HC Deb 16 January 1992 vol 201 cc1166-72

`The following section shall he inserted in the Water Industry Act 1991, after section 14— 14A. The Director General of Water Services may require the appointed company not to engage in specified diversification of its activities if he is of the opinion that the company's ability to meet its statutory obligations would be prejudiced by such diversilication.".'.—[Mr. Alex Cathie.]

Brought up, and read the First time.

Mr. Alex Carlile

I beg to move, That the clause be read a Second time.

Madam Deputy Speaker

With this we will take new clause 53—Water and sewerage undertakers: subsidiary companies— `.—(1) It shall be a condition of appointment that any water and sewerage undertaker shall separate completely its statutory functions from those of any subsidiary company which carries out activities unrelated to its statutory role. (2) The Director shall establish such rules as are necessary to ensure that customers of any water and sewerage undertaker pay no charges or make any contribution to the undertaker for the activities of any of its subsidiaries.'.

Mr. Carlile

The Liberal Democrats recently published a drinking water survey called "Coming Clean on the Water We Drink". It produced some interesting results—rather more interesting than the title, perhaps, for which I am pleased to claim no credit. Our survey found that about 416.000 people in the South West Water area were supplied with water which breached regulations owing to its aluminium content. We know how much concern there has been, in the south-west in particular, about aluminium in water. Another 208,333 people were supplied with water which had come from 10 zones where regulations governing lead were being breached.

It is certainly fair to say that South West Water has undertaken a large investment programme, and it is to he commended, but that programme has failed to make up for years of decay and under-investment in the infrastructure. As a result, a large number of people are still drinking sub-standard water.

It is my view that it is reasonable that, faced with the enormity of this problem, water companies which do not possess sufficient resources to meet their commitments as water suppliers should not, without close regulation, be allowed to diversify their activities, particularly into speculative ventures. The new clause offers a straightforward and necessary additional measure of regulation.

The Water Industry Act 1991 sets up a different corporate structure for the privatised water plcs from that for other utility plcs. The holding company may own other companies, one of which is called the "appointed" company under the Act. That company receives the appointments under the relevant licence. The appointed company deals with the core business, which is water and sewerage works. That core business is regulated, but the holding company may, perfectly reasonably, also own subsidiaries that are totally unrelated to the core business.

That means that Ofwat has no jurisdiction over those associated activities, except to ensure that any diversification does not harm the appointed company's ability to meet its commitments. That in turn means that, although the director general can look at the potential effect of an associated company, relating to the appointed company's ability to meet its commitments, he cannot look at what is happening in associated companies once they have been established by the appointed company.

Last September, Ofwat issued a licence amendment specifically dealing with that issue. The director general, Mr. Byatt, who has exercised great skill in his role—I deprecate the earlier criticism of him—quickly recognised the effects that diversification was having both on the public image of water plcs and on the companies' resources. The decision by Welsh Water, Dwr Cymru, to set up a series of hotels stamped clearly on the public mind the fact that water plcs are engaging in business that is very diverse from water. Wales has some fine hotels, but many of its country hotels are available to any purchaser who can offer a reasonable price because he will not make much money out of them. It may be argued that Dwr Cymru's investment is sound in the long term, but it does not appear to be a sound investment at present.

The licence means that the plcs must certify that they have the necessary financial and managerial resources to meet the appointed companies' obligation under the statute. Ofwat is carrying out a ring-fencing exercise to assess the sufficiency of the resources that are going in to meeting the appointments. However, Ofwat recognises that the issuing of a licence is only a monitoring device and that the regulator cannot forbid diversification, even if it is found that the company does not have sufficient resources to undertake its statutory duties because the resources are being frittered away elsewhere. That is what the new clause is all about.

Who pays for the losses that may occur as a result of diversification? Many companies have gone out of business, and big business is not exempt from that trend. Clearly, it would be wrong for the water companies' customers—those of us who turn on the tap and provide the sewage—to pay for the provision of services that are unrelated to the water companies' main purpose, if those services lose money. Mr. Byatt is on record as saying plainly that the losses made by subsidiaries should be borne by the shareholders of the plcs, not by the customers. Otherwise, a dreadful injustice could result whereby not only would the companies fail to meet their obligations to the detriment of consumers, but they would be forced to stand the losses made by the activities that had diverted the resources away from keeping up the appointments for statutory duties.

To show that I am not exaggerating, I shall focus on some examples of diversification activities, other than the hotels that I have mentioned. There are good and bad examples. Some of the diversifications that have been carried out by North West Water should be considered against the background of the capital expenditure programme to which the companies are committed and the costs of meeting various European Community drinking water, bathing and waste treatment standards—for example, the municipal waste water directive.

Earlier this year, I went bathing in Bournemouth at 3 o'clock in the morning and a very pleasant experience it was, too. Bournemouth's is one of the few beaches in this country that meets the European criteria. You, Madam Deputy Speaker, are welcome to join me next time I go swimming at 3 o'clock in the morning.

The impact of meeting all those obligations already has an inevitable cost consequence for the consumer. Indeed. the Secretary of State for the Environment recently said that water charges may need to increase by 50 per cent. by the end of the century to meet statutory and European Community obligations. So it is important that diversification should not bleed money from the plcs to raise charges even more. Naturally, some diversification is relevant and makes good sense.

North West Water has diversified into activities related to the water business, such as water purification and treatment, which is an acceptable form of diversification. It is important, however, that it be monitored closely because of possible competition implications.

An example of competition implications can be taken, again, from North-West Water. It has acquired several businesses from abroad and at home that specialise in the designing and engineering of water and waste systems. In particular, it has acquired a good company called Water Engineering Ltd., primarily engaged in the design and installation of water and waste treatment plants in the United Kingdom. That key company is involved as a supplier in the £24 billion capital expenditure programme to be undertaken in the next 10 years. A consequence of that ostensibly sensible investment is that North West Water will be involved in buying services from a company that it owns wholly.

That raises the issue of transfer pricing and the dangers of cross-subsidisation between the core business of North West Water and Water Engineering Ltd. It is important that the cross-subsidisation should not be at the expense of the consumer of water services. North West Water has given assurances that it would buy services from its subsidiary at full market rates, and I welcome that assurance. Nevertheless, there is plainly concern about the possible vertical integration of the water industry by such deals.

Ofwat is carrying out a survey of transactions between core businesses of the water plcs and subsidiaries in related markets, and investigating transfer pricing. If Ofwat finds that the survey shows that the public interest is not being served, it is important that it should have powers to deal with such a problem.

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Much less defensible, however, is diversification into completely unrelated areas, especially when the companies involved—the plcs—have very high environmental targets which in many cases they are not meeting. There is plenty of evidence that those targets are not being met. High targets also mean that companies are likely to have higher K factors—as they are called—relating to price increases. That is the case with South West Water, which recently chose not to defer its full K increase for 1992. Its average bill for next year is £91.23, an increase of well over 10 per cent. on 1991.

One appreciates that South West Water has a very high capital programme, which includes investment to end the dispoal of sludge at sea by 1998. However, South West Water, with all those obligations and in addition to possessing six subsidiaries in businesses which relate to water and waste treatment, has a 20 per cent. stake in West Country Television Ltd. That media acquisition might be a good investment, but it is plain that such an investment has no relation whatever to the core business.

The new clause raises an issue of principle: is the regulator to have a full range of powers to deal with the panoply of business conducted by the water plcs in order to ensure that that full panoply is being operated in the interests of the consumer, or is he to have only powers which are restricted to the appointed company, to the company providing the water services? If he has the full range of powers, the public interest is fully protected. If he has only limited powers, it follows logically that there is only limited protection. The new clause seeks to ensure maximum public protection without in any way preventing the privatised companies from conducting their businesses sensibly and with reasonable regard to normal business practice.

Mr. Win Griffiths

We fully endorse all that the hon. and learned Member for Montgomery (Mr. Carlile) said about the need to control the diversification activities of the water companies. Our new clause seeks to do more or less the same as his. We want to ensure that, before any water or sewerage undertaker is appointed to carry out its statutory role, any subsidiary company that it establishes whose activities are wholly unrelated to that statutory role is completely separate from the core business and that the director establishes such rules as are necessary to ensure that, whatever happens to the unrelated subsidiary business, the customers of the water and sewerage undertaker do not contribute in any way.

There is no doubt that the current appointees in England and Wales—the water and sewerage companies—have taken advantage of the immensely beneficial position in which they found themselves as monopoly suppliers of water and sewerage services to buy into businesses which cannot be regarded as related to their core business. Northumbria Water, for example, has bought into cable television; Yorkshire Water is involved in the direct mail business; Thames Water is involved in landscape gardening and Southern Water in vehicle leasing.

I must not neglect to mention Welsh Water, Dŵr Cymru. I usually mention it as its chairman is a constituent of mine and I try to look after his best interests, however he might test my desire to do so. Welsh Water has engaged in some wonderful diversifications which currently include—I believe—a 14.9 per cent. share in South Wales Electricity, which cost, if I remember rightly, more than £300 million. Surely, that money which it claims was raised on the capital markets, could have been much better used to speed up the programme to comply with water quality standards required under European Community directives.

The hon. and learned Member for Montgomery raised a number of serious issues relating to the activities of water and sewerage undertakers in subsidiary businesses which are not related to their core activities. I shall deal with one or two issues which were not fully covered in his speech.

The first relates to the way in which the subsidiary business may receive loans from the core company to develop its activities. I am advised by consultants interested in the water industry that at the moment the accounts of the water companies cannot be sifted to detect whether the subsidiaries are paying the full commercial rate of interest on any loans that they may receive from the core business. That is one reason why we believe that the two activities should be completely separate. The way in which the money may move between the two and the way in which the charges are made for services provided between them should be immediately evident to anyone who studies the accounts of the core business or of the subsidiaries.

Another issue is that of taxation. The water companies were given a highly preferential deal on corporation tax when they were created. I think that it is true to say that, for well over 20 years, they will not have to pay corporation tax. Under the complex group taxation rules, if a core business somehow made a loss in a particular year—I agree that that would be incredible under the present rules—but the subsidiary companies made a profit, that profit would not be subject to corporation tax because it could be subsumed into the accounts of the core business, and corporation tax relief would be given. That would mean a loss of finance for the Exchequer arising in the first place from an extremely beneficial deal given to the water companies when they were created.

It is of course also possible for the core business to subsidise its subsidiary companies. Thames Water has acquired a business that is not directly related to its core services but which is a water industry service that Thames might use itself—it is a subsidiary plumbing company. It would be perfectly possible for Thames to allow that company to provide it with services at a favourable rate. Thames could put business its way, to the disadvantage of other private competitors. I am sure that the Government would be concerned by such a development.

There are all sorts of ways in which core businesses and their subsidiaries might cross-subsidise each other. However, the customers of the core business could be disadvantaged and pay higher water charges because of the way in which the subsidiaries of that business operate.

We lost the vote in Committee on the principle of not allowing core businesses to run subsidiaries in unrelated areas of business, so at the very least the Government should accept these new clauses now, since they contain the sort of rules which will mean that customers paying for core business activities will not suffer from the multifarious and complex operations that are possible under our company and taxation rules. The waters, dare I say it, should not be muddied and no advantage should be taken of customers of a core business.

Mr. Baldry

The two new clauses have a similar purpose—to allow the director general to include conditions in a water or sewerage companies appointment prohibiting it from diversifying. I hope that the House will not think me discourteous if I therefore discuss them both together.

There was some suggestion that the water companies might be in some difficulty in meeting their statutory and other obligations. It is fair to point out that, last year alone, capital spending by the water companies increased by nearly 40 per cent. in real terms, to £2.5 billion. In the current financial year capital spending is planned to show a further increase of more than 20 per cent. in real terms, to more than £3 billion. There is every reason to expect that that will be achieved. As all hon. Members know, the water companies together are expected to spend about £28 billion over the next decade, which works out at investing £5,000 each and every minute on enhancing water quality.

It is clear that we get good value from our water charges. They are among the lowest in Europe, averaging only 43p per household per day for the combined costs of water supply and sewerage—roughly the cost of a single cup of coffee in any cafe in the country. The French, Germans and Italians all pay much more for their water services.

As for diversification, I appreciate the concern that lies behind the new clauses, but I feel that they are unnecessary. Of course it is important that the director general should have the power to ensure that an appointed undertaker's ability to carry out its core business is safeguarded. The legislation already provides for that. The director already has power to impose conditions restricting diversification by water and sewerage undertakers. Section 11 of the Water Industry Act 1991 gives the director wide powers to impose such conditions of appointment as appear to him necessary or expedient. Section 2 of the Act imposes a general duty on the director to exercise his regulatory functions in a manner best calculated to ensure the proper provision of water and sewerage services throughout England and Wales, and to ensure that the undertakers can finance the proper carrying out of their functions.

The director general has already taken steps to ensure that water and sewerage services are not put at risk by diversification. He has agreed to an amended condition F of the instrument of appointment of water and sewerage undertakers, which came into effect on 3 September last year. It requires the appointed undertakers to act at all times in a manner best calculated to ensure that they have adequate financial and management resources to enable them to carry out the regulated activities, including their investment programmes, to submit to the director with their accounting statements a certificate confirming that they will have adequate financial and management resources to carry out the regulated activities for at least the next 12 months, and to submit a further certificate when an appointee or any group company embarks on any activity other than a regulated activity which could be material to the appointee's ability to finance the carrying out of the regulated functions.

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So, condition F already requires the finances of the core business carrying out the regulated activity to be ring-fenced and reported on separately from any other activity. The director keeps the licence conditions under review and I have no doubt that he will take action if there is evidence that the new conditions are not providing adequate protection for the customers.

In my submission these new clauses would not add any protection to consumers or customers, and there is no evidence to suggest that businesses are failing to discharge their responsibilities in every regard.

Mr. Alex Carlile

I am disappointed by the Minister's response, because the purpose of the new clauses is to ensure that, if the director general sees, in his regulatory role, that he ought to be able to take certain actions to correct what is happening, he should be able to take them. Such powers do not exist now, or at least they are not strong enough.

We shall obviously watch what happens to the subsidiaries of the water plcs with great care, and no doubt there will be more opportunities to return to this subject. I am therefore content not to press the matter, and I beg to ask leave to withdraw the motion.

Motion and clause, by leave, withdrawn.

Mr. Win Griffiths

Madam Deputy Speaker, I wanted to ask the Minister a couple of questions—

Madam Deputy Speaker

Order. The hon. and learned Member for Montgomery (Mr. Carlile), who moved the new clause, has withdrawn it.

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