Appearing before the House of Lords Industry and Regulators Committee last week, Environmental Audit Committee Chair Rt. Hon Phillip Dunne MP questioned the effectiveness of water sector regulators Ofwat and the Environment Agency.

Philip Dunne told the Committee that since privatisation, the water sector had had two regulators – the Environment Agency and Ofwat as the economic regulator, commenting:

“There is a question mark in my mind as to whether those two separate regulators have been as effective as they should have been in policing the water companies’ role in relation to wastewater treatment.”

The EAC Chair was giving evidence to the House of Lords Industry and Regulators Committee which is currently conducting an inquiry into the work of Ofwat – he outlined a number of the challenges the water sector is currently facing in the wide-ranging discussion.

Decades of building above ground creating an increasing amount of hardstanding has led to enormous increase in volume of surface water

He told the Committee that decades of building above ground homes and commercial premises, thereby creating an increasing amount of hardstanding on previously porous ground, had led to an enormous increase in the volume of surface water. This had resulted in a surface water challenge, exacerbated by climate change and the volumes of rainfall that are landing across the UK as a result of climate change, with more frequent and more severe storms.

He also referred to “the problem of not investing sufficiently underground in the drainage assets that deal with both surface water and the foul water that comes from an increased population” adding:

“I would go back to about 1960 to ask planners, successive Governments and local authorities ever since why they have not provided the mechanisms to allow for wastewater treatment to be expanded to cope with the volumes that have happened through their agreeing to allow development above ground.”

Philip Dunne explained that at a routine meeting with the EAC the Secretary of State for the Environment George Eustice had acknowledged that the problem would not be resolved until surface water and the foul water drainage systems across the country were separated.

Philip Dunne described this as “a mammoth undertaking” involving changes to somewhere in the order of 600,000 kilometres of underground drainage networks.

He went on to flag up the fact that as a result of the Water Industry Act 1991, on privatisation, the power was given to remove the right to connect for developers connecting the water treatment infrastructure that they put into new developments. In Wales, the right to connect has been abolished requiring developers to connect foul water to foul water systems and surface water to surface water systems.

"Huge amount of infrastructure required to separate foul water and surface water systems"

He told the Lords’ Committee that the EAC had recommended that the same requirement should be introduced across England for all new development. However, the challenge of retrofitting, reworking and disconnecting those systems was enormous, he added, referring to an estimated figure of “somewhere between £150 billion and £650 billion.”

“That covers segregating the drainage systems and building the additional capacity that would be required to cope with the foul water if we had separate systems. A huge amount of infrastructure would be required to separate them.”

However, water companies were not the only part of the problem, he pointed out, saying it was “widely recognised that the water treatment sector accounts for 38% of river pollution.” The balance came from two other sources , with agriculture accounting for about 40% of the phosphate and nitrates found in river systems, and highways and industry accounting for the remainder.

He suggested to the HoL Committee that it would be an interesting for them to ask Ofwat whether it felt that it had “enough influence to secure information from the water companies themselves to get to a good understanding of the basis on which remuneration or dividends are paid”, adding:

“One has to question whether some of the very high bonuses that are paid to companies that are in breach of permits and licences from the Environment Agency are appropriate for a public utility that is providing drinking water and dealing with our effluent.”

Referring to the question of the amount of investment versus prices to the consumers, Lord Burns asked Philip Dunne whether there had been “too much emphasis on keeping down water prices” and “insufficient emphasis on trying to identify which of the investments really could make a difference to this particular problem.”

While it was “pretty easy to call for immediate action” and “everybody would like to see problems resolved overnight” Philip Dunne MP replied, it was” impossible to do” and required significant capital investment, going through the planning system in many cases and “it takes years to resolve very significant infrastructure challenges.”

Philip Dunne - start on separation with new developments and stop the right to connect

In response to Lord Burns’ suggestion that there were ways of prioritising different parts of the network, where “one could begin to look at the places where there are the greatest problems”,  Philip Dunne said:

“I think we start on separation with new developments. We should stop the right to connect.”

“There is a debate going on within government about this issue. It sits within DLUHC. As the Levelling-up and Regeneration Bill goes through both Houses, there may be an opportunity to suggest to the Government that, if this needs legislative change, it could happen through that Bill.

“I am told that legislative change is not needed because it is already in Schedule 3 to the Water Act; it is just a matter of persuading the Government that developers will have to pick up the cost. It thereby runs into the ability for developers to fund this as well as the housebuilding programme, so there is a commercial prioritisation challenge, but I think that is where we start.”

The EAC Chair also said that water company performance can be measured much more easily than that of its regulator, with Ofwat’s performance measured more in terms of its ability to secure against its existing priorities, household bills increasing at a certain level and water supply being available or not available, depending on weather and usage conditions.

Philip Dunne - "the whole regulatory environment is up for grabs at the moment"

Philip Dunne suggested that a good question for the House of Lords Committee to put to the new Chair and the Chief Executive of Ofwat as part of its inquiry as to how they intend to measure their performance and to meet the new objectives of the Strategic Priority Statement.

Describing the whole regulatory environment as “up for grabs at the moment ,” he commented:

“Clearly, the system has not been working. We are getting the tools to measure the eventual outputs. The input measure, from an Ofwat point of view, has always been looked at in terms of capital markets and the weighted average cost of capital. That is the topic around which Ofwat has its debate with water companies.

“It is clear that that in itself is good for dealing with the pricing to consumers point, but it is not such a good measure for dealing with whether there is adequate capital in the system to be able to deal with the priorities that the water companies are being set.”

"The fact that both Ofwat and Environment Agency senior management— the chair and the chief executive of the Environment Agency—are due to change this summer provides a real opportunity. Your inquiry is very timely to be able to challenge those folk. We have a pre-appointment hearing due before the Summer Recess for the new chair of the Environment Agency, as yet not identified, and we will put some of these questions to the Environment Agency. We have had a session with Ofwat. We have also had a session with the Office for Environmental Protection, which has now come in to replace the EU as the regulator of the regulators in this area. It is taking a particular interest in water quality. The whole regulatory environment is up for grabs at the moment."

Philip Dunne MP went on to comment that the Government have “a very significant ambition to build new housing” which needed to be built alongside new investment in treatment facilities to cope with the associated run-off, whether on the surface or underground. The EAC Chair added that he was “proposing to make some amendments to the regeneration Bill to try to facilitate some of this” and explained:

“For example, at the moment, water companies are not able to be recipients of community infrastructure levy or Section 106 funding, which developers are obliged to provide when consents are granted by local authorities. Water companies are not even statutory consultees necessary for development consent. They need to be put in a position where, if they have to deal with the consequences of investment, where developers are making contributions they should be able to make them to help contribute to that infrastructure.”

For existing developments, in his view “everybody would agree that water treatment, particularly if it is helping to improve the environment of our waterways, would qualify as green investment” and the capital markets would be available to fund significant infrastructure projects.

Philip Dunne - "very difficult at this particular time of soaring costs of living to be arguing for increases in household bills"

In response to Baroness Bowles of Berkhamsted’ question about whether the Government’s latest strategic policy statement now ensured that Ofwat balances the need for long-term investment and the affordability of consumer bills, Philip Dunne said:

“ It is very difficult at this particular time of soaring costs of living to be arguing for increases in household bills. That is not something that any of us wants to happen, but I think we have to accept that, if we are to avoid just kicking the can down the road until the next pricing review period, there needs to be greater priority given by water companies through the directions from Ofwat and the Government, through the storm overflows plan, that will feed into the sewerage and drainage management plan under the Act to give it a higher priority.

That will come at some cost, but, as I have just illustrated in the case of the Thames (Tideway Tunnel), it does not have to be an excessive increase in bills.”

Commenting on penalties imposed on the water companies for pollution offences, Philip Dunne said that “by and large, the fines imposed by courts have been at a level where, I would argue, it has been a cost of doing business rather than a penalty designed to change behaviour. “

This had changed when Thames Water was fined £20 million in 2017 and Southern Water was fined £90 million in 2021. In his view, such fines ought not “just to go into the Treasury pot” and “we should think actively about having some kind of river restoration fund, whether local to the catchment or national.”

It would be very useful if the House of Lords Committee wanted to consider the issue, he added, saying:

“If fines are being introduced because environmental harm is being caused, it would be far better to be able to recycle them back into fixing the problem than their just being swallowed up in the general Treasury pot.”