Ministers plan legally binding debt targets for England’s water companies

Exclusive: Move comes as allies of Andy Burnham work on proposals to take water companies into public control

Ministers are drawing up plans to set legally binding debt targets for England’s water companies as they look for ways to avoid another corporate failure such as Thames Water .

Sources say Emma Reynolds, the environment secretary, is working on proposals that would force companies to keep their debt below certain levels for the first time or face legal punishment.

The move comes as allies of Andy Burnham work on proposals to take water companies into public control, which the incoming prime minister has said will be one of his main priorities once he enters Downing Street later this month.

One source close to Reynolds said: “Under the Tories, water companies were allowed to rack up debt and pay out dividends while taking customers for a ride. The secretary of state is putting an end to that, asserting control over poor-performing companies, protecting customers and tackling pollution.”

The fate of England’s water industry is in the balance as government officials and industry executives prepare for Burnham to enter office.

The Makerfield MP has promised to take the “essentials of life” back into public control, but has not yet laid out detailed plans for how he would do so. Allies say he is likely to pursue a model such as those in Paris and Berlin, where water services are run by independent organisations but with most of the shares held by the municipal government.

In a recent online question-and-answer session , he said: “Public control can include a range of measures, from strong regulation to public ownership.”

Reynolds’s plan to set legally binding debt limits could go some way to strengthening the regulations on the industry, and is being worked on as part of an upcoming clean water bill.

In a white paper paving the way for that bill, Reynolds said: “We will consider how the regulator can work with companies and investors to ensure companies do not accumulate unmanageable levels of debt, remain financially resilient to deliver vital services for customers and the environment, and are able to attract further investment as required.”

The Guardian understands Reynolds is working on a plan that would set a binding target for how much debt a company could take on as a percentage of its overall value as determined by the water regulator, Ofwat – known as a gearing ratio.

Ofwat guidance currently says companies should have net debt (total debt minus cash) worth no more than 55% of their value – but many companies are far more indebted than this.

Thames Water, the most financially imperilled of England’s water companies, is buckling under £17.6bn worth of debt, giving it a gearing ratio of 86%. South East Water’s ratio is 75%.

Thames is the subject of a tussle between the government and creditors who are trying to negotiate a £10bn rescue package for the company.

Reynolds recently wrote to Ofwat saying she opposed the proposed deal because it did not do enough to protect consumers, in effect pushing it a step closer to temporary administration.

The environment secretary is understood not to have decided the level at which a binding debt target should be set, although companies that miss it will have to write to ministers explaining why.

Further sanctions will follow if they continue to miss the targets, although these have not yet been decided on.

Water industry figures say companies are likely to accept the measures without resistance if the debt target is set at what they consider to be a reasonable level.

Some warn, however, that they will have less money to spend on improvements to infrastructure such as sewers if they are forced to pay off their debt quickly.