Image copyright Getty Images

Water firms in England and Wales are facing the toughest restrictions on investor payouts since privatisation 30 years ago, the regulator has said.

Ofwat also said water firms would have to cut the average customer bill by £50 over the next five years.

It is also forcing firms to invest billions of pounds to improve their performance and reduce leaks.

Chief executive Rachel Fletcher said she was "firing the starting gun on the transformation of the water industry".

"Now water companies need to crack on, turn this into a reality and transform their performance for everyone," she added.

Water companies listed on the stock market - such as United Utilities and Severn Trent - initially fell, but later traded higher.

Image copyright Getty Images Image caption Ofwat wants water companies to spend more on tackling leaks

There has been widespread dissatisfaction with the performance of many water companies over the past few years. Criticism has centred around some high profile pollution incidents as well as leaks, water quality and high bills.

In January, a review of water companies' business plans found only three out of 17 water firms in England and Wales were of an acceptable standard.

Ofwat's five-year assessment, which comes into effect on 1 April 2020, has been hammered out over the course of this year. The draft determinations were set out in July.

But the latest announcement includes a tougher stance on the return on capital - a measure of the returns that can be paid to investors - in part because of lower interest rates which makes it cheaper for companies to borrow to invest.

Labour's threat to renationalise the water companies had rather overshadowed another looming issue for them - a regulator that had had enough of having sand kicked in its face, and had decided to get tough.

Ofwat's plan to cut bills over the five years from 2020 to 2025 has its roots in water companies' own decision to load up with debt, pay generous dividends to shareholders (often via tax havens) and their failure to deliver service of a sufficiently high quality.

Despite water companies' protestations that service levels have continued to improve, public anger has grown.

Thames Water, the largest of the water and sewage companies in England and Wales, was the focal point - it was fined £1.4m for a serious leak of raw sewage in 2017 - as was Southern Water, which deliberately misreported monitoring failures at its sewage treatment plants.

An analysis for the Financial Times suggests that since privatisation the companies have taken on a combined £51bn in debt, and paid out £56bn in dividends.

The question now is whether the companies whose spending plans have not been cleared by Ofwat will appeal. They have two months to do so.

'Penny drop'

"This is the lowest allowed return on capital since privatisation 30 years ago but is consistent with market expectations for returns in 2020-25," Ofwat said.

Ms Fletcher said in an interview with the Today Programme that it would now be harder for companies to pay shareholders dividends.

"We are seeing increasingly the penny drop with companies, some announcing they expect no dividend in the next five years."

'Tough review'

She said firms had the option of appealing to the Competition and Markets Authority over the price targets.

As it is cheaper for these companies to borrow, bills should come down, she said.

Image copyright Getty Images Image caption The Thames Tideway tunnel is being built in London as part of an overhaul of its sewage systems

"We've said all along this was going to be a tough review," she said. "We think this is the greenest package ever for water companies."

Population growth and climate change will be the big challenges for them in the long term, she added.

What is Ofwat?

Water companies will be able to increase their returns to investors if they meet customer service target and increase their investment.

"Where a company outperforms our allowed costs or expected service levels it should earn a higher equity return; where a company underperforms our allowed costs or expected service levels it should earn a lower return," Ofwat said.

In response the regulator drew up plans outlined in draft form in July which it said would mean "better services, a healthier natural environment and lower bills".

Water UK, the industry trade body, said companies would now work through the details of the "tough price review".

"Today's announcement is a highly important one as the industry looks to deliver for customers and for the environment, today and in the future, said Christine McGourty, Water UK's chief executive, said.

Office of Water Services is the government regulator tasked with overseeing the privatised water market in England and Wales. Scotland has its own separate regulator, the Water Industry Commission for Scotland.

Ofwat monitors the market to see if it needs to intervene to protect customers and to set limits on the price they're asked to pay.