Ofwat, the water regulator, has ordered water companies in England and Wales to cut bills for customers by £50 over five years and spend £51bn on improving services and investment in infrastructure.

The toughest ever crackdown on water industry profits could put Ofwat on a collision course with companies that are considering whether to take the regulator to the Competition and Markets Authority.

Water companies fear that Ofwat may stifle foreign investment into the sector by expecting better service and new infrastructure while charging “unreasonably” low bills. The sector had planned to spend £56bn over the next five years to meet Ofwat’s standards but the regulator has told companies to make do with £5bn less.

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A spokesman for Thames Water, the UK’s biggest water supplier, said: “There are eight weeks to decide whether to accept – or challenge – the determination. We will carefully consider our options and announce our decision in the new year.”

Ofwat told the water companies to cut the amount of water lost to leaks by 16%, which it said would save enough water to meet the needs of everyone in Birmingham, Bristol, Cardiff, Leeds, Liverpool and Sheffield.

Companies have also been told to identify and help an additional 2 million customers who need extra support and to invest more than £1bn to protect communities at risk of flooding.

Rachel Fletcher, the Ofwat chief executive, said: “Today we’re firing the starting gun on the transformation of the water industry backed by a major investment programme to deliver new, improved services for customers and the environment and resilience for generations to come.

“They will be investing the equivalent of an extra £6m each and every day to overhaul services, strengthen their infrastructure and improve our natural environment. And at the same time, customers’ bills will fall by an average of £50 before inflation.”

The changes, part of a price review conducted by the regulator every five years, will take effect on 1 April 2020. Ofwat tightened the screws on the companies’ business plans by cutting the expected cost of raising capital to its lowest since privatisation. Ofwat expects the weighted average cost of capital to fall to 1.92%, from about 3.6% in the current regulatory cycle.

The water and sewage companies, which have had a series of serious pollution incidents, will also have to reduce pollution of sewage into rivers and streams by a nearly a third. They have also been told to prepare for drier weather by spending £450m on exploring new water resources such as reservoirs.

“We’ve said all along this was going to be a tough review,” Fletcher told BBC Radio 4’s Today programme. We think this is the greenest package ever for water companies.”

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Tony Smith, the chief executive of the Consumer Council for Water, said water companies “have had it too good for too long”.

He said: “Most customers will see this as a good deal but more must be done to make sure everyone can afford their bill and ensure there is sufficient investment in safeguarding these essential services long into the future.

“At first glance it appears Ofwat has listened to our repeated calls for it to get tougher and tip the balance back in favour of customers. But we’ll be keeping a close eye on the performance of companies to make sure customers are not short-changed.”