Ofwat calls for a ‘guiding mind’ and stronger powers in its Cunliffe response

In its response to the Cunliffe Commission’s call for evidence, Ofwat has accepted water planning and regulation need to be reset, as well as company performance transformed, if public confidence is to be restored.

The regulator identified three key outcomes that the review should deliver: 

• Reform the strategic planning framework — “The current planning arrangements feature parallel processes, which lack effective strategic guidance, ownership and oversight. This has contributed to slow responses to critical challenges, such as reducing discharges from storm overflows and enabling major new water resources, and created the risk of favouring more expensive, and less environmentally friendly, solutions. We propose a new holistic, strategic planning function for government and regulators to more effectively and collaboratively enable better optioneering and decision making in developing coherent long-term strategic investment plans for the sector. It could build on learning in the energy sector with the National Grid Electricity System Operator (NESO) and give the water sector a ‘guiding mind’ to better plan its development.” 
  

  Ofwat said that around £300bn needs to be invested to deliver necessary outcomes over 25 years, which could take bills to £1,000 pre inflation or £2,000 post inflation. It argued: “It is vital that there is clear ownership over these plans, that the processes do not hold up vital investment and that they facilitate good decisions, so that customers' money is properly spent.”

  
  

• Make the regulatory landscape less complex and more predictable — Tackle gaps and overlaps, to establish clear responsibilities and defined roles. “We propose a package of changes that realign responsibilities across regulators and improve co-ordination across Government, regulators and companies.”

  
  

• Stronger economic regulation —  Ofwat welcomed the Government's proposed reform of regulation for major water projects in the water sector, citing Tideway success. It said: “Further reforms to streamline appeals to price controls and to strengthen our powers with respect to company financial resilience, alongside the reforms we are currently driving, would allow us to better protect customers' interests.”  

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Comment: A desire for more regulatory interference in companies’ finances 

by Verity Mitchell

Two very interesting aspects of Ofwat’s views on finance are revealed in addition to its contention that bills may need to rise to fund additional investment to over £1,000 by 2050, before inflation.

• The panacea of competitive tendering  Ofwat is continuing to press for more competitive tendering, as it claims this is the “only way to deliver 30 new major projects costing around £50bn to secure drinking water for one-third of England and Wales's population.” However, the cost of competitive procurement, without any form of government additional support, has yet to be proved to be demonstrably lower than that of conventional regulated utilities’ project costs. 
  

  Ofwat is keen to expand the Specified Infrastructure Projects Regulations so that there is greater flexibility to use competitive tendering. It claims: “This, alongside plans to extend the Direct Procurement for Customers model, is key to better delivering the increased amount of capital expenditure now required.” It confidently asserts that “competition can drive these costs down and facilitate innovation,” which rather implies that it no longer believes that its own comparative regulatory regime is able to achieve this for large projects. 

• Forcing companies to raise equity – more regulatory risk?

  Ofwat is continuing to explore how it can increase financial resilience post the price determinations announced in December. It says it wants a "proportionate, targeted strengthening of its oversight of companies' financial resilience". It wants to increase the level of corporate transparency through targeted supervision and place further requirements on companies' capital structures. This means it will demand more information about holding company structures and will intervene to strengthen liquidity requirements for companies. 

  
  

  Ofwat wants Special Administration to remain as a credible threat to incentivise companies to seek a market solution to poor financial resilience. However it suggests additional regulatory intervention, which the market may interpret as increased regulatory risk. It says it wants to be granted new powers to direct companies to raise equity as a means to address financeability issues and improve performance. It says that these powers may be an effective mechanism to encourage companies to engage early ahead of issues materialising and to put in place their own contingency plans for raising equity as it is required. 

  The companies, though, have already decided that Ofwat’s equity requirement estimates are too large for AMP8 and that their balance sheets will remain resilient with a higher level of gearing than Ofwat assumes. With new powers, investors may impute an even larger regulatory risk premium on the cost of capital than the extra 30 basis points added for PR24 to reflect Ofwat’s increasingly financially dirigiste aspirations.