Water Bill

Viscount Hanworth Excerpts

Tuesday 25th March 2014 Lords Chamber

There is a pretty substantial public interest in the totality of the behaviour, financing and structure of the water companies. It attracts particular attention around the time of the price review, but it is there the whole time, and it is not currently reflected in the regulatory framework and practices. This amendment would allow issues such as dividend policy, the structure of decision-making within the companies and their taxation requirements, as well as broader corporate social responsibility, to be taken into account by Ofwat when setting the price review. Ofwat would probably rarely use that power significantly to change the price review, but if it needed to, it could. At the moment, I do not see that it can. The public, certain elements of the media and consumers in general all have an interest in this, and I think Parliament should too. I do not think that water companies have yet been effectively called to account, by either the parliamentary process or the regulatory process. This relatively straightforward amendment would at least allow Ofwat the possibility of so doing. I beg to move.

[Viscount Hanworth (Lab)]

My Lords, I support the amendment of my noble friend Lord Whitty. The privatisation of the UK water industry occurred as long ago as the late 1980s, and it was accomplished in a fashion and manner that paid scant attention to the need for an attentive regulation of the industry.

A provision for the public regulation of privatised industries was an integral part of the concept of privatisation but, in many cases, only lip service has been paid to this aspect. The light-touch regulation of the water industry has provided a case in point. It is arguable that, had there been a more active regulation of the industry, it would be in far better shape than it is at present. An active regulator might have prevented the firms of the industry from becoming the pawns in financial manipulations of foreign owners that have had the motive solely of private enrichment.

The firms have been used as tools in strategies of leveraged corporate acquisitions and takeovers that have borne no relation to the ostensible purposes of the industry. The investments in the water industry have fallen short of what they might have been if the profits had been ploughed back. Instead, they have been used to pay large dividends to the owners and to the shareholders.

Finally, it is questionable whether the majority of the firms in the water industry have any clear concept of their social responsibilities. A full provision of information is required to enable interested parties, including the Secretary of State, to assess the performance of the industry. Then steps could be taken to redress the abuses that have occurred in the past and that are liable to occur when there is insufficient regulation. That is what the amendment calls for.

I hope that the Government will be able to accept the amendment. There used to be the so-called “June review” which was assembled by the regulator, Ofwat, but it has since fallen into abeyance, as we have heard. The amendment would reinstate that review, but it would give it more force and it would ensure that it could not fall into abeyance in the future.

[Lord De Mauley]

My Lords, I thank the noble Lord, Lord Whitty, for moving his amendment. We have heard about asking water companies for information, much if not all of which is already freely available in their annual reports and accounts. I have said before that the amendment would, to that extent, simply duplicate existing powers.

What we are really talking about is Ofwat’s ability to examine what companies are doing to ensure that they are not profiteering at the expense of their customers. Although I disagree with the amendment before us, I most certainly agree with the principle that water companies must be effectively regulated. I believe that the regulator is doing its job robustly.

The focus of the amendment is, in particular, on reopening a price review. In fact, Ofwat already has the power to reopen the price review in two ways. It can do this under the “substantial effects” clause of a water company’s licence or by making an interim determination. It is clear that Ofwat has the power to revisit price determinations, if it so wishes. In fact, in October last year, Ofwat consulted on whether or not it would be right to utilise this power with respect to Thames Water. However, given the fundamental importance of regulatory stability in the water sector, it rightly utilises these powers with caution. Ofwat considers carefully whether any intervention it might make would be in the overall interests of customers.

Of course, it must be right that Ofwat does this with the bigger picture of stable economic regulation firmly in mind. The objective of setting prices for a five-year cycle is to create a period of stability during which companies are able to invest and deliver the outcomes that they have agreed with the regulator. They have a period during which they are allowed to receive the benefits of that settlement and then, at the end of the period, prices are adjusted to capture those benefits for customers.

That is what is currently taking place through the price review process. Ofwat believes that by taking account of the current low cost of borrowing it will be able to limit price increases from 2015 to 2020 by between £4 and £25 a year. Accordingly, I am unable to see what purpose the proposed annual returns will fulfil. We should look to the future and look at what Ofwat is doing. Let us be clear about the direction of regulation in the water sector. Ofwat is already taking action to improve standards of corporate governance across the sector. It is putting pressure on water companies to strengthen audit arrangements, board member appointments and governance. Ofwat recently published new principles relating to board leadership, transparency and corporate governance. These set out clear standards for the sector and a clear timetable for their introduction. The response from the water companies has been positive and I welcome this. Ofwat is also consulting on principles for holding companies covering risk, transparency and long-term planning. It has made it clear that the companies’ licences may need to be brought up to date to reflect these reforms and it is already discussing this with the companies. Further reporting burdens will not contribute positively to this process. I hope that the noble Lord will agree to withdraw his amendment.

Water Bill

Viscount Hanworth Excerpts

Thursday 6th February 2014 Lords Chamber

[Viscount Hanworth (Lab)]

My Lords, as I had occasion to remark at Second Reading, some water companies have been making exorbitant profits on the back of the rather generous tariffs that have been allowed by Ofwat. Whereas consumers were once able to disregard the cost of their water usage, it can now be a significant item in their budgets, to the extent that those in poverty may struggle to pay their bills. I have also indicated that the revenues of the water companies have often been used by the owners of those companies for purposes quite unrelated to those of the industry, when they should be used to cover operating costs and the costs of investing in capital infrastructure.

This amendment seeks to ensure that consumers will be adequately informed of the details of tariffs and that they will be properly alerted to any schemes that are available for mitigating the costs when they prove hard to bear. The amendment can also be seen in the context of the various schemes that have been proposed that would alert consumers to their current water usage. This amendment and the one that follows it seek to cast further light on the costs and revenues of the water companies, which continue to be opaque, to say the least.

[Lord De Mauley]

My Lords, I thank the noble Lord, Lord Grantchester, for introducing Amendment 118, which, as he said, would insert a new clause into the Bill to place a legal requirement on water companies to include information on their bills about the Water Sure scheme. The scheme provides a mandatory safety net for low-income customers on a meter who, for reasons of ill health or because they have a large family, use larger than average amounts of water. It caps the bills of these households at the average for their company area.

The eligibility criteria for Water Sure are twofold: the household must be in receipt of a relevant low-income benefit and must have three or more dependent children living at home or someone with an illness that necessitates high water use. It is unfortunately a feature of all means-tested benefits of this sort that take-up, as the noble Lord mentioned, can fail to match eligibility. That is why promotion of the scheme is so important. I am pleased to be able to tell the noble Lord that all water companies already voluntarily provide information about Water Sure on their bills.

In addition, Amendment 118 would require all water companies to provide information about tariff structures and the lowest available tariff. This is not the energy sector—water companies do not have complex tariff structures. In fact, the situation is quite the reverse. The choice for the majority of household customers is between paying according to volume of water used—a metered tariff—or according to the rateable value of their home. All water companies provide information on household customer bills about how to get a meter fitted free of charge. Companies also provide advice to customers on whether or not they might benefit financially from the installation of a meter; a role also performed by the Consumer Council for Water. The cheapest option for each household will depend on the location of the property and the amount of water used by the household. Where a company offers a social tariff, information on whether a household may qualify is provided by the company alongside the customer bill. The Consumer Council for Water works closely with each water company on the information provided on household bills to ensure that customer interests are met. Its very practical advice is that customers are likely to be put off by too much information in their bills.

For these reasons, I cannot agree that customers will be best served by placing an increasing number of legal requirements on water companies to include additional information on customer bills. I believe that the current approach of working in partnership with the body responsible for representing the interests of customers is more likely to be effective. I therefore hope that I can persuade the noble Lord to withdraw his amendment.

Water Bill

Viscount Hanworth Excerpts

Tuesday 4th February 2014 Lords Chamber

Moved by

[Viscount Hanworth]

2: Clause 1, page 2, line 13, at end insert—
“(8) The Secretary of State shall, following consultation, issue rules for the designation of the market operator for the retail non household market, setting out the procedures, responsibilities, status and governance of such market operator.”

[Viscount Hanworth (Lab)]

My Lords, I also thank the noble Lord, Lord De Mauley, for his very helpful approach in informing some of us of the intricacies of the Bill. This is a probing amendment, designed to throw some light on the arrangements regarding the so-called market operator. An electronic search of the Bill fails to reveal a single instance of the words “market operator”. We have been alerted to the intention to create this entity by an organisational flowchart entitled “How Will it All Work?”. This was provided by Defra officials in the course of a seminar that preceded the introduction of the Bill to this House. The words are to be found within a centrally located box that is connected to boxes labelled “the regulator”, “the retailers” and “the wholesalers”. I tend to view such charts from the perspective of the circuit diagrams of electrical engineering, hence I have anxieties about the dangers of short-circuiting or worse. This flowchart contravenes all the rules of electrical safety.

There was nothing in the document presented at the seminar to inform us of the role of the market operator. However, one noticed that the top left-hand corners of its pages were stamped with the logo of an organisation called Open Water. We have been told that Open Water is a programme created to support the Government’s vision for the future of water management in England and that it is to be steered by a high-level group consisting of representatives of Defra, the Scottish Government, the Welsh Government, customers, Ofwat, the Water Commission for Scotland and the water companies. Only Uncle Tom Cobbleigh is missing from the list.

An immediate question is whether this organisation is real or a mere fiction. One way of substantiating the existence of an organisation is to look for its website. The website of Open Water is readily accessible but an examination of what is there only adds to the doubts and confusion. One prominent item on the site is a question and answer file that purports to be an interview, in real time, with the programme director, Keith Fowler. It is clearly nothing of the sort and this assertion is notwithstanding the fact that the document ends by expressing thanks to Keith Fowler for “talking to us today”. I had not previously encountered this kind of bamboozlement.

A somewhat more informative document, available at this website, is titled Market Operator Target Operating Model. This purports to tell us what the market operator will and will not do. However, in places the document is curiously self-contradictory. Thus it is stated that the market operator,

“should carry out monitoring and reporting of market code compliance”,

and have delegated authority to issue,

“warnings and … financial and non-financial penalties”.

It is also stated, in a seeming contradiction, that:

“Enforcement of significant market issues should not be performed by the”,

market operator, and it is said, in an oddly confusing manner, that, if needs be, the market operator,

“should administer, but not arbitrate on, market disputes”.

Clearly, there is need for some clarification here, which is what the amendment seeks.

A further issue that needs to be clarified concerns the steering of a market operator, and its relationship to Open Water. We learn from the aforementioned document that the market operator,

“should be a company limited by guarantee”,

that will be owned and paid for by the water companies, that its set-up costs should be paid for by the wholesalers and that its running costs should be split between wholesalers,

“incumbent retailers, new entrant retailers and self-supply customers”.

A danger that may arise and that needs to be guarded against is that of regulatory capture, a process by which regulatory agencies eventually come to be dominated by the very industries that they have been charged with regulating. The terminology originated in the United States, where it has been used to describe how the intentions of the federal Government have been widely subverted. Aspersions of regulatory capture have already been made against Ofwat; we need assurances from the Minister that the Government are aware of such dangers and will take steps to avert them. I beg to move.

[The Earl of Selborne (Con)]

My Lords, I declare my interests, as I did at Second Reading, that, like the Minister, I am a farmer with an abstraction licence, although I have not been flooded—so to that extent, I do not claim the same interests.

The amendment would require Ministers to issue rules for the,

“designation of … procedures, responsibilities, status and governance”,

of a market operator. I cannot believe that such ministerial control would assist in the implementation of a successful market. In regulated utility industries, whether energy, communications or water and sewerage, the management and control of market operations is initially the responsibility of the regulator, working alongside the industry. Once the market is up and running, it becomes the responsibility of the industry, supported of course by the oversight of the regulator, which provides the framework. This approach helps to ensure that the regulator and the industry work together; the industry will need to adapt to innovation and new circumstances. We recognise that in this Bill we are promoting innovation and we have to ensure that the regulation adapts accordingly. The industry will need to adapt to innovation and these new circumstances, and it is for the regulator and industry to ensure that working practices are aligned in the regulatory framework that we are establishing in the Bill. I simply do not believe that it would be helpful to have a politician—the Minister of the day, of any party—fulfilling the role of controlling the market operator in this far-reaching way.

--- Later in debate ---

[Baroness Northover (LD)]

My Lords, I have no interests to declare except as a frequent user of water and sanitary facilities and, therefore, I am extremely grateful that we do, indeed, have both.

Amendment 2, moved by the noble Viscount, Lord Hanworth, seeks further clarification about the market operator. At his request, I will do my best to be clear and not add to the bamboozlement that he referred to. I say to my noble friend Lady Parminter that we are very grateful to the Delegated Powers and Regulatory Reform Committee for its careful consideration of the Bill. We will respond in due course and make sure that noble Lords receive a copy of the Government’s response.

I am most grateful to the noble Viscount, Lord Hanworth, and to my noble friend for tabling their respective amendments and thus for giving me the opportunity to discuss the market operator, clarify its role and purpose and, I hope, set their minds at rest about any concerns they may have. The market operator will be a company limited by guarantee that will initially be set up by Ofwat. Incumbent water companies and licensees that will operate in the competitive market will own and manage the market operator. As noble Lords will know, Ofwat is accountable to Parliament and has a primary statutory duty to protect customers as well as powers to take action against anti-competitive behaviour under the Competition Act. Ofwat will oversee the overall operation of the market and ensure that it is working in the interests of customers, with powers to intervene if the market operator were acting in any way that was anti-competitive. For example, Ofwat could take action against the market operator under the Competition Act 1998 if its activities were disadvantaging customers.

I should make it very clear that the market operator is solely a facilitator with an entirely administrative role. Despite what the noble Viscount, Lord Hanworth, said, it is not a regulator. The market operator will hold a register of premises eligible to switch. It will also facilitate switching and financial settlement between incumbent water companies and licensees. Ofwat will be involved in developing the licence conditions that will set out how licensees and incumbent water companies must interact with the market operator. Market codes may also be used to set out some aspects of these arrangements. The market operator does not in itself have any formal statutory roles.

Looking somewhat wider than the Bill—I see that the noble Viscount, Lord Hanworth, looks perplexed—I hope that the following remarks may be helpful. There are other examples of such companies set up in retail markets—for example, in the gas and electricity retail markets. Perhaps the noble Viscount needs to look at some other 60-page documents in relation to other utilities. The Metering Point Administration Service company administers switching in the UK electricity market and Xoserve does the same for gas. These are not exactly household names because they do not come into contact with the public. They are private companies set up for and by participants in regulated markets to operate silently in the background. None of these companies was established under statute and none has had its respective remit set out in legislation or by the Government.

The water industry and regulators have already set up a company limited by guarantee called Open Water Market Ltd. The noble Viscount has clearly done a lot of research on this matter. The company will initially be a vehicle to take forward the delivery of the Open Water programme, which is establishing the retail market on behalf of the Government, Ofwat and the industry. A decision will be made in the coming months on whether this company or another one will be established as the market operator for the retail market that goes live in April 2017.

The market operator will be governed by its articles of association and will be accountable to its members, which will be the incumbents and licensees that it serves. As a limited company, it will be subject to the provisions of the Companies Act 2006 and will have to prepare accounts and reports in accordance with that Act. Decisions will have to be made in the future on whether the retail market operator or another body should operate in the upstream market. If there were to be an upstream market operator it would not have roles around the inputting of water or withdrawals of sewage that would properly fall to the Drinking Water Inspectorate or the Environment Agency. The market operator’s role is likely to be limited to registering arrangements and verifying quantities of water input and consumed to facilitate financial settlement arrangements. An example of such a market operator in energy is Elexon, which facilitates settlements for the electricity generation market.

I shall comment on a point made by my noble friend Lady Parminter about market codes being subject to the affirmative procedure and explain that market codes will not be subject to any parliamentary procedure. The regulations under Clause 12 are subject to the affirmative procedure and these codes will be subject to consultation. If my noble friend needs further clarification we can provide that.

Coming back to the issue of what the market operator is, I conclude by saying that the market operator will not have any statutory roles, duties or responsibilities within the retail market of the sort that would need to be set out in regulations. I hope that I have clarified that. It will handle routine transactions and communications between incumbents and licensees to help them to meet their statutory and regulatory obligations, as prescribed by legislation, codes and their licences. The market operator will not take over any responsibilities that properly belong with the incumbents, licensees or regulators. I hope that I have provided some elucidation to noble Lords. Obviously we would be happy to provide any further elucidation that is required. In the mean time, I hope that the noble Viscount will be content to withdraw his amendment.

[Viscount Hanworth]

I thank the Minister for that explanation. She has told us that the market operator is intended to operate silently in the background but I am not sure that that justifies the complete silence of the documentation we have received about the market operator. This is a fundamental part of the architecture of the water industry as it is intended to evolve so the lack of any mention of it in the principal documents is extraordinary. I have made that point rather forcefully but I shall withdraw the amendment as it is a probing amendment. I hope that others will also voice an opinion about the extraordinary lacuna that we have in the documentation if not in the legislation. I beg leave to withdraw the amendment.

Amendment 2 withdrawn.

Water Bill

Viscount Hanworth Excerpts

Monday 27th January 2014 Lords Chamber

[Viscount Hanworth (Lab)]

My Lords, I should like to talk about the financial circumstances of our water companies, but first I must describe some of their recent history and its relevance to their prospects.

From the middle of the 19th century for a period of 100 years, the water utilities in the UK and elsewhere became progressively concentrated under public and municipal ownership. Then, in the UK in 1989, the process was reversed through privatisation. Now the UK water utilities are owned almost entirely by private profit-seeking firms, of which the majority are in foreign ownership. The motives for privatisation in the UK and elsewhere were both ideological and fiscal. By the late 1980s, the water utilities were in a parlous state. Successive Governments, who had been intent on limiting public expenditure, had been unwilling to afford the necessary capital expenditure that was required for maintaining the water network. The water mains were corroded and the sewerage system was in a state of collapse.

The effect of privatisation was to release the water industry from this burden of financial stringency and to allow it to fund its investment by borrowing from the financial markets. Soon, the beneficial effects of the increased capital funding became evident. There were significant improvements in the state of repair of the water network, and the cleanliness of our rivers and beaches began to approach the standards that had been mandated by European legislation. In the six years after privatisation, the companies invested £17 billion, compared with the £9.3 billion that had been invested in the six years before privatisation.

The proponents of privatisation regarded the improvements as a validation of their philosophy. However, the improvements were at a cost to the consumers. Tariffs increased by 46% in real terms during the first nine years after privatisation. Operating profits increased by 142% in the first eight years, which is to say that they more than doubled. The private profitability of the water industry has increased in the ensuing years and has reached astonishing levels, but now there is an impending crisis in the provision of the services. Our water supplies are coming under increasing pressure as a result of a growing population and a changing climate. The summer droughts and the winter inundations that have been experienced in recent years are set to become increasingly severe.

The necessary investments to meet this crisis have not been forthcoming and the Government no longer have the power to compel the private companies to meet the needs. It is only by dint of increasing investment in the water infrastructure that the resulting problems can be alleviated. The requirement is for a nationwide strategic initiative aimed at upgrading the infrastructure, and this is what we should expect from a water Bill. The current Bill falls far short of what is required. It seems to embody the delusions of the protagonists of privatisation.

The intention of the Bill is to address the emerging problems by creating a competitive environment in which the water companies can operate. Thus it has been asserted in a document of the Department for Environment, Food and Rural Affairs that:

“Allowing more competition in the sector will drive forward both innovation and efficiency, by bringing in new players and new ways of thinking, and by using market forces to keep down customer costs”.

The hope is that:

“This will benefit not only customers and stimulate growth, but will also contribute to our future resilience and the environment”.

This prescription must be utterly bemusing to anyone who is mindful of the circumstances of a natural monopoly. It is as if by tinkering at the edges of the industry, the major demographic and climatic problems that we face can be addressed.

It is appropriate, at this point, to examine what has happened to the ownership of the industry since it was privatised, and to explain why the Government can have little influence over its investment decisions. The firms of the water industry have become vehicles for financial profit-seeking by owners who have used their guaranteed profitability to pay exorbitant dividends to themselves. In fact, the ultimate ownership of the firms is often obscure and has to be traced through hierarchies of holding companies back to private equity companies, which often reside in offshore tax havens, or to sovereign wealth funds. The tenure of ownership is often fleeting—five years being a typical duration.

The owners have used the equity of the water companies as a means towards some highly leveraged borrowing of funds that can be used for purposes that have nothing whatever to do with the financing of investment in the infrastructure of the water industry. The attraction of the water companies to the financiers has been on account of the highly assured income streams that they generate. There is no likelihood of a reduction in the demand for water, and some generously remunerative water tariffs are fixed for five-year periods by the regulator Ofwat. Such circumstances are liable to lead to favourable appraisals by the credit rating agencies, which enable the borrowing of funds at low rates of interest.

As a result of their borrowings, the leverage ratios of the water companies, which are the ratios of their total borrowings to the enterprise value—which is the sum of the borrowings and the equity capital—have reached astronomical levels. It is reported, for example, that the leverage ratio of Thames Water reached 80% in 2013; and figures as high as 95% have been reported for other companies. On the eve of privatisation, virtually all the enterprise value of the water companies was in equity capital, which is to say that their leverage ratios were close to zero. A high leverage ratio constitutes a significant tax advantage. It implies that the debt servicing of the company is predominantly via interest payments as opposed to dividend payments. Interest payments are regarded as part of the operating costs of the company and are deducted from the income before the residue is taxed. By contrast, dividend payments enter into the calculation of the tax liabilities.

A disadvantage of a heightened leverage ratio is that it is liable to prejudice the credit rating of the company. Given that variations in the size of the dividend payments can provide a significant buffer in the event of a loss of profitability, the financial vulnerability of a highly leveraged company is increased and, therefore, its ability to borrow is decreased. In consequence of its heightened leverage ratio, Thames Water is facing financial difficulties and cannot borrow the money it needs to finance the Thames Tunnel project. As a private equity company it is unwilling to raise more equity, since this would entail a loss of control in favour of the shareholders. Instead, it is asking for help from the Government.

This may be the first of a series of similar circumstances affecting our water companies. Companies will have difficulty in financing other similar investment projects that will be vital to our future environmental security or resilience, as the Government’s documents term it. Therefore, it is probably inevitable that the Government will have to provide the necessary funds. This should also provide the Government with an opportunity to restore the water utilities to some degree of public or municipal ownership and control.

There is one outstanding example of what can be achieved by the appropriate governance of a water company: Welsh Water, which is run as a not-for-profit company. It was bought from its owners in 2000 at a cut price when it got into financial difficulties through an ill advised programme of diverse acquisitions. The buyers were a group of former industry executives and public servants, and their leveraged buyout was financed entirely by debt. Since this acquisition, the performance of the company has been outstanding. Its surpluses have been invested in the network and have been used to augment the company’s financial reserves. Shares have not been issued but the ratio of the company’s debts to its total asset value has fallen from 93% to 65%, thereby giving it the best credit rating in the entire UK utilities sector. This is a model of responsible ownership and governance that could be replicated throughout the water industry.

Thames Tunnel

Viscount Hanworth Excerpts

Monday 18th July 2011 Lords Chamber

[Lord Henley]

My Lords, that is exactly what Thames Water is proposing in the plans. That is why it wants to consult on them and why it will have to go through the planning process in due course. At the end of that planning process we hope that it will be able to produce the right tunnel, in the right place, that will produce the right benefits.

[Viscount Hanworth]

In the 1960s when we were digging the Victoria line tunnel I remember that we caused minimal disruption around London and that the spoil was carried away directly. Can the Minister tell us why this cannot happen in the case of the Thames Tunnel when there is an easy way of carrying the spoil away—by the river?

[Lord Henley]

Again, it is a matter for the planning process and planning authorities to propose what conditions they think appropriate to impose on Thames Water. Since it is proposed at the moment that the tunnel should follow the river down, I would have thought it might be possible to have a lot of the access points close to the river. It should therefore be possible. However, it is not a matter for Government but for the planning process to consider using the river, rather than roads, for disposal of that spoil.