Considered in Grand Committee
That the Grand Committee do report to the House that it has considered the Water Industry (Specified Infrastructure Projects) (English Undertakers) Regulations 2013
Relevant documents: 2nd Report from the Joint Committee on Statutory Instruments, 3rd Report from the Secondary Legislation Scrutiny Committee
My Lords, the draft regulations before the Committee today are aimed at helping the delivery of necessary, large or complex water or sewerage infrastructure projects. They are designed to help to contain and minimise the risks associated with their delivery to customers of water or sewerage companies, known as undertakers, and also to UK taxpayers. Containing and minimising these risks should correspondingly provide better value for money associated with delivering such projects. It should also help to ensure that undertakers’ customers continue to receive the required or desired level of existing water or sewerage services.
These regulations would enable the Secretary of State or Ofwat to specify by notice an infrastructure project where either is satisfied that two conditions have been met. The first is that the infrastructure project is of a size or complexity that threatens an undertaker’s ability to provide services to its customers. The second condition is that specifying the project would be likely to result in better value for money than if the project was not so specified, taking into account charges to customers and any government financial assistance.
Once specified, an undertaker would then be required to put the specified infrastructure out to tender and a separate Ofwat-regulated infrastructure provider would be designated to finance and deliver the project. These large, complex infrastructure projects raise issues of determining the cost of their financing coupled with a construction risk that is far greater than that normally associated with an undertaker’s typical capital investment.
Enabling an undertaker to tender competitively an infrastructure provider for a large or complex project provides an objective means of testing whether the financing costs of such a project are appropriate or reasonable. Without that tendering process, competitively determining the cost of capital for those types of project would not be possible. The ability to create ring-fenced Ofwat-regulated infrastructure providers between undertakers and large or complex projects would also help to ring-fence their associated higher risks, and should result in more effective risk management for these projects.
Enabling the creation of infrastructure providers would prevent the threat of a large or complex infrastructure project affecting the ability of an undertaker to provide its day-to-day services for its customers, avoiding any resultant extra costs that would ultimately be borne to some extent by those customers.
There have been two public consultations on the regulations. An initial 12-week public consultation was carried out between February and May 2011, seeking views on proposals for new regulations. Thirteen replies were received and a summary published on Defra’s website in September 2011. The second consultation ran for four weeks between 5 November and 4 December 2012. Its purpose was to inform stakeholders representing interests likely to be affected by the proposals; it included draft regulations and a corresponding impact assessment.
The latter consultation was issued by e-mail to 73 contact addresses previously contacted for the 2011 consultation and included the Mayor of London, London MPs with a known interest, EFRA committee MPs, water and sewerage companies, Ofwat and the Consumer Council for Water. Seven responses were received and a summary published on Defra’s website in March 2013.
We have noted the range of views and comments received on the proposed legislation and relating to the proposed Thames tideway tunnel project in London. In particular, we note concerns that provision to enable separate infrastructure providers might allow undertakers to avoid obligations to provide necessary infrastructure themselves within their own financial structures, and so enable the continuation of high levels of dividend payments to shareholders.
It is important to note that the regulations would enable only the Secretary of State or Ofwat to require an undertaker in England to tender competitively an infrastructure provider. This would be only for large or complex projects that they consider would threaten an undertaker’s ability to meet its statutory service provision obligations, and where this would provide better value for money for both customers and taxpayers. This would never be a decision for undertakers, so would not provide an incentive for them to avoid their obligations.
The current water industry regulatory framework is designed so that Ofwat can regulate undertakers so that they do not make excessive payments to shareholders. Customers’ bills are kept as low as possible while recognising that the companies must attract appropriate investment to meet future needs.
Following due consideration of the public consultation, we have decided to proceed with these regulations for the reasons that I have outlined. The ability to enable undertakers to tender competitively an infrastructure provider to finance and deliver a large or complex project will be a useful tool, even if rarely exercised. Enabling the ring-fencing of important infrastructure projects will help to attract necessary private capital at a transparent and competitive price, helping to protect the interests of both undertaker customers and UK taxpayers.
I know that many noble Lords have firmly held views on the merits or otherwise of the Thames tideway tunnel and I look forward to our debate this afternoon, during which I expect that many of these views will be put forward. However, I ask the Committee to bear in mind that the regulations before it today could apply not only to the Thames tideway tunnel but to any large or complex sewer or water infrastructure projects in future. I commend the draft regulations to the Committee.
My Lords, the Minister will be relieved to know that on this occasion, unlike a previous one, I will not seek to give contradictory views to represent the views of some of my colleagues on this side of the Committee. This debate comes at an inconvenient time for Thames Water but, therefore, at an opportune time for Parliament. I will make some general comments and then delve a little into some of the specifics of the Thames tideway tunnel project. In making my comments, I am grateful as ever to the Secondary Legislation Scrutiny Committee of your Lordships’ House. Its third report of this Session brings these regulations to the special attention of the Committee on the grounds that they give rise to issues of public policy likely to be of interest to us. I am particularly grateful that the Committee is willing to delegate me to take forward all those public policy issues. It is right that we should reflect on them.
As the committee points out, the Explanatory Memorandum implies that these regulations are generic and apply to all water and sewerage companies and large infrastructure projects that meet the criteria. That was clearly set out by the Minister. However, the only project to which the regulations are expected to apply over the next 10 years is the Thames tideway tunnel. The impact assessment therefore exclusively estimates the impact of the project in relation to these regulations. We have debated the tunnel before, but there are issues I would like to raise as events have moved on.
First, I will make some generic comments. The arguments put for establishing a separate body to manage the finance, delivery and extraordinary risks of major water infrastructure projects are reasonable. The example of the Thames tunnel is helpful. It will cost more than £4 billion and, while Thames Water will carry out associated investment at its own risk, the cost of the main tunnel is a considerable financial risk to put on a company with a turnover of £1.8 billion. Assuming that Thames Water is well regulated and responsible, there is logic in establishing a separate infrastructure provider to construct the tunnel and have Thames Water effectively lease it back.
These regulations then extend the reach of Ofwat to these providers, which is important to ensure that the public interest is protected. The alternatives discussed by the Minister and in the accompanying papers are to leave things as they are or to require that the project be put out to tender by the water company. Defra discounts the former because Ofwat would struggle to regulate the financial arrangements when they are bound in with the rest of the company’s activities. To some extent, I struggle to see how it can effectively regulate the general finances of a company and then the separate finances of a big project, but cannot manage to do it when they are done together. However, I am happy to believe those involved when they tell me that they cannot. I am also happy with the desirability of a separate provider over the complexity of negotiating a new licence, which is the implication of requiring the company to tender a major project. Therefore, I am happy with the regulations as they stand in the generality.
Let me then turn to the specifics of the Thames tideway tunnel and the figures in the impact assessment. I remind the Committee that I rent a flat here in London very close to one of the sites for the construction of the tunnel, so in that respect have an interest. Thames Water has also been to see me to brief—or some would say lobby—me about the project. I accept the basis of the company’s argument. The capital’s Victorian sewerage system has served the capital well, but urgently needs more capacity to meet the needs of modern-day London. The Thames tideway tunnel will ensure that the capital has a sewerage system fit for purpose for at least another century.
The tidal part of the river remains an environmental and public health hazard. It cannot be acceptable to allow the tidal River Thames to be an open sewer. Sewage discharges into the tidal River Thames breach the urban waste water treatment directive and British taxpayers would face the prospect of substantial fines if the tunnel is not built. Other world-leading cities, including Paris, Stockholm, Helsinki and Washington DC, as well as the Rhine/Ruhr conurbation in Germany, are forging ahead with similar schemes. I agree with Thames Water’s briefing that London is in danger of being left behind and facing substantial fines if we do not act.
I am happy to support the project. The benefits to employment in London should be maximised and the impact on residents minimised, and I am pleased on progress in moving more material off the roads and on to the river during the construction phase. However, I also note the recent remarks by the new chair of Ofwat, Jonson Cox. Interestingly, Mr Cox is a water industry insider. He said last week that some unlisted companies have a moral case to answer over allegations, that they,
“use shareholder loans to avoid UK taxation”,
through “complex offshore holding structures”. He said:
“A good number use high-coupon shareholder loans to improve their equity returns … It appears that this reduces tax liability for the benefit of shareholders”.
He went on:
“Tax policy is not for an economic regulator and these structures may be legal and common in private equity. But some aspects are morally questionable in a vital public service”.
Thames Water has published its annual results this week. It appears that the company pays no corporation tax on its £1.8 billion turnover while continuing to pay executives many times more than the Prime Minister. In my view, this is unacceptable—it stinks. Why should the public be reducing the risk to shareholders of Thames Water through the Water Industry Financial Assistance Act 2012, if it then uses every last trick in the book to maximise shareholder return at the expense of the UK taxpayer? Does the Minister agree that these loopholes must be addressed as a matter of urgency? The logic of allowing profit is to reward the risks, particularly of investment, but that is undermined by excessive profit, excessive executive pay and tax avoidance when Parliament and the Government are acting to reduce the risk to Thames Water customers and shareholders.
When we turn to the impact assessment, why should the taxpayer be funding an extra £5 million of regulatory cost of Ofwat in setting up these arrangements? Could we not find a way of billing Thames Water for this expense, given that Thames Water pocketed a £5 million credit from the Treasury in a year when it made £550 million in profits? Given that the chief executive, Martin Baggs, was awarded a pay rise of 5.9%, taking his basic salary to £450,000 plus a bonus of £274,000 as part of a scheme to,
“reward significant improvement in the group’s financial and corporate performance”,
as well as picking up a further £366,000 in shares next month under the company's long-term incentive plan, maybe the £5 million could be found from senior executive salaries alone. Does the Minister agree?
On the narrow question of the regulations, I am content. On the question of Thames Water fulfilling its moral responsibilities and thereby breaching the trust on which the financing of the Thames tideway tunnel is based, I am not.
My Lords, this has been an interesting debate on a number of issues relating to the draft regulation and indeed to the Thames tideway tunnel. I thank the noble Lord for his views and his insightful interventions. I thank him for agreeing that the general approach we are taking is reasonable. That is perhaps the most important thing to come out of today, and it is extremely helpful. I will come back to his specific points in a moment.
As I indicated in my introduction, it is important that these regulations should be considered separately from the specific Thames tideway tunnel project in London. In summary, the regulations enable the creation of infrastructure providers regulated by the Water Services Regulation Authority, Ofwat, to finance and deliver large or complex water or sewerage infrastructure projects. They provide for the procuring, licensing and regulating of an infrastructure provider that is separate from a water or sewerage company. They set out how the Secretary of State or Ofwat can specify to which projects the regulations would apply and how they designate the company that is to become an infrastructure provider. The regulations are intended to apply to all such large or complex water or sewerage projects that may be proposed in the future, where their application would be considered to result in better value for money for both customers and taxpayers.
I turn specifically to the Thames tideway tunnel, and I think the noble Lord has already made similar points. Climate change, population growth and higher customer expectations of environmental standards and supply resilience are anticipated to require larger and more complex infrastructure than the existing regulatory regime was designed to provide for. For example, changing rainfall patterns are expected to result in wetter winters and drier summers—who would believe it after last summer?—and to aggravate water scarcity conditions in the south and the east. This may lead to an increased requirement for potentially complex arrangements for transporting water.
Moreover, heavy rainfall events are likely to become more frequent—that we can all believe. In London, these events will further strain an already overtaxed sewerage system, leading to more overflows of untreated wastewater, containing raw sewage, into the Thames. Even after ongoing upgrades to sewage treatment works and the Lee tunnel are completed by the end of 2015, just over 18 million tonnes of wastewater will enter the Thames every year from London’s combined sewer overflows when storm-water capacity is exceeded. These overflows currently occur on average about once a week and have a significant environmental impact on the river. They increase the likelihood of fish kills, create a higher health hazard for the users of the river and damage the aesthetic appeal of the Thames.
The proposed Thames tideway tunnel is an example of a large and complex high-risk infrastructure expected to be constructed within the next 10 years. It is also one of the top 40 priority infrastructure investments within the national infrastructure plan 2011. Its construction would intercept storm sewage overflows and ensure that the River Thames meets water quality objectives established by the 2006 Thames tideway strategic study, preventing deterioration and ensuring that the Thames remains at moderate status.
The works would also ensure that the UK met its legal obligations under the urban wastewater treatment directive. On 18 October last year, the Court of Justice of the European Union found the UK to be in breach of the directive in London since 31 December 2000 by failing to have adequate collection and treatment facilities in place, despite our clear commitment to major improvements to London’s sewage collection treatment systems. We are currently in contact with the Commission regarding the measures considered necessary to comply with the terms of the court judgment. The court accepted that the Thames tideway tunnel represents a solution to the problem of the collection system in London. The implication, therefore, is that the tunnel represents a means to come into compliance with the judgment. The urgency of the project is increased by the need to comply with this judgment.
The project is large, complex and high-risk. It requires engineering and construction skills that have been rarely deployed by UK water and sewerage undertakers, certainly in recent years. We consider projects such as these to be better suited for delivery under a separate and parallel regulatory regime, rather than under the existing single regulatory regime for water and sewerage undertakers.
I turn to the noble Lord’s questions. He suggested that Ofwat should be able to manage the finances of a Thames Water and a Thames tideway tunnel combined. I think the point here is that the risk profiles of a standard water company business on the one hand and of a tunnel construction project such as this on the other are significantly different. Pricing against both is, therefore, different. We feel that the tunnel is better priced as to risk in the market as it stands.
The noble Lord raised the recent comments of the Ofwat chairman. Like the noble Lord, we agree with Mr Cox that there must be full transparency in the finances of all water and sewerage companies so that Ofwat can do its job and customers can obtain any benefits resulting from cost savings. The specified infrastructure project regulations would enhance such transparency. They enable water or sewerage companies to tender competitively—as I said earlier, Ofwat-regulated infrastructure providers that finance and deliver large or complex infrastructure projects. This IP tendering process provides an objective means of testing whether the financing costs of such projects are appropriate and reasonable. Without this tendering process, provided by the SIP regulations, competitively determining the cost of capital for a project would not be possible.
The noble Lord asked, effectively, why are the Government not making sure that Thames Water pays all the tax that it should? Thames Water Utilities Limited does pay its tax. All UK companies are allowed to claim capital allowances when they spend on capital investment programmes. That, I feel sure, was the same under the previous Government. Tax relief is allowable against the capital expenditure incurred, which reduces the tax payable, with the aim of encouraging investment by companies. Water and sewerage companies have significant capital programmes in comparison with their revenues. They therefore benefit from tax allowances proportionately more than other companies.
HM Revenue and Customs remains vigilant in ensuring that companies operating within the United Kingdom pay the tax that they are legally obliged to pay.
The noble Lord asked about executive remuneration. Thames Water is a private company and is responsible for setting its own remuneration policy which is approved by its shareholders in the normal way. Ofwat’s regulatory remit is to ensure that customers get a fair deal with good service at a fair price. Ofwat has ensured that water companies, including Thames Water, have kept price rises in line with inflation. Fair and stable returns for the water companies have enabled £108 billion of investment since privatisation to significantly improve service to customers while ensuring that bills are kept down as much as possible.
If water companies fail to provide the levels of service expected by their customers and required by their licences, Ofwat can and does take action, clawing back more than £550 million following under-performance since 2005. Thames Water has met its annual leak reduction target for the seventh year running, is delivering £1 billion of investment and continues to maintain its high drinking water quality.
In conclusion, these regulations would enable the risks and costs associated with these projects to be more transparently captured; better contain the risks and costs of financing these projects, helping to prevent those costs transferring to an undertaker’s other ongoing business and less risky infrastructure projects; help to minimise total final project costs by requiring undertakers to tender competitively an infrastructure provider to finance and deliver these projects; provide an objective means of testing whether the financing costs of a project are appropriate or reasonable; and, finally, enable any government financial assistance for such projects to be targeted at a sole project rather than at a specific undertaker with its range of services.
With those comments, I hope your Lordships will agree to have considered these regulations.
Committee adjourned at 5.22 pm.