Cunliffe Addresses Water Commission Report

Thank you for coming today to this wonderful museum.

We are at one of the birthplaces of the British water industry, one which predates the Victorian age. The Grand Junction Waterworks Company was actually formed in 1811, while the Napoleonic war was still raging, to supply clean drinking water from the junction of the grand union canal in Paddington to households for Londoners. In need of cleaner sources of water, the company moved its operation to Kew, then outside London in 1838, and built this magnificent pumping station with its huge steam engines to pump the water to London. As London grew and needed more water, the company grew and became more profitable until, in 1905, it was taken over by the Metropolitan Water Board along with several other private water suppliers to provide a unified public water supply system for London.

The reliable supply of water that is clean and safe to drink - or to give it the description the Victorians put into law and that we still use today, the supply of water that is "wholesome", is a prerequisite of modern life and it is something that we have become used to and take for granted.

And the same is true of that other prerequisite of modern life, effective sanitation. 20 years after this pumping house opened, London experienced the 'Great Stink' of 1858. After years of suffering a cesspit and sewer system that could not cope with London's growth, with the Thames a "pestiferous and reeking abomination" to quote a newspaper of the time, a decision to close the cesspits followed by a hot dry summer brought matters to a head as the Thames became, to quote Disraeli, "a Stygian pool reeking with ineffable and intolerable horrors". Parliament, literally disabled by the stench, woke up and finally acted. It gave clear direction to the newly formed London Board of Works which in turn adopted the plan of its chief engineer, Joseph Bazalgette. Over the next 15 years, he oversaw the construction of over 1,100 miles of sewers and massive pumping stations that transformed the health of London.

I have more than once thought of the 'Great Stink' when leading the Independent Commission on Water over the last 9 months. While today we enjoy safe water and clean sanitation to a level that would have been unimaginable 165 years ago, there are many parallels: a system under huge pressure from economic and population growth, years of discussion and competing plans as the problem grew, government that did not give clear direction, a level of pollution in our waterways that the public will not tolerate and a point at which it became apparent to all that a fundamental reset was needed. And actually, there is a parallel there - that a bonus for Bazalgette was blocked because it was deemed to too high.

Today the Commission publishes its report which I hope will contribute to that 'reset' that the Government has committed to and that we sorely need. The report is long and detailed - some 460 pages with 88 recommendations covering everything from strategic direction and planning to regulator reform to the water industry supply chain. In an earlier speech I paraphrased Tolstoy to observe that 'while all are unhappy with the current situation, everyone is unhappy in his own way'. Now, looking at the length and scope of the final report I wonder if we have written a Russian novel in response!

But I would defend that length and scope on two grounds. First, and most obviously, the Terms of Reference set asked the Commission to answer these questions, which we have tried to do. But second, and more importantly, if we are to achieve the water sector we need, we need to look at all the factors that have contributed to our 'Great Stink' moment and recognise that those factors, if not addressed, will hamper us going forward.

The water industry, of course, is at the heart of this. And the industry, as a whole, has not met public expectations or maintained public trust in recent years. Some companies have manifestly acted in their private interest but against the public interest. That must be prevented in future. But the industry does not exist in a vacuum. It sits within a framework of law and regulation that operates under the strategic direction of government. And it is not the only demand on our water systems, or the only contributor to the current state of our waterways.

The Commission's report is long and detailed with multiple recommendations because - as I have said - there is no one, single reform, no matter how radical, that will deliver what is needed: we need to act on all of the failures that have brought us to the present pass.

Now, you will be very relieved to hear that I do not intend here to go through all 460 pages and 88 recommendations. But I will highlight, if you permit me, the main themes of the report and pull out some of key recommendations.

First, we need truly strategic direction from government. Barely a week goes by without someone calling for 'a strategy' from you, so it is important to set out I mean by this and the challenges it will entail.

We need to guide the use and development of our water systems and the restoration of our water environment as a whole and over the longer term. We need to chart a path for the delivery of the environmental improvements that the public want to see: to restore ecosystems and sustain our precious waterways for decades to come. However, there are many competing demands on our water systems. Demands to abstract water, demands to discharge into water and demands to enjoy water for recreation.

Only government can set the overall objectives for water and the timescale for achieving them. Only government can set the broad priorities, balance demands when they compete and coordinate the different elements of the system. And only government can decide who should pay and how much the nation can afford. It is relatively easy to set down a list of objectives. Effective strategic governance and guidance is much, much harder. It requires striking difficult balances, making difficult choices, and taking a long-term view.

In the report we recommend government in England and government in Wales produce a National Water Strategy. We set out in detail what it should cover, how it should be produced, and how it should be enshrined in statute to ensure consistent direction can be maintained over the long term. I have no illusions that it will be easy to produce: to govern is to choose but to govern is hard. But, as with the 'Great Stink' in 1858, without such direction from the very top, we will not achieve the change we need.

To connect that high level strategy to action, we need to learn how to manage and plan for water as a system or rather, as a set of regional water systems. Our river basins, aquifers and coasts and the demands upon them constitute complex systems and they need to be managed as such. The water industry, agriculture, transport, local development and land use, and environmental regulation all affect the regional water system and the water catchments that it comprises.

As many respondents to the Commission observed, we are very poor at system planning for water. There are huge, confusing and overlapping planning processes for water industry processes - the industry produces at least nine plans in a process that costs hundreds of millions. These plans drive water industry investment. But there are no such processes driving action in the other sectors that have an impact on the water system. And some water industry plans are not connected to local government development plans or to local voices or those sectors that also have an impact.

Opportunities for local government, agriculture, and water companies and other actors to work together are missed. Opportunities, for example, to implement sustainable drainage schemes that avoid storm water overloading our sewers and causing sewage spills into rivers, or opportunities to balance the nutrient loads that cause such unsightly and destructive algae to bloom in water bodies. And heavy engineering - concrete - solutions to environmental problems are pursued despite local preference for more natural solutions.

Drawing on experience from other countries, the Commission is recommending that regional water system planning bodies are established in England and a national system planner is established in Wales. These would not be advisory bodies or 'talking shops'. Rather, they would take over the role played by the Environment Agency and Natural Resources Wales at present with real authority over water industry investment and real influence over other funding streams that can be directed achieving regional water system objectives, such as agricultural grants.

To be clear, this would not be the creation of a new level of bureaucracy. Rather it would bring existing functions together on a regional water system basis, in England, and a national basis in Wales. It would streamline existing planning processes (the current water industry processes will be streamlined into two plans - one for drinking water and one for wastewater) and most importantly, it would link local development to water system investment, avoiding the situations we see at present where housing and economic development projects are blocked because the regional water systems cannot cope with them.

Alongside strategic direction and regional water system planning, the legislative framework for water is key a part of determining the overall framework for the management of water in England and Wales. The current framework has driven great improvements in certain areas. Drinking water and sanitation standards are now world-leading. Bathing water quality has considerably improved. But the current framework is also complex, inconsistent and out of date and highly prescriptive. The Commission has therefore recommended that it be reviewed to bring the legislation up to date, particularly with regard to the Water Framework Directive which sets the high-level objectives for the environmental quality of water bodies.

The Water Framework Directive sets a target to be achieved by 2027 - at a minimum - and the review will need to consider what targets should be set for after that date. We recommend, however, that the government use the opportunity to consider the scope of the legislation. One area in which we see there is a strong case for broadening the scope of the legislation is to include public health, given the increase in the recreational use of water in recent years. We recommend in England and Wales the Chief Medical Officers are asked to chair task forces to consider how to effectively bring public health into the water quality legislation.

Over the last 9 months I have heard consistent criticism not of the ambition of the environmental legislation, which must be preserved in any review, but about the inflexibility that requires and drives regulators to focus on narrow, engineering solutions rather than being able to take a broader view of overall environmental and other benefits such as may be found in nature based solutions. We recommend also that the review should aim to make the legislation less prescriptive and provide for 'constrained discretion' to enable regulators and local system planning bodies to take decisions in the round on how best to meet environmental objectives.

Strategic guidance, systems planning and legislation - they can set the broad framework. But delivering the outcomes we want for water depends most importantly on having not just the right strategy, legislation and plans. It depends crucially on having the right regulators, regulators that command public confidence and industry respect, regulators that have the capacity and the capability to do their job effectively. And, most important in the Commission's view, in the same way as strategic guidance, system planning and legislation, a structure of regulation that can focus on the water system in the round.

Our assessment is that the current environmental and economic regulators have not achieved what is needed and will not achieve what is needed. There are many reasons for this. It is clear that the Environment Agency has not had the resources, the people, skills, technology to hold the water industry and other sectors that impact the water environment to account. And it is beginning to change I am pleased to say. We're calling for reform of Operator Self Monitoring - moving from water company sampling to digitalised, automated systems - ensuring real-time, accurate data. Crucially, this must sit alongside tightened enforcement of abstraction limits, sludge management, and drinking-water standards. 

And on the economic side, for much of the last 20 years, Ofwat was encouraged to regulate with a lighter touch and to focus on keeping bills down. And it did not have the powers or the capability to supervise the financial structure of much of the industry, which allowed some companies and their owners to take decisions which reflected their private interests but badly damaged both their companies and in the longer term the public interest. We are seeing some of the consequences of that failure to defend the public interest in the news every day. I will return later to this question of how in an industry of private monopoly companies the private interest can be brought into alignment with the public interest and whether the regulator has sufficient powers to ensure that this happens.

When the water industry was privatised Ofwat was established to protect consumers from monopoly power by setting the prices that the water companies charge, to incentivise investment, and to create proxies for competition through financial incentives to drive efficiency. In line with other privatised utilities, Ofwat's approach to regulation was built around econometric modelling of the notionally efficient company to provide the benchmarks for setting prices and financial incentives and sanctions. And the decades immediately following privatisation, investment and efficiency grew. The quality of treated wastewater and bathing water have improved. There has been a 41% decrease in leakage in England since privatisation, driven particularly in the 1990s.

But in more recent decades performance of the industry has plateaued as the public goods demanded of the water industry have grown. In response Ofwat has developed and intensified its use of econometric tools and industry wide benchmarks. The Commission recognises the motivation behind this. But our assessment is that this has taken this approach beyond the limits of its effectiveness and, indeed, to a point where it may have become counterproductive in terms of the performance of the industry as a whole and its ability to attract investment.

In the Commission's view, it is important to have an objective framework for setting prices and incentives based on modelled outputs and based on comparability between companies, this approach alone, no matter how aggressively pursued, cannot drive the improvement of the sector to deliver the public goods that are necessary nor to attract the. There needs to be a fundamental rebalancing of the approach to economic regulation and oversight of water companies towards a closer, judgment-based, supervisory engagement with individual water companies. This will require an equally fundamental shift in capability and also in regulatory culture, which in the Commission's view has become too adversarial on both sides.

The Commission's report sets out how a new 'duty to supervise' should be enshrined in statute, how a judgement based supervisory approach might be implemented and the expert capability it would need in financing and engineering that would be necessary. We also make several important recommendations as to how the price review process - which should be retained alongside and informed by supervisory engagement - might be simplified and reformed. These include changes to the framework of delivery incentives, the allocation of bill revenues to infrastructure renewal, operational maintenance and enhancement expenditure, to the calculation of the return on capital and debt and to the appeals process.

While changes to economic regulation are necessary, however, they will not address the fragmented regulatory landscape for the water industry. Water companies' costs, investments, plans and performance are overseen by four regulators at present in England - Ofwat, the Environment Agency, Natural England and the Drinking Water Inspectorate. Each has a different focus, different objectives and different requirements that overlap and are often in tension. The Environment Agency determines much of the industry's investment needs but the industry's revenues are determined by Ofwat. Companies can be sanctioned by both Ofwat and the EA for the same pollution incidents. Funding of maintenance and infrastructure renewal are the responsibility of Ofwat but the environmental consequences of ageing infrastructure are the responsibility of the EA, as we saw from the report that was published last week.

The regulatory structure at privatisation was set up with separate regulators. As the overlaps have grown and the environmental and other standards have been raised, the need for coordination and resolution of different objectives has grown.

The Commission has not approached the option of major structural change lightly. It is never an easy option. I am all too aware, after many years in the public service, of the costs and risks of breaking up and reforming institutional structures. These costs and risks go beyond the financial: they include the human costs of organisational change, the deflection of management time and focus, the risk of dropping the ball on key objectives, and the breaking up of internal synergies and the need to create new interfaces between organisations.

The Commission has looked hard at potential for coordination mechanisms to address the tensions and overlaps we have identified. Our conclusion, however, is that if the primary objective is securing the reset and long-term change that we need in the water sector, we need an integrated regulator for water.

The Commission recommends, therefore, that in England, Ofwat, the water related environmental protection functions of the EA, the Drinking Water Inspectorate, and the water related function of Natural England, be brought together into a new integrated Regulator for Water. For Wales, which has a different institutional structure, we recommend that the economic regulatory functions now carried out for Wales by Ofwat be transferred to a Welsh economic regulation function located in Natural Resources Wales.

The new regulator for water will become responsible for Ofwat's current duties and roles to protect consumers. But, in line with its Terms of Reference, the Commission has also looked at the broader arrangements for vulnerable customers and those for consumer redress and consumer advocacy currently carried out by CCW.

We have to recognise that the cost of producing water and wastewater services is likely to increase over the medium and longer term as the industry has to replace ageing assets, respond to higher environmental and public health standards and continue to adapt to the challenges of rising population growth and climate change. Against that likely background of rising costs and rising bills, there is a need for a stronger safety net for the most vulnerable who are exposed to water poverty. Water companies already operate social tariffs, spreading the cost of supporting vulnerable customers across their customer base. But the effects of higher costs of water in different parts of the country have different impacts and there is already significant variation in bills that vulnerable customers pay, even taking into account local social tariffs.

It is for government to decide whether and how far to equalise support for the vulnerable in different parts of the country and it is for government to decide to what extent this should be done through water bills as part of a national social tariff, or through other means of support such as the social security system. It is of course for elected government rather than the Commission to decide between those options. The Government has now taken the powers to introduce a national social tariff, and in line with our assessment that stronger support will be needed for the most vulnerable, the Commission recommends that such a tariff be implemented. However, we make no recommendation on the design, the level of support and the degree to which there should be cross subsidy between customers of different water companies. These are highly distributional decisions, and such decisions are not for technocrats but for government to make.

We have also made a number of recommendations on consumer redress and consumer advocacy. On redress, unlike other regulated sectors, there is no mandatory dispute mechanism for customers. The Commission believes that water company customers should have the protection of a statutory ombudsman as exists, for example, in energy. And given the CCW's expertise in this area, the Commission recommends it be upgraded to become the Ombudsman for Water, with Citizens Advice, which has proved to be a powerful consumer advocate and advisory service for customers in other regulated sectors, taking over the role of consumer advocacy for water customers.

In addition, changes we have recommended to the water company Price Review process will also allow appeals against the price determination to be brought by consumers as well as by water companies - again as is possible in other regulated sectors.

Taken as a whole, the changes the Commission proposes should lead to more effective, joined-up regulation and stronger protections for consumers. In the Commission's judgement, if implemented effectively, they will address the shortcomings in regulation that lie at the heart of the poor performance, underinvestment and the failure to protect the public interest that we have seen over recent years.

Regulation must be a key line of defence to protect the public interest. A system of private regulated monopoly utilities - as I have said - will only work if private interests of water companies and their owners are aligned with the public interest in the production of public goods. That is the job of regulation, economic and environmental, to ensure that alignment so that companies are incentivised to produce public goods and avoid public harms.

But, taking the sector as a whole, water companies themselves and their owners must bear a large part of the responsibility for the failures we have seen. Water companies are private companies and their owners are entitled to a return on their investment. But those returns must not come at the expense of the public interest. Water companies operate under licence and the public purpose of their operations is inherent in those licences. Sadly, we have over recent decades seen examples in which companies have pursued their short term private interest at the expense of the public interest and of the long term resilience of the company.

A large number of the responses to the Commission's Call for Evidence expressed disquiet and concern at the inclusion of the profit motives in the provision of water. And I do understand the concerns raised by many about profit in the provision of water and wastewater given some of the experiences we've heard. Some proposed nationalisation or municipalisation or the transfer of for-profit water companies to not-for-profit or similar models. The Commission considered these in line with our Terms of Reference which focus on a privately owned regulated sector and rule out nationalisation or the purchase of companies with public funds for transfer to other ownership models.

But we also examined the performance of different ownership and operational models, public and private, in other jurisdictions. We published our initial analysis in the Call for Evidence, and we invited respondents to submit further analysis and evidence. We have refined our analysis and have published it in full in the final report. I have to say, on the data and comparable metrics available, the truth is that we did not see evidence of a causal link between ownership models and a range of environmental and other performance indicators.

We took from this work two conclusions. First, the regulatory model is key to performance and we need to address regulation. Second, where companies are privately owned it is the business model of the owners, the level of return they seek on their investment, their time horizon for that return, their preference for dividends or capital gain and their willingness to invest further in their company for a fair return. Those are the things that make the difference.

At privatisation it was envisaged that water companies would be owned by long-term investors looking for relatively low risk, low return investments as might be expected form a regulated monopoly utility. Investment vehicles have changed markedly since privatisation. Many investors, including institutional investors, now prefer private, whether listed or unlisted, it remains the case that the industry and the public interest is best served by long term, low risk, low return investors.

The changes to regulation, particularly to economic regulation, are intended in part to lower regulatory risk and to reduce the variability of returns that deter such investors. The Commission has also recommended that Government make the stability of the regulatory system an objective in the National Water Strategy and that maintaining the investability of the sector becomes one of the duties of new regulator for water.

But, just as we need to attract longer term investors to the sector with more predictable regulation, we will need to ensure that owners and managers do not act against the public interest and damage the financial resilience of companies.

So the Commission is recommending giving the new regulator the power where necessary to block changes of ownership, to set gearing levels and, in certain circumstances, to give direction to the ultimate controller of the company. These powers exist in other regulated sectors and they are necessary guardrails in water. We are also recommending making the public purpose of companies clear in the licence condition, bringing company governance in line with the governance code for listed companies and bringing in a statutory for the very senior management cadre, drawing on the experience of the senior managers regime in the financial sector.

I am, you will be pleased to hear, coming to the end. I hope it will not seem like a Russian novel of a report. The final area that all these changes have to address - from strategic guidance to planning to regulation to company performance - is the health of our water industry infrastructure and of the resilience of our water and wastewater systems.

We simply do not know the overall health of the system. Ofwat last oversaw a full assessment over 20 years ago. The asset health measures used in price reviews have been backward-looking, measuring past failure rates to determine and fund the amount and the rate of renewal and other capital maintenance necessary to keep the system operating. Much of water industry infrastructure is underground and very difficult to assess and different companies have different ways of assessing asset health. Not all water company assets are mapped.

We do not know whether enough replacement and renewal has been funded and carried out over the past. But there is strong evidence that we may be considerably behind the game.

When the Scottish regulator switched from using backward-looking indicators, similar to those Ofwat have used, to a forward-looking in-depth assessment, the conclusion was that there had been material underfunding of capital maintenance. Other countries replace and renew at much faster rates than we have maintained. And, as we heard last week from the Environment Agency, infrastructure failure is a major reason for the pollution incidents we are seeing.

So, the Commission is recommending that a forward-looking assessment of our infrastructure is carried out and that national resilience standards are developed for water.

The massive steam pumping engines that filled this engine house operated for over a hundred years and were retired only when steam gave way to diesel and electricity. A couple of weeks ago I visited a much more modern pumping engine hall, just over 50 years old filled with electric pumps that supply drinking water for one third of Londoners. It is a single point of failure for the water supply of all of Canary Wharf. And it is on its last legs. A £400m project to replace the entire facility has finally been approved and work is about to begin on the replacement. Given the limited space and need to keep the facility operating, it is a hugely complex project that will take at least 7 years.

I raise this example not merely to contrast the standard of Victorian engineering with its more modern successors, absolutely humbling though that is. It is also an example of the forethought, timescale, planning and funding necessary to ensure that our water infrastructure continues to serve us into the future, and of the dangers of a patch and mend approach.

I started this speech with the Great Stink of 1858 and the reset it triggered. Change did not happen overnight; it took Bazalgette over 15 years to complete his sewer network and for London's health to be transformed. I hope, following our own Great Stink moment, that the recommendations in the Commission's report will launch the reset that is required. Likewise, change will not happen overnight, and trust will take time to come back. But I very much hope we are now at the beginning of the road.

Finally, it has been a real privilege to lead this work, and as I conclude I would like to thank the Commission Advisory Group for their help, their insight and support and, most of all, the amazingly committed and hard-working Commission Secretariat team for all they've done. Any credit for this report goes to them; any criticism resides with me.

Thank you.