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Proposed measures to fix sector expected on Monday

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Indebted Thames Water fighting for survival

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Regulation overhaul could be proposed

By Sarah Young and Paul Sandle

LONDON, July 18 (Reuters) - Britain is expected to set

out measures to fix its broken water sector on Monday as Thames

Water teeters on the brink of failure, saying it needs a "reset"

of regulation to have any chance of avoiding nationalisation.

The country's biggest water company has been fighting for

its survival for the last 18 months. If it fails the government

would have to step in, adding billions of pounds to already

stretched public finances.

Britain commissioned a review last year into the privatised

water industry in England and Wales, which needs huge

investments to fix aging infrastructure and stem sewage spills

into rivers and lakes that have angered the public.

Former Bank of England deputy governor Jon Cunliffe, who is

leading the review, has recommended overhauling regulation to

lower investment risk, merging regulators to give companies

clearer direction and new rules on river bathing standards.

"Water companies must be made more attractive to stable,

long-term investors," he said in his interim report in June.

"To attract such long-term investors, willing to make the

substantial future investment we need, risks also need to be

lower than they are presently. In large part, this means

restoring confidence in the stability and predictability of the

regulatory system."

Thames Water's creditors have offered it a rescue deal worth

about 5 billion pounds ($6.7 billion), and they, along with the

beleaguered company, are in talks with Ofwat, the water

industry's financial regulator.

But in return they want a regulatory reset, which could mean

flexibility on pollution targets, clemency on penalties and more

time to deliver improvements.

Thames Water Chief Executive Chris Weston told lawmakers on

Tuesday that the company was "extremely stressed and operating

in very difficult circumstances" after it reported a 1.65

billion pound annual loss.

Thames Water suffered a major setback in June when U.S.

private equity firm KKR - its preferred bidder - pulled

out of an earlier rescue plan.

KKR told lawmakers in a letter published on Tuesday that

regulatory risk played a part in its decision, and it would not

have been "able to manage and meet the understandable

expectations on the timing of improvements, risking falling

short in the eyes of the public and stakeholders".

Thames Water, which has 16 million customers in southern

England, forecasts it will face 1.4 billion pounds in pollution

fines and penalties over the next five years.

While the government wants to cut water pollution, it can

ill afford a Thames Water bankruptcy that would add the

company's 17 billion pound debt onto government books, at a time

when the finance minister Rachel Reeves is already close to

breaking her fiscal rules.

The government has repeatedly said it is keeping a close eye

on Thames Water. Environment minister Steve Reed said in June

that his department had "stepped up" preparations for its

special administration regime, a form of temporary

nationalisation.

($1 = 0.7466 pounds)