Select Committee on Constitution Minutes of Evidence

Examination of Witness(Questions 1-19)




  1. Sir Ian, may I welcome you to the meeting of the Committee this afternoon. We are most grateful to you for coming and giving us your time this afternoon and also very grateful to you for the paper you have put in in advance, which is most useful for our purposes since it does summarise a number of points which are very pertinent for our purposes. May I begin by just putting one or two general questions to you and some of the questions I put will relate very directly to the points you very helpfully made in your paper. If we look at the role that you did fulfil as a regulator and if we look at the area of discretion, do you feel you had enough discretion to actually fulfil the functions which were vested in you?

  (Sir Ian Byatt) Well, my Lord Chairman, first of all it is very good to be here because I think it was a very interesting and important job. I enjoyed it and I am very glad to be able to tell your Lordships about it and answer questions. I think it depends what you mean by "discretion" because I think that the key to good regulation is having a proper structure of statutory duties so that you have a separation of ministers, regulators and the companies, the suppliers of water, and I think if that works well then you do get proper accountability, proper incentives on the suppliers and you get the benefits in this case for the environment as well as for customers. So I would like to answer your question about discretion in that context and where there are occasions when my exercise of my statutory powers was in any way unduly influenced, or what have you. I think that generally speaking it worked well, everybody worked well and the system worked well but there was one case I was a bit unhappy about and that concerns the question of leakage from water pipes. Leakage is an endemic thing in water pipes and there is a big issue about what is the economic level of leakage because it costs money to repair pipes and it costs money to provide the water that leaks and it is a question of getting the balance between the two. We thought it very important in the early days of OFWAT to get proper measures of leakage and we established these. Then when we had a drought in 1995 and Yorkshire Water almost ran out of water one of the things we realised with Yorkshire Water was that there was a background level of leakage which was clearly too high and of course the water companies in that situation realised that they needed to do something about leakage. So we got together and started to establish some targets for reducing leakage. It became quite a political matter and the Shadow Secretary of State, Frank Dobson, made very considerable play of the faults of the water companies in having leakage and that was an entirely proper thing for a Shadow Secretary of State to do. Of course it meant that when the new Government came into power in 1997 they wanted to do something about leakage so we had discussions about all that. I showed them that things were being done about leakage. I always felt that they wanted somehow to take over the leakage. Under the legislation the way in which they could take over leakage and set their own standards of leakage was if the regulator asked them to. I thought that would have been quite inappropriate because leakage is at the heart of the operations of the water companies. It is a question of day to day operations as well as the state of the pipes. Also, I was extremely keen that we would not be imposing leakage standards on the water companies which were lower leakage than the economic level of leakage because that would then start costing the customers money and I saw no point in that. So we discussed these matters and when I made my targets each year I discussed these with ministers; I did not consult with ministers, I discussed with ministers, so I was able to continue with my discretion. I wait to see what happens when the new water bill is published to see whether ministers propose to take powers to set levels of performance for water companies because that would involve setting standards for leakage and I think that would be damaging the regulator's discretion. I hope I have not taken too long on that point but that is the only issue where I found I had a problem.

  2. I think that leads into subsequent questions. So your point is that in terms of, if you like, the regulatory framework which you are working within the structures, the powers, were adequate. It was a matter of the relationships, what ministers may expect of you, but you still had the discretion to do that which you felt was appropriate. From what you were saying that was the exception rather than the rule where there was a problem in that context?

   (Sir Ian Byatt) Very definitely.

  3. So could you say a bit more about the relationship because you make the point in your submission that as the regulator you are part of government yet at the same time you are independent of ministers but you have to have contact with them and their officials in order to fulfil your job. I take it from what you were saying that outside that exception the relationships worked fairly smoothly?

   (Sir Ian Byatt) I think the relationships did work smoothly and there were, of course, lots of relationships between OFWAT and ministers and I would see successive Secretaries of State and in the early days of my tenure there were quite a number of those. I would also have quite a lot to do with the water minister and also the senior water official in the Department of the Environment (DOE) but my relations went wider than that and I found it helpful to talk to people in the Treasury, in the Number 10 Policy Unit and also in the Department for Trade and Industry (DTI) because I believed that I was not tied to any particular Department, although I was appointed by one Secretary of State. I also thought it sensible, because I was doing a governmental but a non-political job, to talk to the Shadow Secretaries of State or water ministers and I talked to a succession of those on a regular basis because I thought that the regime should be to the extent possible a non-political regime which would deliver efficiency and benefits to customers and the environment and in the early days of regulation or privatisation water was a bit of a political football—I am very glad to say that that has all gone away—and I wanted to be playing on another field.

  4. So would you see your role in talking to those particular audiences—and of course there is then the wider audience as well that we would like to come on to obviously in terms of public interest and Parliament as the mediator of that—as trying to build a consensus?

   (Sir Ian Byatt) I think my role was first that there should be no surprises around. You cannot avoid surprises entirely but surprises tend to mean confrontation and I thought that you could do things without that so I was ready to tell people generally what I was going to do and hope that they would also do that. So that was one purpose of consultation. There is also of course a number of issues arising in terms of events are always with us and you need to keep people briefed on what is going on and understanding on both sides. Then there was quite a lot of advice that I thought I could helpfully give to ministers. One big issue all the way through and which is still around is the cost of environmental obligations and that drove up prices really considerably in the early days. It was very important to have those things properly costed. I look around at other utilities and see that that has not been done so well, so I am proud of what we did then. We had to keep nagging away at it and, of course, as ministers were setting the environmental objectives they needed to know what the costs were. Another big and important area was metering because back in 1989 households paid for water on the basis of the Inland Revenue's assessment of the rateable value of their house in 1971 when there was not a housing market and the whole question of developing metering was an important political as well as technical matter. Then there was the question of competition in water. In the other utilities competition had come in and what could we do in water, and there were various moves made over the 1990s to try and facilitate that.

Chairman: Thank you very much.

Lord Holme of Cheltenham

  5. Just to follow up the Lord Chairman's question about audiences, I suppose the voguish way in which they are referred to nowadays is stakeholders, so that you have as a regulator various stakeholders, you have ministers and Parliament, you have water consumers and you have the larger public interest in the environment and the price of water and you have the water companies and presumably the water companies' shareholders, whose interests may not always be (although they should be) coterminus with those of the management, and so on. So you have a whole ring of stakeholders around you. I suppose the question that interests this committee, if I can put it this way, is first of all how systematic a process of consultation with those various interests do you have and is there any hierarchy in your mind either in the powers conferred on you by legislation or in your interpretation of those powers? Is there any hierarchy of significance of those stakeholders, for instance the public interest in having the right combination of low water prices, clean water and good environmental provision? How does one balance that against the interests of the profitability of the company and the necessity for new investment in order to provide water in the future, and so on? I do not want to get into the detail but is there a hierarchy in your mind? Are some stakeholders more significant than others, either because that is what your powers say or because that is the way you interpret them?

   (Sir Ian Byatt) I am not sure I thought of it in terms of a hierarchy. I certainly did have systematic consultation with all the stakeholders so that, for example, the water companies were very important and my first job was to go and visit them all because I believe that people matter. Also, I instituted a series of letters, "Dear Managing Director" letters, where I would say what we were doing and what we wanted them to do. So there was a big process of communication. They would come and see me when they had problems and when it came to price setting of course they made their representations against my proposals. So a lot with the companies, a lot with the customers because I appointed the Customer Service Committees and they were a very important part of the whole regulatory arrangements. I would visit the Customer Service Committees in different parts of the country once a year, they would come to me, we would get together and I met regularly with the chairmen. So the role of the customer is extremely important. I have talked about my relationship with Government ministers. We also had close relationships with the drinking water inspectorate and with the Environment Agency. We did not always agree with them, often on the area of what they wanted to do and how much it would cost. Then I would have ad hoc meetings of all kinds and then we had a series of consultations, in fact I was rather proud of the way in which we consulted on almost everything. We took some notice of the consultation and we also—if I may say—cultivated the media I would not like you to think that in the wrong sense of the word but I believe that the way in which we could get across to the public was through the media because by being on a television programme you can be heard by four or five million people. So we had a substantial part of the office dealing with consultations and public relations generally. But how do you do trade-offs? Well, we also encourage research among customers. The customer of course wants water at a reasonable price, the customer wants clean drinking water and the customer wants a good environment, particularly on the beaches. So there was systematic research done and a very recent part of research, which I am glad to report, shows that people are pretty happy with the state of their water. But there were these trade-offs and at the last review we thought that out of a bill of something like £230 the bill could have come down by as much as £60 for efficiency but £30 was ploughed back into higher quality. We thought that was broadly a reflection of the responses which we got from the various actors, trying to put them together in a judgmental rather than a systematic way. So it was pulling things together, everybody being involved in discussions and us making judgments rather than having a hierarchy.


  6. Before we leave the point of consultation with different groups, you mentioned responsiveness to consumers, doing systematic research to find out their views and you mentioned in the paper as well that you work particularly closely with the Customer Services Committees. But I also note in your submission that you mentioned that you were responsible, in consultation with ministers, for appointing those who chaired them and the actual members of them. How were you able to assure yourself that they themselves were representative of the consumer?

   (Sir Ian Byatt) I tried when making my original appointments to get a balance of Customer Services Committees chairmen. I wanted some people coming from business, because business people often have a good deal of experience of dealing with customers, and I wanted people from, if you like, the traditional base, the Citizens Advice Bureau (CAB) kind of base, and I wanted people from wider in the community. For example, one of my Customer Services Committees chairmen had been a chaplain of the fleet. So I tried to have a representative sample. Then we had a system of choosing members to some extent on that basis. We were keen that we would get people from the various communities, from the various parts of the country. So I would have said it was a representative choice of customers rather than, if you like, an electoral choice of customers.

  7. And you would use your systematic survey for public attitudes towards the service delivery?

   (Sir Ian Byatt) Oh, yes. Our first survey was what people thought about metering and that was essentially largely run by the Customer Services Committee, but then we also got professional bodies such as MORI to do surveys.

Chairman: Thank you.

Lord Lang of Monkton

  8. Sir Ian, now that you have laid down your role after, if I may say so, a very successful term of office, I wonder if I could draw from you some general reflections on the nature of the regulation of utilities. They really emerged, did they not, at the time of privatisation to help control the fledgling new companies and prevent abuses of competition and other matters and to give confidence to the consumer? Did you see them then and do you see them now as a permanent part of the governmental infrastructure or did you see them as a transitional phase that might subsequently be subsumed into some other area of government?

   (Sir Ian Byatt) The regulators? I think they are dependent upon the area, so if you take energy there are many areas where you can have competition in the energy markets and the energy regulators, I believe, have been very good in teasing out those areas. Where you can have competition I do not think you need a specialist regulator but each of the utilities has a monopoly area so even in energy there is the monopoly area of the local distribution system in electricity and gas. When you come to water it has not yet been proved possible to have competition on the scale as in energy. I think more could be done in competition on water but it is a long job and it is partly that the technical characteristics of water are not the same as those of energy. In that situation I think it is sensible to have a specialist regulator, partly of course because a large amount of investment is required in that area and you need the knowledge to do it. You could, I suppose, be like the Americans and have a regulatory commission but then you find there is an office of water, there is an office of telecoms and there is an office of energy. So you can skin the rabbit in various ways. I think that some form of regulation will be necessary in the water area and possibly in other areas such as railways.

  9. Do you think that the statutory base on which you operated was adequate? Would you like to see it changed in any way and do you think that you confined your activities entirely to what could be defined as being within that statutory base or has there been any element of mission creep, and if there has not been would you like there to be?

   (Sir Ian Byatt) The statutory base has not been entirely the same. The original Water Industry Act of 1989 was consolidated in 1991 with some changes on the mergers side, and then there was the Competition and Services (Utilities) Act 1992, which pushed competition a bit further and performance a bit further, and then the Competition Act of 1998. So the statutory base has been changing and I have welcomed those changes. Those changes in the statutory base seem to be quite sensible. The broad structure I felt was fine. It enabled us to get much better quality water, much better quality waste water, moderate increases in prices and much greater efficiency. So the proof of the pudding was fine and I am not in favour of changing things unless there is a really good reason because change always costs effectiveness as well as money.

  10. You were not operating in any way above and beyond the terms of the Act? I am not suggesting that you might have acted improperly, I am just asking whether you identified areas on which the Act was silent where you thought you could, with the cooperation of the water companies, act efficiently and usefully?

   (Sir Ian Byatt) There was one area which is of some interest and takes us back to drought and leakage because under the guaranteed standard scheme if a water company fails to deliver water there is a penalty placed upon them, but it turned out that that penalty could not be placed upon them when there was a drought order in place. So at the very time when you need water there is a drought order there and they cannot be penalised. I was promised—and here I can be entirely bipartisan about this—both by the outgoing Conservative Government and the incoming Labour Government that there would be legislation to put this right. I thought in the meantime I would talk to all the companies and we would change the licences so that they made themselves liable to paying compensation even if there is a drought order and there the matter rests. But by and large it is a question of taking the bits of the Act that are relevant and using those. Quite a lot of the Act, of course, you do not even bother to turn the pages on.

Lord Lang of Monkton: Thank you.

Baroness Gould of Potternewton

  11. If I could in a sense follow through from Lord Holme's question when he talked about the sort of volume of the stakeholders, the big circle. One of the things that I cannot get clear in my mind is actually the nature of the organisation in the sense of the actual structure of the organisation and its reference with the various water authorities and I wonder if you could just explain a little bit more about the whole structure and the nature of the way you work.

   (Sir Ian Byatt) We had of course the whole customer service side of the area so there were the Customer Services Committees and there were ten of them in different parts of England and Wales. There was then some central support to look after them. We then had the technical division so I had a group of engineers and a group of economists and accountants who were concerned with the whole process of the price reviews and what the costs were, what the cost of capital was and what the asset base should be. We had a large number of quite tough intellectual problems to sort out, particularly in the early days.

  12. What is a large number? Could you give us some sort of view of the size, please?

   (Sir Ian Byatt) Shall I first say that then we had the sort of administrative support of the office, but then we had the public relations side of the office, which of course worked closely with the rest of the office and when important things were going on they said, "Well, maybe we should be making sure that we are having proper consultations." The issues that we had to try and sort out were firstly the asset base on which you made a rate of return. Nobody had told us what the asset base should be. We decided that the asset base should be more or less what the shareholders had paid for it and updated in line with net investment. Then there was the cost of capital. Nobody knew what the cost of capital was and how could they because nobody had borrowed for utilities in these markets. I remember producing a paper on the cost of capital saying that it was a great deal lower than the bankers had advised the Secretary of State and I was told, you know, that I was an unrealistic man who did not understand the capital markets. Little did I know that I was predicting what happened when Northern Electric had a battle not to be taken over. So the degree of gearing became very much bigger. So there was a lot of process of looking at the cost of capital. Then the whole question of making comparisons between companies because we thought that we had the position where we did not know as much about any one company as the executives did, at least I hope we did not, but we knew about other companies. It is one thing to say "You can do things more cheaply and effectively"; it is much more powerful to say "You can because the people down the road can" and we made great play of the ability to make comparisons. But there is a huge amount of technical work behind that. It takes years, for example, to gather all the information. We spent a lot of time getting really good data. It is, if you like, rather boring work but it is absolutely essential work to getting a good regulatory system.

  13. I wonder if I might ask a slightly different question and this relates to your Customer Services Committees because you have talked a lot about going out and getting information from the customer. I am wondering about the other direction. If a customer is dissatisfied with a water company, with the service they are getting, what is their process in relation to yourselves?

   (Sir Ian Byatt) The handling of complaints is done by the Customer Services Committees and so what we did was first to make sure that the company owned that complaint because it is plain that the company has got to do something about it. So if the company failed to do something about it there are various ways of persuading the company to do things and ultimately the issue might come up to me. Companies did not like having these complaints around and them not being dealt with. The Customer Services Committees got quite good at this and they, for example, would not only listen to the complaint, which is important, but they would sometimes investigate complaints and they got access to the water companies, looking at particular complaints. So whereas I could collect information on numbers of complaints and types of complaints they could collect information on the quality of the answers. One of the Customer Services Committees persuaded the companies that the Customer Services Committee would have binding mediation when there is dispute between the company and the customer. Many of these are relatively small issues. I have seen files that thick, people arguing about small sums of money, which is foolish on both sides. But you do need a process of dealing with those small issues as well as dealing with the big issues like Yorkshire almost running out of water, which I am sure you will remember.

Baroness Gould of Potternewton: Yes, indeed. Thank you.

Lord MacGregor of Pulham Market

  14. I would like to ask you one or two questions about accountability because you had a great deal of independence, authority and power actually and I recognise you had to make very difficult decisions sometimes and decisions which were to a certain extent political, involving difficult judgments. Certainly I know as a Member of Parliament during that period that quite a number of the things that you were involved in I was getting a lot of representations from on all sides, from the consumer obviously and from the companies, and so on. So the question I want to ask you really is, when you were making these decisions who or what was likely to call you to account? I mean by that accountability in terms of justifying your decisions.

   (Sir Ian Byatt) I was set up with certain statutory duties to secure that the water companies properly carried out their functions in good finance and those were my primary duties. So it was my job to make sure that they carried out their functions and if they were not carrying out their functions that was on my head. So that was my job. They could finance them by setting the price limit but that was my job, that was not anybody else's job. Then I was also to protect customers, to promote efficiency and to facilitate competition. The promotion of efficiency in a sense was my job; there was no one else doing it. The protection of customers was a complicated one because customers of course benefited from the higher water quality as well as paying more in the way of price. There I thought it was important to start a proper debate on what I called the cost of quality where I would say "This is what quality might cost" and I tried to do it in very straightforward comprehensible terms, not in terms of millions of pounds, which most of us do not understand, but in terms of how much your bill would go up. Then I said: "Of course the people who are making the decisions on the quality are the ministers so please will the ministers take notice of this and that I am making the decisions on the financing of functions. So whatever the ministers decide then I will finance the functions." I would sometimes do this in what I regard as a relatively challenging way, "Are you sure you really want to spend the money in this way?" I would have liked to have been able to challenge the European Union rather more than in fact I was able to do. So part of who was I accountable to was sort of disentangling the matter but I think the accountability really went very widely because in addition to how you carried out the statutory duties through your stakeholders you had to be fair to all of them. So it was not really a question of having a hierarchy but making judgments.

  15. Yes, the question was really on making judgments. I am not in any sense critical at all of what you were doing because I think it was a very difficult task but the judgment that you made on a particular issue, someone else might have made differently on all the evidence. Therefore I was trying to get to the point as to whether the buck actually stopped with you and did not go any further, or not, and to whom really you felt you were accountable in the sense of justifying your decisions. If I could just take one example, you refer in your paper to appearing on a number of occasions before Parliamentary Committees. Do you think that was an effective way of challenging your decisions or the way in which you made them or were there others?

   (Sir Ian Byatt) Well, Parliament is one way of challenging the executive and an important way of challenging the executive. John Humphries on the Today programme is another way of challenging the executive—

  16. That was the next question.

   (Sir Ian Byatt) —and Panorama programmes ditto, and there was plenty of that. I think it is important that regulators should have a presence, so to speak, so that they can be challenged in this way and of course many of the judgments would be about quite technical matters, "Have the prices come down enough?" Well, they have never come down enough, have they? "Have you allowed enough investment?" There is never enough investment around. So you say on what you based your judgments and they will be your judgments often about quite technical matters. I am not quite sure I am answering your question.

  17. I will put another point. Did you feel as a result of all your experience that it might have been useful to have a board to which you were accountable?

   (Sir Ian Byatt) Everybody needs advice and where did I get advice? Well, I had advice and appointing the people in your office and listening to them is an important form of advice. I had the Customer Services Committees and important advice from them. I also had some senior industrialist who gave me business advice. I also talked to my fellow utility regulators and so I got advice from them. I was in touch with governments and you always get a lot of advice from governments too. Whether it would have been better to have a board as opposed to the single regulator I do not think I feel very strongly about. I think the most important thing is the independence of the regulatory office and the issue is whether a board or a single person contributes most to that. I ask myself, when I look at other regulators, "A lot of people know the name Sir Howard Davies. How many people know the other members of the Financial Services Authority?" I could not tell you all the names of the members of the Federal Reserve System, although I do know the name of the chairman, and similarly the Bundesbank. So in life, particularly in politics, accountability is often very much on individual people so it is important to get the advice. In the end I would stay with the single regulator but I do not feel very strongly about it.

  18. Just a final point on this because you mentioned Howard Davies and there is the issue going on now as to whether the chairman and chief executive of the FSA should be separate and not in a single person. In your experience did you ever feel that there would have been some advantage to you in having more than just yourself, if you see what I mean?

   (Sir Ian Byatt) To tell you the truth, I did not, no. That might sound a very arrogant thing to say but when you have thought about it very carefully and decided what to do and knew you had to defend it against hostile audiences then you went in to bat—and of course not everything I did was right—and you look back and you think, "Well, perhaps I wasn't right", even though you are defending it at the time. So I think there was a sufficient process of challenge outside the organisation as well as the sort of challenge you inevitably get if the organisation works well inside. So, no, I do not think that I would have found it any better and it could slow up decision taking and in the early days things could move very fast indeed.

Lord Acton

  19. Sir Ian, I will ask you about the beginning, if I may. Other than your saying that you were accused of not knowing the capital markets I do not know what your background was before you did this job. If you could briefly point to it?

   (Sir Ian Byatt) Certainly. I started off my life as a university teacher in economics. I went to the economics section of the Treasury as a young don and then I went back to academic life, this time to LSE, and I found the work I had done in the Treasury rather more interesting than work in the LSE. I was then invited by the then Secretary of State for Education, who was Tony Crosland, to go to the Department of Education where he wanted to do educational planning, which meant looking at resources in education. Then I moved to the Ministry of Housing and then to the Department of the Environment and then back to the Treasury and I stayed in the Treasury until I went to OFWAT in 1989.

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