Water companies reeling from the Competition and Markets Authority (CMA)’s proposal to raise the cost of capital and allow higher rates of return for the four companies that appealed Ofwat’s final determination will inevitably be considering their options. Could an interim determination be the answer?
After the publication of the CMA’s initial findings on Anglian, Bristol, Northumbrian and Yorkshire Water, there could be a legal stand for those 13 companies that accepted their determination.
Much of what the CMA ruled on was, by and large, in-line with expectations – adjustments to ODIs, spending on leakage and resilience programmes granted – but the change to weighted average cost of capital (WACC) took everyone by surprise.
Air traffic control services company, NATS En-Route, is rumoured to be the most displeased, because the move – which was at odds with the CMA’s ruling on the Civil Aviation Authority dispute – implies that investing in a regulated water company carries higher risk than in aviation services.
Although legally the determinations for the water companies that did not appeal will be unchanged by the CMA’s ruling, Colm Gibson, managing director at Berkley Research Group, suggests there could be another option.
“The management of the other companies may be considering whether they could trigger an interim determination because, if Ofwat rejects that, they would have the right to appeal to the CMA,” Gibson says.
Individual companies can approach the regulator to make an interim determination that could address the cost of capital within that process. Gibson suggests that the impact of Covid-19, particularly on future levels of bad debt, could well be significant enough to warrant such requests.
Gibson said: “Given that interest rates have fallen since companies have accepted Ofwat’s price control and, that the Bank of England seems to be contemplating negative rates, it may appear hard to argue there should be a higher cost of capital allowance, but once a company meets the trigger criteria for an Interim determination of the K figure (IDok). If Ofwat rejects the IDoK then that can be appealed to the CMA.”
There are two types of interim determination, one would cover any notified items or relevant changes in circumstance. The notified items are specified by Ofwat at the price review, and typically relate to things which were known to be uncertain, such as bad debt and business rates. A relevant change in circumstance would cover a change in legislation or government guidance, which the Covid-19 legislation would likely count as.
The second type of IDoK covers substantial affects, again Covid-19 is arguably a substantial adverse effect. Either would apply for the reminder of the five-year period on a company-by-company-basis.
“It’s a hard one for companies because it’s a two-way thing, there are relevant changes in circumstance that help companies and relevant changes in circumstance that hinder companies. It’s the balancing figure between the two that determines whether they trigger an IDoK,” Gibson said.
Another sector commentator warned that while an interim determination would be a genuine option for some, they are “quite a messy process” that would involve a lot of hard work with no guarantee of being effective.
They suggested a more effective approach would be for companies to collectively by-pass the regulatory process and persuade government that Ofwat’s rate of return is wrong. However, a case to encourage green recovery to boost the post-Covid-19 economy without costing the Treasury may struggle to gain traction at a time when government has so many pressing issues to attend to.
Historically, there have been significantly more triumphs than failures for companies in the IDoK process. Aside from the most recent, Thames 2013, the substantial majority have been successful for the companies.
However, those companies must weigh up whether the time and resources required are worth it – which was a deterrent to appealing PR19, but that risk appears to have been worthwhile, given the CMA’s provisional findings.
Historic requests for IDoK with outcome dating back to 2000 including 12 standard IDoK and three ‘substantial (adverse) effects’.
| Company | Financial Year | Allowed/ Rejected |
change in K | Comment | |
| 1 | Tendring Hundred | 2000/01 | Allowed | +7.5% | |
| 2 | Dŵr Cymru | 2000/01 | Allowed | +3.0% | |
| 3 | Anglian Water | 2000/01 | Rejected | 0.0 | |
| 4 | South West Water | 2001/02 | Allowed | +7.2% | |
| 5 | Dee Valley Water | 2001/02 | Allowed | +4.5% | |
| 6 | Bournemouth & W Hants | 2001/02 | Allowed | +1.3% | |
| 7 | Yorkshire Water | 2002/03 | Allowed | +5.9% | |
| 8 | Severn Trent | 2002/03 | Allowed | +3.3% | |
| 9 | United Utilities | 2003/04 | Allowed | +4.4% | |
| 10 | Northumbrian Water | 2003/04 | Allowed | +6.8% | Substantial (Adverse) Effects |
| 11 | Bournemouth & West Hants | 2003/04 | Allowed | +3.8% | Substantial (Adverse) Effects |
| 12 | Dee Valley Water | 2007/08 | Allowed | +6.4% | |
| 13 | Bristol Water | 2007/08 | Allowed | +4.2% | |
| 14 | Sutton & East Surrey | 2008/09 | Rejected | 0.0 | Substantial (Adverse) Effects |
| 15 | Thames Water | 2013/14 | Rejected | 0.0 |