D Perry Esq
Chairman - Designate
The Proposed Yorkshire Water Mutual
Broadacre House
Vicar Lane
BRADFORD
BD1 5PZ                                                                                                                                      24 July 2000

THE PROPOSED YORKSHIRE WATER MUTUAL

We have consulted publicly on the proposal announced by Kelda on 14 June and you and I have discussed this matter privately. Parliament requires me to act in the manner I consider best calculated to secure that a water undertaker properly carries out its functions and can finance them. This letter sets out to explain what I believe would constitute a proper process for involving customers before a proposed water mutual could make an offer for the assets of Yorkshire Water Services Limited, including the Appointment to supply water and waste water services.

As I see it, in buying, from Kelda Plc, the existing assets of Yorkshire Water Services Limited, the proposed mutual would be acting on behalf of the water customers in Yorkshire. It would need to meet all legal obligations and to deliver service to customers and to the environment. To do this it would be likely to need to invest some £1.5 billion over the next five years and to procure services to operate the old and new assets within the price limits for 2000-05 set last November.

The private equity model has served customers and the environment well. Unless a mutual is fully incentivised and well managed, customers in Yorkshire would bear additional risks. In setting future price limits, the performance of a mutual would be compared with that of other water undertakers who would continue to be incentivised by the disciplines of the equity market.

I therefore think it essential that customers in Yorkshire should support any offer made by a mutual. I look forward to your proposals of how this should be done, either by a vote, or a comparable procedure, to establish such consent. Such a procedure should be consistent with the proposed arrangements for the corporate governance of the mutual.

Such consent should be properly informed and obtained. Before seeking it, you should set out your proposals in a customer circular which should be both comprehensive and comprehendable. (There are some parallels between this and an offer document which a company might issue to potential investors, but it would need to pay full regard to the nature of the audience.)

This circular should establish:

• the complete independence of the proposed mutual from Kelda Group Plc and any associated company;
• details of the proposed Directors of the mutual;
• the constitution of the proposed mutual, with arrangements for appointing and securing the independence of the initial Directors and how they would be replaced, including ensuring that they are fit and proper persons to run this business;
• the arrangements for achieving and maintaining accountability to the members of the mutual;
• the benefits for customers, both in terms of service and price arising from the proposals and explanation of why they could not be achieved under the current structure;
• the structuring of the mutual to ensure that the Chief Inspector of Drinking Water will continue to have such sufficient power as he deems necessary to secure proper standards of drinking water and that the Environment Agency is similarly empowered to prevent environmental damage and asset failure;
• the arrangements for procuring such services as are necessary to operate the assets in the form of a procurement plan, to be agreed with the DGWS. This plan would need to ensure:
  • that the mutual had sufficient control over operations to ensure proper service to customers and to the environment;
  • that the procurement contracts were all properly contestable so that prices were determined in competitive markets;
  • that the procurement contracts would be let in such a way as to avoid a significant reduction in competition (market competition or comparative competition) in the supply of operational services;
  • that in relation to the condition of the assets, proper provision was made for the maintenance of serviceability to customers;
• an assessment of the risks faced by the members of the mutual. This should include a statement on the financial consequences of the proposed purchase of assets, including a broad estimate of the price which would be paid for them, and the scale of the provision to be made for risk.

As a mutual has a different ownership structure from a company, it would be necessary to agree a number of licence amendments relating to:

• constitutional arrangements and accountability;
• the procurement plan;
• independence from operating companies;
• the position of the Chief Inspector of Drinking Water and of the Environment Agency.

It would be helpful to have an agreed process for carrying out this work. I think that you should first take such steps as you believe are necessary for you to be confident that all the Regulators are content with your proposals before you put them to customers. This would involve separate discussions with the Drinking Water Inspectorate, the Environment Agency, the Registry of Friendly Societies and Ofwat. If necessary, we would be ready to facilitate such discussions.

Thereafter, we would need to be confident that you had exposed all the material issues and had devised a satisfactory way of consulting customers. I would look to the Yorkshire Customer Service Committee in particular, to advise the regulator on whether they believed your method of seeking consent would be acceptable to customers.

I am publishing my preliminary assessment. I enclose a copy of the document and the related press notice in advance. A stock exchange announcement will be made at 7.00 am tomorrow (25 July). Please treat as price sensitive until then.

I copy this letter and enclosures to Michael Meacher, Minister for the Environment, Michael Rouse, Chief Inspector of Drinking Water, Ed Gallagher, Chief Executive of the Environment Agency, Geoffrey Fitchew, the Registrar of Friendly Societies, Eric Wilson, Chairman of the Yorkshire CSC and to John Napier, Executive Chairman of Kelda Group Plc. I am also placing it in the Ofwat Library.

SIR IAN BYATT