Water UK, the body which represents all the UK water and wastewater companies at both national and EU level, has expressed concerns about Ofwat’s current regulatory approach.

The comments come in the industry body’s formal Response in submission to the Department for Business, Innovation and Skills (BIS)’s call for evidence to its consultation paper “Principles For Economic Regulation.”

In response to BIS's question whether the division of responsibilities, currently divided between regulator and Government, was sufficiently clear, Water UK said:

“The perception of many in the water industry is that there has been a blurring of boundaries in recent years, with Ofwat taking an increasingly activist role in policy formulation.”

The industry body said it was important that the economic regulator did not have responsibility for independently setting the policy agenda and that its role should instead be to reflect government policy. The regulator should be capable of being held to account by Parliament, the Government and others for the way in which it implemented government policy.

Where the economic regulator was allowed to pursue an independently set agenda, it would in effect become accountable only to itself. Water UK said it was inappropriate for Ofwat to take a policy lead in an area which included market reform, given that the reforms it was advocating require primary legislation which Ofwat itself has no powers to bring forward.

Recommendations made by Water UK in order to rectify this included:

• Ofwat should be required to observe and respect environmental and social objectives being pursued by Government and implemented by other relevant bodies. This requires the Government to issue Ofwat with detailed guidance under the process laid out in the Water Industry Act.
• The Government needs to take ownership of the broader policy debate, including market reform.
• As a matter of principle, regulators should avoid embracing large programmes of work which require reforms that go substantially beyond their existing powers unless they are explicitly instructed to undertake such a review by the sponsoring department.

Water UK said that in Ofwat’s case there may also be scope for duties to be simplified to ensure clarity to Ofwat, Parliament, other agencies, consumers and industry about which activities Ofwat is to be held accountable for, and which activities are for others to perform.

“This would address the problem that, since the privatisation of the water industry, Ofwat’s responsibilities have evolved on a piecemeal basis, generally serving to cloud its focus on efficient delivery of core regulatory functions.”

Water UK said it would not be appropriate for Ofwat to be required to take on additional duties and that Government should generally take care to ensure that the scope of regulators’ functions is not allowed to become too broad.

The industry body believes that consultations should be the primary means of ensuring that decisions taken by regulators are informed, of high quality and rooted in sound evidence. Regulators should also be explicit about the principles of how and when they will consult and this should be set out in published guidelines.

On stakeholder engagement via consultation, Water UK said stakeholders should have clear expectations of what a consultation will look like, how it will be run and how the responses supplied will be taken into account in making a final decision.

“Informal consultations like workshops or discussion papers are not enough”

Interestingly, Water UK also said that while informal consultation processes –e.g.workshops, discussion papers and so on – could inform both regulators and stakeholders on emerging thinking.

“ Great care must be taken to ensure that they are not used as an alternative to, or replacement for, formal consultation on significant issues or to unduly narrow the scope of any eventual formal consultation that is held.”

Ofwat regularly uses workshops and publishes discussion papers to inform a broad range of stakeholders about its thinking on a range of different topics.

Water UK’s submission highlighted the considerable benefits to be had from formal consultation processes which publish full details of the responses considered and how the evidence has been evaluated. These enabled stakeholders to better scrutinize and understand the decisions taken. Partly as a consequence of this, regulators would also apply more disciplined judgments.

Water UK said this could not be replicated when consultation processes were informal and undocumented, or where the evidence base underpinning a decision was not disclosed and commented:

"Regulated companies should be able to understand the reasoning behind decisions based on the regulators’ published decisions themselves. Regulated companies should not have to resort to a legal process in order to discover the basis for the regulator’s decision. “

In response to the question whether existing appeal mechanisms were appropriate, Water UK said that extending the right of appeal to customers, required careful consideration, not least because “the consequences that a customer or customer body faces when they trigger an appeal are incomparable to the uncertainty, financial cost and call on management time that the appeal process imposes on companies.”

Water UK also expressed its concern about the extent and depth of the Competition Commission’s understanding of regulatory issues given the dearth of regulatory appeals in the last ten years, despite the fact that it had “generally performed well when it has been called upon to hear appeals against Ofwat’s decisions.”

The industry body said that the water companies should be able to appeal on the merits of an enforcement action by Ofwat which, for example, imposed a financial penalty on a company or required legal undertakings.

At present the water companies’ only route of appeal is judicial review which it described as “a highly burdensome process, particularly for smaller regulated companies.” Water UK said that the position of the water companies was increasingly anomalous compared to other regulated sectors in this regard.

The submission also says the UK water companies’ principal concern is that “the Government has withdrawn too far from the water sector with the consequence that stakeholders have had to operate with very little in the way of policy direction”.

However, Water UK does not want the Government to make changes to the regulatory framework at fixed points in time nor constrain itself to deal with new policy issues only through cyclical and infrequent strategy statements.

Ofwat’s “value for money” has declined

While Water UK believes that the regulatory framework within which the water sector operates has generally helped to deliver good results for customers over many years, it said that judging the cost-effectiveness of the framework in absolute terms was a difficult and subjective exercise.

Water UK also said it was important for regulators “to recognise and seek to minimise the regulatory burden they impose and take steps to demonstrate how they are driving their own efficiency. “

Over the last five years, the cost of funding Ofwat has risen by over 50%, headcount has increased by over 10% and average salaries by around 40% over the same period.

Water UK said this had happened at a time when there appeared to have been “no significant increase in the scope of Ofwat’s statutory remit" and it was “unclear” to the industry whether the increases had accompanied an increase in the quality of the outcomes for industry and consumers.

Water UK expressed concern that the increased costs instead represented “merely an increase in the intensity of Ofwat’s activity within the same statutory remit.” If it was the case that the increase in costs had in fact resulted from Ofwat’s more active engagement in the policy debate, it would appear that industry – and its customers – had had to meet the costs of a significant increase in the regulatory burden in order to fund activities which were more appropriately matters for government.

Finally,Water UK said that in the absence of any output-based justification, Ofwat’s value for money could be judged to have declined over the period and there was scope for Ofwat to increase its level of accountability for the burden its regulation imposes on industry, commenting:

“Under the Regulatory Enforcement and Sanctions Act 2008, Ofwat is required to review the burdens it imposes, reduce any that are unnecessary or unjustifiable and report on progress each year. It is evident from Ofwat’s annual reports that its approach to this obligation has not been an enthusiastic one, although some other regulators appear to have taken a more active approach.”