The most highly geared water companies could be forced to share up to £230 million worth of financial gains with their customers between 2020 and 2025.
Gearing shows the extent to which a company’s operations are funded by lenders versus shareholders – the higher the level of borrowing, or gearing, the higher are the risks to a business.
Any water company that continues to have debt substantially in excess of the level used by Ofwat to set price controls will be required to share the benefits with customers.
Companies must outline how they will do this in their business plans and submit them by 3rd September 2018.
The decision comes as Ofwat is concerned when companies adopt high levels of gearing, they may increase risk to equity investors and reduce financial resilience but they may also transfer some risk to customers, in the event that a company fails.
It added high gearing may also reduce the ability of companies to adapt to changes to regulatory arrangements that are required in customer interests.
While equity investors benefit from higher returns that are associated with their increased risk, there is no substantive benefit passed to customers, the regulator said.
The reforms aim to ensure the decisions water company boards reach on debt levels, dividends and executive pay must align more closely with customers’ interests.
Ofwat Chief Executive Rachel Fletcher added: “With this package of reforms, we are reducing the incentives for financial engineering, making sure that any companies which do benefit from high levels of debt share any gains with customers. This is another step we are taking to secure a fairer deal for customers.
“At the same time, we are ensuring that water companies are open and transparent about what they pay out to their top executives and their investors. This openness is essential for customers to have confidence in their water company.”