Utility Week talks to David Black about Ofwat’s approach to the assessment of PR19 business plans

David Black, senior director Water 2020, Ofwat

UW: What are the core principles Ofwat will apply to the categorisation of business plans?

DB: There are three main characteristics we’ll be looking for. We want high quality plans that are relevant and which stand up to scrutiny, We want plans which are ambitious for customers, that are really going to push the frontiers in terms of service, in terms of cost, in terms of identifying risks and responding to challenges around resilience. And then we want plans to be innovative. For companies to really show how they can think and work in different ways in order to enable the ambitions they have for customers.

UW: To what extent will the ambition that plans express be anchored in their current performance?

DB: Current performance is definitely relevant. We’ll be asking what companies are learning from their current performance – not just in terms of what they are delivering in terms of service but also looking at how they are engaging with customers.

All of that will inform our view, which is different to PR14 when we focussed very much on the plan. This time we will absolutely be looking at the plan in the context of current performance and the way a company has responded to the challenges it has faced during this period.

UW: Is it true to say that there is a large degree of relativity in the business plan categorisation process? i.e. a firm may fail to be fast tracked, not because it has not submitted a good plan, but because other companies have submitted better plans.

DB: There is mixture of relativity and absolute bars in the categorisation process. For example, the difference between a fast track and a slow track company is that for the former, Ofwat must not be required to make any material interventions in the business plan. So there are range of things which we expect to see in business plan which have an absolute measure.

When you look to the level up – for exceptional – plans here most by definition show something more than other companies have delivered. But we have quite a broad definition of that the “more” might look like. It could be down to extremely efficient costs, it could be about extremely stretching outcomes, it could be about the way they approach the resilience challenge and the level of innovation in the plan.

UW: Do you think the incentives aligned with the exceptional category are enticing enough to make companies want to stretch for it?

DB: We put that question out to consultation. I think that there is a lot of evidence from PR14 that there was quite strong rivalry between companies in terms of gaining enhanced status and we think that there will be even more around achieving enhanced status. There is evidence that management teams are keen for the reputational benefits.

The upfront financial rewards associated with the exceptional category are relatively modest. We think that is right that there is an upfront reward for exceptional companies, but we are clear that the real rewards will come in the delivery of the plan. Any company in the fast track or exceptional categories is going to be much better placed to earn higher return of both on outperformance against cost and outperformance against outcomes incentives.

That’s where the real returns are for shareholders, and we think it works for customers to because real reward only go to companies who are actually delivering for them.

UW: Do you think companies will be able to deliver what Ofwat wants from “high quality” plans in terms of integrity in the presentation and analysis of data? This is something many firms have struggled with, according to Ofwat’s company monitoring framework.

DB: Getting good quality data is an issue – and one which we do not underestimate. It was an issue which emerged in some of the PR14 business plans.

You are right that companies who haven’t succeeded in doing this well within the current period think hard about how they are going to do this for PR19 – and I would say that I think it is a much bigger challenge for PR19. There is a lot of data available and we will expect a lot of consistently present evidence to back business plan.

Companies on the lower tiers of the company monitoring framework need to be very mindful of their issues there and take account of these when formulating their business plan.

UW: The definition of resilience for the water sector has been redefined for PR19 and placed at the centre of the methodology. What do you want company business plans to show in terms of resilience?

DB: Resilience itself is not new for the sector – a lot of what companies do is already about resilience, for now and the future.

However, for PR19 we will expect to see a new level of ownership for the risks that they are facing, as well as involvement from customers which takes into account their view in resilience. This view then needs to be threaded through their plans.

UW: Direct procurement for customers (DPC) is another new element in PR19. How do you expect companies to address this in business plans?

DB: This is an exciting new opportunity, from both a customer and company perspective. We’ve seen a lo0t of appetite and interest from companies and wider stakeholders already and the initial indication is that there are a number of potential propositions that may come forward for PR19.

It’s important that these are high quality propositions, with clear thought about how the company will deliver for customers through the application of direct procurement – both in terms of the procurement itself, and in terms of how the project delivers over its lifecycle.

UW: You say that there is appetite, but we’ve also heard there is some nervousness among companies about using DPC, because of uncertainty around the costs involved in the tendering process and the allocation of risk under the model. Do you sympathise with these concerns?

DB: We’ll be on the lookout for whether companies are really are exploring, in the way that they ought to, the option of utilising direct procurement. But equally, there will be instances in which it is not the right approach. What we expect is that companies can clearly show they have evaluated this as an option.

We’ve done a lot of work around the direct procurement framework, publishing a report on it alongside our draft methodology for the price control and setting out in quite a lot of detail how we see the process working. We’ve moved from a concept in 2016, to having a really quite detailed architecture in the draft methodology.

So no, I don’t have a great deal of sympathy. I think the framework is clear, the intent is clear.

UW: The financial structure of water companies and the returns made by shareholders has recently come under intense scrutiny. Will it play in a company’s favour in the business plan categorisation process if they have moved to deleverage before they submit?

DB: The financial resilience of the sector is important and we’ve been clear about that in our resilience framework. I don’t think that any review of financial resilience needs to be left to the price review – we expect it to be something that companies keep an eye on at all points in time.

We are aware that companies are taking some steps, in terms of ensuring their resilience now, and also looking ahead to the price review. Some companies will have made choices in the past which, due to changes in the framework and the falling cost of capital, may need review. We expect good companies to be in a good place by the time we get to the price review.

But, to be clear, financial structures and the level of gearing firms take on are a matter of choice for their management. The way we regulate ensure that customers do not bear any additional costs – if there were to be any arising from company financing choices.