Ofwat is predicting further growth both in terms of turnover and customer numbers in the competitive new appointments and variations market.

The water sector regulator was commenting in a new consultation paper setting out changes Ofwat is proposing to make to how it monitors the performance of new appointees.

The New Appointments and Variations (NAVs) market is for limited companies which provide a water and/or sewerage service to customers in an area which was previously provided by an incumbent monopoly provider.

A new appointment is made when a limited company is appointed by Ofwat to provide water and/or sewerage services for a specific geographic area which has the same duties and responsibilities as the previous statutory water company. A variation is where an existing appointed company (appointee) asks Ofwat to vary its appointment so it can extend the areas it provides services to.

“We have seen rapid growth in the number of new appointments and variations"

Commenting in the consultation paper, Ofwat said:

“We have seen rapid growth in the number of new appointments and variations in recent years since 2017….

“From an average of 3-4 per year over 1997 to 2007, we have since granted 28 new appointments or variations in 2018, 53 in 2019 and 71 in 2020.

“As of 31 March 2020, there were eight new appointees serving 97 sites with a total of around 42,000 residential properties and 1,000 business properties according to the 2019-20 small company returns as submitted by new appointees.”

Ofwat said this equates to around 100,000 individuals being served by new appointees in England and Wales. The regulated turnover of new appointees has also risen as existing sites have expanded and new sites have been granted.

“Based on the number of variations we have made over the last year, we expect further growth in turnover and customer numbers in the near future,” the paper says.

Ofwat described the proposed new appointments and variations framework as “consistent with (its) wider approach to promoting the targeted use of markets to benefit customers."

Currently, the incumbent regulated water companies publish annual performance reports which include their regulatory accounts, their service performance and information required to reconcile the price controls Ofwat set for them at previous price reviews. Due to their smaller size, and because they are not subject to full price controls, new appointees instead submit a ‘small company return’.

Since 2016, the threshold below which companies are to provide a small company return is £10.2 million in annual turnover. However, some new appointees are expected to overtake this threshold in the coming years leading to full reporting requirements which are “unlikely to be appropriate or proportionate,” the paper says.

Ofwat is now proposing to bring in changes to its existing approach to how it monitors the NAV appointees and to the annual reporting requirements for for new appointees. This includes the information it collects about the financial positions and levels of service delivered by new appointees through the small company return.

The regulator has already brought in a number of changes which will be implemented this year, including the new data new appointees will be required to publish on their websites from July 2021:

• their small company returns in an accessible format;
• a set of financial accounts to a March year end;
• a customer-focused performance summary, to include as a minimum narrative on how the company has complied with the ‘no worse off’ principle and a summary of incidentsand payments made to customers under the statutory guaranteed standards scheme;
• site-specific leakage and per capita consumption data; and
• a statement confirming that the company maintains sufficient financial security.

Commenting on the proposals to evolve its existing approach, Ofwat said its principal objectives are to:

• satisfy itself that new appointees are sufficiently resilient in the round;
• ensure the delivery of good levels of service for the customers of new appointees and that there is compliance with the ‘no worse off’ principle it uses when granting newappointments and variations; and
• ensure that Ofwat’s regulation of, and interactions with, new appointees are proportionate to the risks to customers and size of new appointees.

Ofwat said it would “also look to reduce regulatory burdens where possible, for example by incorporating existing information that new appointees already collect and hold to minimise additional burdens on new appointees.”

Changes to the annual reporting process may also create opportunities to further reduce regulatory burdens and interactions in the medium term, such as in the licensing process, the paper says.

The regulator added that improved visibility of financial, cost and service data should also help to better evaluate and unlock the benefits of new appointments and variations – including when Ofwat designs policies to support the new connections market and develop its approach to future price reviews for large incumbent companies.

Prior to the rise in the quantity of new appointments and variations in recent years, this information has been relatively high level to minimise the regulatory burden on new appointees, reflecting their size and the relatively low risk to customers.

However, according to the regulator:

“Due to the success of the new appointments and variations market leading to rapid growth in the size of some new appointees, and our strategic focus on transforming water companies’ performance, we consider it necessary to review this approach.

“If we do not change our approach, there is a risk that the largest new appointees become subject to full reporting requirements which are unlikely to be appropriate or proportionate.”

Ofwat proposals include new tier system

The consultation paper sets out a number of changes Ofwat is proposing to make, including:

• Introduction of ‘tiers’ whereby the smallest new appointees would have fewer reporting requirements than larger new appointees
• A single consolidated annual performance report, bringing together existing materials and information that new appointees already collect e.g. data required for financial reporting and other relevant metrics that reflect the new appointee’s underlying performance. This could also include relevant measures reported to other regulators e.g. Environment Agency and Drinking Water Inspectorate
• For larger new appointees, and those that provide services beyond the ‘last mile’, a much wider range of metrics, notably in relation to relevant aspects of service delivery
• Removal of the existing £10.2 million small company threshold
• Specifying that small company reporting requirements will apply to all companies where condition B of their licence is suspended - which is currently the case for all new appointees

The thresholds between tiers would be based on an objective metric such as annual turnover or the number of properties connected. Ofwat’s initial view is to introduce two tiers with a threshold of £5 million in annual turnover – this would initially lead to two new appointees in the ‘higher tier’ and six in the ‘lower tier’ based on 2019-20 data. The consultation is seeking stakeholders’ views on how many tiers should exist and how the thresholds between tiers should be defined

In addition to the low visibility of the quality of retail services provided to end customers, the paper says stakeholders currently also have limited sight of the asset health and resilience of the wholesale assets operated by new appointees (principally their on-site networks, although some new appointees operate non-infrastructure assets such as treatment works).

Ofwat is proposing that because the costs of on-site maintenance and replacement are likely to increase over time, there is now a need to have greater visibility of the health and ongoing maintenance of on-site assets operated by new appointees.

The paper also sets out key service areas which Ofwat is proposing that new appointees report against, including:

• customer service;
• affordability and vulnerability;
• operational performance;
• asset health and resilience; and
• the environment.

The paper explains that new appointments and variations can help the regulator to deliver its strategic goals and that by continuing to examine ways to evolve the market,Ofwat aims to:

• transform companies’ performance – by facilitating effective monitoring and enabling the development of markets where they can bring the biggest benefits to customers,supporting greater innovation and better value for money for customers;
• meet long-term challenges – by promoting collaboration and partnership between stakeholders, supporting improved sustainability and the delivery of environmental andnature-based solutions;
• provide greater public value – by holding companies to account for the services they deliver, encouraging better value for money and that all market participants deliver more for customers, society and the environment.

According to Ofwat, the new framework has the potential to improve resilience, innovation, and the sustainable and efficient use of water resources and wastewater systems. It should also support key priorities relating to housebuilding and sustainable development. 

An effective approach to monitoring the performance of new appointees should also ensure that customers, including those in vulnerable circumstances, are protected and facilitate rising performance standards across the sector.

Deadline to submit responses to the consultation is 26 April 2021 – click here to download the consultation paper.