OREANDA-NEWS. UK water sector reforms proposed in December would weaken the credit profiles of regulated utilities by increasing business risk, Fitch Ratings says. We would not expect the impact to be large enough to lead to downgrades, but the reforms would add to pressure on an industry that also faces rising risk of political intervention following government criticism of the regulator.

The Water 2020 consultation from industry regulator Ofwat sets out proposals that the regulator is considering as part of the next five-year regulatory price control review. Ofwat wants to promote competition in the water resources and sludge segments, which represent 11% of the sector's regulated capital value, by introducing new price controls separate from the core water and wastewater network controls. It also proposed changing the inflation index used for indexation of the regulated capital value, which may lead to lower returns, and opening competition for direct procurement contracts over GBP100m.

If implemented, the proposed reforms will probably result in further erosion of the water companies' cash flows. This will have a negative impact on key credit metrics such as net debt to regulated asset base and post-maintenance and post-tax interest cover, which are already under pressure at some companies.

We expect most companies to be able to maintain credit metrics in line with the guidelines for their ratings over the current five-year price control period to 2020. There is a risk that ratings of more highly leveraged companies with secured covenanted structures could come under pressure. But even these companies would have some flexibility to reduce dividends to maintain credit metrics.

We also believe the sector faces heightened risk of political intervention following recent criticism of Ofwat by the government and recommendations for changes to the way it regulates water companies. The potential impact of a government-driven shake-up of the sector is hard to gauge, but it could undermine current regulatory principles, creating uncertainty for stakeholders.