EFRA quizzes Sir Jon Cunliffe

Sir Jon Cunliffe was questioned last week by Environment, Food and Rural Affairs (EFRA) Committee members on both the Water Commission’s interim conclusions and his response to their report. Sir Jon explained that some major recommendations are still to be finally decided and that he is intending to undertake further limited consultation about some areas. He wants the Commission to deliver something definitive enough to begin to restore public confidence, and also recommendations for short-term, deliverable change.

He indicated that the restoration of public trust through improvements to companies’ performance and water asset health will take time, and that this needs to be explained to the public by Government. Public engagement could also be increased with better regional interaction which is absent in the current regulatory structure.

Sir Jon emphasised that it was the responsibility of Government to set high level water policy. In his view, policy had developed somewhat arbitrarily out of a strategic vacuum historically. There had been no milestones set and no prioritisation of desired outcomes, just a wish list.

On overlaps and gaps between regulators, he commented that merging regulators might not necessarily be the panacea that delivered better transparency. It might internalise tensions that would be better be arbitrated publicly.

He reiterated several times that government budgetary constraints meant that Government taking the whole sector back into public ownership, which several of the Committee members asked him to consider seriously, was an unrealistic and unaffordable option. He was careful to explain the important roles of debt and dividends in attracting capital to finance investment. He was also keen to examine the merits of different types of water ownership. He pointed out, as the Committee’s own report had done, that publicly-owned Scottish Water and not-for-profit Welsh Water had not delivered the best outcomes for customers in terms of asset resilience of performance respectively.

He considered change was needed to the regulatory regime to attract the appropriate type of long-term capital providers that look for a lower-risk, lower-return investment proposition. He questioned the effectiveness of Ofwat’s continued use of a notional company capital structure in setting bills, and suggested that Ofwat’s focus on delivering too low an assumed cost of capital, which had been highlighted by the National Audit Office, had produced a perverse incentive for companies to take on higher levels of debt to maximise returns.

The most significant underlying theme seemed to be that of adopting a supervisory model for water which, from his banking background, he seems to believe will be an improvement. Comparative regulation would remain, but according to to Sir Jon, there had to be a better understanding of the operational and financial risks and challenges of each company, rather than one-size-fits all use of econometric models. Supervisory powers needed to extend to all parts of a water group, including holding companies and so-called ‘midcos’, not just to the ring-fenced regulated utility.

He indicated that regulators should now have access to ever-increasing amounts of data that the companies receive from sensors on storm overflows or wastewater treatment plants, which should improve the quality of regulatory information. In his view, one of the problems is that assets are not properly mapped, particularly the private sewers that the industry adopted in 2011. He also shared that companies have not attended well to the emergency processes needed when assets fail and erode public trust.

Sir Jon was also somewhat sceptical about the efficacy of Outcome Delivery Incentives. Repeated penalties, he suggested, even for an improving company, simply prolong underperformance and do not reward progress. He seemed to be exploring recovery standards to break the cycle in which some companies find themselves.

Finally, he was questioned about leadership and culture in water companies. He highlighted the tension between penalising senior executives with the need to attract the highest quality of management with a wide range of experience. He questioned whether the new legislation banning bonuses for certain penalties is either the right incentive or correctly attached to the right events. Using bonuses or penalties across a wide spectrum of non-executive employees might not be appropriate either. He told the Committee that there are other levers to affect the behaviour and culture of senior managers, such as codes of conduct. A better combination of levers is needed that is more appropriate for a large public service industry.