Memorandum by Water UK
1. Water UK represents all water and sewerage
operators in the UKprivate companies in England and Wales,
and the public sector in Scotland and Northern Ireland. This evidence
refers to the regulatory arrangements for England and Wales, and
primarily to the economic regulator, Ofwat. The industry has five
regulatorsOfwat, Environment Agency, Drinking Water Inspectorate,
English Nature and the Health & Safety Commission.
2. Water industry turnover is around £6.5
billion per annum, operating expenditure is around £2.5 billion
and investment by the industry is of the order of £3 billion
3. The regulatory system in place for the
last 14 years has delivered. The water industry has been transformed
since 1989, providing wholesome water of record quality to 99
per cent of the population and delivering a huge environmental
improvement. It would be wrong to say there is a crisis in regulation.
However it is legitimate to ask how regulation should evolve to
meet the needs of the future.
4. It was believed that economic regulation
would lessen as competition increased. This now seems an unlikely
perspective for the water industry in the light of Government
policy on competition and the continuing obligations coming from
5. In 1989 the challenge facing industry
and regulators was to ensure that huge amounts of capital were
raised to finance a maintenance backlog and environmental and
quality improvements. This investment has been a success, bringing
service improvements and environmental benefit. Over the same
period Ofwat also set prices having regard to future efficiency
targets. The industry has delivered efficiency savings to the
benefit of customers.
6. The previous Director General of Water
Services, Sir Ian Byatt, said in a speech in 2000 (at the end
of his term of office)
"Since 1989, bills have been driven upwards
by obligations, mainly for higher standards of drinking water
quality and for better protection of the environment. Higher efficiency
has been a countervailing force. Over the fifteen years the annual
average household bill will have risen by some £38. Quality
improvements will have accounted for an increase of £99,
while other improvements and the growth of supply will have accounted
for an increase of £22. Offsetting these efficiency improvements
will have accounted for a decrease of £83."
7. We are now in a different position. The
industry remains capital intensive but big efficiency savings
will be harder to achieve. This means customers are likely to
face a larger share of the cost of any new legal obligations.
Also the level of uncertainty is greater than at any time in the
past both in terms of the number of issues and the quantum of
value. This brings into sharper focus the question of customer
choice on what the industry should deliver and suggests a greater
role for parliamentary scrutiny.
8. Increased Parliamentary accountability
would encourage the regulators to deliver better regulation in
the interest of all stakeholders.
9. More accountability of Ofwat to Parliament:
Parliamentary inquiries after every
Annual hearings on Ofwat's activities,
including reports on compliance with better regulation principles
(which should be statutory duties);
Support for a special Select Committee
for the Utilities to facilitate this role.
10. Parliamentary review of the activities
of the joint regulators group, this group currently escapes scrutiny.
11. Greater clarity on the role and impact
of Government on regulation:
Clear and continuing commitment of
ministers to the independence of the economic regulator;
Better regulatory impact assessment
of proposed changes;
Better coordination of regulators
led by Government.
12. Stronger appeal rights:
During and after a price review,
a more streamlined appeal mechanism to an independent body on
Ofwat's methodologies and decisions;
On other regulatory decisions, appeal
on the merits of the case to an independent body.
13. The performance of regulators is reviewed
by Parliament. We think this is healthy, to reduce the danger
of regulators not following best practice, or to avoid an undue
exercise of discretion, or to prevent regulatory burdens from
escalating rather than declining.
14. Recent reports about the water industry
Environmental Audit Committee (EAC)
report on Water Prices and the Environment (this examined the
1999 price review);
National Audit Office (NAO) and Public
Accounts Committee (PAC) reports on Pipes and Wires;
WS Atkins report on the efficiency
of the economic regulators;
Better Regulation Task Force (BRTF)
report on the economic regulators.
15. There have also been some NAO reports
on specific aspects of regulation eg leakage, customer service
and a number of Competition Commission reports on price review
and merger cases. Water UK has approached the Parliamentary Ombudsman
on one regulatory concern but he was reluctant to get involved
in reviewing the issue.
16. The EAC report has been influential
and has led to significant changes in the way the 2004 price review
is being conducted. The NAO report on Pipes and Wires collected
a lot of useful evidence and led to important conclusions that
are to be found in the PAC report. The NAO's own conclusions were
relatively weak and Water UK wrote to the PAC about this (our
letter was published with the PAC report).
17. The BRTF report is possibly the only
report that fully reflects the views of the regulated companies.
The regulators did not like the conclusions and have criticised
that report heavily. The Government response was broadly helpful
but with little commitment to action.
18. Water UK suggests that the Parliamentary
arrangements could be better coordinated along the following lines:
Price reviews should be scrutinised
once completed. Following Treasury guidance, best practice is
that the review should be by a third party, not by the regulatory
office (Ofwat's own review of its price review in 1999 was unsatisfactory
and should not be repeated).
The Ofwat budget and level of regulatory
intervention is not really challenged effectively in the eyes
of our members. The WS Atkins report was favourable to Ofwat because
it is not as extravagantly funded as some other regulators. Ofwat's
costs have tended to rise and there is no evidence of efficiency
improvement. The two Competition Commission reports on the two
companies that appealed against the 1999 price review recommended
streamlining price reviews but there is little evidence that this
has happened. The Environment Agency has savings targets (about
£66 million over three years).
There ought to be reviews of Ofwat's
other regulatory activities by NAO.
19. As it is difficult to give utilities
regulators sufficient attention using the existing committee structure
Water UK would support other options such as a utilities committee.
20. A joint economic regulators group also
exists. It produces a thin and inadequate annual report. It does
not publish agendas or minutes. Government appears to think it
should have a role in agreeing best regulatory practice, but it
does not discharge this role very effectively, and only a few
reports have appeared so far. Water UK believes that recommendations
for improving the accountability of this group should be developed
by the inquiry.
21. Water UK believes that the primary relationship
is between water customers and the company serving them. One of
the achievements since privatisation is the development of better
customer service and responsiveness to customers concerns.
22. Water UK supports the separation of
Ofwat and WaterVoice. However, the future challenge is an increasing
diversity of views amongst customers about what they expect and
a five yearly price review may not be sufficiently flexible to
respond to this. What if customers want something different in
different parts of the country? Parliament could scrutinise this.
23. Water UK is broadly content with the
changes proposed in the Water Bill for Ofwat; these include a
reformulated primary duty, a new sustainability duty, a Board
structure for Ofwat, and separation of Ofwat and WaterVoice. However,
these are not fundamental reforms.
24. Water UK's concerns about economic regulation
relate to the following issues:
Political and regulatory uncertainty,
and adherence to better regulation principles;
Lack of effective appeal rights;
Corporate governance for the new
Board proposed in the Water Bill.
25. Ministerial interventions; there have
been a number of interventions, eg an intervention by the Minister
for the Environment (Michael Meacher) during the 1999 price review
which effectively set a price target for the regulator. The price
target setting was criticised by the EAC, and subsequently Defra
Ministers have emphasised the independent role of the regulator.
A recent survey of City investors on behalf of Water UK found
that investors were strongly in favour of an independent regulator.
26. Leakage; Sir Ian Byatt stated in his
evidence to the committee that he felt political pressures to
reduce leakage fettered his discretion, and can lead to inefficient
leakage targets being set for political reasons. He indicated
that the political role in standard setting should be limited.
Water UK supports that view.
27. Regulatory impact assessment; the Cabinet
Office guidelines are fine but practice by Government Departments
including Defra is poor, and Water UK welcomes the BRTF/NAO initiative
to raise standards especially to ensure that costs and benefits
are properly addressed when new obligations are being proposed.
28. There is a risk that unfettered exercise
of discretion leads to unpredictability and uncertainty. One example
is changes in cost of capital methodology at price reviews. In
the 1999 review Ofwat allowed the extra cost of embedded debt
in setting price limits, but in the 2004 review they are only
prepared to make an allowance in exceptional circumstances. A
long term industry that is required to invest heavily and thus
needs to raise large amounts of capital needs more consistency
and certainty about methodologies used in price reviews.
29. There exists a large variety of positive
and negative incentives that are intended to encourage compliancean
overall performance incentive, payments under the guaranteed standards
scheme, financial penalties (as proposed under the Water Bill),
adjustments at price reviews, prosecutions, name and shame. Regulators
are not short of levers to influence performance.
30. Best practice regulation; ensuring that
better regulation is fully integrated into the culture of regulatory
behaviour. The DTI solution is to put principles and duties on
the face of the law (Communications Bill especially clauses 3,6,7,8)
but Defra's approach is to require Ofwat to prepare a code of
practice (Schedule 1 of the Water Bill). We think the principles
of better regulation should be statutory duties on which Ofwat
should report to Parliament.
31. As the BRTF report on the economic regulators
indicated companies view the Competition Commission as the "nuclear
option", and judicial review is considered too limited as
an effective remedy.
32. Accordingly Water UK together with the
Electricity Association commissioned Oxera and Norton Rose to
produce a study of ways of improving appeal rights relating to
price reviews and other regulatory decisions. This study has been
published and discussed with government, regulators and stakeholders.
33. As part of our work on the Water Bill,
Water UK will be pressing for amendments to improve appeal rights.
Appeal rights throughout water legislation are unsatisfactory
and should be improved.
34. The Water Bill proposes a new Board
structure for Ofwat, and the DGWS has taken steps even under existing
arrangements to appoint non executive members of his existing
board. Water UK has no particular view on structures. We are interested
in how the Board will operate eg will papers and minutes be published
(as happens in the case of the Environment Agency), will companies
have direct access to Board members, and is there a procedure
for reviewing decisions that companies and other stakeholders
35. The relationships between regulators
are of considerable importance to water companies and can lead
to regulatory uncertainty if not well managed. In the 2004 price
review these relationships are being managed by a "regulators"
group led by Defra. There is limited involvement of companies
in this process, and it is not clear to whom this group is accountable
or under what terms of reference it operates.
36. In the case of a complex activity such
as the five yearly price review the roles of other regulators
should be better coordinated with Ofwat. In the last price review
Ofwat issued guidance in its final determinations report (Appendix
E) that was not accepted by the Environment Agency. The EA wrote
to company managing directors notifying them of their view. Water
UK believes that regulators should not issue guidance unless all
regulators have agreed that guidance, where appropriate.
37. Water UK is pressing for an amendment
to the Water Bill to encourage better coordination. The recent
Water Environment and Water Services (Scotland) Act requires the
Scottish Executive and the Scottish regulators to coordinate their
activities, and this is a helpful precedent.