“If you bake your assumptions about the future into your regulatory structures and your methodology then you have the effect of ossifying the sector, or you dampen innovation, or you do damage”

Cathryn Ross bounds into the room with a happy smile, bursting with even more energy than usual. In the final few weeks of her tenure as Ofwat chief executive, Ross has plenty to do – not least, publishing the final methodology for PR19 on December 13. But today, she’s taking an hour out to reflect on her four years in post and ask, what’s left to be done in the water sector?

Ross joined Ofwat for her second stint at the regulator in 2013, from the Office of Rail Regulation. Come January, she’ll be making her first foray into the private sector, as director of regulatory affairs at BT. The industry consensus, as companies await news of her successor, is that she leaves a job well done. While the relationship between the regulator and the sector is not always in perfect accord, it’s come a long way since Ross joined, in the dark days following the Section 13 debacle that saw water companies in a public standoff with their regulator. The fundamental changes planned in PR14 have all but been achieved, and further change is on the horizon with next price review. Against the odds, the business retail market was opened to competition on time, and customer bills are going down in real terms.

Despite these achievements, water finds itself is at the centre of a political storm, with Jeremy Corbyn’s Labour party leading the charge to renationalise the sector, and the media – even the usually pro-markets Financial Times – openly questioning the legitimacy of the privatised companies.

How did it come to this? According to Ross, it’s been bubbling under for quite some time: “Although [the Labour party manifesto commitment to renationalisation] came out of left field, actually the underlying issues have been around for a long time and I think the message is beginning to be understood, that those issues are things that companies need to take ownership of and do things about.”

Companies are not just trotting out the story about what’s been achieved since privatisation, they are now tackling some of the substantive issues, and I think that’s a good place to be

Those underlying concerns, says Ross, are: value for money, “that’s a hygiene factor”; connection with customers; board leadership, transparency and governance. Ofwat, under Ross and chairman Jonson Cox, has been banging the drum on these issues for years, and today Ross notes considerable progress. However, she warns: “These are essential public services, people think about water as human right, so the legitimacy bar is very high, and I suspect it is probably the case that the debate around renationalisation if anything has set that bar a little higher still.”

Companies are responding, to Ross’s obvious satisfaction. In the past few weeks, Thames Water, the sector’s outlier on many of these issues, has announced the appointment of well-respected former SSE chief executive Ian Marchant as its new chairman, with a remint to review the company’s governance and transparency, and shut down its offshore financial arrangements in the Cayman Islands. In similar vein, Yorkshire Water announced in October plans to leave the Caymans, and is now setting about an ambitious programme of investment aimed at boosting its performance to upper quartile within the next two years.

Ross is pleased, reflecting: “[Companies are] not just trotting out the story about what’s been achieved since privatisation, they are now tackling some of the substantive issues, and I think that’s a good place to be. Clearly if you are for renationalisation on ideological grounds, that’s not going to shift you, but if you’re an advocate of renationalisation because you don’t see any other means of regaining public trust and confidence in essential public services, then some of these changes – the Cayman Islands, financial resilience, building on that connection with customers – all of that stuff actually helps to address the underlying concerns.”

It was a different story a few weeks ago, when Ross took to the stage at Moody’s annual conference, delivering a message designed to be a “wake up call to even the hardest of hearing” (her words), that companies must get their houses in orderThe speech raised eyebrows across the sector and delighted the tabloids.

Usually firm but fair, her tone felt different that time. Deliberately so? “The reason I was being intentionally pointy was because at that moment my concern was that the sector was perhaps too quick to use the narrative about what had been achieved since privatisation and not quick enough to spot that the debate had actually moved on and that there were some real substantive issues that need to be addressed.” She acknowledges the progress made since, though is reluctant to take the credit.

Ross gave another speech a few weeks later – “there’ll be no more speeches!” – which made headlines for different reasons. Companies that were irked by her tub thumping the month before perhaps had even more reason to worry as she outlined a dizzying pace of change in the ten years ahead that would threaten their very business models.

What I think all this amounts to between now and 2024 is a fundamentally different contractual matrix in the sector.

She explains her thinking today, her characteristic rapid-fire tones, delivering well thought-through arguments. On the one hand, she sees customer-driven change, which, as she outlined in her speech, may see the customer’s “primary interface” happening with a connected homes intermediary, which “seamlessly” chooses and switches services on their behalf, according to their needs and wishes. This raises questions about, for example, the value of customer data and the potential for some customers’ data to be more valuable than others. “Does society believe that it is fair for some customers to pay this price for the same service that other customers pay a different price for? Is that ok?”

On the other hand, there are industry-driven changes, around the creation of markets, for bio-resources, water resources, and major capital projects via direct procurement. This, coupled with the tough efficiency challenges facing water companies in the next review, creates “a much tougher, more challenging set of make or buy decisions, but with a far greater set of options over where to make those decisions.”

Ross looks ahead to a world where customers deal directly with utility aggregators and utilities management services, which contract with a water company, which in turn contracts with other water companies, and a range of third parties, for services such as bio-resources, water management and the operation of part of its network – not to mention the potential development of regional system operators for water resources. “What I think all this amounts to between now and 2024 is a fundamentally different contractual matrix in the sector.”

So the next price review, PR24, is likely to entail the creation of a radically different framework that allows for a much more complex value chain. Should PR19 have laid the groundwork for this? Ross shakes her head emphatically. “No – no, no, no,” – it’s clearly a question she’s given some thought. “When we were doing the PR19 methodology, we did ask ourselves actually quite frequently whether we needed to build more into it to reflect the changes that could happen, and we consciously decided that we wouldn’t do that precisely because we don’t know what was coming.

“The danger is as a regulator, you really can’t know the future, so if you bake your assumptions about the future into your regulatory structures and your methodology then you have the effect of ossifying the sector, or you dampen innovation, or you do damage.”

There’s an interesting contrast here with the energy networks sector, which is currently considering whether to move back to a five-year regulatory cycle, having found that change is outpacing the current eight-year framework. “I’m very glad we didn’t go for eight-year controls,” says Ross with a smile.

Ross is keen to challenge the idea that the introduction of retail competition to the domestic water sector would be the gamechanger, insisting that whether or not it happens – “I really don’t know” – customer and market driven change in the sector will be dramatic. Of the business retail market, she lauds the effort involved in getting it open on time, and insists “for six months in, it’s going really well.”

On to the more immediate business of the day – the PR19 methodology set to come out in the middle of this month. Will it contain any surprises? “Not much. You’d be surprised if I said there would be, this whole thing has been built up through a very transparent, iterative process.”

I think it’s a great thing that we are putting out the indicative Wacc in December

That process has allowed for an open debate on key areas such as Ofwat’s approach to setting the cost of capital, which a number of companies have challenged on the grounds that it doesn’t take enough account of historic financial trends. Ross has made no secret of her views on these challenges – in her most recent speech, she said: “We received a number of responses along the lines that we couldn’t possibly move away from an approach to the cost of capital heavily based on history and regulatory precedent because… well … that would be … unprecedented. I don’t think I’m giving much away if I say that we weren’t very impressed with those arguments.”

The regulator has been clear that the cost of capital will be a historic low in the next price review, reflecting the economic environment and ensuring value for customers. Does she have anything to add?

“I think it’s a great thing that we are putting out the indicative Wacc in December, and I say that because it feels like quite a brave place for a regulator to be.”

She adds the “giant caveat” that the final Wacc will be published in December 2019, and a lot can happen between now and then. But: “I think people should not be afraid to be brave, I really do.”

Another key element of PR19 is the ramping up of financial incentives and penalties for key areas of delivery, Outcome Delivery Incentives (ODIs). Aimed at replicating the pressures and rewards of a competitive market, ODIs have been embraced by many water companies. However, in its response to the draft methodology for PR19, one of the Ofwat’s key stakeholders, the Consumer Council for Water, suggested that such incentives, which come out of the customer’s pocket, should be linked explicitly and solely to customer outcomes.

“Customer satisfaction is still a relatively new measure in the sector, it is a multi-variant measure, and I think our concern was that if we place too much weight on customer satisfaction and not enough weight on stuff that can more concretely be measured and observed and delivered by companies, we ran the risk of not necessarily creating perverse incentives but not quite getting the balance of incentives right.”

One of the things I am most proud of over the past four years has been the transformation within Ofwat

With the finishing touches being put to PR19, Ross can take a moment to reflect on what she achieved in her four years at Ofwat – and she’s keen to focus more on a human level than on regulatory red tape, speaking winningly of the “amazingness of human beings”.

“One of the things I am most proud of over the past four years has been the transformation within Ofwat – we have come an enormously long way in actually quite a short space of time.”

Certainly, there’s an energy coming out of Ofwat today that has little to do with the musty old regulators of yesteryear – and it’s a culture change that Ross believes water companies would do well to emulate: “It’s very similar to what we’ve been asking the water companies to do, in terms of being open and confident and embracing change and thinking about new ideas and being agile not just in terms of working anywhere, any place, but in terms of mindset.”

With so much done, and so much left to be done, why has Ross chosen to leave now, before the conclusion of the price review she has shaped? Her answer goes back to the transformational change she has outlined for PR24, and her belief that the chief executive of Ofwat, whoever that may be, needs to spend the next few years getting ready for it. For that reason, she says, her original plan to leave shortly after the conclusion of PR19, would have been disruptive at a critical moment.

And why the private sector after a career in the civil service? “It’s time to do something different, it’s good for people to do something they’re not sure if they can do. I’ve not done anything like this before.”

Ofwat has yet to announce her successor – conscious, perhaps, that she’ll be a hard act to follow. As one water company chief executive tells Utility Week: “She’s made a huge contribution to the sector – she’s been a thought leader, and the way she’s interacted with companies, occasionally driving us, occasionally cajoling us, but always from the perspective of ensuring that we meet the needs of customers now and in the future.” As the water sector faces up to a future defined by uncertainty, one thing’s for sure: Ross will be sorely missed.

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