority and that, as I have said, any intervention that puts pressure on the public purse would be considered very seriously and as a last resort.

The noble Baroness, Lady Bakewell, asked a lot of questions. I am not sure that I will get to all of them but I will reflect on the ones I have missed and make sure that she gets a written response. The first question was about the Government’s position on Thames Water. As the noble Baroness is probably aware, water companies are commercial entities; it is not appropriate for me or any member of the Government to comment on the position of a specific company. It is for the company and its investors to manage the company’s financial resilience in the context of its licence and broader statutory obligations.

The second question was about why no companies are listed in Ofwat’s leading category, or how many are failing—I think that was the gist of the noble Baroness’s question. It is clear from Ofwat’s performance report that there has been a marked decline in the performance of a number of water companies over the past year or so. This has been driven by company-specific factors but also by the effects of extreme weather, including an unusually hot, dry summer and a winter that brought multiple freeze-thaw events in 2022 and 2023. There are also live enforcement cases against six companies, which precludes a leading rating where an enforcement case is under way. Specifically, there was a question on how many companies we think are going to fail; I am not aware of any companies that are about to fail. I do not have any information on that at all.

The third question was about why the hive down provisions have been introduced. Without them, only a direct sale of assets would be possible. This is likely to be much more expensive and complex to implement from a tax perspective as you would not benefit from the no-gain, no-loss treatment on transfer. It is probably also important to recognise that, if you get to the point of insolvency, the quickest route to providing the services that are absolutely critical is to package up what the company has to deliver in that hive down and get it back into the hands of somebody who can operate the business in the most effective way. Tying it up, with all the debt and the other complications that go with an insolvency, will just complicate and delay the issue.

I turn to the question from the noble Baroness, Lady Bakewell, about breaching environmental standards. As I stated in my opening speech, a water company can be placed into special administration on performance grounds where there is either a serious breach of their principles or statutory duties or an enforcement order that it is no longer appropriate for it to continue to hold its licence. One of the principal statutory duties held by a water company is under Section 94 of the Water Industry Act 1991, which says that a water company has a duty to deal with the contents of sewers effectually and provide the necessary infrastructure for that purpose, including meeting the requirements of the Urban Waste Water Treatment (England and Wales) Regulations 1994. This is key as, without treatment, urban wastewater has significant adverse impacts on our water environment.

Finally, the noble Baroness, Lady Hayman, asked a number of questions. I think I have touched on a few of them as I have gone through here. One of the issues that she focused on specifically was how Ofwat will regulate underperformance. Following the publication of its performance report in November 2023, Ofwat published the financial penalties and payments for all water companies. Ofwat required 13 companies to return £193 million to customers for underperformance in 2022-23. This money will be returned to customers through bills over the 2024-25 year. On the action that the Government are taking on underperformance, industry performance is below the level that the Government and regulators expect and the Government are taking action, alongside Ofwat, as we progress.

Both the noble Baroness, Lady Bakewell, and I asked about the unusual position in which we will find ourselves, where a subsidiary company can be set up, meaning that the company is not competitive or living up to its responsibilities financially. I drew the parallel with chapter 11. Is this the first time that we have done this in the UK or is there another parallel? My noble friend could write to me on this.

It might be easier if I wrote specifically on that. Is my noble friend referring to the special administrator’s duties?

If I have understood correctly, if a subsidiary company is set up for the purposes of the company continuing to act, does that mean, as with chapter 11, that it does not need to pay off its creditors or debtors? Is this the first time that it has happened in this country?

I am a little unsure on that, so perhaps the best thing for me to do is write.

I think we have covered the questions for which I have answers, and I will write to the noble Baronesses on a number of other questions. With that, I commend these instruments to the Committee.

Motion agreed.