Anthony Legg, Director Economic and Financial Consulting at FTI Consulting, sets out an expert overview of the range of reforms in the Government’s new Water Bill for Waterbriefing.

The much-anticipated Water Bill was published last Thursday setting out a range of reforms for the water sector in England and to a lesser extent in Scotland and Wales. The Bill contains a few important changes relative to the Draft Bill published in July 2012, most notably in relation to Ofwat’s powers and duties and to the (reduced) extent of upstream competition.

Overall, incumbent companies and their investors will likely be happy with the reduced extent of upstream competition and with an increased emphasis on resilience and long-term planning, but some may be disappointed at the absence of an option to voluntarily exit the retail market and the limited extent of proposed changes to the M&A regime.

Ofwat’s powers and duties

The Bill includes two new duties for Ofwat: a primary duty to further the resilience objective and a general duty to secure that incumbents do not unduly discriminate in favour of their own retail businesses.

The resilience duty, foreshadowed in recent government consultations, requires Ofwat “to secure the long-term resilience of water supply and sewerage systems against environmental pressures, population growth and changes in consumer behaviour”. The big question, however, is how will this duty interact with Ofwat’s other existing duties and what, if any, implications does it have for Ofwat’s approach to PR14?

On top of the changes to its duties, Ofwat has also been given a range of new responsibilities: several sets of new codes and charging principles will need to be developed with the objective of facilitating more competition, while Ofwat has also been given a range of new enforcement powers. While most of these extra responsibilities were foreshadowed in the Draft Bill, Ofwat – working with stakeholders through the OpenWater programme – will need to work quickly and effectively to deliver on these responsibilities ahead of retail market opening slated for 2017.

Retail competition

As widely anticipated, the Bill proposes to introduce competition in the non-household retail market and to establish a pan-GB market (albeit only available to a subset of business customers in Wales). One minor surprise in the Bill in this regard is a provision enabling the Secretary of State to remove the consumption threshold before new licensing arrangements are introduced, perhaps with the intention of giving him more options to help to further stimulate the burgeoning competition between incumbent retailers that has started to emerge over the last 12-18 months if he deems it necessary.

Despite many parties pushing for a change, the Bill does not include any provisions to enable incumbent companies to voluntarily separate, and potentially divest themselves of, their retail businesses. While companies have already been taking measures to reduce their retail cost to serve, some may now look to Ofwat for regulatory protection against stranding of retail assets (the replacement of which in future might not be covered by Ofwat’s 2015 RCV ‘guarantee’) by the emergence of retail competition.

Upstream competition

The government appears to have given some ground to incumbent companies and their investors who have raised concerns about the impact of upstream licensing provisions included in the Draft Bill: the final Bill no longer includes provisions enabling new entrants to provide just network or retail (last mile) infrastructure. This limits the risk of incumbents facing asset stranding if a new entrant was able to supersede some of their existing RCV. Competition is, however, permitted for wholesale water and wholesale wastewater activities in relation to premises served by a new retail entrant, and for the disposal of sewerage matter (e.g. sludge) more generally.

The Bill also confirms an intention to remove the Costs Principle, but we will need to wait for further guidance from government to develop a clearer view about how access prices might be set in future.

Sustainability and resilience

The Bill includes a number of provisions aimed at encouraging water trading, some limited reforms of the abstraction licencing regime and changes to better align planning cycles. In combination with the new resilience duty placed on Ofwat, the Bill clearly places more emphasis on long-term planning and more efficient usage of constrained water resources. A further step in this direction is the decision to empower companies to construct sustainable drainage systems, a power that many had lobbied for since its omission from the Draft Bill.

Mergers and acquisitions

The Bill does not propose to increase the revenue threshold at which a merger is likely to be referred to the Competition and Markets Authority (CMA), which will replace the Competition Commission next year. Instead, a duty has been placed on the CMA to keep the threshold under review and provisions introduced which mean that a referral is no longer compulsory, although in reality it is still the likely outcome for mergers involving larger companies. Although this shift may potentially put a dampener on acquisitions of some of the remaining small WoCs, the recent mergers between South Staffs and Cambridge, and of the three previously-Veolia WoCs, may suggest the barrier posed to small company mergers by the threshold may not be that great in any case.

Next steps

To conclude, the publication of the Bill is obviously just another step in the legislative process, so what ultimately becomes legislation may yet evolve further. However, it now seems likely that the Bill will come into force in coming months, well ahead of PR14 Final Determinations and the end of the parliament.

About FTI Consulting:

The Economic and Financial Consulting practice of FTI Consulting provides clients with analysis of complex economic and financial issues for use in legal and regulatory proceedings, strategic decisions and public policy debates.

The firm’s UK water and wastewater team has advised many of the water companies in England and Wales in relation to expected regulatory and legislative reforms. – including support to companies during PR09, assisted Bristol Water with its appeal to the Competition Commission in 2010, supported the Northern Ireland Utility regulator with the conduct of a price review and worked with the Water Industry Commission for Scotland on a range of issues around opening the Scottish retail market to competition.

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