Ofwat’s latest annual report and accounts highlights its direction of travel in AMP6 – and also flags up significant failings in Ofwat’s own internal processes and financial management during 2013-14.

On the 2014 Price Review,, the report reiterates that changes the regulator has made to its methodology could bring more than £2 billion in benefits to customers, as well as substantial cost and financing efficiencies. Commenting on the water companies' AMP6 Business Plans, the report says that the quality was significantly better than at the same stage at previous price reviews, with evidence of  a real change in approach.

The report also highlights an increase during the year in the number of applications for Water Supply Licences and expressions of interest to apply – something which is likely to continue with the advent of competition. Ofwat said the introduction of a new retail market in England in 2017 is expected to drive innovation in water efficiency techniques at customers’ sites, as it has done in Scotland, while  upstream reforms in England could drive efficiency from increased opportunities for trading water resources.

Key area of focus on Ofwat's internal management difficulties

However, the key area of focus in the report is Ofwat's own publicly acknowledged internal organisational and financial management failures during 2013-14.

Commenting on Ofwat’s internal organisation, the report says that during 2013-14 the regulator began a programme to transform itself into a leaner, more focused and more efficient and effective organisation. The programme includes improving management of people, skills, leadership,  financial management, programme and project management.

These are key issues for Ofwat - from 2015-16 onwards it will be subject to a settlement imposed by HM Treasury through the Comprehensive Spending Review. The regulator will need to deliver significant efficiencies and cost reductions as a result of being required to operate within a much tighter budget.

During the year Ofwat had to address a significant and – unforeseen- financial overspend of £5.6 million. In addition to its core regulation operating budget set at the start of the year of £21.5 million, a further reserve claim for £2.4 million was approved by the Chief Secretary in July 2013, together with a special licence fee of £3.2 million recovered from the water companies in August 2013, £0.85 million of which was returned to them via a credit note at 31 March 2014.

The annual report attributes the overspend to the 2014 price review which involves substantial change in how Ofwat regulates the water sector, stating:

“ The new methodology was published on 25 July 2013, and therefore did not align with the budgetary cycle, meaning that the total costs of delivering the new methodology could not be fully understood at the time the 2013-14 budget was set. “

NAO: “significant failure in Ofwat’s financial planning”

Commenting in the accompanying report the Comptroller and Auditor General at the National Audit Office is required to make on Ofwat’s financial statements, Sir Amyas C E Morse said:

“The need for such a large supplementary estimate indicates a significant failure in Ofwat’s financial planning……..

“When preparing for the 2014 price review, Ofwat’s new senior management team identified that the Department lacked the necessary skills and capacity to complete the required work effectively. The Board therefore agreed that Ofwat should develop an outsourced delivery partner role to provide greater flexibility to deliver the review.”

“The partnership arrangement was put out for tender, which was subsequently won by PricewaterhouseCoopers. As well as lacking the necessary skills and capacity, Ofwat had also failed to include budgetary cover for the partnership element of the price review exercise when it agreed its budget with HM Treasury to cover its published forward programme covering the financial years 2011-12 to 2014-15. The value of the delivery partner contract to support the price review, which will be incurred in 2013-14 and 2014-15, is up to £6.45 million.”

Incentive payment to PwC of £701,000 to deliver PR14

The annual report also sets out details of fees being paid by Ofwat to PricewaterhouseCoopers (PwC) - in July 2013, Ofwat entered into a contract with the consultancy as its Delivery Partner for PR14.

The contract includes two incentive payments intended to secure good value for money from the Delivery Partner contract – Ofwat has provided for £701,000 which represents the estimated maximum possible incentive payment due upon satisfactory completion of the risk-based review, which concluded on 4 April 2014. Following completion of an assurance exercise, a recommendation will be made to the Ofwat Board about whether the incentive payment, or part of it, is due in June 2014.

Concerns about Ofwat’s organisational capability

Ofwat’s annual report says that during the 2013-14 financial year, a number of concerns about Ofwat’s organisational capability and effectiveness were highlighted, stating:

“ In particular, the budget forecasting problems and the need to raise an additional licence fee were symptomatic of problems with corporate planning and an organisation in which accountabilities for delivery and budgets within programmes and projects were not always clear. In addition, the administrative errors that led to the need to seek retrospective HM Treasury approval for expenditure in two areas was symptomatic of underlying cultural factors, also identified by Ofwat’s internal auditors, of a culture where – at times – delivery took precedence over compliance.”

 The report says the underlying capability issues are currently being addressed and that the organisation’s leadership has been transformed during the year with a substantially strengthened Board. However, it says that without significant transformation, it is unlikely that “Ofwat will be a high performing organisation well placed to fulfil its vision and refreshed strategy to deliver for customers and the sector.”

Ofwat- “we need to ensure we do a few critical things really well”

During the second half of 2013-14, Ofwat initiated a major Business Transformation Programme, described as a key priority, which is intended to change Ofwat’s culture to embed delivery through programmes and projects, with clear accountabilities for outputs, financial planning and management, as well as a better understanding and management of risk. The report states:

“The pressure to transform Ofwat at the same time as delivering PR14 will demand excellent management of a number of strategic and operational risks. In particular, the scale of the internal and external change agenda will mean we will need to prioritise rigorously, and ensure we do a few critical things really well.”

 “This has been a challenging financial year for Ofwat, particularly as a result of the issues that arose with the budget and irregular legacy expenditure.”

However, despite these specific issues, the report says that internal audits have covered a wide range of internal control issues, all of which delivered ‘substantial assurance’. On that basis, while recognising the issues that need to be addressed through the Business Transformation Programme, and the action already taken to clear up historical poor practice, Ofwat says it is “able to conclude that overall internal control is effective.”

Risk assessment for the 2014-15 financial year remains high

Looking ahead, the annual report says the risk assessment for the 2014-15 financial year remains high. The main areas of risk are:

• reputation and credibility, particularly linked with the successful delivery of PR14 and dealing with any challenges of Ofwat’s decisions;
• the need to deliver a major business transformation programme to enable Ofwat to operate within the Comprehensive Spending Review settlement from 1 April 2015, at the same time as the organisation faces significant delivery pressures associated with PR14; and
• associated risks of stakeholder engagement – with the price review, Ofwat’s refreshed strategy and delivery of the Business Transformation Programme.

Click here to read the annual report in full