At the start of this month, Open Water’s market architecture plan told water companies preparing for business retail market opening to focus their immediate efforts on ensuring they met level playing field requirements. That is, the need to ensure all retailers in the market have equality of opportunity to compete for customers, irrespective of size, history or relationship to the wholesaler.
Exactly how companies should go about this is, though, is far from clear. The Water Act does not prescribe legal separation, and other competitive markets sport a variety of different models and degrees of wholesale-retail division.
The industry will get guidance from Ofwat on regulatory expectations regarding the establishment of a level playing field. The regulator shared its initial thoughts on this last September in a discussion paper, and licence conditions are likely to follow in due course. Moreover, its arrangements for PR14 – four discrete price controls for each water company business area (water wholesale, wastewater wholesale, household retail, and non-household retail) – put the foundations in place for organisational separation.
In the meantime, a recent thought leadership paper from market design and governance specialist Gemserv has gone a fair way towards putting flesh on the bones of Open Water’s requirements. It spells out why a level playing field is essential: aside from the penalties associated with contravening competition law, there is the danger the market is dragged into disrepute before it even gets going, damaging consumer, new entrant and investor confidence.
Perhaps more importantly, the Gemserv paper provides direction on what specific actions water companies could take to ensure they comply. It cautions: “Whilst some additional information may be forthcoming from Ofwat, and from licence and market codes development, it is clear that ultimately the buck will stop with the companies and a proactive stance towards these issues is advisable.”
Gemserv explicitly acknowledges that it is up to each company to decide what it does, but from its experience in other markets it recommends clear, organisational separation. It lists as merits of this arrangement that it:
• helps water companies align their operations with the new market;
• protects against potential legal action and mitigates the risk of non-compliance fines;
• protects against potential reputational damage;
• helps water companies demonstrate that they take their obligations seriously;
• assists in briefing staff on their responsibilities;
• helps in communicating with customers who does what in the new market;
• gives focus to those parts of the business and can lead to better outcomes for both the retail and wholesale activities;
• allows wholesale activities to be further developed in readiness for changes proposed for 2019 and beyond without unduly impacting on the retail business.
The paper concludes: “Business models lacking full separation or virtual separation may be possible, but the case to prove that non-discriminatory behaviour is not operating would be more onerous, and potentially open to challenge by both new entrants and the regulatory authorities.”
Gemserv identifies the internal business areas likely to require intervention to achieve organisational separation as: organisational structure; processes; data ownership and access; IT; finance; people; communications with customers; and office space requirements.
It notes that companies will have to make a call in regard to each item as to where to strike the balance between ensuring compliance and footing the bill for implementing change. However, it suggests two sensible “early actions”: separating activities supporting non-household customers into an organisational unit and location; and erecting Chinese wall information barriers to prevent information leakage.
More broadly, Gemserv urges companies to prepare their organisational structure for the competitive market, and to ready their compliance arrangements. The latter could include designating compliance officers and deploying compliance codes, plus monitoring and compliance statements.
Finally, each company should be designing and implementing its market readiness programme, so it is able to engage with all stakeholders in a timely fashion. The paper says: “Key activities will include the development of wholesale tariffs and retail default tariffs, the development and accession to any legal agreements and codes and a full programme addressing the processes and systems needed for market opening and inter-operation.”
Drawing on its extensive work in other markets, Gemserv also identifies some common pitfalls and potential trouble spots. Lessons from electricity suggest new entrants will closely scrutinise incumbents’ wholesale and retail cost allocations, and will question in particular: compliance with regulatory guidance; whether incumbent retailers bear an appropriate proportion of costs; and that there is no cross-subsidy in place.
Second, plenty of other markets have thrown up doubts over information access and commercial confidentiality where wholesalers and incumbent retailers share integrated IT systems. Incumbents need to carefully consider whether to stomach the up-front cost of developing new separated systems for peace of mind, or to re-engineer existing systems.
Finally, perhaps the hardest trouble-spot is employee behaviour. Staff will need to be briefed clearly on any new role they take on in light of competition, and trained on how to operate in the new market. This could be a real challenge for employees used to monopoly markets. Gemserv notes there is as much danger from staff “sleep-walking into non-compliance” as from explicit attempts to discriminate.
The Gemserv paper The Importance of a Level Playing Field for the English Water Market is available at bit.ly/gslpf.
Karma Ockenden is a freelance journalist