TO MANAGING DIRECTORS OF ALL

WATER AND SEWERAGE COMPANIES

AND WATER ONLY COMPANIES

25 November 1997

REPORTERS TO THE DIRECTOR GENERAL OF WATER SERVICES

In MD126 (20 March 1997) I consulted on a proposed process for the appointment of Reporters for the 1999 Periodic Review. I sought comments on the proposals by 5 May 1997.

The proposed changes were broadly welcomed by respondents. A summary of the responses to the proposals is attached (Appendix 1 and 2). In The business planning process, customer consultation and information requirements for the 1999 Periodic Review (July 1997), I indicated that Ofwat would make specific proposals on the arrangements for Reporters in the autumn.

I enclose a protocol I am minded to implement for Reporters. I believe the enclosed protocol achieves a sensible balance in this area. It avoids disruption to the reporting process and enables work to proceed with the technical audit of the information submissions for the 1999 Periodic Review. I believe it is consistent with the current licence conditions since it sets down the job I want them to do and the mechanism I shall use to approve their appointment.

In Section 6 of the protocol I have set down my intentions to carry out regular external reviews of Reporters. Such reviews will play an important part in demonstrating the effectiveness and consistency of the reporter audit of company information submissions. The first external review will be carried out in 1998.

Please revise your contracts with the Reporter and reporting teams to reflect the protocol. Where these contracts are time limited please follow the appointment procedure set down in Section 8 of the protocol for any subsequent reappointments or new appointments.

We have completed our assessment of the performance of individual Reporters on the recent 1997 July Return, (including supplementary reports requested from some companies). There is some room for improvement in the focus of a number of Reporters, I do not, however, consider it necessary to terminate any of the current appointments on poor performance grounds. The performance of individual Reporters will be discussed at the next joint workshop.

I C R BYATT

APPENDIX 1

Resume of responses to MD126 (20 March 1997)

1. Responses received by closing date (5 May 1997)

Ofwat has received 30 separate responses (ten Water And Sewerage Companies (WASCs), 11 Water Only Companies (WOCs), Water Companies Association (WCA), three Customer Service Committee Chairmen and six named Reporters) (see schedule - Appendix 2).

The most frequently expressed views are at the front of each list.

2. Arguments accepted

The areas either unchallenged, or supported by responses were as follows:

• The need for reporting activity
• Reporters must be seen to be independent
• The Reporter's primary function is to assist the Director General
• Reporters should be accessible to the Quality Regulators
• Ofwat will set criteria for selection and performance assessment
• Current financial burden of reporting (except small WOCs)
• Continuity of personnel is important

• The Director decides on the Reporter from a shortlist submitted by the company

Main arguments expressed:

• Licence change assumed necessary (three WASCs, five WOCs, WCA)
• What is wrong with the present arrangements? (three WASCs, two WOCs)
• Undermines Reporters' independence
• Little benefit to customers in Ofwat reviewing 80 or so tender bids
• The Director General is taking on responsibilities of nominating subcontractors
• It eliminates fee negotiation and reduces competition
• There may be tactical bidding
• Not appropriate for the Director General to dictate costs
• Fee disputes could arise over additional work
• Appointment should be by mutual agreement

• The company carries out competitive tendering to establish a short list

Arguments against:

• The cost of tendering will be very high (two WASCs, one WOC, two Reporters)
• There is only a limited pool of possible Reporters (one WASC, one Reporter)
• The tendering procedures are a matter for the company (one WOC, WCA)
• Selection based on market price not value
• Low price may mean low effort
• Prices may be inflated
• The nature of the task is too varied to make competitive tendering successful
• Problem if whole industry tenders at once
• There may be selective bidding
• Too expensive for small companies
   
• Where he is not satisfied the shortlist meets his criteria the Director may wish to examine submissions from other candidates

• Companies may be held to ransom (one WOC)
• Should not appoint outside shortlist (one WASC)
• Could appoint from an Ofwat approved list (one WOC)
   
• The contract will be between the company and the Reporter; the company will be responsible for the day to day administration of the contract

• Problems with legal status under contract (one Reporter)

• Decisions need to be made this year; contracts for no more than three years subject to annual review

• The Reporter will be required to submit detailed audit plans prior to the report year

Reporter and Contract Specification

Some advocated named Reporters as at present, but others thought that only teams could be nominated if the whole industry had to tender at once. It was also suggested that small Reporter organisations would be precluded from bidding because of lack of breadth in experience (one WASC).

Too much specification will lead to the loss of the flexibility in the current arrangements.

Several respondents argued for a detailed specification of reporting needs and the standard of reporting expected, but it was also suggested that it is currently too early in the process to deliver this.

One WASC suggests that it would be more efficient for Ofwat to appoint Reporters and remain responsible for their activities and costs. They suggest that the companies could be charged via the licence fee

Selection Criteria

This should include price, but with this weighted highly (one WASC) or possibly as little as 20% (World Bank approach suggested by one Reporter). If EU criteria were to apply then 'economically advantageous' might have to include longer term benefits for customers.

It was argued that because of the variability of this specialist work, EU rules might not apply. Challenges to conformity with EU rules can introduce long delays in awarding contracts.

Pleas for exemption

A few companies which have recently either market tested or changed Reporters have asked to avoid repetition of the process ( this may be reasonable for three WASCs and two WOCs, but not for two WOCs who last made changes in 1993).

Timing of changes

One WASC suggested that implementing these changes in the run up to the 1999 Periodic Review could lead to a loss of expertise built up in previous years and present a steep learning curve for newly appointed reporters. It is suggested that a more appropriate time to make the transition is immediately after the Periodic Review.

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APPENDIX 2

RESPONSES TO MD126
APPOINTMENT OF REPORTERS FOR THE 1999 PERIODIC REVIEW

Anglian

Bournemouth & West Hants

Cambridge

Essex & Suffolk

Folkestone

Mid Kent

Mid Southern

North West

North Surrey

Northumbrian

Severn Trent

South East Water

South Staffs

South West

Southern

Thames

Three Valleys

Welsh

Wessex

York

Yorkshire

Central CSC

Yorkshire CSC

Welsh CSC

Water Companies Association

Binnie Black & Veatch - D J Arnell

Halcrow - J S Bateman

Halcrow - B Walton

Halcrow - J Beaver

Halcrow - J Davies

Pick Everard - D W Smith

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REPORTERS TO THE DIRECTOR GENERAL OF WATER SERVICES

Introduction

The reporters and reporting teams act as professional commentators and certifiers on the regulated activities of individual water undertakers and water and sewerage undertakers (hereafter termed water company).

The reporter and reporting team's primary duty of care is to the Director General of Water Services (Director) with the objective of assisting the Director to fulfill his statutory duties.

The reporter and reporting team also have a duty of care to the water company.

This document sets down:

- the scope and content of reports to the Director (section 1),

- the role and general requirements of reporters (section 2)

- other guidance for reporters (section 3),

- the relationship between reporters and auditors (section 4) and

- the annual performance review criteria (section 5),

- arrangements for the external review of reporters (section 6).

- the contractual aspects and other related matters (sections 7),

- the appointment procedure for reporters (section 8).

1. REPORTERS - REPORTS TO THE DIRECTOR

Reports on water information submissions

The reporter shall provide the Director with a report of the audit of any water company information submission if so requested by the Director. A copy of the report shall be sent to the water company.

Guidelines

The Director will issue guidelines to the reporter on the scope and questions to be addressed in any audit of a water company information submission.

Supplementary investigations

The Director may require the reporter to carry out supplementary or special investigations of particular aspects of the water company business. In these instances Ofwat will provide special guidelines and terms of reference.

Audit plans

The reporter shall submit to the Director (with a copy to the water company) an outline audit plan of a company information submission or a supplementary investigation. In developing the audit plan the reporter should understand the company intentions. Such discussions should take place quickly to enable submission of the outline audit plan within 15 working days of triggering the requirement or in the first quarter of the submission period (submission period shall be taken as time between the issue of reporting requirements and company submission date).

The outline audit plan (maximum 5 pages) shall cover:

- a method statement

- the key questions being addressed in the audit

- the proposed schedule of audits

- the personnel involved

- the estimated costs of the requirement together with a proposed ceiling cost for the work.

The water company may wish to make representations on the outline audit plan. Such representations should be made within 5 working days of receipt of the outline plan.

Approval of audit plans

The Director, taking account of any representations made by the water company, will agree the outline audit plan and set a ceiling cost for the audit work. The reporter shall proceed with work as set down in the outline audit plan unless the Director requires changes.

Stand-alone reports

The reporter's reports to the Director shall be free standing.

The reports are expected to cover the following points where they are relevant to the company submission being reviewed; and based on the audits carried out:

- whether the water company submission has been prepared in accordance with the guidance issued by Ofwat,

- disclosure (if not fully exposed in the submission) of the material assumptions that underpin the water company data submissions,

- the scope and extent to which the material assumptions have been challenged by the reporter and/or the financial auditor,

- the reporter's assessment and opinion on the company's material assumptions,

- any material/significant areas where the reporter's opinion is different from that of the water company,

- the response to specific questions or areas of concern raised by the Director,

- the reporters assessment of the quality assurance procedures used in relation to the production of the submission.

- an assessment of any allocation of forecast expenditure and assumptions on transfer prices between:

• appointed and non-appointed businesses
• appointed business and associated companies
• water and sewerage services (if appropriate)
• output categories

• capital maintenance
• quality enhancements and the compliance programmes
• efficiency improvements
• enhanced service levels
• supply/demand balance
• leakage

- an assessment of the reasons for changes to information/policies submitted previously.

- an assessment of the methods and procedures adopted by the water company for the production of the submission in respect of the following general aspects:

• statistical methodology
• identification of shortfalls in outputs
• asset serviceability and condition identification
• changes in explanatory factors
• the achievement of the appropriate economic balance between capital expenditure and operating costs solutions
• estimating methodology
• standard costs
• special circumstances claimed by the water company

Additional information

The following should be annexed to the reporter's report:

- the organisation, structure and personnel used by the reporter;

- the arrangements made to ensure satisfactory liaison and coordination of certification and financial audit with the water company auditors.

- the quality assurance procedures used in relation to the certification of the company submission, and a schedule of the specific documentation that exists in support of the report;

- a summary of the meetings held, inspections carried out and audit trails followed,

- a breakdown of time and costs

Areas of concern

Areas of concern or challenge identified by the reporter shall normally be resolved with the water company prior to submission to the Director. The company should address these concerns in its submission or make the necessary changes to remove the cause for concern, all to the reporter's satisfaction. The reporter should annex to the reports to the Director a summary schedule of these concerns and challenges and how they have been resolved.

Areas of disagreement

The reporter must draw to the Director's attention in his report on submissions any significant areas where agreement cannot be reached with the water company.

For the avoidance of any doubt the areas of disagreement must be summarised in a separate section of any report made to the Director.

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2. REPORTERS - GENERAL REQUIREMENTS

Duty of care to the Director

The reporter's and reporting team's role is to assist the Director fulfill his statutory duties. The reporter and reporting team primary duty of care shall be to the Director. The reporter and reporting team also have a duty of care to the water company.

Required experience

The reporter's role assumes a relevant knowledge of the technical, operational, financial and regulatory aspects of the water industry. The reporter and key members of the reporting team will require detailed understanding of the regulated business of the water company. For new appointments such an understanding must be obtained in the first six months of the appointment.

Named individuals

The reporter and reporting team to be appointed shall be named individuals. The reporter shall be assisted by a team. Each member of the reporting team must be appropriately qualified and be competent for their team role and in all respects be acceptable to the Director. The reporter shall take all reasonable steps to avoid changes in the team. Prior approval of the Director will be required for all changes in the reporting team.

General requirements

The reporter and reporting team:

- shall be completely independent from the water company;

- must not be engaged in consultancy studies or other service contracts associated in any way with the preparation of submissions for the water company during the period in which the certification responsibilities would be required;

- shall be required to give undertakings to the Director that information provided in the course of their work under the contract for the provision of services will be properly protected.

Level of audit

The reporter shall be responsible for deciding on the appropriate level of audit required to address the Director's guidelines or specific questions. The level of audit must be sufficient for the reporter:

- to satisfy himself or herself as to the adequacy of methods and procedures proposed and adopted by the water company to provide information in conformity with the Director's information requirements;

- to monitor and audit the water company's work to satisfy himself or herself that it is consistent with the methods, procedures, policies and assumptions stated by the water company;

- to test that there are coherent and explained links between the current submission and earlier relevant submissions from the water company;.

- to identify the extent to which the methods and procedures adopted by the water company for the production of submissions:

(1) cover the scope of the work as outlined in issued guidance;

(2) apply a credible system of quality assurance;

(3) are adequate for producing estimates of expenditure needs (where appropriate)

- to test that the methods and procedures are followed rigorously and accurately by the water company;

Single level certification

It is not necessary for the reporter separately to validate company data or systems if this duplicates earlier scrutiny by the Auditors. The reporter will need to be able to confirm the adequacy of the scrutiny. The reporter shall acknowledge and report such validation. Any findings from such validation that have been incorporated in the report shall be identified.

Audit records

The reporter must maintain proper and adequate audit records cross referenced to reports made to the Director. The audit records must be retained until the Director authorises their disposal. On termination of a reporter's appointment the audit records shall be retailed for a period of not less than seven years. The current reporter must be able to have access to these records during this period.

Comparative information

From time to time the Director will publish information on the comparative performance of the appointed water companies. The reporter is required to have regard to the relevance of such information and draw any interpretation which may assist the process of certification and preparation of accompanying commentaries.

Water company policies

The reporter shall be expected to be aware of the water company's policies and assumptions underlying its approach to the submission.

Access to the reporter

The Director has direct access to the reporter and reporting team on any matters within the terms of reference of the appointment.

EA, DWI, DETR & WO

The Environment Agency, Drinking Water Inspectorate, the Department of the Environment Transport and the Regions, and the Welsh Office shall have direct access to question the reporter and reporter team on particular matters that impact on their statutory duties with respect to the water company.

Confidentiality

From time to time the Director may require the reporter to maintain confidentiality of any communications to / from the Director or on any special investigations the reporter is carrying out. In normal circumstances the Director will expect the reporter to keep the water company informed.

Duration of contracts

The contract for the provision of services for the reporter and reporting team shall extend for no longer than 36 months.

Annual performance review

The Director will carry out an annual review of the reporter and reporting team's performance with respect to the requirements set down by him in both general and specific terms (see section 5).

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3. OTHER GUIDANCE

The quality framework

In carrying out a review of the water company's submissions the reporter must be fully conversant with the quality framework and guidelines under which the water company currently operate and will operate for the review period.

The water company is required to seek and obtain confirmation from the relevant quality regulator as to the timing and phasing of the quality compliance programme(s) projects.

Reporters need to be able to confirm the status of each element of the compliance programme(s) has been confirmed by the relevant quality regulator.

Material Assumptions

In certifying the information submitted by the water company the reporter should ensure full exposure within submissions of all material assumptions that the water company has made. The reporter will be expected to comment on any material omissions including the consequences of the omission.

Material assumptions should be subject to scrutiny and where appropriate challenge. The extent of challenge is a matter for the reporter's judgement. In all cases the reporter's report should make clear the scope and extent of the challenge.

In the areas of financial and accounting assumptions the reporter should obtain comfort from the water company's auditors properly to comment on the submission and to confirm that the assumptions are understandable and reasonable in the context of the information available at the time.

Allocation issues

The reporter should pay particular attention to the water company's allocation of projected expenditure between output purpose and cost matrix. This should cover the challenge of assumptions and compliance with those within the company.

High expenditure areas

The reporter's audit should be directed at those areas of the water company proposals where expenditure is projected to be and has been high. In this way the limited resources of the reporter can be directed at these areas that likely to have the greatest influence on the Director's determinations.

Adequacy of audit

In all areas the certification effort must be demonstrably sufficient to support any opinions given in the report.

Efficiency assumptions

The reporter should confirm or otherwise report on the water company's quantification of efficiency improvements in their projections. This applies to both operating costs and capital costs across all the output categories.

Areas of concern

Both in audit and challenge of material assumptions the reporter must address the areas of concern identified by Ofwat in the lead up to submissions. Normally these will be identified in specific guidance and correspondence, but the reporter should address issues or concerns raised in publications or at joint meetings between the parties.

Further explanations

The reporter shall provide such further explanation or clarification as the Director may reasonably require following receipt of the submissions and reporter's report.

The reporter should be available to respond quickly to such requests.

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4. REPORTER/AUDITOR RELATIONSHIP

Working with Auditors

Reporters need to work with the financial auditors to provide the necessary effective and focused scrutiny of the submissions particularly where there is overlap with regulatory accounts.

Guidance

The following points are drawn to the attention of the reporter and the financial auditor:

- scrutiny of the information in specific tables/submissions could be allocated to either the reporter or the financial auditor depending on who normally reviews such information;

- both reporter and financial auditor should be familiar with the Director's reporting requirements

- the arrangements must be robust to challenge on the grounds of weaknesses in the scrutiny due to either skill and experience gaps associated with scrutiny of engineering or financial information, or , where the audit practice of accepting a statement of adequacy from water company officers falls short of these requirements;

- these weaknesses could be overcome by agreeing at a working level exactly how relevant issues are dealt with, and proper definition, confirmed in writing, as to the financial auditing work to be done in support of certification.

- reporters may use their own financial specialists to carry out the necessary certification work provided that the financial auditors are consulted on issues where future reporting on accounting matters is affected.

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5. ANNUAL PERFORMANCE REVIEW

Annual performance review

The Director will carry out an annual review of the reporter and reporting team's performance with respect to the requirements set down by him in both general and specific terms.

Evaluation criteria

The annual review will be structured around the following criteria:

- the overall quality of the work carried out and reports submitted to the Director,

- the degree of assistance the reports give to the Director and his staff in their assessment of the company submissions,

- timeliness of the report[s],

- the ease of understanding of the report[s],

- the completeness of both the water company submission[s] and reporter's report[s] with respect to the reporting requirements and specific questions asked by the Director,

- evidence of the technical expertise that has been applied,

- the level of time commitment given to the work by both the reporter and members of the reporting team,

- the costs incurred and how these compare with other such reviews and audits.

Other performance reviews

The Director will also carry out reviews of the reporter and reporting teams performance on specific information submissions using similar evaluation criteria to these set down above.

Results of the Performance Review

The Director shall inform the reporter and water company of the results of the review(s).

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6. EXTERNAL REVIEWS OF REPORTERS

External Reviews

The Director shall appoint a review team to carry out regular external reviews of the reporter arrangements.

These reviews would investigate:

- the consistency of individual reporter reports to Director over time and between companies.

- the work carried out by reporter's and reporting team's in preparing their reports to the Director.

- the effectiveness of the arrangements for reporters under this protocol.

- other specific matters the Director deems appropriate.

The Director will set down the terms of reference for each external review.

Reporters, reporting teams and water companies should cooperate with the review teams appointed by the Director for these reviews.

The Director would expect to publish the results of the external reviews and the actions he intends to take arising from the review findings.

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7. CONTRACTUAL ASPECTS AND OTHER RELATED MATTERS

Form of contract

The water company shall enter into a contract with the reporter and reporting team approved by the Director. This contract shall be consistent with the protocol for reporters issued by the Director.

Remuneration

The water company shall pay all the costs for the work carried out by the reporter and reporting team. The remuneration of the work of the reporter and reporting team shall be based on time based charges within the fixed ceiling of costs for each particular audit or supplementary investigation.

Termination on poor performance

Where the Director is not satisfied with the reporter or reporting team's performance the contract will be terminated by the water company. The Director shall inform the reporter and reporting team in writing of the reasons for the decision. This correspondence will be copied to the water company.

Termination by the Director

If so directed by the Director the water company shall terminate the contract with the reporter, reporting team or member of the team.

Termination by the water company

The water company shall not terminate the contract with the reporter and reporting team unless the Director has approved the termination.

Confidentiality

The reporter shall ensure that information and data obtained from an water company or any consequential results of the reporter's work on any submission shall not communicated to other water company or third parties.

Unhindered access

It shall be the water company's responsibility to allow the reporter unhindered and timely access to the assets, systems, data, working papers, relevant personnel and other records associated with the carrying out of the water company's regulated activities.

The water company shall make facilities available, subject to reasonable prior notice and at reasonable hours, to allow the reporter for the purpose of carrying out a review required by the Director:

- to inspect and make photocopies of, and take extracts from, any books and records of the water company maintained in relation to the carrying on of the regulated activities;

- to carry out inspections, measurements and tests on or in relation to assets used by or any premises occupied by the water company maintained in relation to the carrying on of the regulated activities;

- to take on to such premises or on or in to any assets such other persons or such equipment as may be necessary for the purposes of preparing and completing a report.

The water company shall not be required to do anything which is outside its control; or to do, or allow the reporter to do, anything which would materially disrupt the water company's business (unless it is essential that that thing be done to enable the reporter to prepare his report).

Access to the Auditors

The water company is under an obligation to arrange for unimpeded access to and from the financial auditors as required by the reporter.

Responsibility for information submissions

It should be noted that the water company has sole responsibility for its submissions of information to the Director.

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8. APPOINTMENT OF REPORTERS

Short list

The water company shall establish a short list of a minimum of three reporters and their respective teams who meet all the requirements laid down by the Director. The short list should be established following competitive tendering. The water company should inform Ofwat of the reporters from whom it is seeking tenders. The Director shall provide the water company with a list of evaluation criteria for the purposes of meeting the Utilities Contract Regulations 1996.

Suitability of short list candidates

The Director shall assume that the appointment of any of the short listed reporters would be acceptable to the water company.

Submission of short list

The water company shall submit the short list to the Director. The submission must include:

- a recommendation as to the most appropriate reporter and reporting team to appoint,

- a tender evaluation report covering all tenders received by the company,

- details of the short listed reporters and their teams, including relevant experience and proposals on how each reporter intended to carry out the role,

- a critical appraisal of the shortlist explaining why the water company considers its recommended reporter and reporting team is best suited to provide the Director with the services required.

Director's evaluation

Ofwat will review the company submission and recommendation. This review will involve interviews with the short listed candidates where this is appropriate. Account will be taken of individual reporter and reporting team performance on previous appointments where this is applicable and relevant to the decision being taken.

If the Director is not satisfied with the short listed candidates he shall inform the water company. In the first instance the Director will review, (and interview where appropriate) other candidate(s) from whom tenders were sought. If one of these candidates meet his requirements then the water company will be informed and asked to extend the shortlist submission to include this candidate(s). The water company will be given the opportunity to make representations.

If none of the candidates meet the Director's requirements then the water company shall submit a revised shortlist following a further competitive tendering exercise.

The Director may advise the water company to seek tenders from a specific reporter(s).

Director's approval

The Director shall:

- approve or not approve the appointment of the reporter and reporting team recommended by the water company, and/or

- approve the appointment of one of the other short listed reporters and their reporting team, or

- not approve all candidates submitted by the water company (and so trigger the need for a revised shortlist).

The Director inform the water company of his decision and his reasons for it.

Exceptional short term appointments

In exceptional circumstances and where the Director has not approved any of the candidates submitted by the water company he reserves the right to require the company to make a short term appointment (not exceeding six months) of a named reporter and reporting team. This expedient would only apply where a delay in the appointment of a reporter would create serious difficulties for the Director in carrying out his statutory duties. The water company will be given the opportunity to make representations.

Appointment of reporter

The water company shall appoint the reporter and reporting team approved by the Director. Copies of the appointment and contract for services shall be forwarded to Ofwat.

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