MD 146

TO ALL MANAGING DIRECTORS OF

WATER AND SEWERAGE COMPANIES

AND WATER ONLY COMPANIES

8 March 1999

THE 1999 PERIODIC REVIEW: TIMETABLE AND PROCEDURES

My round of formal meetings with all the companies has now been completed. They have been constructive and they have helped to resolve or clarify areas of disagreement and differences in perception between us. They should help to minimise surprises in the Business Plan which you are currently formulating for submission to Ofwat, and publication, next month.

In MD 145, also issued today, I finalise the framework for setting prices. In this letter, I confirm details of the timetable and procedures for the remaining stages of the 1999 review as follows:

• overall timetable;
• draft determinations;
• consultation on draft determinations;
• final determinations;
• Monitoring Plan reporting requirements; and
• further details.

The overall timetable until new price limits come into force is:

1999

By 9 April Companies submit Business Plans

By 16 April Reporters submit their reports on Business Plans

By 16 April Public versions of Business Plans placed in public domain

By 7 June Companies submit July Returns

27 July Draft determinations of price limits published

By 6 September Companies submit written representations on the draft
                                 determinations

13 September        Director's meetings with companies to hear their formal
to 15 October        representations

By 30 September Written representations on the draft determinations from CSCs                                  and other interested parties

18-22 October      Director's meetings with CSCs to hear their comments

By 30 November   Final determinations of price limits published

2000

January    Companies inform the Director if they cannot accept their final determinations

February   Director makes references, if any, to the Competition Commission

By 31 March     Companies publish Monitoring Plans

1 April                 New price limits in force

Ofwat's series of annual reports will be published, as usual, during 1999. We intend to bring forward the publication of some of them to the dates listed below. These dates may change. We will advise you.

1999

May Tariff structure and charges

June Annual report

September Financial performance and expenditure

September Levels of service

December Leakage and efficient use of water

December Unit costs and efficiency

In light of the views of the Customer Service Committees and other consumer bodies, I am undertaking a review of the current Guaranteed Standard Scheme and intend to issue a consultation paper shortly. While I would not expect the proposed changes to have a material impact on your Business Plan, I believe you should be aware of my intentions in this regard.

Draft determinations

I set out below details of the timetable and procedures for draft determinations under five headings as follows:

• leading up to receipt of Business Plans;
• receipt of Business Plans;
• receipt of July Returns;
• contacts; and
• publication of draft determinations.

Following the round of working level and formal meetings with companies, we have exchanged correspondence covering a range of issues relevant to the forthcoming Business Plan submissions. As a general rule, your Plan itself will avoid the need for further correspondence this month. I do not, however, propose a final deadline on all exchanges affecting Business Plans, between now and their submission, because I do not wish us to rule out sensible late changes.

Receipt of Business Plans

Business Plan

Your Business Plan (Parts A, B, C & D) should reach here by 12 noon on 9 April 1999 at the latest. Any earlier submissions would be welcome. The attached Annex 1 sets out requirements.

Ofwat's Executive Support Team will contact your company in the week before the deadline to confirm the expected time of delivery of your Business Plan. In order that we can contact you in case of any problems I would be grateful if you could give the team details of how you can be reached from 9 April onwards (a pro-forma is attached as Annex 2).

A single reference copy (hard copy only) of the non-confidential elements of the whole Business Plan will be placed in the Ofwat library in April 2000 or after re-determination by the Competition Commission. By then, the Business Plan will have been overtaken by the final determination and Monitoring Plan.

Public version

In MD138 you were asked to supply a single page summary of your company strategy for the Ofwat website and library, together with a longer public version of the Business Plan for CSCs and other interested parties. This material in the public domain will enable the periodic review dialogue between you, your Board and me to continue and involve all other interested parties.

The public version of the Business Plan should reach my office by 12 noon on 9 April 1999 and a copy should also be sent directly to your regional Customer Service Committee. The public version of the Plan will be placed in the Ofwat library no later than 16 April 1999. A one-page summary will be added to the Ofwat website (http://www.open.gov.uk/ofwat) shortly afterwards. Arrangements for publishing your plan locally will be for you to decide.

I assume that your company will also publicise this material, and be ready to explain the ranges for customers' bills proposed by your Board.

Reporters' reports

Your company's Reporter will be working closely with your staff this month, during the formulation of your Business Plan, to check that it complies with Ofwat's reporting requirements and guidelines and to ensure that all material assumptions have been exposed. This scrutiny by Reporters will facilitate informed comparisons between companies which take account of factors affecting the consistency and comparability of individual company information.

I will need your Reporter's report, summarising his review of your company's information and incorporating the work of the Auditor, by no later than noon on 16 April 1999.

Press notice

I intend to issue a press notice in the week beginning 12 April 1999 announcing that companies' Business Plans have been received and confirming when my draft decisions on revised price limits will be made public. It may be necessary to refer to any companies which have not met the 9 April deadline.

Receipt of July Returns

You should send me your company's annual July Return for the financial year 1998-99 by noon on 7 June 1999. Regulatory Accounts are not required to be published until 15 July 1999 and, therefore, the financial sections of the July Return will be treated as price sensitive material for this short period because some data will be for companies who have not announced their results by 7 June.

Your Business Plan should include all the information you wish me to consider in setting revised price limits for your company, including your best estimates of 1998-99 out-turn figures. Your July Return, therefore, would need to include an explanation by your company's Board of any material changes to specified key numbers submitted with Business Plans. Please do not wait until 7 June, if you are aware of material changes beforehand.

I will receive annual reports on company performance from Quality Regulators by 1 July 1999.

The July Return and Regulatory Accounts will be placed in the Ofwat library in December 1999.

Contacts

Companies

If the process of strategy formulation and dialogue with your company has been successful, there should be no material issues raised in the Business Plan of which I am unaware. You will need to explain the linkage between your latest assumptions/data and your 1998 information submissions where these are material to the price limit determination. Once your Business Plan has been received and analysis has begun, however, there will inevitably be issues which will require clarification or further investigation.

We will send any written queries to your company as soon as possible in April and would appreciate a quick turnaround. Only in exceptional circumstances will we accept amendments to Business Plan forecasts at the aggregate level because they will have been signed-off by your Board, and scrutinised by your Reporter and Auditor. (Any such amendments would have to go through a similar process of sign-off and scrutiny.) We will, however, take account of material adjustments and transfers between sections of the Business Plan resulting from errors and misinterpretations of the reporting requirements.

CSCs

Companies' Business Plans should reflect their consultation with customers.

I am asking the regional Customer Service Committees (CSCs) to provide written responses on the public versions of the companies' Plans by 4 June 1999. They should comment on:

• whether they believe that the strategy for each company achieves the right balance between service levels, prices and tariffs for customers, and meets their expectations as to priorities for improvements; and
• how they have been consulted and involved in the business planning process, up to submission of Business Plans to Ofwat.

Reporters

I may wish to pursue some points with Reporters, either in writing or discussion, after receipt of Business Plans. You will be kept informed of the scope and content of any such discussions.

Media and others

In the unfortunate event of a leak, or in response to questions about rumoured figures, Ofwat will not make any comment, either in general or on the specific case of any company. Listed companies have their own obligations to the Stock Exchange. We would both, therefore, adopt a "no comment" approach.

Publication of draft determinations

There will be two components of draft determinations:

• A national publication setting out the individual company K factors, infrastructure charge limits, expected levels of bills; the key outputs required during the five years 2000-01 to 2004-05; and the views I have taken on revenue, operating and capital expenditure, and return on capital. Some numbers will be company-specific, others will be industry-level only.
• A confidential letter setting out an explanation of factors behind the draft determinations, together with figures, specific to each company.

I will publish the draft determinations on 27 July 1999. There will be a Stock Exchange announcement, press conference, analysts' briefing and media interviews.

Consultation on draft determinations

The 1999 Periodic Review, to date, has involved a two-year business planning process. During this period, I have already consulted on the approach, methodology, information to be collected and broad ranges for price limits. The final stage of consultation and comment will follow publication of draft determinations on 27 July 1999.

Company representations

You will have the opportunity to make final representations to me, in confidence, before I settle the price limits. You will be invited, therefore, to make written representations by no later than 6 September 1999 including a proposed agenda of the issues on which you would like to focus in a formal meeting with me. The formal meeting will provide a final opportunity for you to present your written representations. I have no plans to publish the record of such meetings, although they would be available to the Competition Commission should the particular company wish to be referred to the Commission.

The formal meetings will begin during the week beginning 13 September 1999. A formal agenda will be circulated by Ofwat on the basis of your written representation, including any additional items I wish to cover, a week in advance of the meeting. Details of the time and date for our meeting will be arranged separately by my Private Office with your office. I would prefer that these details were kept confidential.

I do not intend to copy to Reporters the record of my discussion with you, although there may be points arising from that meeting on which I might require Reporters' advice.

The price limits or underlying figures in my draft determination may be changed as a result of representations you and others make to me.

Customers' views

I will ask the regional Customer Service Committees (CSCs) to say whether in their view the draft determinations fairly protect customers' interests and, in particular, to comment on matters which had already been raised but they felt had not been sufficiently taken into account. I am ready to meet individual CSCs to listen directly to their views, after I have completed my meetings with the companies, ie after 15 October 1999.

I will consider written representations from the national consumer associations, welfare groups, business customer organisations and others on draft determinations by no later than 30 September 1999. As with earlier consultation documents, direct briefing through small seminars, coupled with support from my Assistant Director, Michael Saunders, will help understanding and so generate informed comment. We will meet separately with representatives of business customers.

Environment Agency and environmental interest groups

I have worked closely with Government Ministers, the Environment Agency and the Drinking Water Inspectorate at each stage of this review, in a process which has led to final decisions by Ministers on quality programmes. The Environment Agency and the Drinking Water Inspectorate have advised on environmental priorities, both at a regional and national level. In addition, environmental interest groups have been consulted at each key stage of the Review.

I will consider written views on the balance of costs and benefits of quality outputs allowed for in draft determinations. My Assistant Director, Bill Emery, and Chief Economist, Tony Ballance, will be ready to explain to interested parties the approach to critical issues and to clarify particular points. Written representations will be required by 30 September 1999.

Investors and lenders

I will continue during 1999 to receive corporate finance advice from Singer and Friedlander. I will, nevertheless, welcome the views of independent merchant bankers, institutional shareholders, broking analysts and others in the City on the assumptions in draft determinations covering the cost of capital, the appropriate levels of key financial indicators and other financial matters.

As with earlier consultation documents, David Rees, my Corporate Finance Adviser will be available to meet with investors and lenders to explain my approach to critical issues and to clarify particular points.

Written representations from investors and lenders will be required by 30 September 1999.

Public domain

All written representations from companies and other interested parties that have not been marked as confidential will be placed in the Ofwat library in April 2000.

Final determinations

Final determinations will set price limits to allow your company to carry out and finance its functions under the Water Industry Act 1991 for the five years 2000-01 to 2004-05. I will explain the reasoning behind changes to the draft determinations and set out what assumptions have been made as to the functions. The licence provides mechanisms for dealing with relevant changes in circumstances that would allow revisions to these price limits during the price limit period.

A national publication will set out the final determination. Each company will receive a formal notification of the determination and a confidential letter explaining in outline the reasons for any changes from draft determinations in the light of their representations, and the public consultation.

I will include a clear definition of the minimum outputs in my 1999 final determinations. These minimum outputs will be a subset of data from Business Plan reporting requirements.

I intend to announce my final determinations by 30 November 1999. This will allow submission of your company's 2000-01 Principal Statement by 31 January 2000, and your company's 2000-01 Draft Charges Scheme.

There will be a Stock Exchange announcement, press conference, analysts' briefing and media interviews.

Your Board will have a choice of accepting my final determinations or requiring a re-determination by the Competition Commission. If it is the latter, you will need to inform me within two months of the final determination. Irrespective of your decision, my new price limits for 2000/01 will stand until revised by the Commission.

You may accept the price limits but, for example, decide to commit to more outputs or to finance and deliver the company's operations differently. You will need to take a view on what the company will have to do during the period taking note of our assumptions and the protection afforded by the licence.

Monitoring Plan reporting requirements

The new price limits for K factors and infrastructure charge limits will take effect from 1 April 2000.

I will set out later this month the reporting requirements for your company's Monitoring Plan (AMP3) which you will publish following my final determinations and by no later than 31 March 2000. This will be in a common format, specified by Ofwat for all companies.

The Monitoring Plan will provide a public record of your company's planned minimum outputs, performance and key activities to be delivered within the agreed price limits. This will be used to assess the performance of your company year-by-year throughout the price limit period. I will require each company to set down its programme of outputs, the anticipated profile of customer bills and its strategy for maintaining serviceability to customers extending at least to planned levels of activity. I will not require expenditure and financial forecasts unless variations between actual expenditure and our expectations become implausibly large, or where the April 1999 Business Plan provides no clear strategy nor one that is consistent with the final determination.

The Monitoring Plan will be placed in the Ofwat library in April 2000 or after re-determination by the Competition Commission. A one-page summary will be added to the Ofwat website (http://www.open.gov.uk/ofwat) at the same time.

I assume that your company will also publicise the Monitoring Plan, and be ready to explain how customers' bills in practice will differ from those proposed by your Board in their Business Plan submission in April 1999.

My proposed approach to monitoring during the period 2000/01 to 2004/05 is outlined in Annex 3. I propose to review the scope and content of the July Returns reporting requirements for 2001 onwards, at the beginning of 2000. There will, however, be no substantive changes to the JR2000 reporting requirements.

Further details

Finally, further details of the precise arrangements for your advance notices, announcements, announcements to the Stock Exchange and publication of my draft and final determinations will be confirmed to your Regulatory Director or other appropriate contact by my Executive Support Team. You should note, however, that Ofwat will not wish to discuss the content of its own or companies' press notices.

I C R BYATT

20 bound copies of The company strategy (Part A)

 

10 bound copies of The business plan: eight key components (Part B)

 

10 copies of the public version single-page summary of The company plan for future services (Part C)

 

10 bound copies of the longer public version of The company plan for future services (Part C)

 

10 bound copies of Supplementary information (Part D)

 

3 bound copies of any additional supporting information, including 3 copies of any market research reports which are referred to in the company's submission

 

1 loose leaf copy of the Business Plan submission (Parts A, B, C & D) and any additional supporting information

 

1 information capture system disk (which must be consistent with hard copy), including disk for Supplementary Information (Part D5) Quality Enhancement

 

1 if possible, a portable document format (pdf) file copy of the public version single-page summary of The company plan for future services (Part C)

Companies' performance

The information needed to assess companies' performance year-by-year throughout the price limit period is considered below, under four headings:

• outputs
• prices
• serviceability to customers
• comparative competition

Monitoring delivery (or otherwise) of the specified outputs will be the primary consideration. The required minimum outputs will be set down in some detail in final determinations. There should be no margin for error on the delivery of these minimum requirements.

The quality outputs will be consistent with Ministers' decisions. Ofwat, together with the quality regulators, will review companies' progress on these outputs, some of which will be related to maintaining current performance and others to phased improvements.

Outputs will generally be monitored on an annual basis, through the July Returns and MD109 reports from the quality regulators.

Evidence of a likely failure to deliver required improvements could trigger additional reporting (eg quarterly reports) by the company, scrutinised by Reporters. Regulatory concerns could lead to requirements for formal undertakings.

Failures to deliver the required minimum outputs will lead to regulatory action including compensation payments and/or bill refunds to customers, and prosecution or enforcement proceedings by the quality regulators. Shortfalls will be recorded and quantified in cost terms. An interim determination will be triggered by Ofwat if the costs are material, if not, shortfalls will be carried forward to the 2004 review.

Prices

The second consideration will be checking companies' performance to ensure that their charges are in accordance with Regulations under the Water Industry Bill, take due account of guidance given to the Director by Ministers on social and environmental matters, avoid undue preference, undue discrimination and do not rise by more than the limits set. Ofwat is likely to have new powers to approve company charging schemes, under the terms of the Water Industry Bill currently before Parliament. The Director will consult in due course on these matters.

Price monitoring will focus on the annual Principal Statements and Draft Charges Schemes, submitted each January.

Serviceability to customers

The third consideration will be monitoring serviceability to customers, in particular maintenance of the asset networks for both current and future customers. The focus will be on assessing trends in service performance indicators, but linked to measures of capital maintenance activity and taking due account of short-term variability. Monitoring Plans should set out companies' strategies in this area.

Comparative competition

The fourth consideration will be comparing companies' performance, to simulate a competitive market. This will involve comparing and publishing service and financial performance, and year-by-year relative efficiency.

Ofwat's annual analysis of levels of service, unit costs and relative operating (and capital maintenance) efficiency will continue. The best and worst performers will be identified and praised or sanctions applied, as appropriate.

Ofwat's publications will provide information for the companies' Remuneration Committees to take into account when deciding on executive remuneration.

Preparing for the 2004 review

Companies' costs and year-by-year out-performance will need to be recorded and understood, so that relevant factors can be reflected in judgements and decisions at the 2004 periodic review.

It will be especially important to quantify annual out-performance, since uncertainty in this area would be detrimental to incentives.