Ofwat has set out its approach for approving the water companies’ charges to customers in England and Wales for 2015-16, together with details of data the companies will need to send to Ofwat as part of the process.

The water industry regulator said it recognised that the 3 October submissions were not the companies’ definitive views of their 2015-16 charges, as a number of factors will need to be updated – for example, the final revenue allowances in line with the final determinations, and November RPI.

Ofwat said:

“This is a crucial point in the price review process. The charges that companies set are those that customers face through the bills they receive, and that competing retailers face through the margin that they are to compete against. Poorly structured charges can lead to unacceptable fluctuations in bills, discrimination between customer types non-compliance with the revenue controls, and can potentially lead to cases of (illegal) margin squeeze.”

The companies’ Boards remain accountable for the assurance processes for the development of charges. However Ofwat has decided to set some additional requirements to help ensure that companies have undertaken suitable checks and balances as “it is clear in some cases from the draft set of charges that some companies have significant deficiencies with their charges schemes with less than four months to charging publication.”

Ofwat said it has taken a risk-based approach to assess how well developed the companies’ draft charging proposals were when they were provided alongside their draft determination representations on 3 October.

In order to identify the companies that must provide additional information and/or assurance, companies have been assigned to one of three ‘tiers’, with each tier required to provide a different level of assurance based on their 3 October charging submissions.

The first consists of companies where through Ofwat’s high-level assessment of their charging submission no material issues were identified. The second consists of those where Ofwat identified some fairly material issues, but consider these are likely to be addressed through a few relatively minor changes/additions. The third category consisted of companies that submitted charging information that contained some material and widespread issues. Where the issues are greater, Ofwat requires a greater level of assurance from companies in advance of approving their charges.

Commenting on the categorisations, Ofwat said:

“Our review of companies’ charges has not been definitive in scope and detail. For example, in many cases we have not checked the validity of the charging multipliers companies have proposed. This has simply not been possible in the timeframes available to us, and is not in keeping with a risk-based approach. So, it should not be taken for granted that even a company placed in tier 1 will necessarily comply with the price controls, competition law, and/or its other duties and obligations if its final proposals reflect the draft proposals that we have reviewed.”

As well as the 18 largest water and sewerage and water only companies, there are six ‘small companies’ – Cholderton & District Water and the five ‘new appointees’ that provide water and (or) sewerage services to a small number of customers.

Ofwat has historically taken different approaches to approving their charges because these companies are very much smaller than the 18 largest companies.  The regulator intends to continue with a lighter-touch risk-based approach for the small companies.

Next steps

Tier 3 companies must provide Ofwat with an update of how they are seeking to address each of the issues Ofwat has identified by 12 December 2015. From 12 December there will only be five weeks until companies will be required to submit their charges for approval. Ofwat said it expects the tier 3 companies to have made “substantial progress” in addressing the issues.

The 18 largest companies will need to provide the information by 16 January 2015 for Ofwat to approve their charges by the end of January ahead of publication on 2 February 2015.  Small companies will be required to send their statements of assurance by 6 February 2015, followed by Ofwat’s approval of small companies’ charges schemes on 13 February 2015.

Ofwat’s reasons for assigning companies to each category has flagged up some interesting areas where the regulator has identified risk levels associated with the individual AMP6 Business Plans. Bristol Water, Dee Valley and Portsmouth were all categorised at high risk in three of the following four areas which the companies were assessed against:

• Bill effects analysis
• Revenue compliance - wholesale
• Revenue compliance – household
• Revenue compliance – non- household

A number of the other companies were also assessed as being at risk against the criteria – with the regulator commenting in a number of instances that the reason for each individual decision suggested “a potential lack of understanding of the form of control.”  

From 2015-16, there will be a fundamental change in how companies develop their charges - Ofwat has moved from a single integrated control to four separate controls: wholesale (water and wastewater) controls and retail (household and non-household) controls. This supports the significant market reforms introduced by the Water Act 2014, which include introducing choice for all non-household customers in England from 2017.

In future years Ofwat does not expect to run a charging approvals process, as the approvals framework will be replaced by charging rules as a result of the Water Act 2014.

Click here to read Ofwat’s information and requirements for large and small companies