Select Committee on Constitution Minutes of Evidence

Examination of Witnesses (Questions 320-339)



  320. But putting that with the last little exchange we had, it sounds as if Ofwat spends a lot of its time justifying what it has done, rather than deciding what to do; is that pejorative?
  (Dr Elphick) I think clearly it does make sense for Ofwat to do a review, just so that it can learn lessons, as any other organisation would do, so we are not saying it should stop doing them altogether, we are just saying there would be benefits if a completely independent organisation, for example, a select committee, were also to conduct such a review, because clearly that would have issues with regard to accountability that cannot exist when Ofwat is reviewing itself.

  321. And are you subscribing to the previous witnesses' view about select committees, or is this something you have arrived at independently?
  (Dr Elphick) I do not know if it is quite independent, but certainly the Water UK view is that it could be useful for there to be a select committee in regard to utilities, partly because it would provide a growing centre of expertise within Parliament in regard to the activities of the regulators. Also it is the case at the moment that the regulators, well they may be defending their decisions at the Competition Commission but they may not, it just depends whether or not companies choose to appeal, it might be quite a good discipline to know that they would be defending their decisions in regard to quinquennial price reviews in front of a select committee.

  322. There is a limit to the number of select committees either House can furnish, and a limit to the scope of responsibility or purview that any select committee can have. What would you think would be the extent of the responsibility of the select committee you are advocating, would it extend beyond or would it not extend as far as all utilities, for instance?
  (Dr Elphick) I do not feel terribly well qualified to say, but my suggestion would be that it should be, I would have thought, utilities, because there is quite a lot of commonality of issues across the utilities. Were it to branch out, for example, also to include the Financial Services Authority then some very different issues would start to come in; if it was specific just to energy then it is going to be two very select committees, to take up your point. So I would have thought utilities is a fairly well-defined group of regulators which could be covered.
  (Mr Weeden) In the evidence, we are trying to set out the sort of work we felt needed to be done; we are not expert, obviously, on what the right institutions are, I think we do know roughly the sort of work that ought to be done.

  323. The impression I got from a question I asked some time ago of your predecessors, which was, in what way would this body be better qualified than the regulator to make the decisions that we were putting before it, was that the answer seemed to be (a) the width of view, and (b) the length of experience. Would you add anything to that, or would you say that any independent responsible body that was composed of the same people for a sufficient number of times and they had a wide enough view would eventually be wiser than any individual regulator?
  (Mr Boudier) If I could just add to that. I think it is very important that we pick up this point of transparency, and I think a body that you have just been talking about would be well enabled to look at the decisions which were made by the various regulators and look at the justification for those decisions and how transparent they were made back to the regulated companies.

  324. And something will depend on the legislation setting it up, presumably?
  (Dr Elphick) Indeed. For me, there is a complete distinction really between the role of the Competition Commission, about whose decisions are supplanting the decisions of the regulator, and clearly then they do need to have at least as great an expertise on the technical issues as the regulators, and can reasonably claim to have that. Whereas, if the suggestion of a select committee were to be accepted then it would not be fulfilling that sort of role, it would not be overturning the decisions of the regulator, I would have thought, it would simply be bringing them to account. But we are not proposing that the price limits will be determined by the select committee, the price limits are appealed to the Competition Commission.

  325. Nevertheless, matters will be brought to it, I understood, I may be wrong in this, on appeal?
  (Dr Elphick) That was not what I was saying. Certainly, I did not intend to say that. What I was proposing was that the appeal mechanism would be the Competition Commission, as it is now; it is just that at the moment you can appeal to the Competition Commission only on the package, and we thought there would be benefit in being able to appeal on specific but substantive methodological issues as well. I was not suggesting there would be any right of appeal to the select committee, it would be just a means of the regulators discharging their accountability to Parliament, in a way that is not quite so easy at present.


  326. Yes, the Select Committee would not be a decision-making body, because any select committee would be advisory, and, therefore, coming back to the previous witnesses, and what I was saying there, in a sense, would be shining a spotlight on the activity of the regulator?
  (Dr Elphick) Precisely.

Earl of Mar and Kellie

  327. I believe that certainly the regulators work from criteria set down by Parliament, and on that particular issue I do think that a utilities select committee would be able to monitor whether these criteria are the right ones, and indeed then to report to Parliament as to whether perhaps there ought to be a change. So I think we have learned so far that the regulators work around promotional competition and consumer interest. Now I am aware that there has been a considerable problem in the water industry, in terms of leakage and therefore considerable need to renew the infrastructure. Is a regulatory process at the present moment helping or hindering that process of renewing the infrastructure, is it, in fact, limiting the amount of infrastructural renewal that you can do, or is non-leakage something which the regulators see as being in the consumer interest?
  (Mr Boudier) I think the point you raise is a very wide one, in that we were pleased to see the recent Defra publication of "Directing the Flow" because that seemed to us to set out the needs of the industry and the various stakeholders over a long time-line, over a 20-, 25-year period, and what are we aiming for. In that context, you could see then a five-year price review setting, if you like, the pace at which that longer-term vision gets delivered. So, in part answer to your question, the fact that we have five-year price reviews, or have had them, without that bigger picture, I think has led to short-term views being taken. And, in terms of the work on capital maintenance, certainly one of the outcomes of the last review, that all the companies felt, was that there was a trade-off between the need to deliver new quality obligations, emanating from European standards, and capital maintenance, and therefore asset replacement and renewal; and if there was a trade-off there it was to the extent and detriment of the capital maintenance side. So that is a big kind of issue about how does that particular issue get resolved, because of the increasing environmental work coming from Brussels. And then, just to go back to flotation and the companies that were floated, it was envisaged that by the year 2000 most of the new quality obligations emanating from Brussels would have been delivered and that companies would have been moving more towards a steady state capital maintenance cycle; that has not proved to be the case, and indeed looks like not being the case perhaps for the next 20 years.

  328. Right. To go on then, I live in Scotland, where we have one water authority, but in England and Wales you have got a number of water companies obviously delivering water to consumers; are they actually in competition with each other, or does each water company, in fact, have what I am going to call a regional fiefdom? And the question beyond that is, some water companies' infrastructure will be worse than others, or perhaps it averages out, I do not know, but, regulation, which I think means a standard price across the whole of England and Wales, or perhaps it does not, may be hindering the process more in some parts of the country than in others; or have I got it all wrong?
  (Mr Boudier) You are right to say that there are regional monopolies, and there have been lots of discussions around the potential for opening up competition, and the Water Bill that is going through Parliament now indicates there could be some competition for larger customers, from memory, I think it is over 50 megalitres, and that covers probably only a very few customers in England and Wales. To the best of my knowledge, it has never been the intention to charge a regional or an average single price in England and Wales, and so you have got the differential tariffs and pricing, both for unmeasured customers and for metered customers, in England and Wales, the South West, from memory, being the most expensive company, in terms of price to customer, and Thames Water in London, I think, being the lowest.

  329. So each company must negotiate its price with the regulator?
  (Dr Elphick) Yes, and the tariff structure as well.

  330. And justify that; so the regulator is not trying to hold prices even, it has to be justified locally?
  (Dr Elphick) They started at different levels at privatisation and actually have diverged since privatisation, and that is because what underpins all of this is the investment to improve quality, in particular to meet European Union Directives. In the case of the South West of England, they had a very large amount of expenditure to do because they had so many beaches, they have a small population, and therefore their bills had to go up quite a lot faster, even in percentage terms, than through other parts of the country; so now probably it is 100 per cent more expensive in the South West, for example, than it is in London.

  331. I am beginning to get the impression that there the issue of competition does not really exist?
  (Dr Elphick) Certainly, it is not the case that it is the primary focus of Ofwat. I think, in the case of Ofgem, their primary focus has been the promotion of competition. In the case of Ofwat, at the moment, they do not have a duty to promote competition, they have a duty to facilitate competition. And the reality is the scope for competition in the water industry really is very modest, and, for that reason, the primary duty of Ofwat, in practice, has been balancing the interests of stakeholders, and in particular balancing the interests of customers against the interest of investors.

Lord Fellowes

  332. First of all, I must declare an interest, in that I am employed as a consultant chairman by a water treatment company. That said, I was very struck by your paragraph 25 in the written evidence, about ministerial interventions, and in a way it goes to the heart of one of the fundamental questions we are asking, which is to whom the regulator is accountable. Now I know that the price of water is a particularly contentious issue, but do you think that the Minister for the Environment would agree if effectively he set a price target for the regulator, question one? And, secondly, you talk of a number of interventions, do you mean by that a number of interventions in the water industry or across the regulatory picture as a whole, and I wonder if you can elaborate a little about what other interventions there have been?
  (Dr Elphick) For me, the big picture is, much as British Energy said, it seems to me that the economic regulator should be independent of ministers in regard to economic decisions, but should follow ministerial guidance in regard to social and environmental issues. Now, clearly, the practice is not quite as tidy as the theory, but I think, for me, that is where the theory starts, and so I think it was the case that the Minister for the Environment, for the 1999 review, gave indications in regard to prices which were starting to breach the independence of the regulator in regard to what was clearly an economic issue.

  333. Can I just ask, was the water industry consulted, when he gave those indications?
  (Dr Elphick) No.
  (Mr Weeden) No; he was issuing quality guidance, and he just happened to say, in passing, "Oh, by the way, we think that the regulator could achieve at least a 10 per cent price reduction."
  (Dr Elphick) I think the other example which comes to mind of intervention was the one which Sir Ian Byatt gave, I think, in his evidence to you in regard to leakage, which again he regarded as an economic issue, and yet ministers felt it was appropriate for there to be intervention on that issue.
  (Mr Weeden) On your other question about what are the other interventions, immediately after the Government came into power, in 1997, there was a water summit, and that led to the Ten-Point Plan, which the companies agreed to, which set a number of objectives for the companies, and obligations, and new things for them to do, sort of out of the blue; that is really the other thing we were thinking of here.

  334. It seems to me that you are saying that in some respects the regulator is not accountable to Parliament so much as to a minister; or am I jumping too far across a gap there?
  (Dr Elphick) I think it does depend on the issue. As British Energy said, it seems to me appropriate that democratically-elected politicians should take social decisions about, for example, fuel poverty, or whatever, and that, therefore, it is appropriate for ministers to be giving clear guidance to the regulators on such social issues, and then the role of the regulators is to implement that guidance. And so, on those sorts of issues, they are being guided by ministers. I do not think, however, that cuts across their accountability to Parliament in regard to the overall fulfilment of their duties as laid down in statute.


  335. If I can pursue the point then about the broad aspect of accountability of regulators, because, turning to paragraph 20 of your paper, there you refer to the joint economic regulators group, and clearly are quite critical of aspects of its operation, I think, from the point of view of transparency. And then your final sentence is: "Water UK believes that recommendations for improving the accountability of this group should be developed by the inquiry." Now, later on, you make suggestions for the ways in which the co-ordination of the group can be improved. I wondered what you had in mind, in terms of recommendations for improving the accountability of the regulators group; in other words, what are the things we should be looking at, if we were trying to improve the accountability of that group?
  (Mr Weeden) I think it is not clear what the role of this group is exactly; either it is a club of regulators which needs to meet just to discuss matters of common interest, or it has some objectives. Now it may or may not have certain objectives, but I think our understanding is that Government wishes this group, as it were, to improve standards generally, across the regulators, taken as a whole, and move to some sort of common view on matters where you should take a common view. I think there are only two reports actually which have appeared so far, one relates to regulatory accounts, where arguably one wants to set standards, have common methodologies throughout the regulators on regulatory accounting; and the other relates to cost of capital, where, again, arguably, certain parameters of the way you calculate the cost of capital should be the same across all the regulators. But those are the only two reports that have appeared; and even though this group has been meeting, and I think has produced at least four annual reports, nevertheless, only two substantive reports of interest to the wider public actually have appeared. So, if there is a clear objective for this group, we are not quite sure of it; but assuming there is one then clearly someone should be reviewing whether it is meeting that objective.

  336. Okay; so that is the sort of thing we should be looking at, the statement of the objective, perhaps more regular reports, in pursuit of that, more substantial reports, publications of agenda, and so on?
  (Mr Weeden) Absolutely.

  337. Thank you very much. There, and there are other proposals that you make, not least the point about including principles, indeed, just perhaps in statute, for regulators, so there are a number of recommendations. But one of the concerns I have, in terms of the paper, is to what extent the changes you draw to our attention, you recommend, would actually address what quite clearly is one of your key concerns, and that is the problem of political uncertainty, and you have touched upon it in various analyses and it is in the paper. From your point of view, it helps to have certainty to have some idea of what is happening. Therefore, clearly, from your point of view, uncertainty creates tremendous problems, dangers, so the reasons why you want to avoid it are obvious to us; but I am wondering whether what you are proposing would actually address that, get to the heart of that problem?
  (Dr Elphick) I think the new Director General of Ofwat is taking very seriously the need to reduce uncertainty. He fully accepts the argument that the City regard the biggest risk we face as being regulatory risk, and therefore his actions determine our cost of capital, and therefore the prices which customers pay; so he accepts that argument. And I think, for example, he is talking more than his predecessor to the City directly, which is helpful in allaying some of their fears, and he is trying to put in place, to some extent, rather technical features of the next price review, which will reduce uncertainty, by sort of listing things which are uncertain in advance and then saying they can be dealt with in a specific way later. So I think there are things already happening which are an improvement.
  (Mr Weeden) In paragraph 11, we have said "commitment of ministers to the independence of the economic regulator," that is really important, and, equally, better regulatory impact assessment by Government of changes, where we do think there are significant weaknesses.

  338. Indeed, yes. But, a commitment by ministers to the independence of regulators, then you have got the question of enforcement, so you may say, "Yes, we accept that they should be independent," but then how do you actually police that and make sure that ministers actually abide by the commitment? I fully take the point about the regulatory impact assessments, but there is this problem of ensuring that what is desirable is enshrined, if you like, and there is a method of policing it. And I wonder whether, from what you are saying, one route is, if you like, a statutory route, how much can you enshrine in statute, you pointed out some ways for doing that, in terms of the principles, and so on, and whether one can go down further that route. Or is it the case, coming back to the question I was putting to the previous witnesses, and I think this comes back from the answer you have just given, Dr Elphick, that one is dependent upon who the regulators are, the extent to which they accept the points that are being put and then act on it and put the mechanisms in place for ensuring a greater degree of certainty? So are we dependent, to a large extent, upon who is appointed, which then raises the prior question of who is appointed in the process of doing that, should we be looking at who it is, rather than more statutory duties imposed on them?
  (Dr Elphick) I think there is a sort of multifaceted answer to this. The depersonalisation of regulation, it seems to me, helps here, and so the Ofcom model of a non-executive chairman, a chief executive, executive directors, non-executive directors, does seem to be helpful, in terms of dealing with this issue. For ministers and regulators frequently to reassert the independence of the regulator on economic decisions is helpful; and, after all, we had a survey of investors recently, and 96 per cent of them said that they regarded the independence of the regulator as being very important, so just a frequent reassertion of it would be helpful. And, I suppose, a final thought, to come back to that idea of a utilities select committee, again, that might be helpful, because it could be expected that such a committee would be inquiring into whether or not that independence had actually been manifest in the previous price review, and the mere fact that they know that is coming might help to ensure it does happen.
  (Mr Boudier) To add to that, I think one of the things we are looking for is a much greater degree of clarity, and I think we come back to, at the heart of this, very clearly, that it is for the Government to determine the objectives and to determine the framework for regulation, and for the regulator to fulfil his duties within that. And so what we are looking for is clarity of what is the Government objective, a transparency of delivery by the regulator in doing his duty, and an ability to review that periodically.

  339. And tied in with the other point you are making, which is both protecting the independence of the regulator but, at the same time, ensuring, we talk about accountability, but I think what might be a better word is answerability for the decisions, particularly through the parliamentary route, so it is not somebody else second-guessing, or anything like that, but it is then justifying, being called to answer, if you like, on the public record, for the decisions that are taken?
  (Dr Elphick) Yes.

   (Mr Boudier) And I think that has a calming, indirect influencing role on the regulator, because the regulator then, from time to time, will say, "Well, if I make this decision, I know I've got to come back to a committee, how will that be viewed?".

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