Water reform: From Ofwat to what?

At 464 pages long, and containing 88 recommendations, the Independent Water Commission (IWC) report  ¹³ Independent Water Commission, Final report, GOV.UK, 21 July 2025, www.gov.uk/government/publications/independent-water-commission-review-of-the-water-sector  is probably the last roll of the dice to avert nationalisation of the water industry. Building on an interim report’s recommendations for better strategic planning and a proposed new supervisory approach to regulation, it includes proposals for a 25-year National Water Strategy, nine new regional water authorities, and greater consumer protections. It also calls for enhanced regulation across a range of areas including water company ownership and governance, environmental performance, public health, and what the industry calls “asset health” – or in other words the condition and maintenance of the sector’s crumbling infrastructure. 

The wide-ranging report’s most headline-grabbing recommendation, though, is to scrap Ofwat, the economic regulator of the water sector.

Ofwat’s abolition seeks to reform both structure and approach

The government has already agreed to abolish Ofwat in advance of its full response to the report in the autumn. The replacement regulator will need to rebuild trust with water companies, investors and the public while also improving alignment between private and public interests.

In England (our focus here) the IWC recommends that Ofwat be replaced by a new water regulator that combines Ofwat’s responsibilities with the work of the Drinking Water Inspectorate and the water-related environmental responsibilities of the Environment Agency and Natural England. In Wales, where the IWC recognizes that the landscape is different and many powers are devolved, it recommends that Ofwat’s economic functions are transferred into Natural Resources Wales. 

Combining functions in this way enables the reach of the regulator to more closely mirror the activities of the water companies being regulated – and the IWC cites Ofcom as another regulator whose broad remit is justified by the corresponding breadth of the businesses it oversees. As with Ofcom, though, this will create a large and diverse institution that will need to successfully integrate a range of specialisms.

Just as important as the structural change is the proposed new supervisory approach, which mimics financial regulators’ methods of evaluating the business models and performance of individual firms. The IWC says the new regulator should have greater discretion – within bounds – to treat firms differently according to their circumstances, relying commensurately less on economic models to benchmark performance. Other ideas drawn from financial services include powers to ensure water companies are appropriately capitalised and to require financial support from parent companies when necessary, as well as a new accountability regime for senior management. 

It is surprising that some of these approaches are not already in place and their introduction raises two questions. Firstly, how easily can the necessary expertise – and an operating model that can integrate econometric, supervisory, asset management and environmental data and perspectives – be developed and maintained in the water regulator? Secondly, what read-across should there be to other highly regulated markets (such as rail, energy, or communications)? 

An effective transition will require difficult choices and a deft touch

Abolition of a public sector organisation very often involves a transfer, rather than a cessation, of responsibilities. Our research on both abolishing and setting up public bodies has revealed that the work of implementing such structural changes is often underestimated. Recruiting, retaining and motivating staff during a period of very public uncertainty, while also maintaining public and political confidence in the emerging new organisation, will require strong senior leadership from the start.

The tension between political urgency on one hand and a long term planning horizon on the other mean that this transition will, perhaps more than most, need to maintain one regime while developing another. Government and the new regulator will need to agree, from a risk based perspective, how fast to change and how much effort to put into ongoing planning processes that will eventually be superseded. The burden on water companies could also be increased by transition to a supervisory approach, although the IWC argues this should be mitigated by better information flows and streamlined reporting requirements to a single regulator. Careful implementation will be needed.

The IWC’s report is wide ranging – but doesn’t address everything

Despite its length and the wealth of recommendations, the IWC report is not comprehensive. Its recommendations must interact with those in the Corry review of Defra’s regulatory landscape  ¹⁴ Corry D, Delivering economic growth and nature recovery: an independent review of Defra’s regulatory landscape, GOV.UK, 2 April 2025, www.gov.uk/government/publications/delivering-economic-growth-and-nature-recovery-an-independent-review-of-defras-regulatory-landscape  and the national infrastructure strategy  ¹⁵ HM Treasury and National Infrastructure and Service Transformation Authority, UK Infrastructure: A 10 Year Strategy, GOV.UK, 19 June 2025, www.gov.uk/government/publications/uk-infrastructure-a-10-year-strategy  for example.  

The option of nationalizing water companies was ruled out of scope due to its high cost  ¹⁶ Defra and Independent Water Commission, Independent commission on the water sector regulatory system: terms of reference, GOV.UK, 23 October 2024, www.gov.uk/government/publications/independent-commission-on-the-water-sector-regulatory-system-terms-of-reference  – but short of that there remains a question around whether industry consolidation is required. Some water companies are small (e.g. Cambridge Water) and there are a range of ownership structures (e.g. Essex and Suffolk Water is owned by the Northumbrian Water Group). The new regulator’s proposed powers might enable it to require change where current structures are not conducive to adequate investment, but greater clarity is needed.

Bringing multiple aspects of water regulation under one roof places considerable pressure on the new regulator’s leadership as the system’s overall guiding mind – particularly insofar as the regional water authorities will also sit under the regulator. It will be important that Defra, as the sponsoring department, is upskilled to both oversee and support such an organisation and enabled to plan over a sufficiently long term time horizon for the regulator and the department to be pulling in the same direction.

The ultimate test will be infrastructure investment

The new regulator will not, ultimately, write the National Water Strategy, and the trade-offs between consumer prices, asset health and environmental protections are the government’s to make. But the credibility and predictability of the regulatory regime will depend on this strategy and will, in turn, affect both public and investor confidence in the sector.

Bills are already increasing to fund large amounts of new infrastructure. If the public are to see improved sector performance, companies will need to continue to deliver their infrastructure programmes against the background of a changing regulatory system. At the same time, investor confidence is essential insofar as further infrastructure spending continues to depend on attracting new private capital. Where expected returns are low, they must also be seen to be low risk to seem attractive.

Reform is essential. Making these reforms stick will not be easy, but the IWC’s proposals offer a credible alternative to an expensive nationalisation. Jon Cunliffe and his team have worked fast and delivered a suite of recommendations that should be taken seriously by the government and the public.