Chief executive’s view: Glasnost good for regulation

Provided the process is transparent, customers are empowered, and the benefits of outperformance can be shared, detailed ­dialogue ­between the regulator and those regulated is good for all parties.

There are many lively, ongoing debates about utilities – how they should be regulated, how further competition should be introduced, have market experiments failed, should there be more state intervention… Unfortunately, however, there seems to be much less attention on how best to promote the customer interest in the round, in both the short and long term.

This increasingly polemic debate suggests there is a growing need for companies, regulators, financers and governments to understand and respect each other’s roles. Without the detailed discussion necessary to balance the interests of all those parties, outcomes for customers and the environment may be far from ideal from an economic and wider sustainability perspective. Furthermore, any lack of political consensus will only delay capital expenditure or increase its cost.

Regulators tend to shy away from detailed dialogue with those they regulate, fearing accusations of regulatory capture. But is such a fear justified? In my view it need not be, providing the process is transparent, customers are fully empowered, and mechanisms are in place genuinely to share the benefits of outperformance.

The Glas Cymru model is an interesting case in point. This not-for-dividend, public interest but private sector company appears to engender transparency, stability and customer acceptance. It might have been thought that the absence of profit-maximising shareholders, and accountability only to customers through members essentially appointed by the board, could have resulted in an unduly cosy consensus – particularly as Ofwat cannot set the company as tight a budgetary constraint. But the fact is that customers in Wales do now receive better value for money, and Glas Cymru is able to reduce its net debt while also providing continuing customer rebates (the only company to have done so).

Implementing a Glas Cymru-like structure in Scotland is not an option. However, we wanted to achieve a transparent governance framework, one that would encourage dialogue and build on the kind of customer involvement that exists in Wales.

Our role is to set charges that are consistent with “the lowest reasonable overall cost” for Scottish Water to deliver the Scottish government’s objectives for the industry. The key word here is “reasonable”, for it seems to imply a balance between the interests of ­government, the company and customers.
Government has many potential interests: customers, timely delivery of environmental improvements and the wider economy. Customers want both value for money and investment in the environment, in improving resilience, and in addressing leaks. Scottish Water rightly wants to feel it can realistically meet the challenges set and be recognised for its performance.

The current Strategic Review of Charges includes all the elements we had when setting prices previously, but with two main differences.

The first is the establishment of the Customer Forum. Chaired by a former Scottish government minister, the forum includes household and retailer representatives. Its role is to interpret the word “reasonable”.

The second change is that all stages of the price review now take place in the open.

At previous reviews, in best “sherpa” fashion, we assessed what might be possible based on our analysis of Scottish Water’s performance, the performance of other companies, and the external environment. In doing so we would take account of emerging priorities from the government and the drinking water and environmental regulators. But we would not have shared this preparation with Scottish Water.

Scottish Water’s sherpas would then develop its business plans and propose an initial, then revised price profile. Next we would analyse the revised plan in some detail, then publish an alternative version in a draft determination. Further diplomatic ping-pong ensued, leading to a final determination.

What has already become apparent is the impact our two changes in approach have had on the level of engagement between us and Scottish Water. This dialogue started in earn­est when we shared our initial thoughts of what might be possible for the next regulatory control period with Scottish Water and sought its response. We then published our methodology, which we had discussed with stakeholders over many versions. In between, Scottish Water published its 25-year strategic plan, then a series of service improvement reports.

Once the business plan is published this month, the forum will start its discussions with Scottish Water. We will publish a series of papers identifying what we see as the strengths and weaknesses of Scottish Water’s plan and setting out our views on the range of regulatory inputs consistent with ‘the lowest overall cost’ of delivering ministers’ objectives.

The aim is to allow the forum to negotiate with Scottish Water on a level playing field and to reach informed agreement with it on a reasonable outcome to the price review. If the forum agrees an outcome for customers and the environment that is consistent with our published range of regulatory inputs, their agreement would form the basis of the draft determination. As such, the forum is fully motivated to achieve the best possible outcome for customers.

Importantly, Scottish Water also has the opportunity to know what will be required of it in the next regulatory control period – a full year before it starts. This is good for the company, the supply chain and customers.

Our new regulatory framework is characterised by a “trust but verify” approach. The prospects for a successful outcome appear to be very good. It appears that customers in Scotland may end up paying less and getting more than seemed likely at the start of the process. Our benefit sharing mechanism further protects customers and allows Scottish Water to enhance its reputation with its customers.

Increased dialogue, transparency and the addition of customer challenge – in short, Glasnost – seem likely to achieve a better result for all parties.