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Announcement:

Moody's: Water Bill continues to progress with potential negative credit implications for UK water sector

02 Jul 2013

London, 02 July 2013 -- Moody's Investors Service has today said that it continues to view the Water Bill published by the UK government as credit negative for the existing vertically integrated monopoly water companies in England and, potentially, Wales. The Bill, introduced in the House of Commons on 27 June 2013, shows that the government's plans for changes to the water sector remain largely on track. In particular, Moody's views as credit negative for these companies one of the main elements of the Bill, namely proposed reforms to support competition in the retail and upstream segments.

The rating agency notes, however, that the impact of increased competition may be limited over the medium term and that the regulator's discretion in implementing a number of the proposed changes has been reduced since a draft of the Bill was published in July 2012.

According to the government, the Bill will deliver policy in four areas: (1) growth -- a water sector that supports a growing economy; (2) resilience -- helping to ensure that water is available to supply households and businesses without damaging the environment; (3) choice -- offering choice and flexibility to customers; and (4) flood insurance -- to help manage the financial risk of flooding.

The Bill provides for retail competition in water and wastewater services for non-household (NHH) customers and the creation of a cross-border market in Great Britain. Retail competition in England and Wales is expected to begin in 2017 -- a competitive market already exists in Scotland -- following changes proposed by Ofwat to implement disaggregated price limits for existing companies in respect of retail and wholesale activities from the start of AMP6.

Moody's notes that competition in Wales will be subject to decisions by the Welsh Assembly, with the Welsh minister responsible for water, Alun Davies, recently saying that he will not allow Welsh Water (A3 stable) to face competition.

The impact of retail competition will be a function of the way in which Ofwat sets price limits for the wholesale and retail activities as part of PR14, and subsequently, and the number of customers switching supplier. However, analysis by Moody's shows that the impact on most companies is likely to be modest over the medium term (see UK Water Sector: Stable Despite Changes to Regulatory Environment, October 2012). Whilst some of the existing vertically integrated companies suggested that they may welcome the ability to exit the retail market following the introduction of competition, the Bill does not provide for this option.

Increased wholesale competition is proposed, with changes to be made to the existing Water Supply Licensing (WSL) regime to allow new entrants to supply water services to NHH customers. New entrants will also be able to provide wastewater services to such NHH customers. The existing 'costs principle', which governs the charges levied by incumbent operators for use of their resources and assets, is being abolished with new charging codes and rules to be set by Ofwat. Meaningful upstream competition would likely be credit negative for incumbent operators but Moody's does not expect this to crystallise over the medium term.

In response to concerns around the potential stranding of water company assets, the Bill modestly reduces the scope for upstream competition by removing the proposed network infrastructure authorisation. This would have enabled new entrants to own and operate their own infrastructure (mains, pipes, storage and treatment), connected to an incumbent water company's network and used to supply water in order to bypass parts of that network. A similar "last mile" retail infrastructure authorisation is also no longer proposed. The scope for new entrants in upstream infrastructure services is thus reduced, reinforcing the principle of incumbent operators retaining ownership and responsibility for the core network. Government will also work closely with Ofwat to improve the existing regime of inset appointments to meet the requirements of a growing population.

A February 2013 report by the House of Commons Environment, Food and Rural Affairs (EFRA) Committee highlighted that the July 2012 draft Bill provided only a broad framework and left too much detail to be decided by Ofwat. The Bill now limits the regulator's discretion by (1) allowing the Secretary of State or the Welsh Ministers to veto changes to company licences that the regulator may propose as a result of the Bill; (2) requiring government to produce guidance for Ofwat with respect to setting rules and codes for inter alia bulk supply; and (3) allowing government to direct Ofwat not to issue new rules or codes, or to amend them as directed. Companies may also appeal proposed code changes through the newly formed Competition and Markets Authority (which succeeds the Competition Commission).

The Bill sets a new primary duty for Ofwat, to secure the long-term resilience of water supply and sewerage systems, although it is unclear how this may interact with the regulator's existing duties, which include 'contributing to the achievement of sustainable development', or affect PR14. A further duty is also proposed, to ensure that companies do not show undue preference or discrimination in their dealings with other operators.

Subject to its progress through Parliament, the Bill could be passed into law during the current session, which runs until April 2014.

****

NOTE TO JOURNALISTS ONLY: For more information, please call one of our global press information hotlines: New York +1-212-553-0376, London +44-20-7772-5456, Tokyo +813-5408-4110, Hong Kong +852-3758-1350, Sydney +61-2-9270-8141, Mexico City 001-888-779-5833, São Paulo 0800-891-2518, or Buenos Aires 0800-666-3506. You can also email us at mediarelations@moodys.com or visit our web site at www.moodys.com.

Stefanie Voelz
Asst Vice President - Analyst
Infrastructure Finance Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Neil Griffiths-Lambeth
Senior Vice President
Infrastructure Finance Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Releasing Office:
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Moody's: Water Bill continues to progress with potential negative credit implications for UK water sector
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