The financial difficulties of English and Welsh water companies have reopened the debate over whether privatisation left the sector unable to finance itself. This paper tests two competing explanations: that Ofwat’s regulation was too tight, or that owners’ financing choices left companies fragile. The answer matters for who pays. If regulation was inadequate, customers may need to fund higher returns; if vulnerability came from financing choices, costs should stay with investors.

Approach:

• Return adequacy: compares Ofwat’s allowed cost of equity with the market-implied cost of equity of listed water-company parents (1995-2025), using four equity-valuation models and enterprise value relative to regulatory capital value (RCV).
• Financial structures: reconstructs how the 10 water and sewerage companies financed themselves after privatisation, covering equity retained in each appointed company, loans to entities above the regulatory ring fence, and how capacity was restored after 2020.
• Common stress test: the 2021-23 inflation shock is used to compare these structures.

Key findings:

• No persistent under-remuneration: the only shortfall supported by conventional inference is at PR99, where the implied return exceeded the allowance by 3.2-4.3 percentage points. From PR04 onwards, no shortfall is robust across specifications.
• Allowances were generous later: at PR09 and PR14 the allowance exceeded the implied return by 0.86 and 2.5 percentage points, a result that holds across 15 specification combinations.
• Timing weighs against the regulatory explanation: listed groups traded around or below regulatory asset bases in the first decade of private ownership and at a premium in the second. The PR99 shortfall predates the rise in gearing, while PR09 and PR14 fall within the period in which gearing rose and vulnerable structures were built.
• Distress was company-specific, not sector-wide: regulatory equity ranged from 17% of RCV at Thames and Anglian to 40% at Dŵr Cymru.
• Recorded dividends alone do not explain which companies experienced distress: among securitised companies, 2011-20 dividends ranged from 1.3% of RCV at Thames to 6.7% at Anglian (both gross of intra-group flows), yet Thames and Southern, despite recording relatively low dividends, later needed intervention.
• Equity buffers and owner support mattered most: Thames and Anglian entered 2021 with almost identical gearing and index-linked exposure, but Anglian Water Services benefited from £1,165 million of group-funded new share capital, while an additional £750 million of conditional shareholder funding envisaged for Thames was not delivered. Dŵr Cymru, despite greater index-linked exposure, avoided comparable distress, supported by a substantially larger equity buffer.

Regulatory implications:

• Return adequacy should be judged against the notional company, which can remain the benchmark for setting allowed returns and insulating customers from company-specific financing choices.
• Financial resilience must be assessed on the actual company, including equity within the appointed business, claims elsewhere in the group and owners’ capacity to provide support.
• Setting prices on a notional structure and monitoring resilience on actual structures are distinct regulatory tasks.

Ultimately, the paper argues that protecting customers requires not higher returns across the sector, but effective regulation that allows efficient financing costs while ensuring that investors, rather than customers, bear the additional risks created by company-specific capital structures.