Water Act 2014 paves way for reform in the water sector

The Water Act 2014 (the Act) received Royal Assent on 14 May 2014, nearly a full year after it was first introduced into the House of Commons. The Act introduces a package of measures designed to reform the water market in England and Wales, whilst maintaining a stable regulatory environment. It represents one of the most significant reforms of the water industry since privatisation in 1989. The main change to the Act since its introduction to Parliament in June 2013 is to include, partly in response to industry pressure, the ability of an existing undertaker to exit the non-household retail market.

Key reforms in the Act are as follows:

FULL OPENING OF COMPETITION IN THE (NON-HOUSEHOLD) RETAIL MARKET IN ENGLAND FROM APRIL 2017

• The Act gives the power to the Secretary of State to remove the current threshold requirement in so far as it relates to business premises supplied using the supply system of a water undertaker in England (the current threshold is 5Ml/a). The UK Government had said at the time of introducing the draft bill that retail competition is expected to be introduced in England in April 2017. In anticipation of market competition, the Open Water Programme was launched by Ofwat in September 2013 to implement the wholesale and retail market reform and has published in January 2014 its recommendations for high level market design.
• Similar powers are granted to the Welsh Ministers in respect of the supply systems of those water undertakers operating wholly or mainly in Wales (Welsh Water and Dee Valley Water). However, the Welsh Government currently does not support any further opening of the retail market to competition. Until such time as that position changes, the retail market in the areas served by those two undertakers will therefore remain as it is under the current water supply licensing (WSL) regime (with a threshold of 50Ml/a).

EXPANSION OF THE CURRENT WATER SUPPLY LICENSING REGIME AND INTRODUCTION OF SEWERAGE LICENCES

• The water supply combined licences are to be replaced with ability of a licenced supplier to hold separate authorisations on a national rather than on a site by site basis for one or more of the following: (a) a retail authorisation; (b) a wholesale authorisation; (c) a restricted retail authorisation; and/or (d) a restricted retail authorisation and a supplementary authorisation. The authorisations (c) and (d) are intended simply to retain the current WSL regime as it applies to the supply systems of those undertakers wholly or mainly in Wales.
• Water undertakers are precluded from holding a water supply licence. They must set up their own separate company and apply for a supply licence should they wish to enter the national market (as a number have already done under the current WSL regime).
• A new sewerage licensing regime made up of similar authorisations is also introduced. Three types of authorisation are provided for: (a) a retail authorisation; (b) a wholesale authorisation; and (c) a disposal authorisation. Given sensitivities around third parties using the public sewer system, the granting of sewerage licences for wholesale and disposal are subject to stricter rules on consultation and approval.
• It is expected that the introduction of a revised regime to open up retail and wholesale competition in relation to supply to all non-household customers in England will make it easier for businesses, charities and public sector customers to take control of their water use and switch their water and sewerage providers. While enabling provisions are provided for in the Act in respect of Wales, the new WSL and sewerage licensing regimes will not apply to the supply systems of those undertakers wholly or mainly in Wales until such time as the Welsh Ministers decide to bring these provisions into force.

A JOINT RETAIL WATER MARKET BETWEEN ENGLAND, WALES AND SCOTLAND

• The Act introduced new sections into the Water Industry Act 1991 (“WIA91”) and the Water Services etc (Scotland) Act 2005 enabling the Secretary of State and Scottish Ministers, respectively, to allow applications for water supply or sewerage licences of the retail and restricted retail authorisations types made to Ofwat to be treated as applications for the equivalent licences from the Water Industry Commission for Scotland (WICS) (and vice versa). The Act requires each of Ofwat and WICs to forward applications for such water supply or sewerage licences to their regulatory counterpart in England and Wales or Scotland (as applicable). There are however no equivalent provisions in Scotland for the licensing of wholesale, supplementary or disposal authorisations.
• The intention is to develop a seamless market for water supply and sewerage retail services for non-household customers across England and Scotland. In Wales that market will be limited for the time being to eligible (non-household) water supply customers consuming more than 50MI/a.

RETAIL EXIT

• As a late addition made during the passage through the House of Lords, the Act now includes the ability for incumbent water or sewerage undertakers to exit from the non-household retail market. The UK Government’s main concern in allowing this had been about the impact on customers and so restrictions have been introduced so that exit is subject to approval from the Secretary of State, who in turn is required to consult a range of stakeholders including Ofwat, the Welsh Ministers, Consumer Council for Water, water undertakers in England, water supply licensees and sewerage licensees.
• Exit regulations to be made by the Secretary of State could include provisions for the orderly transfer of relevant non-household business to an eligible licencee or licencees. They may also include protections for both the household and the non-household customers affected. This new provision would allow water undertakers to exit their non-household retail supply market and to operate their own separate UK/GB-wide retail supply businesses, potentially signalling a radical shake-up in the structure of the industry reflecting the vertically unbundled model now operating in Scotland.

NEW PROVISIONS TO FACILITATE BULK SUPPLY AND SEWERAGE CONNECTIONS

• There is a general consensus that there is a need to increase the interconnectivity between undertakers so that water resources can be used more flexibly and efficiently. Since privatisation, companies have made significant investments in integrating their own water supply networks but the volume traded between them has remained fairly constant at about 4–5% of total supplies.
• The Act amends the WIA91 to allow for the introduction of new codes and charging rules to increase transparency and streamline negotiations between undertakers for bulk supplies of water (replacing the current sections 40 and 40A of the WIA91). This covers both the incumbent water companies and new inset appointees looking to develop their own new water supply networks within an incumbent’s area. The provisions for bulk water supplies are mirrored in respect of mains connections to undertakers’ sewerage systems (replacing the current section 110A of the WIA91).
• As under the current legislation, Ofwat can step in where it is satisfied that a proposed bulk supply is necessary or expedient for the purposes of securing the efficient use of water resources and the parties are unable to come to an agreement themselves. However, the Act gives Ofwat new powers to develop legally enforceable codes for bulk supply and sewerage connection agreements. These may set out standard or specific terms and conditions, which may be mandatory or not, and may include principles for determining what terms and conditions and charging arrangements are suitable for particular agreements. Ofwat will also have the power to require undertakers to act in accordance with the codes when negotiating agreements and to the powers to enforce those it determines itself.
• The new rules on bulk supply agreements will apply to agreements made before the coming into force of the Act and those made voluntarily.

REFORMS TO THE SPECIAL WATER MERGER REGIME

• The current special merger regime for water is regarded as a disincentive to consolidation in the industry. It is also perceived to create uncertainty as to the deference to be given to maintaining a sufficient number of independent water companies to operate the system of comparative regulation when setting price controls.
• The Act reforms the special water merger regime by introducing further exceptions to the obligation on the Competition and Markets Authority (“CMA”) automatically to refer certain water mergers for a full “Phase 2” investigation (previously a reference to the Competition Commission). Specifically, the Act enables the CMA to accept undertakings from the water companies in lieu of a reference and to proceed if the merger is not likely to prejudice Ofwat’s ability to carry out its duties, or if it does, if the customer benefits relating to the merger outweigh the impact on Ofwat’s ability to perform that function. In the latter case, the CMA is required to take Ofwat’s evaluation of the merger (as made against a statement of methods for assessing such impacts) into account before making a decision.
• Acceptance of any undertakings in lieu is also to be weighed up against the “the need to achieve as comprehensive a solution as is reasonable and practicable to the prejudicial effect” on Ofwat’s ability to make comparisons between water enterprises and the effects on any relevant customer benefits.

NEW DUTY TO "FURTHER THE RESILIENCE OBJECTIVE”

• The WIA91 has been amended to give Ofwat a new primary statutory duty to further the “resilience objective”. Put simply, this objective is to secure the long-term resilience of water supply and sewerage systems as regards “environmental pressures, population growth and changes in consumer behaviour”. The Act explains that action needed to secure resilience may include promoting long-term planning and appropriate investment, increasing efficiency in the use of water and the use of a full range of appropriate measures to manage water resources.
• Further duties relating to the market reforms are introduced in Chapter 3 of the Act. These include a general statutory duty to secure that incumbents do not unduly discriminate in favour of their own retail businesses. This general duty is likely to have more specific application under the reformed WSL regime, for example when undertakers are dealing with both their own retail businesses and other retail licensed suppliers.

APPROVAL OF CHARGES SCHEMES

• The Act removes the requirement that undertakers’ charges schemes do not take effect until approved by Ofwat. Undertakers will however be required to adopt their charges schemes in accordance with enforceable rules to be prescribed by Ofwat. Ofwat is also given new powers to direct undertakers to make changes to schemes in the following year and, “if absolutely necessary, in year, to take such other action as is appropriate”. The Act makes similar provisions for charges for connections, water mains, public sewers and for moving pipes.

FLOOD INSURANCE SCHEME TO BE INTRODUCED FROM 2015

• Further to the Government’s negotiation with the insurance industry to ensure that properties in the high risk of flooding areas can secure affordable insurance against flood risk and expiry of the Statement of Principles (in July 2013) which governed floor insurance for domestic and small business premises, the Act introduced the Flood Re (or the FR Scheme) reinsurance regime. Subject to obtaining State aid and Prudential Regulation Authority approvals, the scheme intends to manage, over an up to 25 year period, the transition to risk-reflective pricing of flood insurance for eligible household premises by providing a levy based insurance pool. Further details of the scheme are expected to be set out in secondary legislation.

MEASURES TO TACKLE UNSUSTAINABLE ABSTRACTION AND EXTENSION OF ENVIRONMENTAL PERMITTING REGIME

• While the Act does not directly address issues affecting “upstream” competition (as identified in Professor Martin Cave’s report back in 2010), it does include a requirement on the UK Government to address unsustainable abstraction by placing a duty on the Secretary of State to report to Parliament on the water abstraction reform in England. This reform must be presented to Parliament by 14 May 2019 (i.e. within 5 years of the Act receiving Royal Assent).
• The Act also contains a specific provision removing the water undertakers’ rights under the Water Resources Act 1991 to be compensated in the event that the Secretary of State or the Welsh Ministers require abstraction licences to be revoked or varied.
• The Act also enables the Secretary of State or the Welsh Ministers to make regulations to include water abstraction licences, water impounding licences, flood defence consents and fish pass approvals as environmental permits under the Environmental Permitting regime. This is expected to simplify the existing complex permitting regimes, avoid duplication and enable various activities to be covered by a single permit where appropriate.
• Finally, the streamlining applies also to the frequency with which undertakers must review their drought plans extending this to a maximum five yearly cycles (instead of three) and thus aligning with the approach taken on the Water Resources Management Plans. The majority of the provisions in the Act including those concerning threshold requirements and Ofwat’s duties come into effect in July (at the end of 2 months from the date of Royal Assent) the date for the remaining provisions is to be specified.

For Water Act 2014 as published, please see here.

For our previous law-now on the draft Water Bill please see here.