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Ofwat proposing £8.5m fine on United Utilities Water for breaching intra-group trading rules

Ofwat proposing £8.5m fine on United Utilities Water for breaching intra-group trading rules

WATER SERVICES REGULATION AUTHORITY News Release (PN 08/07) issued by The Government News Network on 18 April 2007

Ofwat today published for consultation its proposal to fine United Utilities Water £8.5 million for non-compliant trading arrangements with associate companies.

This is the first time that Ofwat has proposed to impose a fine on a water company for non-compliance with transfer pricing (intra-group trading) rules. The size of the proposed fine reflects the seriousness with which Ofwat views the failure by United Utilities Water to comply with its licence conditions.

Under its licence United Utilities Water must market test for services that it procures from companies within the United Utilities group. But the north west water company has repeatedly breached its licence by failing to do this. Market testing enables water companies to obtain the best combination of price and quality of service for their business needs.

Failing to market test has the potential for customers to pay higher prices than would otherwise be necessary. However, Ofwat has already adjusted the water company's price limits downwards in 1999 and 2004 because of intra-group trading to protect consumers from paying higher costs.

Ofwat's proposed fine relates to breaches that have taken place between October 2005 and March 2007. They relate to United Utilities Water's trading arrangements with Vertex Data Science, United Utilities Facilities Management, United Utilities Property Solutions, United Utilities Networks and Your Communications (later THUS Group Plc).

Philip Fletcher, Ofwat Chairman, said:

"We take these breaches very seriously. Our job as regulator is to protect customers by ensuring they pay the minimum necessary for high quality sustainable water services. This depends on Ofwat being able to measure accurately companies' costs when it sets price limits. This is made very difficult when water companies fail to establish transfer prices in line with current market rates.

"We have warned United Utilities Water over several years and reduced their price limits at successive reviews to protect customers. Despite this the company has continued to trade with associates in a way that if left unchecked has the potential to harm customers' interests.

"We consider the proposed fine to be a proportionate response. It sends a clear message that water companies must comply with their licence conditions. This ensures the regulatory regime is not undermined to the disadvantage of customers."

In December 2006 United Utilities Water provided Ofwat with a legally binding undertaking to make changes to its trading arrangements with its associate companies by 30 April 2007 to ensure these complied with its licence. Ofwat is monitoring the company's progress in delivering the undertaking and its future trading with its associates.

Ofwat has given interested parties 28 days to respond to the proposal. It will then take a final decision in this case.

Notes to Editors:

1. The Water Services Regulation Authority (Ofwat) is the economic regulator of water and sewerage companies in England and Wales. It exercises its powers in a way that it judges will allow companies to carry out their functions properly, and finance them. Its duties include protecting the interests of consumers, wherever appropriate by promoting effective competition.

2. Copies of the 'Notice of Ofwat's proposal to impose a penalty on United Utilities Water Plc', are available on the Ofwat website, http://www.ofwat.gov.uk or from the Ofwat Library by phoning 0121-625 1373.

3. In its report 'Financial performance and expenditure of the water companies in England and Wales 2005-06', Ofwat made it clear that it was disappointed with United Utilities Water's lack of progress with remedying concerns identified in previous years in relation to transfer pricing.

4. The value of the trading arrangements that Ofwat considers comprised the breach are significant - about £95m in the period October 2005 to March 2007 (equivalent to around 8% of the company's turnover for the 2005-06 charging year). Ofwat has estimated the value of the likely cross-subsidies over the same period to be around £16m. This does not impact on customers' bills for 2005-10 and represents a level of inefficiency for United Utilities Water. Customers' bills are governed by price limits effective from 2005 and these were adjusted to offset the impact of cross subsidy from United Utilities Water to other parts of the group.

5. During 2005-06, United Utilities Water breached its licence conditions by failing to establish prices by market testing for eight trading arrangements with associate companies. Seven of these arrangements continued in 2006-07. The associate companies were:

* United Utilities Networks Limited, for the installation and maintenance of water meters and connection services;

* United Utilities Facilities Management Limited, for accommodation charges, photocopying, courier charges, property maintenance, cleaning, waste disposal, catering and other office support;

* Your Communications Limited (later THUS Group Plc), which provided telephony services to United Utilities Water;

* Vertex Data Science Limited, for the delivery and management of customer and IT services; and

* United Utilities Property Solutions Limited, for property management, building surveying and telecommunications services.

6. A financial penalty may not exceed 10% of the company's turnover as set out in Water Industry (Determination of Turnover for Penalties) Order 2005 (SI 2005/477). United Utilities Water's regulated turnover for 2005-06 was £1.2 billion. The proposed fine represents 0.7% of this turnover. Penalties are paid into the Consolidated Fund and are not returned to customers.

7. Ofwat's power to impose financial penalties came into force in April 2005. This power is not retrospective.

8. Ofwat has already announced that it is proposing to impose financial penalties on Southern Water (see PN 13/06, 31 March 2006), on Severn Trent Water (see PN 16/06, 8 June 2006) and on Thames Water (PN 21/06, 19 July) for their failures to meet customer service standards. These press notices are available on the Ofwat website. Ofwat will consult on the final scale of a financial penalty in each case when the full extent of the customer service failures and the company's response is known.

9. Representations about or objections to the proposal to impose a fine should be made by 5pm on 16 May 2007 to Keith Mason, Director of Regulatory Finance and Competition, Ofwat, 7 Hill Street, Birmingham B5 4UA, or by e-mail to keith.mason@ofwat.gsi.gov.uk They should be clearly marked 'United Utilities Water Proposed Penalty'.

10. Responses will be placed in our library and made available to the public, unless respondents have clearly indicated that they do not wish this to happen. In general, we will honour this request, but there may be circumstances in which, under the Freedom of Information Act 2000, we would be obliged to disclose responses.

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