Ofwat has launched a new consultation on its proposed set of charges scheme rules that would apply to charges schemes from the 2016-17 charging period - which also includes early stage consultation on the regulator’s emerging thinking in relation to wholesale charging rules and special agreements.

The water industry regulator is seeking views on specific areas where it sees charging rules evolving next year and beyond. The Water Act 2014 made changes to the Water Industry Act 1991 that will allow the Water Services Regulation Authority (Ofwat) to set rules about charges schemes. From 1 November 2015 it will remove the requirement for the charges schemes of water companies to be ‘approved’ by Ofwat  instead, allowing the regulator to set charging rules which schemes must comply with.

The paper states:

“We consider that charging rules can play an important role in driving further efficiencies and enabling appropriate and effective use of markets. Charges that reflect appropriate costs send signals that will enable and incentivise the creation of value through efficiency. They will also send important information to market participants on whether to supply or not, whether to make or buy.”

Describing the proposed rules in the paper as ”the beginning of a journey”, Ofwat said the rules will evolve to reflect market developments and reflect the learning it obtains as new information becomes available to assess existing rules.

The proposed rules will apply to all water companies (including new appointees). The consultation is also seeking to provide stakeholders with a clear understanding of the direction that Ofwat sees charging rules developing over the next year—and how they relate to wholesale charges—and further in the future.

The regulator is not proposing to introduce fundamental changes to existing charging principles, given that 2016-17 will be the first charging year that companies must comply with charging rules, and that the rules will be issued relatively late in 2015.

In the spring of 2016 Ofwat will consult on a separate set of rules about wholesale charges –the paper sets out some of the proposals and issues currently under consideration. Following the consultation next year, the regulator will then set rules about wholesale charges to be in place for the further market opening in April 2017.

In addition to setting rules about charges schemes, the WA14 allows Ofwat to set charging rules in relation to other types of charges. For example, charges for retailers, for the provision of wholesale water and sewerage services by the water company; charges for upstream service providers, for the provision of access to the water company’s infrastructure.

As part of the consultation Ofwat is seeking views on how best can site area-based surface water drainage charges be adopted and what lessons can be learned from how companies have moved to this basis so far.  The paper says that some companies have already adopted an area-based component within their surface water drainage charges schemes. Ofwat says this more closely reflects the costs customers place on the system, as sites with large non-permeable areas cause greater levels of rainwater to drain into the system.

However, the regulator says it recognises that moving to area-based charges can cause significant incidence effects on bills if not managed carefully and effectively. UK Government guidance takes the view that the introduction of area-based charging “should not have an unduly negative impact on organisations that provide a wider benefit to society” . Ofwat says it is “currently not minded to set a requirement for non-household area-based charging for 2016-17” and is instead seeking views from the water and sewerage companies that have not yet adopted this approach to surface water drainage charging, on how best such an approach could be adopted.

According to the regulator, some companies apply reduced charges in an overly simplistic way by only allowing a reduced charge where they know that no surface water is draining from the property into the public sewer, commenting:

“We consider this binary approach to be inappropriate, and that companies should consider offering partial discounts should a customer be able to demonstrate that through installing sustainable drainage systems they have significantly reduced the amount of surface water that drains into the public sewer.”

Transparent surface water charges can lead to high amount of SUDS retrofitting

The consultation papers says customers can reduce their charges by making surfaces more permeable or installing soakaways, thereby reducing the volume of rainwater flowing into sewers, and consequently the costs that the company incurs. Ofwat  says this leads to lower bills to customers overall, puts more water back into the environment and may also delay or avoid the need for significant new capital schemes which could be expensive for customers and harmful for the environment.

The paper cites Germany as an example, where adopting transparent surface water drainage charges and subsidies has led to a high amount of retrofitting of sustainable drainage systems (SUDS), particularly green roofs and water reuse systems. In North-Rhine Westphalia, approximately six million square metres of surface area was disconnected from the sewer between 1996 and 2004.

Stable charges: Ofwat “currently minded” to retain 5% as threshold for a ‘significant’ bill increase

On stable charges, the consultation refers to the UK Government’s draft guidance which sets out the expectation that customers should not face disproportionate changes in charges year-to-year where usage does not change markedly.

For 2015-16 Ofwat required companies to undertake proportionate impact assessments and handling strategies whenever the nominal value of a customer bill was expected to increase by more than 5% from the previous year (for a given customer type assuming a constant level of consumption). The regulator is “currently minded to retain the 5% figure” as a threshold for a ‘significant’ bill increase and proportionate impact assessment – although it is still committed to keeping this threshold under review.

Predictability of charges

Outlining proposals for the predictability of charges, the consultation paper says it is important that charges are communicated in such a way that customers can have a reasonable idea of what their bill will be ahead of receiving it. As with previous years, Ofwat will set a requirement for charges schemes to be published ahead of the new charging year, with companies required to publish their charges scheme no later than the first working day of the February immediately preceding the charging year for which they have effect.

Ofwat minded to retain requirement for annual Board assurance

In recent years, Ofwat has approved companies’ charges schemes based on their Board’s assurance that their charges comply with their legal obligations. In future charges schemes will no longer require the regulator’s approval and will instead set rules for charges schemes and, where necessary, take action if companies then do not comply with them (ex post action).

However, Ofwat said it has found requiring companies’ Boards to provide assurance of their charges to be “a powerful tool for ensuring that Boards are engaged with their charges”, thus generating real company ownership of their responsibility to ensure that charges are fair and reasonable.

In view of this the consultation papers says “Ofwat is currently minded to retain a requirement for companies’ Boards to provide …an assurance statement each year, and for companies to publish their Board’s assurance statements, no later than the time they publish their charges schemes.”

The paper also says that despite the progressive shift in focus, which the new framework enables Ofwat to make, from ex ante regulation (where it checks compliance in advance), to ex post action, the regulator considers that there is still likely to be a benefit in companies submitting  a statement of any significant changes that they anticipate in their charges from one year to the next.

Ofwat is proposing to set a requirement for companies to provide a statement three weeks before publishing the charges schemes for the new charging year.

The statement will confirm whether the water company is expecting any changes to its charges scheme to result in a significant bill increase and, if it is, the size of the increase, the type of customers affected and what communication the company has had with the customer, and whether any assistance has been offered. The statement will also provide details of any significant changes in charging policy from the previous year.

Future developments and next steps

The draft rules proposed in the consultation, for implementation in 2016-17, are about charges schemes made under the Water Industry Act 1991 (WIA) and relate to charges for end users (retail customers). The Water Act 2014 also introduces powers for Ofwat to set charging rules in relation to other types of charges.

The consultation paper sets out future developments related to charging rules about wholesale charges.– the “access” charges made by water companies to providers of retail services to end-users.

Ofwat says the emphasis is in anticipation of the opening of the retail market to competition from April 2017 to all non-household customers of English water companies.

The regulator is planning to consult and set rules on wholesale charges next year – as well as any specific rules required to support the new interim supply code in the market – so that they are in place for the further opening of the market for retail services for non-household customers in England in April 2017. Ahead of that Ofwat intends to set rules about wholesale charges that retailers (licensees), including new entrants, will have to pay water companies in return for the provision of bundled wholesale water and wastewater services to support retail service provision.

The Water Act 2014 made changes to the Water Industry Act 1991 that will allow the Water Services Regulation Authority (Ofwat) to set rules about charges schemes. From 1 November 2015 it will remove the requirement for the charges schemes of water companies to be ‘approved’ by Ofwat  instead, allowing the regulator to set charging rules which schemes must comply with.

Deadline for responses to the consultation by 30 September 2015. Click here to download the consultation document.