Water White Paper

Water for Life, H.M. Government’s “vision for future water management”, was published on 8 December 2011.  Topics covered include environmental sustainability, affordability, water efficiency, infrastructure planning, and developing a competitive marketplace for business customers.

The Paper emphasises that the water sector has largely been a success story over the last 22 years, having invested over £90 billion in improved infrastructure and higher environmental standards.  High quality drinking water, secure supplies to households and businesses, effective removal of wastewater, and a flourishing water environment are all cited as features of the sector that we must preserve, whilst at the same time thinking differently about the delivery of these outcomes for the future.  The effects of climate change, and a growing population, will put more stress on our water environment and infrastructure.  The measures outlined in the Paper are targeted at ensuring a resilient water sector, in which water companies are more efficient and customer focussed, and in which water is valued as the precious resource it is.

Key steps to achieve this vision include reforming the water abstraction regime, providing guidance to water companies on the introduction of social tariffs, and a suite of reforms to the market for business customers.

Reforms to the abstraction regime will introduce, the Paper tells us, a regime resilient to the challenges of climate change and population growth, whilst affording better protection to the environment.  A consultation on proposed changes will be launched in 2013, to be followed by the introduction of legislation early in the next Parliament, with a new regime in place by the mid to late 2020’s.

Government wishes to see increased inter-connection in the water supply system, linking water company networks at appropriate points.  This will enable water resources to be used more flexibly and efficiently, although it is recognised that the energy required to pump water makes transfers expensive.  Bulk transfers envisaged at this stage are therefore short distance ones only.

Trading of abstraction licences is to be made easier, through removal of barriers to trade.  The Environment Agency will improve market information, including online publication of average trade prices, volumes and locations.  The Agency will also examine large unused licences, using its existing powers where appropriate to revoke licences which are not needed.

Defra has recently launched a consultation on establishing the principles to be used in determining whether the revocation or variation of an abstraction licence is necessary to protect water resources from serious damage, and whether compensation will be payable.  The closing date for responses to the consultation is 3 May 2012.

Other sustainability measures addressed within Water for Life include collection and reuse of rainwater, recycling grey water, reuse of treated water from sewage works, and tackling diffuse pollution from both rural and urban sources.

In relation to affordability (ensuring that everybody has access to an affordable water supply), Government will publish guidance to water companies on the introduction of social tariffs which would enable companies to offer more support to customers at risk of affordability problems.

Defra had published a consultation paper in October 2011 inviting views on draft guidance on social tariffs to water companies in England.  The consultation period closed in January; final guidance is expected early in 2012.

The Water Industry (Financial Assistance) Bill has commenced its passage through the Parliamentary legislative process, having received its first reading on 2 February 2012.  The Bill will insert additional provisions into the Water Industry Act 1991 to allow Government to provide financial assistance through reduced charges (i.e. a £50 per year reduction to household customers in the South West) and to provide financial assistance for major water infrastructure projects (e.g. the Thames Tunnel scheme).

In relation to competition within the water sector, Water for Life outlines the reforms that Government is minded to implement.  A separate paper “Water for Life – Market reform proposals”, was also published by Defra in December 2011.  This paper adds more detail to the announcements made in the White Paper around market reform.  The key points can be listed as follows:

  • No fundamental structural change to the sector.
  • Development of a retail market, but without enforced retail separation of water undertakers.
  • Further reduction of the WSL eligibility threshold to zero, providing choice to all non-household customers in England.
  • A new market for retail water and sewerage services for England and Scotland, creating a single market.
  • Development of a statutory market code and common contract, avoiding the need to negotiate a separate agreement with each water company.
  • Removal of the in-area trading prohibition.
  • Repeal of the costs principle, to be replaced with a transparent pricing regime for wholesale charges, based on charging rules to be produced by Ofwat and WICS in accordance with Government guidance.
  • A new self-supply licence, allowing suitably qualified customers to purchase a wholesale supply for their own use.
  • The WSL combined licence will be unbundled, to allow market entrants to operate upstream services such as inputting water to a network, without an obligation to provide retail services.
  • A new network licence, enabling an entrant to own and operate infrastructure which is connected to an incumbent company’s network.

Important next steps will include the publication of a draft Water Bill in early 2012, and a Water Bill as soon as Parliamentary time allows.

For further commentary on the Water White Paper, please refer to our briefing note dated 20 December 2011, “Water White Paper – Something for Everyone?”, available on the Eversheds website.

The Welsh Government published its Written Statement on Water Policy in Wales, on 12 December 2011.  Whilst only 6 pages in length, this document nevertheless manages to touch on a broad range of topics, from affordability (a key priority) and development of social tariff guidance, to tackling bad debt, to retail competition (Welsh Government remains to be convinced that it will deliver any measurable benefits for Wales), to nitrate vulnerable zones, to consultations on sustainable drainage and mandatory build standards for sewers.  The Welsh Government has committed to develop a Water Strategy for Wales and intends to consult on proposals for the Strategy in Spring 2012.

Ownership changes/merger rules

The second half of 2011 saw a number of ownership changes within the water sector.  Further activity has occurred in 2012, following the inclusion within Water for Life of Government’s statement that it is strongly minded to reform the sector merger rules.

Following the acquisition of Cambridge Water by South Staffordshire Plc, the Office of Fair Trading referred the merger to the Competition Commission, as required by the merger rules within the Water Industry Act 1991.

The Competition Commission, in order to ensure that the two businesses remain separate and unchanged pending determination of the reference, has accepted from South Staffordshire, its owner Alinda Capital Partners and Cambridge a series of interim undertakings.  These require that no action is taken which might result in integration of the businesses (for example, IT systems are to remain unchanged), that assets are not disposed of, that no substantive changes are made to key staff and that commercial information is not shared.

The Commission has recently published its statement of issues in relation to the acquisition, and will analyse whether the merger might adversely affect Ofwat’s ability to use comparisons when setting price limits, when it is monitoring and incentivising performance and regulatory compliance, and on its ability to identify and spread best practice.

In performing its analysis, the Commission will consider whether Ofwat’s proposals to reform its approach to price setting and monitoring and compliance would alter any adverse impact.  However, proposed reforms of the regulatory framework which are described in Water for Life will be taken into account only to a limited extent, due to uncertainty about the timing and scope of such reforms.

Ofwat has published its initial submission to the Commission regarding the acquisition, asserting that the acquisition will prejudice Ofwat’s ability to make comparisons, resulting in a small detriment to customers which could be remedied by passing back to customers some of the financial benefits from merger.

Ofwat has already taken the opportunity to make minor modifications to Cambridge’s licence conditions F (ringfencing) and P (undertakings from ultimate controller).

Elsewhere within the sector, in January 2012 China Investment Corporation acquired a 8.68% stake in Thames Water, purchased from Santander.  Albeit not a major transaction, this perhaps suggests that Water for Life was successful in reassuring investors that the sector’s stable regulatory regime is not about to be overturned.

Following the acquisition by Capstone in October 2011 of a 70% stake in Bristol Water, Ofwat confirmed in February 2012 that the acquisition creates no regulatory issues.

Meanwhile, Veolia is seeking to dispose of its three UK water companies.  It remains unclear whether the regulatory authorities would regard a sale to a single buyer as a merger, given that the companies are already under common ownership.  Pending sale, Veolia has approached Ofwat regarding the unification of the management and licences of the three businesses.

In relation to water sector merger rules, Water for Life suggests an increase of the turnover threshold for automatic referral to the Competition Commission, from £10 million to £70 million.  In addition, a two-tier referral system may be introduced, allowing a water company to avoid a referral by giving undertakings– these might include maintaining separate price controls, or divesting part of the business.  These proposals will form the subject of consultation.  If these proposals are implemented, we might see greater consolidation of the current 22 water undertakers.

Tackling bad debt

Ever since the prohibition of disconnection of water supplies to household premises for non-payment of water charges (introduced by the Water Industry Act 1999), bad debt has been a growing problem for water businesses and for the majority of customers, who bear the cost of non-payment by a minority, adding an average of £15 per annum to every bill.

One of the restricting factors for water companies is the need to pursue occupiers of premises for payment, but alongside a difficulty in maintaining up to date occupier records for tenanted properties.  The Flood and Water Management Act 2010 contains a provision (not yet implemented) to assist companies, by requiring non-occupying owners of residential premises to provide information about the occupiers to the water company, failing which the owner will become responsible for payment of the charges.

Defra published its consultation paper, “Tackling Bad Debt in the Water Industry”, in January 2012, on the regulations which will specify the details that landlords must provide.  The paper puts forward two possible approaches; firstly a formal requirement to provide details of the occupier, or alternatively a scheme for voluntary provision of those details. This second approach would avoid infringing a Government commitment that, so far as possible, micro businesses should be subject to no new regulation for three years from April 2011.  Perhaps not surprisingly, the voluntary approach has been described as unworkable by industry commentators.

The consultation closes on 16 April 2012.

Ofwat’s proposals to modify licence conditions

On 21 December 2011 Ofwat published its paper, “Section 13 proposals by Ofwat to modify the conditions of appointment of all water only and water and sewerage companies”.

In its preamble, the paper describes itself as a consultation inviting comments; however it also states that it is a notice under section 13 of the Water Industry Act 1991, meaning that rather than merely provide comments, companies may be expected to either accept or reject the proposals (although section 13 does allow companies to make representations).

The principal change proposed is to allow flexibility to move away from a single price limit set every five years using the RPI+K approach, to a framework within which Ofwat could determine the number, length, nature and form of price controls.

This would allow Ofwat, for example, to set separate wholesale and retail price limits. A wholesale price cap would be expected to use the regulatory capital value as the main mechanism for cost recovery, linked to RPI, as is currently the case.  However, Ofwat does not consider that a return on capital approach would be appropriate for setting retail price limits, because of the small asset base for retail services, and therefore a margin-based approach might be used in this instance.  Likewise, price reviews for asset intensive parts of the business might occur at intervals of longer than 5 years, whereas retail prices might be set for shorter periods.

Ofwat highlights the wider discretion granted to other sector regulators when they set price limits.

The paper contains an example of the proposed licence modifications, based upon the licence of a water only company.  The amended wording makes it clear that the link between a price cap (K) and an inflation index (whether RPI or some other index) may be appropriate only in particular circumstances.  The example also contains the consequential changes which would be required in respect of interim determinations, the substantial effects clause, and infrastructure charges – these do not appear to be significant.

At numerous points throughout the paper, Ofwat is at pains to emphasise that its proposed modifications should not result in an appreciable change in the regulatory risk of the sector, and do not undermine Ofwat’s commitment to a stable and transparent regulatory framework.

Notwithstanding Ofwat’s “Next Steps” section, in which is states, “If companies agree with the modification we are proposing, we will amend their licences……..”, it is difficult to see how the board of directors of a water company could accept amendments to that company’s licence, without first having sight of the specific wording proposed for that company.  Indeed, in accepting a modification in these circumstances, a director might be considered as acting in a manner contrary to his statutory and regulatory duties.

Furthermore, if these proposed modifications were to be regarded as having a material impact on a company (which seems likely to be the case), that might trigger consequences contained in financial covenants, including a need for consent from the covenantees.

Despite these objections to the manner in which Ofwat is seeking to obtain company consent under section 13, Ofwat aims to have matters resolved, including if necessary a Competition Commission referral and determination, by Autumn 2012.

The period for commenting on the proposed modifications ends on 29 February 2012.

Changes to freedom of information and data protection laws

The Protection of Freedoms Bill (PFB) is currently making its way though Parliament and is likely to be passed in 2012, amending the Freedom of Information Act 2000 (FoI).

FoI applies to public authorities named or within listed categories in Schedule 1 to FoI, but does not apply to water undertakers, nor does it apply to bodies owned by a combination of public authorities or a combination of public and private owners.

PFB will extend FoI to cover bodies owned by the wider public sector.  PFB does not define “the wider public sector”.  The Information Commissioner’s Office has stated that the term is unclear and requires legal clarity through a definition in the legislation.

Whilst “wider public sector” does not appear to include water companies, information disclosed to and held by such a body will be accessible under FoI, and companies should therefore remain mindful of this when releasing information to such bodies.

Data protection law is also about to receive a revamp.  The European Commission has developed a new data protection framework, which builds on the existing data protection principals.

Once adopted, the new law would apply directly to member states without the need for national legislation.

Some new principles will be introduced – for example, data minimisation will require personal data held by companies to be kept to a minimum; the requirements for showing that  a data subject has given consent to the use of his data will be tougher.

We may also see enhanced enforcement powers, alongside financial penalties of up to 5% of turnover in the event of breach.

UK businesses, including water companies, will need to revisit their data protection compliance policies, in order to ensure that the new requirements are adequately addressed.

Likely timescales for adoption and implementation of the new rules are lengthy, possibly two years away yet.