Annual Report and Accounts 2010

Dear Shareholder

Introduction

I want to set out in this letter how governance underpins our activities in Severn Trent and describe how we apply the principles of good corporate governance as set out in the Combined Code on Corporate Governance issued by the Financial Reporting Council (FRC) in 2008 (Combined Code).

Compliance with the Combined Code

The Combined Code sets out standards of good practice that listed companies are expected to follow in areas such as how we structure the board appropriately and develop its members, how we pay and reward our executive team, our accountability and audit, and our relationship with our shareholders.

From 1 July 2009 to the year ended 31 March 2010, Severn Trent was fully compliant in its application of the Combined Code. From 1 April 2009 to 30 June 2009, we did not comply with Code Provision A.3.2 which requires that at least half the board, excluding the chairman, should comprise independent non-executive directors.

Martin Houston’s unplanned resignation as a non-executive director in January 2009, due to his other work commitments, meant that we needed to appoint another independent non-executive director to your board but it had to be the right director, able to demonstrate complementary skills and experience, to assist in our decision making. We appointed Gordon Fryett with effect from 1 July 2009.

Our compliance with the Combined Code demonstrates our commitment to the highest standards of governance and corporate behaviour. The Combined Code will be replaced next year with the UK Corporate Governance Code. The events in our corporate markets over the past two years necessitated a review of the Combined Code and your board encouraged and supported the changes that the new Code will bring to bear. Our response to the consultation on the review of the Combined Code is available for you to review on the website of the Financial Reporting Council, (FRC) www.frc.org.uk

Board membership

From 1 July 2009 the board has consisted of me, your non-executive Chairman, five executive directors and five independent non-executive directors. Together, as a unified board, I believe we bring an appropriate balance of innovation, experience, independence and challenge to ensure effective decision making.

Photographs of the members of the board, together with their biographies and a description of the skills that they bring to bear, can be found on the board of directors list.

Role of the Chairman

I joined the board in October 2004 and was appointed Chairman on 1 January 2005.

During my time as your Chairman, we have successfully established a strong and committed executive team who are driving continuous improvement throughout Severn Trent’s activities.

With effect from the end of this year’s AGM, on 20 July, I shall retire as your Chairman.

The board engaged Zygos, an independent executive search team, last year to lead the search for my successor and Richard Davey, your senior independent non-executive director chaired the Nominations Committee in the search and recommendation of a successor.

I am delighted that Andrew Duff has agreed to be your Chairman and, having been appointed to the board on 10 May 2010, will stand for reappointment at the AGM.

The role of the Chairman is to lead a unified board, facilitating its members at its meetings, and to be responsible for ensuring that the principles and processes of the board are maintained in line with the Board Governance document.

Agendas for our meetings are agreed in consultation with the Chief Executive (CE) and Company Secretary, although any director may request that an item be added to the agenda. I have authority to act and speak for the board between its meetings, including engaging with the CE. I report to the board and committee Chairmen as appropriate on decisions and actions taken between meetings of the board. I also meet with the non-executive directors without the executive directors present, to consider the performance of the executive directors and to provide feedback.

Senior independent non-executive director

Richard Davey is the senior independent non-executive director. He chairs the Remuneration Committee and is a member of the Audit and Nominations Committees. The board has agreed that Richard Davey will act as Chairman of the board in the event that I am unable to do so for any reason.

During the year, Richard chaired the Nominations Committee, leading the search for my successor.

Due to my role on the steering group and advising the Institute of Chartered Secretaries and Administrators (ICSA) on the review of the Higgs guidance on board effectiveness, Richard also led our board’s response to this consultation. Our response can be found on the FRC website www.frc.org.uk

Non-executive directors

Your non-executive directors are appointed to the board to contribute their external expertise and experience in areas of importance to the group such as corporate finance, general finance, corporate strategy, environmental matters, general management and supply chain management. They also provide independent challenge and rigour in the board’s deliberations and are encouraged to make independent assessments of the company’s competencies. The non-executive directors, led by Richard as the senior independent non-executive director, meet without me at least once a year, where there is an opportunity for them to appraise my performance.

Your board has reviewed the status of the non-executive directors and considers them all to be independent in character and judgment and within the definition of this term in the Combined Code.

Chief Executive

The board has delegated all responsibility beyond its matters reserved to the CE to achieve the company’s strategy. The CE, Tony Wray, is empowered to take all decisions and actions that further the company’s strategy and which in his judgment are reasonable, having regard to the CE limits set out in the company’s Group Authorisation Arrangements (GAA).

Executive directors

The executive directors support Tony in driving strategy forward in Severn Trent. They are committed to implementing strategy in a responsible way that takes account of our commitment to long term responsible stewardship of the business, the environment, our customers and the communities in which we live and work.

Role of the Company Secretary

All directors have access to the advice and services of the Company Secretary, Fiona Smith, and the Company Secretariat team. The Company Secretary is responsible for ensuring that the board operates in accordance with the governance framework it has adopted and that there are good information flows to the board and its committees and between senior management and the non-executive directors.

In her role as the group’s General Counsel, Fiona is a part of the Severn Trent executive management team with responsibility for the Business Resilience and Security, Company Secretariat, Legal, Risk, Compliance and Insurance teams.

The appointment and resignation of the Company Secretary is a matter for consideration by the board as a whole.

Induction

On joining the board, directors are evaluated and then provided with a comprehensive and individualised induction pack that includes notes on the group structure, the regulatory framework of the operating businesses within the group, financial reports and business plans and information on our governance framework.

Meetings are arranged with members of the executive management team and external advisers who provide support to the relevant board committees the directors may serve on. Visits to operational and office sites across the group are also arranged for directors joining the board.

Continuing professional development

Regular seminars, arranged to coincide with board meetings, are held to update and refresh the board’s knowledge and understanding on a variety of topics. During this year, we had sessions to understand and examine the construction and delivery of our business plan for the next five years.

Moving forward, we will be creating individual programmes for learning and development. The programmes will be reviewed by your Chairman with each director as part of the annual performance and effectiveness reviews undertaken by the board.

Performance and effectiveness reviews

In 2008/09, the board participated in a formal evaluation of its own performance and that of individual directors. To ensure independence and objectivity the review was externally facilitated by Praesta Partners LLP. We noted that although the board was effective across key aspects of its role and supporting processes, the directors felt that they needed to move the emphasis of the board’s attention from detailed operational issues to long term strategic issues.

In 2009/10, working closely with Tony Wray, your CE, and Fiona Smith, the Company Secretary, we structured the content of the board and committee agendas to support that move in emphasis.

In April 2010, the board commenced a review of its effectiveness and the effectiveness of its key committees. That review is being led by me, your Chairman, assisted by Fiona Smith, and facilitated by Lintstock, an independent firm of corporate governance advisers. The review is in the form of an online questionnaire to be followed by a series of confidential interviews between each director, the Company Secretary and me. I shall present the results of the review to the board at its meeting in July and the results of that review will form part of my successor’s induction pack.

Board processes

We have processes in place regarding:

• our tasks and activities (board membership and administration);
• the matters specifically reserved for our decision making, the authority delegated to the CE, the accountability of the CE for that authority, and guidance on managing the relationship between us and the CE; and
• the boundaries on CE action (CE limits).

An approved Board Governance document outlines those processes and is available on our website www.severntrent.com

The board has reserved the following for its own consideration:

• the appointment of the CE, directors, the Company Secretary and the Director of Internal Audit;
• the strategy and budgets of the company;
• the GAA which set out the group’s delegated approval limits;
• decisions regarding the company and its subsidiaries required to be made by the company’s GAA, constitutional documents, statute or external regulation; and
• the approval or adoption of documents (including the publication of reports and statements to shareholders), required to be made by the board by the company’s GAA, constitutional documents, statute or external regulation.

Board meetings

We have regular scheduled meetings throughout the year.

Papers, including minutes of board committees held since the previous board meeting and performance reports, are circulated in advance of each meeting.

There is an agreed procedure in place which allows directors to take independent professional advice in the course of their duties and all directors have access to the advice and services of the Company Secretary. Where a director has a concern over any unresolved matter he/she is entitled to require the Company Secretary to minute that concern. Should the director later resign over the issue, I, as Chairman, will bring it to the attention of the board.

Board attendance in 2009/10

Gordon Fryett was unable to attend one scheduled board meeting due to a family commitment arranged prior to his appointment to the board.

Bernard Bulkin was unable to attend one scheduled board meeting due to overseas business commitments.

In both cases, the directors reviewed the relevant agenda and papers and provided comments to me in advance of the meeting.

During the year, we finalised and submitted Severn Trent Water’s business plan for AMP5. In working through this process with the executive management team, we considered the impact of our plans on all of our stakeholders and used our risk management process to help us understand and assess that impact both for the five year period of our plan and our 25 year strategic direction statement.

In addition to the formal board meetings, your board attended one full day strategy session this year, where the board and executive management team together considered Severn Trent Water’s Draft and Final Determination and Severn Trent Services’ growth plan. During the financial year, nine ad hoc meetings of the board were convened to consider such matters as Severn Trent Water’s Draft Determination, Severn Trent Plc’s preliminary and interim results and interim management statements.

Board committees

We have established committees of the board to deal with specific issues or approvals, as and when necessary.

The four permanent committees of the board assist in the execution of its responsibilities and the board delegated some of its responsibilities to those board committees. The committees assist the board by focusing on their specific activities, fulfilling their roles and responsibilities, reporting to the board on decisions and actions taken, and making any necessary recommendations.

The terms of reference of the Audit, Remuneration and Nominations Committees comply with the provisions of the Combined Code and are available for inspection, together with the terms of reference of the Corporate Responsibility Committee, on the company’s website (www.severntrent.com) or may be obtained on written request from the Company Secretary at the address given on the back cover.

Each of the committees has reviewed its effectiveness and terms of reference during the year and any necessary actions have been identified and reported to the board.

Reports from the Chairmen of these committees are set out in this report.