In an Expert Focus article for Waterbriefing, Tom Sharpe QC discusses some of the issues about the water companies' options on deciding whether or not to appeal regulatory determinations in the run-up to the publication of Ofwat’s Final Decisions on the draft Business Plans in the 2019 Price Review.

A number of water companies will soon be faced with a decision to accept Ofwat’s determinations or appeal. Energy transmission determinations are on the near horizon. If a company is unhappy with its determination, should it appeal?

Over the last ten years there have been three water appeals, two brought by Bristol Water and one by Sutton and East Surrey, both small water-only companies. The first and last time a WASC appealed, was South West Water, in 1995.

The ED-RII01-FD appeals, involved Northern Power Grid and British Gas Trading. Northern Ireland produced no less than four energy appeals, Phoenix, Northern Ireland Electricity, Firmus Energy, and the System, Operator Northern Ireland (“SONI”), appeals.

There is therefore limited experience to go on.

The downsides – costs, time and projects put on hold

On the downside, first, most importantly, there is the diversion of senior management time which should never be underestimated. It is a very demanding process which can only be delegated so far. The CMA likes to hear from CEOs why a regulator has got it wrong and what the consequences would be if a determination is upheld. While the bulk of the process will be in the form of written submissions and technical meetings with the CMA staff, with limited interface with all the CMA panel members, the company’s case must be decided upon, endorsed and, above all, understood, by very senior management. They must be prepared to defend it in formal hearings.

Secondly, many projects will be put on hold pending the resolution.

Thirdly, there is the cost, in lawyers, accountants, economists and others, most of whom are essential to get the company’s case across persuasively.

The position is further complicated in water appeals. In energy network decisions parties can appeal on specific issues and face winning or losing on those issues. In water, the whole determination can be reopened not just those aspects a company does not like. So, even anything favourable is potentially at risk. This added uncertainty has undoubtedly influenced many water companies in their decision to appeal in the past; it is hard to justify asymmetric treatment between water and energy.

A balance therefore has to be struck between living with an imperfect but certain settlement, or appealing it with an unknown or imprecise idea of what might follow.

Any company considering an appeal starts one down

Any company thinking of appealing starts one down. The typical situation is where the utility regulator has spent months, or in the case of Northern Ireland, years, seeking to modify a licence to remedy some imagined deficiency. By definition, any attempt to ensure consent has failed. By the time the decision has been made, there is a good deal of material in existence, most of which, by definition, unhelpful to the company. Further, there are procedural problems in introducing new points or new evidence on appeal which could have been led earlier.

So, at the risk of understatement, the company starts from a position of disadvantage.

Battle ground in most price control appeals is “financeability”

The battle ground in most price control appeals lies in the notion of “financeability”, that the price control leaves insufficient revenue for an efficient undertaking to finance its functions. The Acts impose a duty on each regulator to secure that each company must be able efficiently to provide and finance its core licensed services.

In a slightly formulaic way, companies must advance arguments that the allowed revenues are too low and there are insufficient potential gains in efficiency to permit the proper financing of its functions and/or that the cost of capital is too low, inhibiting its ability to raise new money or reward old investment.

Arguments based on poor process and unfairness are seldom successful. This is not because regulators are models of regulatory propriety. It is more lack of CMA interest and, perhaps, more fundamentally, that breaches of good regulatory practice can seldom demonstrably lead to any material change in the determination.

Little can be learnt from past experience in regulatory appeals. It is the nature of appeals that several arguments will be made, some of which will be successful, some of which will not. No appeals have resulted in resounding victories for the companies. Arguably, the most significant appeal was Phoenix Natural Gas, where an attempt, retrospectively, to reduce the regulatory asset base was overturned. In this case, the Competition Commission (as it was) asserted the importance of stable regulatory expectations both to companies and to the capital markets. But most appeals are less dramatic than this.

In water appeals everything in theory is up for grabs

On the asymmetry between water appeals and energy ones, in water, in theory, everything is up for grabs and any calculation must take into account the possibility that new matters will emerge or matters which the regulator deemed settled can be reopened. This was the fate of South West Water in 1995, as it discovered to its cost. In practical terms, the appetite of the CMA to graze over every matter in a determination must be limited. But the possibility exists nevertheless and cannot be discounted.

Energy appeals are more disciplined - with no right to appeal

Energy appeals are more disciplined. First, there is no right to appeal: the CMA may refuse permission if there is no reasonable prospect of success. Secondly, the appellant must specify in points of appeal precisely where the regulator went wrong. Anything not challenged will stand. Thirdly, any party affected may appeal as may consumer bodies. In addition, undertakings which could appeal but decide not to appeal may nevertheless make representations to the CMA about the grounds of appeal of others. It can be a bit crowded.

This presents issues of case management on issues, for example, of preserving confidentiality. The CMA can control this process by not allowing some interveners to attend the hearings or restricting access to written submissions or by other means.

In energy, it is not an appeal on the merits but nor is it a narrow judicial review-type appeal based on “reasonableness”. It lies somewhere in between. There are situations where the CMA will cheerfully admit that it might have taken a different view to that of the regulator. But they say it is not their job to substitute their own judgment simply because it might have done something differently. The standard is not one of “reasonableness”; the test is whether the regulator went wrong by reference to the statutory tests; and mere error is not enough. It must be material to the decision impugned.

CMA appeals - very intensive experience but not to be frightened of if case is good enough

I am an admirer of the role of the CMA in this process: the quality of the people involved, and the depth with which they engage, is impressive, and I should add that if a company has something it wishes to hide, forget it, as in all probability it will be revealed. Appeal is particularly important if companies feel that the regulatory and political wind has turned against them.

The CMA is quite proud of its reputation for independence and has not been shy recently of criticising regulators’ shortcomings so, in the CMA, the dice is not loaded against the company.

Moreover, the process has become much more professional, transparent and disciplined, as well as being time-limited. It is a very intensive experience but not one to be frightened of if the case is good enough.

About the author: Thomas Sharpe QC has acted in most regulatory appeals in water, energy and communications, in the Competition and Markets Authority, and its predecessors, and in the High Court, since the first water appeal, South West Water in 1995, as well as in many UK and EU cartel, dominance and state aid cases in the UK and European Courts, including Albion Water. He practises at One Essex Court, Temple.