Utility Week - authoritative, impartial and essential reading for senior people within utilities, regulators and government
Issue link: https://fhpublishing.uberflip.com/i/1309237
24 | DECEMBER 2020 | UTILITY WEEK Policy & Regulation Analysis Ofwat furious at CMA verdict The CMA's findings in favour of appellants against their PR19 determinations was a slap in the face for Ofwat, as the water regulator makes clear in its own response to the CMA. Ruth Williams reports. O fwat's submission in response to the preliminary redetermination from the Competition and Markets Authority (CMA) shows just how displeased the regula- tor feels at the outcome. The determinations it spent years completing were undermined by the CMA in a matter of months. The main point of contention was the CMA's decision to raise the weighted aver- age cost of capital (Wacc) from 2.97 per cent to 3.49 per cent for the appellant compa- nies (Anglian, Bristol, Northumbrian and Yorkshire). Ofwat accused the CMA of making both substantive and procedural errors relat- ing to the consistency and rationality of its approach, the adequacy of its reasoning and the use of evidence – which Ofwat alleges was "selective and flawed". Although the statutory deadline is set for 18 March 2021, the CMA is aiming to make a final decision by December. Ofwat has urged the CMA to make full use of the available time, although – because of necessary busi- ness planning – this would bind the appel- lants to the regulator's final determination until the start of the following financial year in April 2022. Ofwat is not only concerned about what the ruling would mean for customers in terms of higher bills, but also the implica- tions for the sector over the longer term. One analyst tells Utility Week the findings "com- pletely cut across" work Ofwat has done over the past five years to align incentives between customers, shareholders, and man- agement teams. The CMA opted to "aim up" on Wacc, set- ting it at the higher end of the range to off- set investment risks. It defended its choice on the basis it had done it before. How- ever Ofwat argues there is no evidence for this, saying it appears to be a "significant mistake". Ofwat asserts there is historically no link between higher returns and new investment. The CMA has largely agreed with the water regulator on allocated finance for projects over the five-year period, meaning the addi- tional money will primarily go to sharehold- ers rather than benefitting customers or the environment. Ofwat describes the approach as "the panel making a radical break with the estab- lished position without acknowledging or justifying that result". As recently as July this year, the CMA ruled that aiming up on the cost of capital was not necessary in the case of air traffic controller service provider NERL appealing against the Civil Aviation Authority. Ofwat questions if the CMA considered and rejected its previous ruling in the aviation sector, ask- ing what changed in such a short time. It accuses the CMA of being inconsistent in its approach and deviating from regula- tory precedent by selectively endorsing and ignoring other standing policies. One sector commentator suggests that "messing around with the cost of capital will antagonise other water companies to start reaching out to their lawyers for legal grounds to object" to the ruling. War of the regulators? Sources suggested the generosity of the rul- ing could lead Ofwat to seek a judicial review. However, Dominic Nash, head of Euro- pean utilities research at Barclays, says it would be unlikely: "The CMA ruling on cost of capital is positive for the companies but it is in the range that Ofwat and Ofgem had set out – albeit at the higher end, so it will be difficult for Ofwat to challenge this by appealing through a higher court." Another commentator suggests: "It has been a little bit face-losing for Ofwat and they are naturally upset by the ruling, as is evident in their response, but to have two regulators essentially suing each other is a ridiculous situation to be in." Ofwat has not ruled out such a move but stated it hopes not to reach that point. Ofwat had 15 months between receiv- ing dra business plans in September 2018 and publishing its final determinations in December 2019. The CMA, by contrast, had little over six months since submissions were made in March to thoroughly review four business plans. The CMA indicated it is seeking further evidence on issues that it has not yet reached a verdict on, including leakage, which Ofwat suggests is evidence the process was rushed. Given the seriousness of the issues, Ofwat is concerned the watchdog has insufficient time to arrive at its conclusion. The expertise of the panel has been called into question by several sources who asked whether – especially in the time available to re-determine four companies – it has suf- ficient knowledge and resources to make its judgements. Ofwat says there is "no good reason for the panel to compress its procedure" and adds that "promptness cannot outweigh the needs of procedural fairness or the impera- tive for the panel to correct its errors". Shaking the regulatory bedrock The water regulator has been outspoken that the CMA's decision undercuts its ability to regulate, for example with the fast-track process. Severn Trent, United Utilities and Pennon Group all gained fast-track status and accepted Ofwat's cost of capital, but now could be getting a worse deal than those whose plans were rejected. An extreme consequence could see man- agement teams seeing more value in appeal- ing than engaging with Ofwat leading to even more approaches to the CMA at PR24, which could collapse the process. However, one analyst argues that although any company would naturally like a higher cost of capital, having an extra 18 months of certainty to plan is ultimately more valuable. Ruth Williams, water correspondent To read further reaction to the CMA's initial findings, go to https://utilityweek.co.uk/fast-and- flawed-pressure-mounts-on-cmas-pr19-stance/