Industry and Regulators Committee

Corrected oral evidence: The work of Ofwat

Tuesday 5 July 2022

11.20 am


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Members present: Lord Sharkey (In the Chair); Lord Blackwell; Baroness Bowles of Berkhamsted; Lord Burns; Lord Cromwell; Baroness Donaghy; Lord Eatwell; Lord Reay; Baroness Taylor of Bolton.

Evidence Session No. 5              Heard in Public              Questions 44 - 52



I: Professor Catherine Waddams, Centre for Competition Policy, University of East Anglia.




Examination of witness

Professor Catherine Waddams.

The Chair: Welcome to the committee’s fourth evidence session for its inquiry into the work of Ofwat. We have before us as a witness Professor Catherine Waddams of the University of East Anglia. Welcome, Catherine. You have before you a declaration of Members’ interests. The session is being broadcast live on parliamentlive.tv and a full transcript is being taken. The transcript will be made available shortly after the meeting to enable any corrections to be made. The first question is from Lord Burns.

Q44            Lord Burns: Thank you and good morning. Could we discuss Ofwat’s statutory objectives, please? How far do you think they are appropriate? In particular, to what extent does Ofwat have to manage trade-offs, and how well do you think it achieves this?

Professor Catherine Waddams: Thank you very much. I was a member of the Ofwat board until last year, so please accept my answers in that light. I do not want to appear more independent than I am, so to speak, but I have studied this as an academic.

Because Ofwat’s statutory objectives have increased so much, I sent you a picture of how these duties have gradually increased over time. I am afraid it is rather illegible, for which I apologise; I can send you a clearer one. There is a dual problem—or a dual challenge—here. They are a mixture, really. The original duties—or objectives—of regulation were to constrain private monopolies so that the decisions they took were in the interests of general welfare, more or less. There was no specific issue at that time about particular people's welfare. That is one thing that has come up—the protection of those who are vulnerable in some way. Although it was in some of the original privatisation Act, it has been expanded a lot. One issue is who we are thinking of when we look at the objectives. Another is that the final objectives that we have in this diagram are a funny mixture. Furthering the consumer objective is obviously a policy objective; that is fine. I would see competition as a means to meet that end sometimes. The issue is the mixture of policy objectives, a basic wanting to make sure that the service is provided, and the means to meet those objectives. That would be my top-level response to your question.

Lord Burns: When it comes to simplification, you would like to see a sharper division between what you describe as the policy objectives and the means to an end. Can you clarify how far you think it is possible to rework it in the way that you suggest?

Professor Catherine Waddams: That bit of it is fairly easy to rework. There are other improvements that I would recommend that are probably more difficult in practice, but it does not seem impossible to me. I was reading through the principles for regulation from 2011, and the Government's commitment then, and it seems to me that it would be possible to look at the various things that Ofwat has been asked to do and to put them in that kind of categorisation or hierarchy. Of course, that is true not only of Ofwat but of other regulators. I think that would be possible to do. Whether anybody has the time or energy to do it is another question.

Lord Burns: How far do you think having this combination has made the job of Ofwat more difficult? One issue we are going to discuss with witnesses is the extent to which more emphasis has been given to bills as opposed to some of the investment in infrastructure, et cetera, that people are now beginning to be very worried about. Has the complexity of it affected that, or is that just another basic underlying trade-off that Ofwat has had to deal with throughout the price reviews over the years?

Professor Catherine Waddams: The trade-offs are between different objectives and that is a problem. I would argue that that should sit with the Government or Parliament, not with the regulator. Here I can use introspection: I do not think that Ofwat is unclear about the difference between an objective and a means to obtain it. For example, on competition, which you were speaking to the last witness about, Ofwat is clear that we want to protect consumers and competition can sometimes be a good way of doing that, but sometimes there are better ways. I do not think it muddies the waters internally in Ofwat, but it makes it much more difficult for other people to hold it to account, in a sense. So, it is more an external than an internal issue.

Lord Burns: In what aspects would you say that people have found it difficult to hold it to account?

Professor Catherine Waddams: I guess the supply of finance is one issue: suppliers would argue that they need more financenot surprisingly, that is their job. Ofwat is clear about how it trades off necessary financing against consumer welfare. This is not really between different categories of objectives, but another issue is the question of average consumer bills and whether you are going to be helping particular groups of consumers. That is a trade-off that I do not think is proper for Ofwat itself to make; that would be better coming from Parliament. It is very difficult. I guess that is a case where it has to make its own trade-offs.

Lord Burns: To take the specific case of your membership of Ofwat, what were the biggest challenges and decisions that you faced as a member?

Professor Catherine Waddams: For me personally, as a member of the board, it was about getting the balance between having a broad overview of the industrythat is what a board should be doing, not getting immersed in the detail—and having to understand what that detail was and how it affected the big picture. For me, and I think for other people on the board, that was a challenge, particularly when it came to price control. You get such detailed arguments from the companies—properly, they want to know where these figures come fromand it is quite difficult to keep that overview while at the same time, as I say, understanding how the detail informs that overview.

Q45            Lord Reay: Does Ofwat receive sufficient strategic guidance from the Government on how to balance its objectives, particularly in relation to the tension between long-term investment and bills? Does the Government’s strategic policy statement provide enough prioritisation for Ofwat to make trade-offs in this area?

Professor Catherine Waddams: The answer to the first part of your question is yes and no. Does it receive sufficient strategic guidance? It receives a lot, but it is not always consistent, so it is does not always help Ofwat to be able to say, “The Government would like us to do this rather than that”. It is not so much about the quantity of the strategic guidance; it is more that its focus could be improved from Ofwat’s point of view so that it knew what was in the public interest, which is what it is established to look after in a very particular way.

On the tension between long-term investment and customer bills, the question is: customer bills when? I think there is a question later on about current and future consumers. Again, that is a question on which there should be high-level guidance from outside Ofwat. Particularly now that there is a more general sustainability issue, one needs to have a clearer idea of how the Government and Parliament see long-term sustainability as against immediate cheapness.

The other issue is that of course it is not just bills; investment is often about security of supply and making sure that there is enough water for people, so there is another trade-off there. The regulator has to decide what, on aggregate, peoples preferences are between having no risk at all of ever being deprived of a water supply and a higher bill, because the two are balanced against each other.

Q46            Lord Reay: Do you welcome the National Infrastructure Commission’s recommendation that boards of regulators should be given the power to seek direction from the Government when considering policies with significant distributional consequences? Could you talk a bit about the advantages of such a mechanism?

Professor Catherine Waddams: There are two advantages. One, at the Ofwat level, is that the Government would be telling each of their armsor each regulatorwhat their trade-offs and preferences were, so they could be consistent across regulators, and that is important.

The other advantage, as part of that, is that it means there has to be a joined-up policy. If I have difficulty with my water bills, I probably have difficulty with my energy bills, my food bills and all my other bills; the issue is poverty rather than water poverty or fuel poverty. Leaving it to individual sector regulators to try to deal with an issue that is systemic in generalwe see that a lot just at the moment, because of the current challengesis unlikely to end up with the best possible way of addressing those issues. If a central body looks at those issues and tries to see ways of addressing them, it might well come back to individual regulators, including Ofwat, and say, “Part of what we’d like you to do is something specific in the area of water bills”. But that is unlikely to be able to address the issues on its own, so it would be better if it were part of a much bigger and more joined-up approach. That would be my reason for supporting that NIC suggestion.

Lord Cromwell: Trying to summarise what you have said, is it fair to say that your view is that the diversified and broadened set of objectives that are in tension with one another are effectively a case of mission creep that has been inappropriately foisted on to the regulator by Parliament, which should have been doing the job itself?

Professor Catherine Waddams: I think I agree with that. Do I agree with “mission creep” in particular? I think we all want to do good things across the board, and it is painful to see that we cannot do them all simultaneously. The job of economists is to prick that particular balloon and say, “There are trade-offs. Here are the great benefits, but what are the costs? Perhaps mission creep is what happens. I think it comes from just the right place of wanting to do good in all these areas, but it is so difficult to confront those trade-offs—and those trade-offs change, of course.

Ofwat and other regulators have a really important role in understanding what those might be and in informing the people who might be subject to those good intentions about what the challenges might be, but I am not sure they are the right people to say, “These are the trade-offs between them”. They have another role, which, once the trade-offs have been decided, is to implement them, because they are closer to the particular situation.

Q47            Lord Blackwell: We have had various suggestions that the scale of investment that is now required to deal with the creaking infrastructure, future water supply, sewage leakages, environmental issues and so on is actually an enormous step change. Either in your time on the board or from your academic research, do you have any sense of the scale of the investment that is required and whether it is fundable privately through the returns that would be required, with the impact that would have on bills, or is it a challenge that requires government intervention?

Professor Catherine Waddams: I suggest that it might be helpful to think of two sorts of investment. One is, as you say, for the maintenance of existing systems. For water, as far as I know, we will be using those networks in the foreseeable future. Unlike some bits of energy, where there is a whole question about whether they are the right networks, for water at the moment we do not have an alternative technology that challenges them. We have a new technology in terms of how we make those networks fit for use. I am not sure how much we need to replace the pipes or how much they can be made stronger through other means. That means a lot of money.

As an economist, I feel that it probably should be funded by water consumers, because they are the people who can benefit from it. On the other hand, since we are all water consumers, and since, like energy, it is regressive in the sense that low-income people pay a higher proportion of their income for water than others, there may be a case for saying that this should be a kind of public goodthe service, not necessarily the ownershipand therefore there should be some funding from taxation. I can see how an argument could be made for that if the effect on bills, particularly on those for low-income consumers, seemed to be disproportionate.

There is another sort of investment, which would be more in the supply side rather than the distribution side. There, I think, there are new ideas of how one can best provide water, and it is not necessarily by pouring concrete and digging a big reservoir. We need to be clear that we have explored all of those adequately, and that is one of the things that Ofwat does. Companies are much keener on pouring concrete because it increases their capital base and therefore their return, and it is their job to argue for that, but it is not always clear that that is the best way in all cases.

Of course, the other issue is that a lot of investment that we might like to see is in sewerage, which is a particularly unpleasant form of failure when it goes wrong. It does not go wrong very often but it is very unpleasant. Again, there is probably quite a lot of investment to be made there. Gosh, those of us who are old enough will remember that we used to pay for it through the rates. Is that a public service that we would like to have—a distribution system? Is there another way of funding it, if we really think that is the way to go? That is worth looking at; I do not know the answer.

Lord Blackwell: Do you think Ofwat has an estimate of the scale of investment needed for both sewerage and storm infrastructure?

Professor Catherine Waddams: Yes. The companies say in their business plans what is needed, in no uncertain terms. They can invest whatever they like. The question is what Ofwat will allow them to charge the consumer for. I do not think Ofwat has been slow in allowing companies to improve the resilience of their distribution networks; I do not recall that as being a particular issue.

Q48            Baroness Donaghy: Good morning. Does Ofwat have the necessary powers to meet its objectives, especially in relation to environmental issues in the water sector? Does it need greater powers to ensure that water companies improve their performance, or is the issue that existing powers have not been used sufficiently?

Professor Catherine Waddams: That is an interesting question. The model has not quite worked the way that it should have done in theory. In terms of Ofwat’s objectives, rather than the Environment Agency’s objectives, which are different but often concern the same things, the idea is to give the companies incentives not to pour poison into our water supplies or to breach what they are required to do, particularly in terms of putting wastewater back into the system. Because it is that sort of incentive scheme, it is slow and retrospective. As you know, companies are allowed to charge consumers for a certain amount on condition that they meet these quality levels. The problem then arises: what if they do not? Well, you do not find out immediately, because it is all retrospective, so that is one issue, and the fines may not be quite the right level. There is certainly some evidence of what economists would call optimal breach—optimal for the companies, that is; it is worth risking the fine. You will not meet your standards and you know you will be fined. That suggests that either the fine is not harsh enough or we do not detect the breaches enough. There are two aspects.

Does Ofwat have the powers? It seems that the system has not worked very well in recent years. I think that is because of this incentive idea, which seems to have broken down, because the incentives do not seem to work all the time. I think they do somewhat; we hear about the cases where they do not work but I think there are cases where they do. So, I am not sure it is the powers so much as the framework and the structure of the fining system, if you like.

Baroness Donaghy: Do you think that the cuts in the Environment Agency budget, together with the potential cost of litigation, mean that it perhaps has not maximised the obligations that it has to pursue water companies in breach? Do you think that has had an impact on Ofwat’s attitudes?

Professor Catherine Waddams: I am afraid I do not really know enough about the Environment Agency to comment on that. My guess would be that cuts do not help, if that is what they are doing. In terms of the Environment Agency and Ofwat jointly doing things, which they have done and are doing at the moment, I think, it is quite a slow process because you have to wait for both organisations. From the outside, it appears as though there is a lot of buck-passing; from inside Ofwat, it did not feel so much like that. For example, I was involved in fining a water company that had lied to us—it had changed the readings so that they were untrue. The Environment Agency was looking at it at the same time. So, there is sometimes a bit of an issue of co-ordination, and there is a bit of an issue of speed. My impression was that we would get there in the end, but that would not necessarily be quick enoughby that time, in this particular case, the entire management and board had been replaced. Again, there is a problem with retrospective enforcement: you are enforcing against something that has gone, and you want the current people to co-operate with you as much as they can to make things better for consumers. The time lag can be problematic in that sense—you are fighting yesterdays war rather than what needs to be done today.

Lord Cromwell: You have largely answered what I was about to ask you.

Professor Catherine Waddams: Sorry.

Lord Cromwell: No, that is excellent.

Professor Catherine Waddams: That is the trouble with giving us the questions in advance, you see.

Lord Cromwell: You are romping ahead. I was simply going to say that, as you have highlighted, Ofwat is not the only regulator with an interest in water; there is, obviously, the Environment Agency, among others. You have indicated that that can be a problem, with confusion and delay at times. My question is simply: how can it be done better?

Professor Catherine Waddams: There was a suggestion that we should have another body to oversee the lot of them, and that did not feel right. I wrote some notes on this. It goes back a little to the discussion at the beginning about whether we have clear oversight from the Government or Parliament about what is supposed to be being done, and whether we know what the trade-offs between them are. It is interesting that, if you say to an environmental body, “You set the standards”, and then the economic regulator must allow the money for those standards to be reached, you tend to get—although this does not seem to be our experience, really—too much environmental protection because, as is intuitively obvious, it is not considering the cost of it; whereas if you get the regulator in at the beginning, all those arguments will be together on the table.

I have forgotten to look up the name of it, but there is a long-term plan in the water sector, which is a little odd for Ofwat, because the long-term plan is agreed and then you get your five-year plan, and Ofwat has to fit into it. I have also seen evidence that there is quite a lot of co-ordination between the bodies because they recognise that there are these potential clashes.

How could it be done better? With clear guidance on what the priorities are; by asking how you trade off better environment sustainability against bills today and how you trade off future versus present, and so on; and by the bodies talking to each other, rather than creating yet another body to co-ordinate. Going back to a previous question, they need to be adequately resourced.

Lord Cromwell: You have highlighted the “What do you want for Christmas? This is what we can afford” dichotomy there. Is there a formal basis on which these organisations talk to each other, or is it down to individuals to make it happen? I agree that we should not create another body, but is there a structure, a regular meeting, basis or anything like that that puts them together as equals to resolve these problems?

Professor Catherine Waddams: I do not know whether there is a formal mechanism. I know that they meet fairly regularly and I know that there is informal contact, but I am afraid I do not know the answeror perhaps I do. I think Ofwat started something; it is more local, and it gets people in particular areas to talk to each other about what the issues are, but how formal it is I do not know.

Q49            Lord Eatwell: You have already answered the question that was assigned to me about whether there should be an overarching body, so I will take advantage of my slot to go back to the point you made just now about a water company that had lied to the regulator about a regulatory issue. I was a financial services regulator for many years, and if someone lied to us, they would be deemed not fit and proper and thrown out of the industry, so I am really quite struck by what you have just said.

I would be interested if you could reflect a littleif it is appropriate, and I understand if it might be deemed not to be—on how that issue was dealt with. It reflects on two aspects: first, the powers of Ofwat, and, secondly, the relationships between Ofwat and the water companies that it is deemed to regulate. Could you reflect on that a bit and compare it with what would be a definitive sanction in financial regulation?

Professor Catherine Waddams: That is a very reasonable question. I was chair of the case committee when Ofwat looked at this, so I knew about it in some detail. It is all in the public domain. Lots of people said to us, “So what do you need to do to lose your licence?”, which I think is kind of the question that you are asking. We asked ourselves that too as we were finding the appropriate sanctions that we should put on this company, and we said at the end, “Yes, what do they have to do?

One of the issues that arose, which is terribly human really, was that by that time the company had completely new management. Good for the company, in the sense that it had thrown out the old one that had been dishonest, and it helped us if the company co-operated with us. I think that explained our reluctance to remove the company’s licence entirely. We tried to be as harsh as we could in those contexts. This is a bit embarrassing, but we were quite proud of ourselves that we levied a bigger fine than had ever been levied beforethis was a serious business and so onbut immediately, of course, you think, “Was it really enough?” We did not feel at that stagethis is the retrospective nature of itthat it was helpful to take away the licence. It is a question of where you are. It was not the same management that we were still dealing with.

You asked about the relationship with the water companies. I did not feel as if we were in their pockets in any sense. We had a—how would we put it?—fairly firm relationship with them. I do not want to say combative”, because that is not quite right.

Lord Eatwell: To take this point a little further, if Ofwat had felt it appropriate to take away the licence of the company that had behaved in this wayor at least the rogue management had behaved—would that have been an easy thing to do, or are you rather stuck with the company that you have, because switching from one to another is extremely difficult? In financial services there is typically plenty of competition, so if you remove just one financial operator there are still plenty of people to do the job. What I am really saying is: are you stuck with companies? Are they relatively difficult to shift, because they are the people in place who are able to do the job of ensuring that water comes out of customers taps?

Professor Catherine Waddams: There is not the competition that there is in financial services, obviously, but I do not think there is a fundamental reluctance to take away a licence. I should make it clear that I am not speaking on behalf of Ofwat in any sense—these are my personal recollections from the past—but I did not feel there was any reluctance to do that. In fact, occasionally we had little exercises in which we faced particular issues to see how we as a board would respond—I am sure you have been in such exercises yourself—and whether we would be at the end of a telephone when we needed to be contacted, and things of that kind. So I do not think there is any reluctance in principle.

It would be costly, and costs end up falling on the consumer, so we would have been very careful—as I am sure Ofwat still isabout doing things that impose costs on consumers. It is perhaps not on the scale of the costs in energy that we have seen from failing firms, but, still, it is not costless. We felt that we could find someone else to take the licence on if that was where we were going. I do not think we thought, “We can’t possibly do that”, but, given the management that we were dealing with at the time, we did think that although it was not ideal—it never is—the best route was to deal with them.

They were two sorts of things that we did. We said, “You’ve benefited from these lies so you sure as heck do not retain that benefit. That gets paid back to consumers immediately because they did not get the service you were charging for. And, on top of that, we’ll fine you because you were acting inappropriately and breaking the licence in that sense”.

Lord Eatwell: I see. Thank you.

The Chair: Were the individuals who managed this errant company sanctioned in any way at all?

Professor Catherine Waddams: I cannot quite remember what happened to them. I am personally in favour of much stronger sanctions for individuals, I have to say, because it might concentrate their minds if they were unable to participate in boards as a result of their actions. There was discussion of that, but I am afraid I cannot quite remember it. We did not sanction them individually because we cannot, but I think they can be sanctioned through criminal investigation, which the Environment Agency was also undertaking at the same time. That comes back to the point about it being slightly confusing, because we were not always exactly clear about what each other was doing, so that could have been handled better. But that is exactly the way to go to discourage people from such behaviour.

Q50            Baroness Taylor of Bolton: Much of what I wanted to ask about has been answered; Lord Burns talked about the price review. In your written evidence you mention that water companies can say—whether this is valid is another matter—that the mechanisms in the price review prevent them from fulfilling some of their role.

First, do you think that is right? Secondly, given your experience both as an academic and as a former board member of Ofwat, are there things that you would do about the price mechanism? Would you change the parameters? Do you think it is constructed in the right way? Do you have positive suggestions for how it could be improved?

Professor Catherine Waddams: Thank you for following that up. The issue is the way that the argument is framed in the public arena. The water companies, as part of their role of getting the best revenue they can for their shareholders, put the argument across in a particular way. I see that as part of what economists call gaming, which does not mean what it does to most people; it is just following—as Lord Eatwell will know only too well—what your own best interests are and pushing for them in the ways that are most likely to bring reward.

The recommendation that I would like to make, and I hope this would work, is for much more transparency about what people are saying and to whom they are saying it. At the moment—this is not true only in the water industryyou do not lose much by pushing your argument wherever you can, whether with politicians or with influential people in general. There is not much for a company to lose by doing that, but it can change the way in which the whole discussion is viewed externally and therefore change the outcome and make it much more difficult for the regulator, which cannot, and I think should not, engage in those sorts of activities itself.

That ties in with appeals. If a company appeals against a pricing decision, for example, can it lose as well as gain? It can, and sometimes it does. An appeal to the CMA, for example, is not without risk to a company, and I think that is as it should be. I would like to see a much more open discussion so that the issues are aired more—although I realise that there are some complications in that in terms of modern mediabut also so that these things are open and that it is fair for everyone to discuss that and understand why it is, for example, that particular claims are made. As I say, that was my personal frustration, which is why it went into the evidence. The companies would argue, “We can’t possibly fulfil our duties”, when actually we had shown them another way in which they could fulfil their duties but it was not one that they liked, and of course they did not advertise that. The set-up at the moment means that it is too easy for that to happen.

In terms of practical suggestions, clarity of objectives is one thing that would help—I am sorry to keep going back to that—but then so would transparency in the discussions that follow around that. That would be my suggestion.

Baroness Taylor of Bolton: I see what you are saying about transparency but the impression I am getting is that the balance of power is very much with the water companies—the cards are stacked in their favourbecause they have this way of doing things. Some transparency might help. The dividends have been very significant. When you have a monopoly, the risks are not really there to any great extent, so maybe the balance of power in the negotiation is very much stacked in the companies’ direction.

Professor Catherine Waddams: The regulator will always be as hard as it feels it can, and then—from looking back at the history of price reviewsdiscovers that it turns out not to have been as hard as it thought. That is partly in relation to information. It is very difficult to do anything about the fact that companies have information that no one else can have or, in a sense, should have. The imbalance there is one difficulty.

There is also a huge imbalance in resources, as you have perhaps suggested. Think about the resources that a company’s regulatory department has: its job is to get a good regulatory settlement, and that is what it will use its resources doing. Compare that—thinking about your previous witness—with the resources available to bodies that represent consumers or individual consumers. I know that consumer bodies have found it very difficult to put forward their arguments precisely because they have had fewer resources. Compare it too with a regulators resources, which, again, are rather slim compared with those of a company. So there are all sorts of things that companies can do.

I suppose the solution, if we really care about this, is that we need to put resources into the other side of the argument so that we can hear the argument transparently and be sure that everyone has a voice, since some voices are much more muted than others. However, that costs money. I have forgotten how much your previous witness said went on to our bills, perhaps 86p—

Baroness Taylor of Bolton: 26p.

Professor Catherine Waddams: That might go up if we gave them more voice.

Baroness Taylor of Bolton: But it might be worth it.

Professor Catherine Waddams: It might indeed.

The Chair: I want to ask about the information asymmetry that you mentioned a moment ago. Why can Ofwat not simply require full disclosure of the information held by water companies?

Professor Catherine Waddams: Well, to go back to the information that water companies have, it was sometimes surprising what they did not know about their own operations. One problem is that if the regulator says, “We’re going to do a dawn raid and get all your data, they will make sure they have even less available. Although I absolutely agree with the spirit of your question, the practice of it might go a bit in the wrong direction.

The Chair: You could of course make the same observation about the financial services industry, but it does not behave like that.

Professor Catherine Waddams: Why not? Partly because it is competitive, perhaps—I am looking at Lord Eatwell but he is not responding. I used to look at those different costs for different customers in energy, and because I am so old I started doing it when they were nationalised. The companies knew very little about it, and why should they? They were required to charge everyone the same amount so it would have been a waste of money to have that information. What I was surprised about was how slow they were to learn that information, particularly in areas where they were still monopolised. Perhaps competition makes you find out more? I do not know. Lord Eatwell might come back on that.

Lord Eatwell: Anyone running a business ought to have full information about the factors that affect their business; that is the obvious point. The issue about disclosure that the Chair has raised is a very important one. There are two big issues. One is the nature of funding, dividends and so on, and the other is the sewage issue, which has exercised minds quite significantly over the last several months. One would think that full disclosure of perceived risks in the latter case, and full disclosure of the nature of decision-makingthe model used, if you like—was something that as a regulator I would like to have in my pocket. The Chair has raised an interesting point, and I wonder if you could reflect quickly on it. There are lots of things that we know about the sewage issue, so let us take the dividend question. There must be a particular model determining dividends. Is that model revealed to Ofwat?

Professor Catherine Waddams: I do not think so. It is all about outcomes rather than that, though there will be discussions between senior Ofwat staff and individuals in companies. All I can tell you is that I do not think the board ever saw those, but it may well be that in those discussions there is probably a closer exploration of that issue.

Lord Burns: I want to go back to Lord Eatwell’s earlier question about what to do in a case where executives are misbehaving in a company.

I worked in the water industry from 2000 to 2010, and my memory is that Ofwat had considerable step-in rights in the case of a water company that was in difficulty in any way, and that it actually had the powers to intervene at quite a high level. You suggested that to do so would be very expensive, but I do not quite understand why that should be the case. It is not like an energy company, which, as we have seen recently, has been collecting money and then becomes insolvent so there is a loss. In this case, it would surely just be a case of putting in some new management in order to continue the business; in every other respect it would remain the same. It does not seem to me to be quite as much of a challenge as you suggested to change the management of a company that turned out to have been misbehaving.

Professor Catherine Waddams: I agree that it would be less of a challenge than in energy, where there are different issues. Indeed, there is that power to change the licence. The issue in this case was that there was a new management, in a sense, and it was not that management that was under scrutiny. That is the problem where things come to light afterwards. It was mainly a timing issue there, I think.

Lord Burns: I understand that.

Professor Catherine Waddams: Perhaps I overstated the cost, but it is not free to do it.

Q51            Lord Blackwell: We have heard that a number of water companies have tariff schemes offering a lower tariff to people on social benefits or to low-income households, but it varies around the country. Given what we were talking about earlier, about the potential need for significant investment and the implications that will have for bills, do you think there is a case, or indeed a need, to create a uniform social tariff for low-income households? What would be the impact of that on everyone else’s bills?

Professor Catherine Waddams: Starting at the end, it depends on how generous they are, of course. I would be in favour of national—England and Wales-wide—co-ordination of social tariffs. This is a political issue, it is part of a much bigger problem, and it would be much better if the Government and Ofwat helped devise social tariffs and decided what was appropriate. That would involve being open about the cost to other people if it was decided that the best way to help with the current challenges was through water bills. That is an open question that needs, as I said earlier, to be considered in a much more general context.

There is another question, which is: should it be the same everywhere? It is not clear to me that it should. For example, the needs in Cornwall may be different from those in Norfolk or indeed parts of Wales. In principle at least, I would be in favour of local solutions, albeit mandated at national level. However, that could be very difficult to sell in practice. I can see letters being written to newspapers—because I am old fashioned, but I am sure there would be other noises made—so it may be simpler, just for the reasons of acceptability and apparent equity, to make it a national scheme. However, one would have to note, for example, that different areas have different levels of need, so it might not be appropriate to have exactly the same social tariff or indeed the same implication for bills across the country, although, as I say, it might be difficult to get the publicity right on that.

Lord Blackwell: Does Ofwat have the powers to introduce that, or would it need legislation?

Professor Catherine Waddams: I do not think Ofwat has introduced any social tariffs; I think companies have introduced them.

Lord Blackwell: I mean, to create a national scheme.

Professor Catherine Waddams: Oh, for a national scheme? No, I think Ofwat should be involved in it because it knows about it, but I do not think Ofwat should be saying what it should be, because that power should lie elsewhere. The price cap is always given in terms of average revenue, so how that is collected from different consumers is not generally part of the settlement that Ofwat makes.

Lord Blackwell: It is up to the companies.

Professor Catherine Waddams: Yes.

Lord Blackwell: To go back to the discussion about dividends, I am not clear on the extent to which that is a discussion that Ofwat has with companies. It is easy to say, “Wouldn’t it be good if this money went out and more money went into investment?” But the scale of investment we are talking about may well need new capital, in which case, remunerating existing shareholders so that they are prepared to stump up more money becomes quite important. Is that something that Ofwat engages in?

Professor Catherine Waddams: Ofwat has discussions with companies along the lines of “What might it look like if you doubled your dividend this year in the light of what is happening to your prices?” Of course, the object of this form of regulation is that companies should make profits, and that should drive what they are doing. So in some ways you could say that profits could be a sign of the success of the system, but that is a difficult one to sell as well.

Ofwat certainly should not have direct power over what dividends are given—not with this model of regulation. You would need a new model of regulation if you were going to try to control that. Companies in their own best interests might sometimes feel that they want to exercise a little self-control; indeed, sometimes they do.

The Chair: Thank you. Could I go back to the issue of seeking directions, which is the NIC’s recommendation, which I think you endorsed? Does the Secretary of State currently have the power to issue a direction to Ofwat?

Professor Catherine Waddams: Well, it has its guidance, and Ofwat has to have due regard for that guidance. There is legislation. Of course, one of the difficulties is that each of these sectors reports to a different Secretary of State. One would hope that they all joined up at the top, and that is why regulators would like guidance from the Government. If one could line all of those up, the guidance itself could be consistent across the sectors. Since everybody has to have due regard to it and say how they have followed it, that might be a way of drawing it together, but I do not think it would be a legislative requirement.

The Chair: Whereas in fact, giving the power to seek directions probably would.

Professor Catherine Waddams: If Ofwat were to seek a direction, it would be a direction when it came.

The Chair: Yes, it would. Okay.

Professor Catherine Waddams: The problem is that it would be wonderful if it worked well, and I can see that working really well in a good system.

Baroness Donaghy: I understand from the answer to an earlier question that if there was a complete sweep of the board and different people in charge, Ofwat would take the pragmatic approach that it is best to work with them to maximise the new situation, rather than fight old battles. But would you say that there is rather a long time between issuing some indication that there is a problem and the bailiffs arriving? It seems to me that they get at least a years notice that the bailiffs might arrive, and that gives them plenty of time to either improve or pack their cases and disappear to, say, Australia. You said that these things take a long time. Would you say that there is an area of taking action that could be improved in that direction?

Professor Catherine Waddams: Yes. It would be good if it were quicker. The case that we were dealing with was really quite historical, much more than a year old. It would be lovely if they improved and that was the response. You want justice to be done, in a sense, and you want things done thoroughly. So, again, there is a trade-off against instant response. Ofwat collects its data in retrospect anyway, so you already have a year because you are collecting last years data, so there is an inevitable time lag. It would be nice if it were shorter, but getting it very short would probably compromise other aspects of the process.

Q52            Lord Reay: If inflation stays stubbornly high, do you see it having a material effect on the upcoming price review?

Professor Catherine Waddams: The price is linked to inflation, so water bills will just go up with inflation. So in a sense it does not matter, but it matters if particular things become more expensive. What might be more of a problem is if water companies cannot get all the materials they need. There were problems at one stage with chemicals and concerns about that.

It is not so much a problem of inflation. If particular things are not available or if particular prices go up much more than anticipated, companies might find it difficult to live within the price cap. The link with general inflation would be that the price goes up by inflation, minus whatever.

Lord Cromwell: You intrigued me earlier when you suggested, I think, that pouring concrete was not the only way to get more water, and you hinted that perhaps other technologies could be used. Could you elaborate a little more on what you had in mind when you said that?

Professor Catherine Waddams: The more natural process is for purifying water rather than necessarily building a sewerage system.

Lord Cromwell: This is to treat sewage rather than to generate water.

Professor Catherine Waddams: And to hold water; perhaps people from a water company would answer that question better than I would. Sustainable urban drainage systems, I understand, mean that you need less from a reservoir, so there may be ways of holding water other than those ways. As I say, your colleagues may know more about this than I do.

The Chair: Thank you very much for your time and your valuable evidence.