Cathryn Ross, Chief Executive at Ofwat has warned that water companies who fail to meet the regulator’s expectations can expect more intrusive assurance processes and more burdensome regulation.

The comments came in a speech by Ms Ross at the Marketforce Water 2014 conference on Tuesday setting out the regulator’s perspective on the 2014 Price Review and beyond, and what Ofwat’s new strategy means for both the regulator and the wider water sector.

She prefaced her talk by saying that with 12 December fast approaching – the date when Ofwat publishes its final determinations on the AMP6 Business Plans, there was a still a lot of work to be done – with decisions still to be made and models to run.

Saying that the acid test of any review is what it delivers for customers, Ms Ross  said: “…looking at our draft determinations, I am really pleased with what this programme has achieved”, adding that PR14 will see the companies deliver what customers want.

This was attributable to the fact that PR14 has been the "biggest ever programme of engagement in the sector." Companies had engaged directly with over a quarter of a million of their customers. Instead of companies building their business plans and then going out ‘to get customer support’, like they did at PR09, at PR14 business planning has started with the customer. Every single company had achieved a step change in customer engagement from PR09.

At PR14 Ofwat had made some significant changes to the way it regulates, Ms Ross said, setting out the 2014 price review principles as follows:

• Customer engagement
• Focus on outcomes rather than outputs
• More flexibility for companies to deliver those outcomes in the most efficient way possible – getting rid of regulatory rigidities.
• Balance of risk and reward that genuinely aligns the interest of capital and company management with the interest of companies – so that investors can make a good return but only when they are delivering what customers want.
• Corporate governance and culture matters – an  emphasis in PR14 on Board leadership, governance and transparency.

Ofwat's vision for the water sector - trust and confidence

Ms Ross said  that the view that PR14 is  a “one-off correction – a bit like the 1999 review, perhaps – after which there will be a return to ‘easier’ times” was not  the case. PR14 and the principles it exemplifies are at the heart of Ofwat’s new strategy and would take the sector through the next periodic review and set the agenda for the one after that.

The new strategy started with Ofwat’s vision for the sector -  trust and confidence in the provision of vital public services which are built around two main components: outcomes and strong, effective relationships.

On  outcomes, Ms. Ross commented:

“…the wrong thing to do here – no matter how tempting – would be for us to write down a list of the expectations of customers and society and regulate to that. I know that some people would like to see us to do that – for some people that is what ‘strong’ regulators do.”

“But it would not be right and would not in fact best serve customers. Rather, we need to put in place a framework that encourages companies to take responsibility for what they deliver – for understanding what customers and society expect, recognising that different people have different priorities and that priorities change over time, and to deliver on that.”

“You can see that this is what we have done, for example, in PR14 – where companies have proposed an astonishing 399 outcomes and incentive frameworks that will see them rewarded for doing more of what customers want and penalised where they fall short. “

Ms. Ross also said the relationships the water companies had both with their customers and wider society, including the supply chain, needed to be open, honest, transparent and fair, commenting:

“When service providers put themselves in that wider context and think about doing the right thing across all those relationships you do see some different behaviour.”

“For example, this year companies opted to give back £700 million to customers by not taking their full price control settlement. Actions like that really serve to strengthen those relationships and boost the sector’s legitimacy.”

Ofwat's own vision to be “respected, stretching and leading edge“

Posing the question of what sort of regulator Ofwat wanted to be, Ms Ross said the vision for Ofwat was to be “respected, stretching and leading edge.“ The regulator would be focused on outcomes and would not be going back to regulating to outputs .On relationships: “We will understand and nurture relationships too – we will not insert ourselves in the relationship between companies and customers, for example, but will set frameworks that encourage and reward companies who step up and take real ownership of those relationships.”

Companies who don’t get it right subject to more intrusive assurance processes and more burdensome regulation

Ofwat would look for and place great weight on the assurance it received from the water companies as to whether and how they are doing the right thing and would take a risk-based approach to that assurance. Ms. Ross explained:

“Where companies have ‘form’ they may find this quite burdensome. But where companies can convince us that they really have stepped up are really delivering and building those strong relationships, they will see us take a less intrusive approach.”

“Where we are not satisfied by the assurance we receive we will step in to protect customers, to provide that critical safety net. Overall, we will challenge the companies – management and investors – to step up, to take responsibility for delivery, for challenging themselves constantly to improve for their customers, and for managing the complex set of relationships they own.”

“If they get it right, we will support any outperformance they earn. And they can expect additional flexibility within our regulatory framework and a less intrusive approach. Companies who don’t get it right will be subject to more intrusive assurance processes, and more burdensome regulation.”

 Ofwat would be transparent about what it is doing and why – which would make it clear who isn’t getting it right, but would also give them an opportunity to learn. We expect, for example, our new financial monitoring framework to prompt some powerful conversations between investors and company managers."

Ms. Ross also set out Ofwat’s priorities over the next few years, including:

• promoting better information that shows how the sector is doing:
• implementing the Water Act reforms – including a focus on the non-household retail market opening in 2017
• doing more to reveal transactions and costs and cost drivers within the wholesale part of the value chain (where 90% of the costs sit) –enabling more effective regulation,  markets to work better and reveal better information for use by managers and investors.

Scope for significant efficiency gains in wholesale part of the value chain

Commenting on the allocation of costs and the RCV, Ms. Ross said:

“I can say now that we see scope for significant efficiency gains, specifically allocative and dynamic efficiency gains – in the wholesale part of the value chain. We will approach discussions with an open mind, and we will listen to what we hear. We will have closed down the more sensitive issues in this area in 12 months’ time.”

On casework, Ofwat would focus more on strategic cases, which the sector’s new alternative dispute resolution scheme supports. The regulator is also looking at whether it can make more use of arbitration to “push this further. “

Ms Ross said Ofwat was expecting more strategic cases as it moves towards market opening and would  be more proactive in ensuring that the messages from casework get through to “those who need to know – so they can change their behaviour pre-emptively. “

“I fully recognise that our new strategy implies further evolution in our regulatory tool kit. And that will bring challenges for us – in terms of our own capability and resourcing – which is why I have put in place an ambitious transformation programme to support it.”

"Sector needs to think outside the envelope of the traditional vertically integrated water company"

Ms. Ross concluded:

“But there is a lot more to do – building on the sorts of examples I have outlined here, in terms of really thinking through the customer lens, thinking about the outcomes they want to see and really thinking creatively about how those outcomes are delivered. And the sector needs to be thinking outside the envelope of the traditional vertically integrated water company – making better use of new technologies, seeing the customer more as part of the solution. “

Click here to read the speech in full