Water 2020: our regulatory approach for water and ...

1 2016 Water 2020: our regulatory approach for waterand wastewater services in england and WalesTrust in waterWater 2020: Our regulatory approach for Water and wastewater services in england and wales 1 About this document This decision document sets out the future regulatory framework for the Water and wastewater industry in england and wales to enable the Water sector to address the challenges it faces and to help build trust and confidence among customers and wider society. It outlines the changes to company licences that flow from the new regulatory framework. It also sets out specific areas for further consultation about the role of markets and the regulatory framework for the 2019 price review. We intend this document to help promote a shared understanding of our approach to regulatory design and the implications, costs and benefits associated with it. Water 2020: Our regulatory approach for Water and wastewater services in england and wales 2 Contents Executive summary 3 1.

2 Introduction 9 2. Focusing on current and future customers 18 3. Securing legitimacy of future price controls 56 4. Moving beyond waste 91 5. Tackling Water scarcity 128 6. Enabling direct procurement for customers 183 7. Targeting regulation for networks 196 8. Implementing our decisions: licensing and next steps 213 9. Summary of our consultation questions 227 Water 2020: Our regulatory approach for Water and wastewater services in england and wales 3 Executive summary This document sets out our decisions on the design of our Water and wastewater services regulatory framework in england and wales . Our vision for Water and wastewater services in england and wales is one where customers and wider society have trust and confidence that their Water and wastewater services are of a high quality, provided in an environmentally sustainable way, resilient and affordable. The resilience of these services is a critical part of this.

3 Customers want confidence that clean, safe drinking Water will be reliably available and that they can rely on their wastewater being taken away. Society needs confidence that these services will be provided today and in the long term, without compromising the natural environment, and more widely that decisions taken today will not impoverish future generations. Delivering this vision relies on everyone in the sector working together and working with those outside the sector, such as community and farming groups listening to customers and tackling long-term challenges. The Water sector is facing critical challenges. These challenges suggest that if we do not change, then there is an increasing risk that the future could be characterised by disengaged customers and low levels of legitimacy; where precious Water resources are not used as efficiently as they might be putting greater pressure on the environment; and where opportunities to tackle affordability and deliver more for less are not seized, resulting in higher bills for customers.

4 We need to address these challenges together to ensure that customers needs, priorities and concerns are heard and responded to, both now and in the future . Our new regulatory approach will help to secure a resilient future for Water , for the benefit of customers, the environment and wider society. We are making changes to the way we regulate in future to play our part in building trust in Water . Here, we summarise the main elements of our future regulatory approach for wholesale markets and the price review in 2019 (PR19) and beyond, building on the successes of our previous price review (PR14). In July 2015, we published a discussion paper on the challenges facing the sector and the role economic regulation and markets could play to enable the sector to meet these challenges. We also opened the marketplace of ideas, with Water UK, to enable stakeholders to contribute to development of our thinking.

5 In December 2015, we published our consultation on the regulatory framework for wholesale markets and the 2019 price review, building on and drawing Water 2020: Our regulatory approach for Water and wastewater services in england and wales 4 from contributions to the marketplace of ideas. This set out proposals for the design of the future regulatory framework for Water and wastewater services in england and wales , addressing both the role of markets and the role of regulation, which we see as complementary. Since then, we have had productive and wide-ranging discussions about our proposed regulatory framework with a variety of stakeholders. We have listened carefully to, and considered, the views and evidence put to us and thank all participants for their engagement. This process of engagement has helped to shape our thinking and our subsequent decisions. The decisions (and further areas for consultation) we set out here build on the debate and the contributions made to it by all those involved.

6 In that context, this document constitutes an important milestone in developing our approach to PR19, and one that we are pleased to have reached at this early stage in the current control period. At the heart of our regulatory framework for Water and wastewater services is the desire to strengthen the approach to customer engagement and outcomes to ensure a continued focus on current and future customers. PR14 saw the biggest ever customer conversation in Water and wastewater services . Our new regulatory approach places even greater expectations on companies to understand the needs of all their customers, including those in circumstances which make them vulnerable. This requires more diverse approaches to understanding customers priorities, needs and behaviours. Specifically, companies should look to build a robust, balanced and proportionate evidence base, fully exploring how they can make use of operational data and information gained from innovative approaches (including experiments) in addition to survey data, focus groups and other research.

7 The understanding of customers priorities, needs and behaviours that companies gain should inform the development of business plans, including performance commitments, that drive the delivery of resilient services now and in the longer term. Our regulatory framework also strengthens the role of local independent Customer Challenge Groups (CCGs) to challenge companies even further to improve the quality of their customer engagement. By raising the bar on customer understanding and engagement, we want customers to be more involved in helping shape Water and wastewater services , both now and for the future . In this regard, we would welcome examples of companies proposing solutions co-created with customers or communities. Our regulatory approach emphasises the importance of trust and confidence in Water and wastewater services both now and in the future . Credible and legitimate indexation of customer bills is central to trust and confidence in the sector.

8 Previously, our price controls have been linked to the retail price index (RPI). This means that customer bills have been linked to RPI. RPI is no longer an official statistic its robustness has been called into question and its use by government and regulators is diminishing. RPI is more volatile than other commonly used Water 2020: Our regulatory approach for Water and wastewater services in england and wales 5 measures of inflation, risking more uncertainty for customer bills. We have had extensive and constructive engagement with customer groups, companies and investors about whether and how to change inflation measures within our price controls. Other regulators have also sought views on this issue. We will be changing our indexation for customer bills and companies assets to a more legitimate measure of inflation, the consumer price index (CPI, or CPIH). We will decide between CPI or CPIH in our methodology statement for PR19, which we will consult on in July 2017.

9 The basis for indexing revenues and the regulatory capital value (RCV) will be different from the beginning of the next control period. We will index revenues to CPI/H from the start of PR19 and transition the indexation of the RCV as it stands at 1 April 2020. We will index 50% of the RCV at 1 April 2020 to RPI. The rest of the RCV, including all new RCV added after 1 April 2020, will be indexed to CPI/H, and so the proportion of RCV that is indexed by CPI/H will increase through 2020-25. The transition of the RCV will enable company financing to adjust to the new measure of inflation and help companies manage the impact on bills. This means that, from 1 April 2020, inflation on customer bills will be linked to CPI/H helping to maintain customer trust and confidence, and potentially reducing bill volatility. We provide a statement of principles we will apply when considering the transition of the indexation of the RCV beyond 2025.

10 We do not think it is desirable to set the transition path for the proportion of RCV indexed to CPI/H beyond 2025 at this time. The decision on the speed of transition beyond 2025 will need to be made by reference to relevant factors at the time, including analysis based on up-to-date information and following consultation with stakeholders. Our new regulatory approach will promote markets to inform, enable and encourage greater efficiency in england and, where it aligns with Welsh Government policy, in wales . To meet future challenges, we need to ensure that Water and wastewater services are resilient, efficient and taking a long-term approach . New markets places where buyers meet sellers can benefit customers, the environment and wider society through choice, resilience and information. We are taking steps to inform, enable and encourage the development of two new markets sludge (which is becoming recognised as a bioresource and we use this term in place of sludge) and Water resources where there is potential to unlock substantial benefits for customers, companies, investors and the environment.