Troubled water: How social contracts could redeem the UK’s water industry

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By Professor Andy Mullineux
Department of Finance, Lloyds Banking Group Centre for Responsible Business

Water, water everywhere,
Nor any drop to drink

Climate change has given new meaning to the poet Samuel Taylor Coleridge’s famous lines. While the UK has recently experienced heavy rains and severe flooding, the United Nation’s World Water Day reminds us there are many parts of the world still struggling to access clean water and sanitation.

But the UK’s privatised water utilities aren’t without their problems. Run as local monopolies, they have been underinvesting in infrastructure while distributing substantial dividends to shareholders and taking on increasing debt. Public trust has been undermined by high charges at the same time as repeated water leaks, hosepipe bans and scandalous effluent emissions have been routinely occurring.

The industry’s regulator, Ofwat, has responded by telling water companies to cut average water bills by £50 over the next five years and invest £51bn to improve services for customers and the environment. Wary of the impact on profits, some of the companies have already decided to appeal to the Competition and Markets Authority for a softening of this ‘remedy’.

Moreover, Ofwat has also been encouraging the water monopolies to state their ‘purpose’ in terms of their environmental, social and governance (ESG) objectives and obligations to stakeholders – including consumers, employees, local communities and shareholders and bondholders. In future, Ofwat could hold the water companies to account by measuring the extent to which they fulfil their stated purposes in what is essentially an implicit social contract with their stakeholders.

Ofwat’s aim is to encourage the water companies to pursue social contracting as a means of re-building their reputations, helping to restore trust with the public and thereby encourage consumers to be more careful users of water. This approach offers the opportunity to reduce the weight of rules in water regulation in favour of a more principles-based approach. As this evolves, regulatory monitoring of adherence to principles could be progressively replaced by a stewardship model of monitoring by investors and ESG-based auditing. Eventually, it could see water executives’ pay linked to ESG performance as a means of rewarding responsible business practice.

This pioneering approach could obviously be applied to other regulated utilities services in the UK, such as gas and electricity, but perhaps to retail banking too. Banks have public duties and social responsibilities and are also trying to rebuild their reputations and restore trust after the financial crisis and a series of scandals, including the miss-selling of PPI and Libor rate-fixing. The banking regulators could follow Ofwat in requiring banks to announce statements of purpose and then use them to form the basis of an implicit social contract with stakeholders – including borrowers, depositors and savers.

Despite its problems, the UK’s freshwater and sanitation systems are undoubtedly world-leading compared to many other countries. But the industry’s adoption of social contracts could also see it lead the way as a model for more socially and environmentally responsible business that – some day – all companies might emulate.

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