Ofwat has suggested in its response to a consultation that the Government’s proposed change to the special merger regime in the water sector could be “detrimental” to its ability to protect customers.

In May/June 2012 the Government ran a consultation which proposed raising the threshold of the special merger regime to £70 million from the current threshold of £10 million i.e. mergers of companies with a turnover of less than £70 million would not be referred to the Competition Commission.

Ofwat claims that the Government has not clearly explained why it wishes to make the change or outlined any benefits resulting from the change.

The regulator clearly states its objection in its response:

“We are not confident that this change is justified at this time and can find limited evidence to support it. In fact what evidence we can find leads us to suggest that the change could be detrimental to our ability to protect customers.”

The figure of £70 million as a threshold is dismissed by Ofwat as an “arbitrary number”, which purely comes from the general merger regime of the Office of Fair Trading, whereby any merger is exempt from scrutiny if the company being acquired has a turnover below £70 million.

Any change in the special merger regime would have to be based on an objective assessment of the number and type of comparators Ofwat needs to ensure the regulatory regime can still protect customers, the regulator argues, and a figure of £70 million is irrelevant.

However, Ofwat instead supports a step-by-step change in the merger regime that will “allow a removal of restrictions where benefits can be clearly defined, provide more flexibility for mergers to be considered and be more proportionate.”

It supports measures to introduce a two-stage test for mergers, which will allow a more proportionate approach depending on the nature of the merger, Ofwat claims. It proposes replacing the automatic reference to the Competition Commission with a decision on whether to refer.

The regulator also urges the Government to investigate the potential for introducing a more flexible licensing regime that would allow existing companies to merge and acquire the retail operations of other businesses.

Fundamentally, Ofwat argues that in order to facilitate retail mergers, a water company’s Instrument of Appointment would need to change, rather than the special merger regime.

The document states:

“These changes will allow a more flexible, proportionate merger regime to apply in the water sector. At the same time, because a significant majority of the services provided in the sector will remain under monopoly provision, proportionate and appropriate protection of customers can still be provided by the regulatory regime, using comparisons where effective and efficient.”

Ofwat has repeatedly said that any loss of a “comparator” will have a negative effect on its ability to regulate and protect the customer, although it is open to a gradual change in merger reform which preserves its ability to regulate adequately.

Over the past few months water company chiefs including Steve Mogden at United Utilities and Richard Flint at Yorkshire Water have said that consolidation in the water industry is necessary, particularly in the water-stressed region of South East England, something which Ofwat has not commented on but appears at odds with its wish to keep as many players as possible in the industry.

The Draft Water Bill, published by the Government in July 2012, has set out the plans for ambitious reform in the water industry, opening up the retail market to non-household customers and fostering competition.

It will be interesting to see how everything plays out between all parties involved in the water industry over the next few months.