Select Committee on Constitution Minutes of Evidence

Memorandum by Water UK

  1.  Water UK represents all water and sewerage operators in the UK—private 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 regulators—Ofwat, 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 per annum.

  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 the EU.

  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 Price Review;

    —  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 include:

    —  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 compliance—an 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 object to.


  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.

Water UK

March 2003

previous page contents next page

House of Lords home page Parliament home page House of Commons home page search page enquiries index

© Parliamentary copyright 2003