Select Committee on Constitution Minutes of Evidence

Memorandum by Ofwat


  1.  Ofwat considers that the British system of independent economic regulation and customer representation has made an important contribution towards protecting the customer and citizen from the adverse affects of monopoly, and others agree. For example, the Comptroller and Auditor General commenting on 10 April 2002 on the publication of his report "Pipes and Wires" (HC723) said:

    "The way that the regulators have used their price reviews to drive down the costs of the major utility networks while the quality of the service delivered has improved, represents a great success story".

  2.  At the same time, as unelected public appointees, Ofwat takes very seriously its accountability to Parliament. We are creatures of statute and work within that framework, subject to judicial review of our actions. The current Water Bill makes proposals which will change our constitution.

  3.  We are financed by water customers, but subject to token votes which ensure that our expenditure is subject to parliamentary scrutiny and audited by the National Audit Office both for regulatory and propriety and for value for money. The process has not so far identified any major shortcomings.

  4.  We report on our activities annually to Parliament and the National Assembly for Wales through the Secretary of State for Environment, Food and Rural Affairs and the Welsh Assembly Government. WaterVoice (the statutory Ofwat Customer Service Committees whose Chairman together form the WaterVoice Council) is at present a part of Ofwat but speaks separately from the regulator and presents its own annual reports. The Status of WaterVoice is likely to change once the Water Bill is enacted. It will present separate evidence to the Committee.

  5.  We consult widely and publicly on our proposed forward programme. Our regulatory proposals are subject to full public consultation and we are committed to following the principles of good regulation established by the Better Regulation Task Force: transparency, accountability, proportionality, consistency and targeting.

  6.  Ofwat's key decisions are subject to external review, notably by the Competition Commission on price limits and licence changes and by the Competition Commission Appeals Tribunal on competition cases. The Director General and Ofwat staff have frequently appeared before Parliamentary Select Committees, including the Environment and Public Accounts Committees, to give evidence on our business. We meet and correspond frequently with members of both Houses of Parliament and of the National Assembly for Wales. We attend appropriate specialist all-party groups. We supply factual material to Ministers for use in response to parliamentary questions and debates.

  7.  We have adopted the Nolan principles in conducting procedures for appointments by the Director General. These currently include the four non-executive advisory directors on the Ofwat Board, the 10 WaterVoice Committee Chairmen, all of whom are paid an appropriate fee, and the voluntary members of WaterVoice Committees. Ofwat is a non-ministerial Government department. Its staff are civil servants and are subject to the established rules governing their appointment, pay, conditions and behaviour, scrutinised on behalf of Parliament by HM Treasury and the Cabinet Office. There are, for example, rules of conduct to guard against possible conflicts of interest.

  8.  The evidence below responds to the Committee's guidance on the issues to be addressed, following their list of questions.


  9.  The Water Industry Act 1991 vests the relevant powers in the Director General of Water Services (DGWS) who is supported by Ofwat. The current Water Bill before the House of Lords proposes to substitute a Regulatory Authority and a new independent Consumer Council for Water. The key statutory duties of the Regulator are set out in section 2 of the 1991 Act, to be amended by the Bill. Ofwat's budget is financed under the water companies' licences by customers. The resources raised in 2003-04 will amount to £12.6 million. Further powers, for example in the Competition Act 1998 and Enterprise Act 2002 apply to water as to other sectors.


  10.  This is a matter for Government and Parliament. In this they may be assisted for example by the Better Regulation Task Force (report on economic regulators) and by the National Audit Office (eg its report "Pipes and Wires").


  11.  Philip Fletcher is the current DGWS, appointed in 2000 following public competition in accordance with Nolan principles. His own appointments to his advisory Ofwat Board, follow the same principles and have involved a representative of the Civil Service Commission. The appointment of chairmen and members to WaterVoice Committees follow the same principles. The total WaterVoice membership at 31March 2002 was 131, of whom 55 (42 per cent) are women and 13 (9.9 per cent) members of ethnic minorities. This compares with the national averages of public appointments of 34 per cent women and 4.8 per cent from ethnic minorities.


  12.  The Act requires DGWS to exercise his powers in a way that he judges will enable efficient water and sewerage companies to carry out their functions properly and to finance them. This requires Ofwat to make judgements about what revenues and companies need to collect. The resulting price limits must allow the companies to secure a reasonable rate of return on their capital. This is to ensure that lenders and shareholders are willing to invest in efficiently operating companies.

  13.  The DGWS must also balance his duties to ensure that customers' interests are protected, that efficiency and economy are promoted and that effective competition is facilitated.

  14.  In terms of outcomes, over £50 billion of private sector investment from 1989-2005, financed by water customers, has brought about a very significant improvement in the quality of drinking water and of the water environment generally, both rivers and coastal water. (Thus over a decade, the number of samples failing to meet rigorous drinking water quality tests at the tap have fallen from one in 100 to one in 700 (99.86 per cent success).) The chemical quality of rivers and canals has risen from 84 per cent classified as good or fair to 94 per cent and coastal bathing water compliance with standards from 66 per cent in 1988 to nearly 99 per cent in 2002.

  15.  Water customers' bills have risen in real terms on average by 20.1 per cent since privatisation in 1989. This incorporates a 12.5 per cent reduction in 2000, reflecting the greater efficiency of the industry in response to incentive-based price cap regulation. The Water Industry Commissioner for Scotland estimates that Scottish water and sewerage bills in 2001-02 were 60 per cent higher than would have been needed if the three former Scottish Water Authorities had been operated as efficiently as their English and Welsh counterparts. Since each company remains an effective monopoly in its own area, large or small, the regulator and shareholder between them have provided the incentives which have enabled the industry to improve so markedly.

  16.  At the same time, Ofwat and WaterVoice have sought to ensure that customers receive a better service. On the evidence of the performance measures used by Ofwat and reported annually there have been major improvements, for example in reducing unscheduled interruptions to supply, improved billing procedures and in handling complaints.

  17.  Price competition has developed slowly. The Water Bill will increase, for customers using 50 Megalitres or more a year, opportunities to seek competitive suppliers, but the majority of customers will continue to be served by companies with effective monopolies.


  18.  Companies may refer Ofwat's decisions on price limits or licence changes to the Competition Commission to be re-examined from scratch. At each price review, two companies (now out of 23) have appealed in this way. Some decisions may also be appealed to the Competition Commission Appeals Tribunal. Our decisions may also be subject to judicial review. So far, one such challenge (on the use of pre-payment meters following the ban on disconnection of domestic customers) has led to us having to change our policy and another was rejected. Administratively, as with other Government departments, Ofwat's handling may be referred to the Parliamentary Commissioner for Administration.


  19.  The summary of evidence sets out the main avenues of accountability to Parliament. External audit is conducted by the National Audit Office. By definition, in the light of the statutory functions given to the regulator, his decisions are taken independently of Government departments and other public bodies. However, as a non ministerial Government department, the normal Civil Service disciplines apply, for example in achieving value for money and following the principles laid down for public servants.


  20.  (a)  Ofwat's primary statutory duties are to enable efficient companies to carry out and fiance their functions, while also protecting customers' interests, promoting economy and efficiency and facilitating effective competition. It is essential that we approach our tasks in a transparent way, designed to minimise unnecessary regulatory uncertainty. Within the confines of commercial confidentiality, we consult widely on our approach to issues. We hold workshops to describe and discuss our policy approaches and meet the companies and others to discuss issues. We publish five annual reports on different aspects of the performance of the industry in response to regulation. We thereby enhance their accountability for the provision of a public service by private sector monopoly companies. We try to ensure that the basis of regulation is fully understood by the companies themselves and their own investors, bondholders and other lenders. This helps to hold down the cost to them of raising finance and thereby, through the system of incentive-based price cap regulation, the cost of customer's bills. As examples, we now publish our forecasts of companies' regulatory capital values and the financial model we use to set price limits.

  21.  (b)  The impact of regulation on the economy is hard to access precisely, but the contrast between the efficiency of the privatised industry in England and Wales subject to economic regulation since 1989, and the public sector equivalent in Scotland, where economic regulation has only just been introduced, is enlightening (paragraph 15 above). We make international comparisons beyond the UK and publish an annual report on this. It is hard to make exact comparisons but the evidence suggests that the water industry in England and Wales is towards the leading edge of performance worldwide. Information included in a recent UN study indicates that water quality in the United Kingdom is ranked fourth in the world, only in Finland, Canada and New Zealand is water quality better.


  22.  We have a duty to ensure that customers' interests are protected. The Water Bill proposals will enhance this duty. At present, water customers are represented by WaterVoice—nine regional Committees in England and one in Wales, whose Chairmen together form the WaterVoice Council. Although part of Wales, whose Chairman together form the WaterVoice Council. Although part of Ofwat for budgetary and staffing purposes, WaterVoice, which has no counterpart in the other member states of the European Union, speaks independently (and sometimes critically) of the regulator. The Committees hold their meetings in public, at which members of the public have an opportunity to express their views. Overall, the regulator and the customer representatives work closely together and consult frequently with each other.

  23.  Ofwat has a recently improved website explaining its purpose and approach and publishes reports and leaflets designed to explained its role and offer advice both to companies and customers, on issues ranging from the increase in bad debt following on the statutory ban on disconnections to the rights of tenants on caravan parks in respect of their water bills. Ofwat and WaterVoice together receive complaints where a water company is felt to have failed to deliver an acceptable service. The WaterVoice Committees deal with most complaints. We also investigate complaints that the Committees cannot resolve and make representations to water companies to try to achieve a fair and reasonable outcome. In most cases we have no legal powers to force water companies to act on our recommendations, but in practice they nearly always do.


  24.  Through press notices, articles, interviews on radio and TV as well as consultation documents, we encourage interested groups to contribute their views on matters affected the public as customers or citizens. In addition, we have undertaken, along with WaterVoice, Government, the water industry, environment regulators and interest groups, joint customer research in preparation for the coming periodic review of price limits. The first phase of this research suggests that most customers are broadly satisfied with the service they receive and consider it represents reasonable value for money (details on the Ofwat website——the work was carried out by MORI). But there are a number of issues to pursue further in a second phase of the report. We also consult directly organisations that have a specific interest in out work, for example through workshops and seminars.


  25.  Complaints, other correspondence and surveys, and the views of WaterVoice as representatives are important factors in guiding regulatory action. For example, although the number of cases of sewer flooding arising from inadequate sewerage have fallen, public expectations have hardened and this extremely unpleasant event is regarded as unacceptable. Accordingly, we have agreed that companies which produce well argued plans for additional work to curb sewer flooding in the current price review period (2000-05) should proceed with them, and will be remunerated within the limited provisions for adjustments between periodic reviews, where there is customer support. However, regulators are neither instruments of a particular administration nor representatives of the public. They are the holders of statutory offices with certain specific duties to carry out.


  26.  Regulators take their decisions independently. They take account of good practice elsewhere and of the views of the Competition Commission and of their peers. In Ofwat's case, an important driver of better regulation has been the development of our monitoring activities which allow us to compare companies' performance on an objective basis. These comparisons help amongst other things to decide what efficiency gains are practicable within the sector as a whole.

  27.  At the same time, Government and others, notably the environmental regulators, WaterVoice and the companies themselves make an essential contribution to effective price reviews. Thus, the decisions on the overall programme needed to enhance environmental quality, partly in response to European directives, are for Environment Ministers in DEFRA and the Welsh Assembly Government for England and Wales respectively. The Government from time to time publishes guidance and its views on issues associated with the water industry. We take account of this in our decision making process. In the water sector there is no subsidy from the national or local taxpayer to the main functions of the industry, which removes one possible complication.

  28.  Independence could be compromised if it were believed that Government and the regulator were not safeguarding regulatory independence. Statute and guidance should clearly establish which office is responsible for each aspect of the regulatory system to minimise the scope for duplication and confusion. Government Ministers have continued to make clear the importance they attach to the independent role of the regulator.

Office of Water Services

March 2003

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