Don’t bottle it: a once-in-a-generation reset to water regulation

“Keep focusing on where you want to end up…!” I’m currently teaching my daughter to drive, and find that focusing on the middle distance helps with road positioning (and stress levels!). Last month’s launch of a call for evidence by the Independent Water Commission also asked respondents to focus on where we want to be in the longer term. The Independent Water Commission, chaired by Sir Jon Cunliffe, is seeking views to reset the water sector and its regulation, and his speech launching the call for evidence described the complexity of the current system, while acknowledging that “something has clearly gone wrong”. 

There is a welcome focus in the launch document on the importance of building a better understanding of asset life issues, and planning for maintenance. Aligning regulation to the detail of asset performance is a key part of the answer to the malaise in the sector, whose current reputation has been unfavourably compared to the banking sector in the aftermath of the 2007 crash. 

The defining characteristic of the financial services sector during that period was a lack of public trust, and Sir Jon has identified the goal of the Commission as creating an “industry and regulatory system that is trusted by the public, by customers, and by investors”.

We have inherited the sector for which the regulatory system was originally designed

The current legal and regulatory framework was originally designed for light-touch regulation of a sector which, at privatisation, was empowered to focus on enabling shareholder-driven efficiencies and promoting long-term investment to support inter-generational stewardship of key assets. The drivers for privatisation included encouraging a significant tranche of investment into the sector in order to meet EU environmental standards at that time.

The current reset must achieve a similar step change in order to enable the sector to meet the key external challenges of climate change and a less stable macro-economic context. Tackling water shortages and reduced biodiversity, as well as dealing with pollution from multiple sources affecting our rivers and coastlines, requires a coordinated, long-term response.

Increased complexity of regulation

The report highlights that Ofwat’s original objectives to protect consumers and to ensure the effective operation of companies and the delivery of statutory functions have been expanded over time. The regulator now has five general duties, and a range of other objectives and duties that it must attempt to balance in carrying out its functions. At the same time, Ofwat has become more prescriptive in how funds are applied, including for example, introducing performance commitment deliverables into the price review process.

The Commission acknowledges that the legislative framework has been amended in a piecemeal fashion to achieve ‘corrections’ and shorter term goals. Regulators have ramped up enforcement of standards that companies may argue they are not funded to meet, and there are increasing forays by regulators and policymakers into the detail of companies’ governance, including involvement in corporate structures, and the appointment and remuneration of directors. 

These developments risk disempowering companies and encouraging a reactive approach to regulatory oversight. The gaps in the legal and regulatory framework, together with contrasting areas of overlap between regulators, create administrative and regulatory uncertainty for companies and, crucially, investors. In the meantime, there are significant contributors to environmental degradation that are poorly regulated, for example management of highway runoff, and septic tanks, which are often poorly maintained by property owners.

Best practice models of collaboration and purpose-driven growth

The report considers the prospect of increased powers for regulators, and the potential merging of economic and environmental regulation. It also notes the importance of encouraging planning frameworks which can support growth and infrastructure renewal. Positive examples include the work of the Regulators’ Alliance for Progressing Infrastructure Development (RAPID), and the model of ‘ethical-based’ regulation introduced in Scotland. 

Promoting long-term stewardship will undoubtedly require companies to rebuild customer trust. To enable this, policymakers and regulators need to empower companies to develop governance supporting a longer term focus on the external challenges, in turn generating stable returns and attracting additional investment. “Focusing on where you want to get to” has never been more relevant.