Nobody expects the In(dependent Water) Commission: major shakeup of water regulation and what it may imply for other regulated sectors

It could be a pivotal moment for water in England and Wales. Against a high-profile and increasingly biblical-sounding industry rap sheet including drought, flood, pollution and financial ruin, it was high on the incoming Government’s list of priorities in 2024 to instigate reform. The Water (Special Measures) Act 2025 aimed to pick off some lower-hanging fruit by introducing tougher offences and penalties for polluters, but the more ambitious initiative was the appointment of an Independent Water Commission (“IWC”) tasked with laying the foundations for a fundamental “reset” of the sector. The IWC published its report (the “Report”) on 21 July 2025, setting out some eighty-eight recommendations for major regulatory overhaul. While of course hugely significant for the water sector, the ripples are likely to be felt across other regulated utilities including energy, given that some common aspects of regulatory design have come under fire. Building on our previous high level overview of some of the key aspects of the Report from a health, safety and environment perspective, we look here at the Report through an economic regulation lens, both as to its direct application in the water sector and as it may have an impact more widely across other regulated utilities.

More holistic, longer-term planning

The Report emphasizes the need for long-term planning that takes a whole-system view (across e.g. the natural water environment, water and wastewater infrastructure, pollution, public health…) while also addressing diverse regional circumstances. Recommendations in this regard include:

1. Holistic Government policy directives – As detailed in our previous LawNow, the publication of a National Water Strategy, under which the Government sets out long-term cross-sectoral targets and priorities across the whole water system, and a Ministerial Statement of Water Industry Priorities (replacing the existing Strategic Policy Statement regime), to provide the detail underpinning this.
2. Independent system planning – In place of the current patchwork of planning mechanisms driven by appointed water undertakers, as briefly touched on in our previous LawNow, the establishment of new “system planner” bodies to take a more holistic, directive approach in providing “strategic, cross-sectoral spatial plans”, aligning with the Government strategy documents. The Report expresses a preference for the system planners to be wholly independent, though integration with the relevant water regulator remains on the table. The proposal is that there will be one “regional water authority” for each river basin district in England, and a single nationwide system planner in Wales. To ensure consistency in assumptions and metrics between the regional water authorities in England, a light-touch national co-ordination function (potentially within DEFRA) is proposed.
3. Longer-term system planning horizon – Conducting both Government strategy and system planning on the basis of a twenty-five-year planning horizon. While strategy documents and price controls will remain on a five-yearly review cycle, investment plans will be expected to take a longer-term view. The Report advocates a “5/10/25” model, under which strategy and investment planning will take a long-term view while adopting a more detailed approach for the shorter term. For example, in the context of project planning, the first five years of longer-term projects would be fully-funded, and there would be a presumption that projects for the ten-year horizon would proceed as planned, but details for plans beyond the ten-year mark would necessarily be higher-level in nature.

Consolidation and simplification

A key theme of the Report – and one that arguably applies to other regulated sectors – is addressing the overcomplexity, duplication and inconsistency that has built up in the regulation of the sector as it has developed piecemeal since privatisation. The hope is that simplifying the matrix of obligations to which appointed water and wastewater undertakers are now subject will promote better outcomes and more efficient expenditure. Recommendations in this regard include:

1. New single water regulator for England – As perhaps the most headline-grabbing initiative (and as noted in our previous LawNow), creating a new water regulator, replacing Ofwat and the Drinking Water Inspectorate and absorbing the water functions of the Environment Agency and Natural England, remaining independent from Government. DEFRA has already committed to take this recommendation forward immediately (while they continue to consider the other recommendations in the Report).
2. “Constrained discretion” for the regulator – Relaxing the complex matrix of statutory duties that constrains the discretion of the current water regulators to provide more flexibility in the individual case.
3. Simplification of price control appeal process – In line with proposals in the Government’s “Smarter Regulation” workstream consultation, considering moving away from the resource-intensive “redetermination” process where water companies appeal their price controls to the Competition and Markets Authority towards a more “standard” appeal procedure (like the one used for energy network price control appeals).
4. Rationalisation of legislation – Consolidating the legislative framework, including key secondary legislation in relation to wastewater treatment.
5. Rationalisation of performance incentives – Making the “performance commitments”, and corresponding “outcome delivery incentive” rewards and penalties, imposed on water undertakers via their price controls fewer in number, clearer and more realistic.
6. Rationalisation of business planning documents – Streamlining the nine distinct types of plan that water companies are currently required produce (from their price control business plans to specific plans for water resources management, drinking water safety and pollution reduction) down into two: one for water and one for wastewater.

Removing barriers to infrastructure investment

Regulation of infrastructure investment is a topic discussed across regulated industries. Grid upgrades to address grid and capacity constraints which restrict output from renewable generation or gas network upgrades that are needed to facilitate the transport of hydrogen gas all require policy makers and regulators to take a more sophisticated approach to price regulation and providing the right signals to the market.

In the water context, very significant expenditure is needed to renew and enhance water infrastructure across England and Wales, due at least in part to recent levels of investment that “have not kept pace with changing environmental standards or population growth”. Facilitating the injection of capital needed to fund this expenditure is a key theme of the Report, which recommends measures including:

1. Price control reforms – In addition to the rationalisation of performance commitments/outcome delivery incentives and the streamlining of business planning processes referred to above:
   1. Introducing a common WACC methodology – Considering requiring the Competition and Markets Authority to set a common methodology for determining appropriate weighted average costs of capital for each regulated sector. The Report envisages that, in order to facilitate returns at an appropriate level to attract the degree of investment that is needed, the historically relatively low levels at which cost of capital has been set for water companies needs to be addressed. While the UK Regulators Network has published guidance in recent years to try to standardise the approach on setting costs of capital across regulated utilities, it is suggested that there have still been divergences between the approach taken by each regulator. However, the Report also emphasizes that the focus of reform should be on managing risk for investors rather than simply aiming to increase their returns.
   2. Refining pace at which “slow money” is released – Expressly recognising that the age and condition of the water company’s assets should be taken into account when setting the rate at which its regulatory capital value (i.e. the allowed capital expenditure that the regulator designates for recovery over time) is to be recovered.
   3. Removing Quality and Ambition Assessment – Abolishing the incentive to align business plans with the regulator’s views and benchmarks, in order to keep focus on the factors most relevant for each region and remove perverse incentives in business planning.
2. Land planning reforms – Alongside developments in system planning, driving reforms to land planning processes and permitted development rights in order to accelerate the timescales within which infrastructure can be delivered.
3. Fostering supply chain and skills ­– Requiring the new system planners to publish an assessment of actual capacity in supply chains and human resources against what water companies will actually need to deliver on system plans.
4. Closing ongoing enforcement actions – “Cleaning the slate” with water companies going forward by bringing Ofwat’s back catalogue of enforcement cases to a close.
5. Regulatory sandbox – No doubt inspired by the similar initiative Ofgem introduced a few years ago, the Report proposes the introduction of a “sandbox” whereby water companies can apply to the regulator for temporary reliefs from regulations that would otherwise prevent them from trialling innovative infrastructure solutions.

Corporate governance, financial resilience and trust

A central policy challenge in the water space is how to encourage consumers to part with more cash to fund desperately needed infrastructure investment when public trust in the water industry could be said to be at an all-time low and a number of water companies are in financial distress. Ofwat introduced significant further oversight mechanisms for water companies deemed to exhibit performance issues in its final PR24 determinations, including requirements for further evidence on financial resilience, contingency of expenditure allowances on demonstration of capability to deliver and a “turnaround oversight regime” under which water companies are made subject to enhanced monitoring and ringfencing. The Report builds on these initial steps by proposing measures including:

1. Stronger regulatory oversight – Empowering the new regulator to supervise and engage deeply with water companies (rather than largely relying on price controls). Among other things, the Report flags the need for the regulator to have access to sufficient resources for its enhanced role, including by means of recruitment of suitably qualified staff without being held back by public sector pay controls.
2. Enhanced financial supervision – Building on the work done by Ofwat in PR24, formally introducing a range of mechanisms for monitoring and enforcing financial resilience, including publishing risk factors with respect to the financial health of water companies, giving the regulator powers to block certain changes in control and set minimum capital levels, establishing a balanced turnaround regime for companies in distress and developing a framework for companies to demonstrate that they are well-prepared to hand over their operations in the event of special administration.
3. Strengthened corporate governance standards – Aligning standards with the UK Corporate Governance Code, establishing an accountability regime for senior managers.
4. Moving away from “totex” approach – In order to avoid companies being incentivised to avoid expenditure on vital asset renewals, in the context of water company price controls, ring-fencing cost allowances for operating expenditure, base capital expenditure and enhancement capital expenditure, rather than allowing water companies to be flexible between these categories within a general “totex” allowance.

Comment

The Report demonstrates a clear ambition to draw a line under recent media acrimony and “reset” public perception of the sector, while acknowledging that this will be easier said than done.

Although the abolition of Ofwat seems to have dominated the headlines on the Report, the tone of the Report is principally one of rationalisation rather than censure. For example, the intent appears to be that the new regulator will broadly inherit Ofwat’s existing personnel and resources (together with those of the DWI, EA and NE to the extent subsumed). In its terse response to the Report, Ofwat acknowledges that the Report “sets out important findings for how economic regulation is delivered”. It will be interesting to see if any of the observations from the Report might read across to the outcomes on DESNZ’s Review of Ofgem: call for evidence, which are yet to be published. While narrower in scope than the Independent Water Commission’s review, the Review of Ofgem does raise some similar questions on the role of the regulator, such as streamlining of duties, extension of remit and resourcing. This also highlights the need for the regulator to take an active role in adapting to an evolving landscape and encouraging investments into areas of greatest need and benefit for the long term.

The proposals on holistic system planning have clear parallels with the energy sector: for example, extension of the planning horizon was a key pillar of Ofgem’s proposals in the RIIO-ED3 Framework Decision, and the establishment of the National Energy System Operator (under the Energy Act 2023) marked a move towards long-term planning across energy vectors.

While the drive for regulatory simplification will be good news for many, not everything in the Report pulls in that direction – for example, the direction of travel on financial resilience and supervision could add rather than subtract red tape.

The proposed reforms to water price controls, too, will be of interest across regulated industries. For example, “totex” allowances, depreciation of regulated asset value, price control deliverables/outcome delivery incentives and a Business Plan Incentive (equivalent to the Quality and Ambition Assessment that the Report proposes to bin) are all features of the energy network price controls imposed by Ofgem, so it will be interesting to see to what extent any of the thinking in the Report may ultimately bleed across utility sectors.

As with the energy sector, supply chain and resourcing challenges have been identified as significant barriers to infrastructure delivery. In the electricity sector as well as water, it seems there is no compelling “silver bullet” solution here. To some extent, it will inevitably take time for the supply chains and appropriately qualified human resources to develop organically. This will no doubt remain a critical obstacle to the pace and scale of infrastructure development required.

The downsides of any radical reform are inevitably likely to include the generation of up-front transaction costs and business uncertainty. The process of creating the new water regulator alone (which, as noted above, the Government has already committed to implement) is expected to take at least two years – and the remaining smorgasbord of recommendations will of course take time for the Government to digest, approve (or reject) and implement. The Report proposes various measures to assist the industry with the transitional phase – but the next few years are likely to be critical for the urgent actions needed across the industry, so the reforms (to the extent adopted) will come at a difficult time.