With PR19 in mind, water and sewerage undertakers will need to focus on the lessons from TMS’s experiences, particularly as regards setting ODIs, subcontracting and ongoing regulatory reporting.
The Water Services Regulation Authority (Ofwat) has issued a provisional decision to impose a penalty on Thames Water (TMS) for its failure to comply with its statutory duty under s.37 of the Water Industry Act 1991. This duty consists of the need maintain an efficient and economical system of water supply within its area in relation to its management of leakage during AMP6 (the current price review period). The penalty imposed is a nominal one as Ofwat has secured substantial undertakings from TMS to benefit its customers to compensate them directly for TMS’s failings. This update highlights a few of the more interesting points from Ofwat’s provisional decision, with particular reference to company business plans for PR19.
Breach of statutory duty
Historically breaches of statutory duty by water and sewerage undertakers have been very difficult to establish with any clarity. However, the introduction at PR14 of Performance Commitments and Outcome Delivery Incentives (ODIs) has resulted in companies being required to come up with clear performance figures in key areas for the purposes of rewards and penalties being applied. TMS’s leakage ODI had a ‘cap and collar’ as regards rewards and penalties. In this case, TMS’s leakage performance figures had fallen significantly below the ODI collar level. The leakage ODI collar was thus a clear benchmark against which Ofwat could assess general performance of TMS’s s.37 duty.
This is an extremely significant point for water and sewerage undertakers to take note of, as it demonstrates how Ofwat can use company performance against ODIs to not only penalise within the ODI itself. It can also, where performance is below that envisaged within the ODI, use the ODI framework as a benchmark to support a finding that the company has also breached its statutory duties under s.37 in relation to water or under s.94 in relation to sewerage.
Breach of licence conditions
Ofwat also found that TMS had breached conditions F6A.1 and F6A.2A of its licence. These are common across all water and sewerage undertakers and require them to:
- have adequate financial resources and facilities, management resources, systems of planning and internal control to enable it to carry out its regulated activities
- annually provide Ofwat with a certificate of adequacy covering these and to notify Ofwat as soon as they are aware that it might not be possible to repeat the certificate of adequacy.
TMS had outsourced its leakage management to its Alliance partners and sought to achieve its committed performance levels through the incentives it had in its contracts with those partners. Unfortunately, TMS’s Alliance arrangements did not bring about the necessary alignment of understanding and incentives required. TMS did not maintain close levels of oversight to identify and correct this, and there were deficiencies in TMS’s upward reporting, including consistently overly positive reporting (amber rather than red in RAG reports). Finally, when TMS did uncover the scale of the problem it then failed to reflect this in its certificate of adequacy and also failed to notify Ofwat of any issues between certificates being issued.
Ofwat’s provisional decision states that but for the undertakings given by TMS it would be facing a financial penalty of approximately £25m (approximately 3% of TMS applicable turnover). TMS's significant package of undertakings includes bill reductions for customers, increased spending on leakage management, monthly leakage performance reporting, further engagement with customers, independent monitoring of leakage performance, additional Board level scrutiny and independent detailed auditing of TMS’s Condition F certificates in future. As a result of these undertakings, Ofwat’s proposed fine is reduced from approximately £25m to a nominal penalty of £1. This is consistent with Ofwat's drive to secure real benefits for water and sewerage undertakers' customers where possible rather than impose financial penalties which go directly to the consolidated fund.
There are two significant legal messages to take from this decision. Firstly, particularly with PR19 in mind, ODI performance levels provide a benchmark against which it is much easier for Ofwat to assess whether water and sewerage companies are in breach of their statutory duties. This matter related to the water supply system duty under s.37 Water Industry Act 1991, but the same applies in relation to the sewerage system duty under s.94 Water Industry Act 1991. Secondly, Ofwat expects transparency from the companies it regulates and has demonstrated that it has the regulatory tools to enforce this. Companies would be wise to err on the side of over-communication rather than under-communication about potential issues.