Notice of ’s proposal to impose a penalty on Southern Water Services Limited

Consumer Council for Water Response July 2019

1 Introduction

1.1 The Consumer Council for Water (CCWater) is the statutory consumer organisation representing water and sewerage customers in England and Wales. CCWater has four regional committees in England and a committee for Wales.

1.2 We welcome the opportunity to make a representation on Ofwat’s proposal to issue Southern Water with a financial penalty amounting to £37.7 million reduced exceptionally to £3 million for significant breaches of its licence conditions and its statutory duties. This reduction is on the basis that Southern Water has undertaken to pay customers £123 million over the next five years, some of which is a payment of price review underperformance penalties the company avoided paying in the period 2010 to 2017 and some of which is a payment to customers for the failures set out in the notice, paid in lieu of a penalty.

2 Executive Summary

2.1 CCWater concur with Ofwat’s view that the details of this case are truly shocking. It will have seriously undermined the trust that Southern Water’s customers and stakeholders have in the company and this will not be easily won back.

2.2 While we welcome the steps agreed between the company and Ofwat to put Southern Water back into compliance, these arrangements are nothing more than we would have expected any responsible company to already have in place. We therefore question why this has had such a significant influence over the size of the proposed penalty. We ask for further clarification as to how and why Ofwat has arrived at a penalty of 6.7% of turnover given the gravity of this case and the potential for Ofwat to go up to 10% of turnover.

2.3 We have also asked for consideration to be given to the wastewater customers who move out of Southern Water’s area this year and will therefore, under the current proposed repayment arrangements, not receive any rebate on their bills.

3 Southern Water’s Failings

3.1 The seriousness of Southern Water’s failings cannot be over-emphasised. The company has shown a complete disregard for their wastewater customers and for the environment that they are entrusted to protect. The findings from Ofwat’s investigation, as described in the Notice, and widely covered in both the national and local media, will have undoubtedly damaged the company and undermined customers’ trust in the company and the sector more widely.

3.2 The failings relate to the management, operation and performance of Southern Water’s works. These assets are fundamental to the delivery of an effective sewerage (or wastewater) service and are relied on to ensure that bodies of water, such as rivers, streams, or our coastal waters, are not polluted by untreated or inadequately treated wastewater effluent. The is currently investigating the full impact that the poor performance of these assets has had on the environment. The company’s customers and local stakeholders will be appalled to think that these highly valued and sensitive habitats and natural water resources were so blatantly disregarded, particularly as the environment has emerged as a key priority for customers and stakeholders in the region through PR19 related research and engagement.

3.3 In addition, the operational failures have been compounded by Ofwat’s findings that Southern Water deliberately manipulated the sampling regime to cover up the failures and in doing so misreported data about the performance of its wastewater treatment works. The company “failed to have adequate systems of planning, governance and internal controls in place to be able to: manage its wastewater treatment works; accurately report information about the performance of these works; and properly carry out its general statutory duties as a sewerage undertaker, to make provision for effectually dealing with and treating wastewater”.

3.4 What has been particularly shocking, is that there was “concerted practice” to deliberately conceal the poor performance, involving senior management, that lead to the avoidance of financial penalties that would have been due if performance was accurately reported. As a result, customers’ wastewater bills have been higher than they should have been for a period of over seven years.

3.5 Furthermore, the Board and senior management at that time, failed to have sufficiently robust controls and systems in place to ensure its data was accurate and what was reported was factually correct. At best, this would suggest that historically the Board has not fully discharged its responsibilities, at worst, it would suggest that financial performance incentives drove inappropriate behaviours within the company – from the top down.

3.6 We therefore welcome the proposed internal and external assurance measures now being put in place, and that Ofwat intends to oversee this assurance reporting. We think that independent external assurance will be particularly important in this case given the company’s historic misreporting. However, the company’s customers and stakeholders will ultimately be looking to Ofwat and the Environment Agency to ensure Southern are fully compliant going forward.

4 Proposed Reparations

4.1 The Notice states that under the terms of the Act, as amended, Ofwat can only apply a penalty for up to five years prior to the date the Notice is served (2014), although the failings have been found to go back to at least 2010.

4.2 Southern Water have been subject to earlier investigations and one of these resulted in a finding that the company had been misreporting customer service performance data for a number of years. The investigation concluded and a penalty was levied on the company in 2008. The company had been acquired the year before by Greensands Holdings Limited. The then new owners of the company gave assurances at that time that such practices would not be repeated. We agree strongly with Ofwat, that the owners should have acted on this regulatory intervention and ensured that the appropriate systems and safeguards were put in place across the organisation to avoid a repeat of this serious reporting malpractice. They clearly failed to do so.

4.3 The environmental consequences of the poor management and performance of the wastewater treatment works are yet to be fully established. We must await the outcome of the Environment Agency’s investigation to understand the full extent. In addition to environmental damage, there are further consequences of the company’s actions for customers: they have effectively paid more than they should have for their wastewater service; and, perhaps more importantly, have been misled about the company’s environmental performance over a number of years – the resulting loss of trust will not be easily restored by the current Board or senior management.

4.4 The measures that Southern Water is already putting in place appear to address the problems identified in terms of operations, management and governance, but these are basically the minimum we would expect for a company responsible for delivering such an essential service, in a highly regulated environment, but one where the company benefits from a monopoly position in the market. We therefore welcomed the Chief Executive of Ofwat’s recent letter to all the water and sewerage companies reminding them of their obligations in this regard, also the direction and focus Ofwat has given company Boards on their roles and responsibilities regarding governance more generally. It is with this in mind that leads us to question the proposed size of the reparations package for Southern Water given the seriousness of this case and the implied culpability that the investigation revealed.

4.5 The proposed fine for failing to meet its licence obligations is £3m. This would have been £37.5m (representing 6.7% of the company’s turnover). However, the company has agreed to make £34.7m direct payments to customers, which is why Ofwat propose to reduce the fine. As enforcement fines applied to water companies go to the Treasury Consolidated Fund customers do not see any direct benefit. CCWater therefore supports the principle of ‘restorative justice’ where companies return money to customers instead. The approach being proposed by Ofwat is therefore consistent with CCWater preferred approach and earlier Ofwat enforcement actions where companies that have misreported data. However, the Notice does not explain why or how this figure was arrived at. It is said to be 6.7% of the company’s turnover. As Ofwat are able to fine a company up to 10% of turnover it would be helpful to understand why the circumstances of this case did not warrant a higher sanction especially as this is not the first instance of misreporting by Southern that has led to Ofwat enforcement action.

4.6 The Notice states that “Although there have been instances of deliberate misreporting in the past and failures of internal systems of controls, the additional element of a contravention of a core and general duty (in this case section 94(1)(b)) means that it is the most serious contravention that has occurred. It is also the third enforcement investigation we have carried out to date involving Southern Water, one of which also concerned the deliberate manipulation of data. We consider that these factors justify the imposition of a penalty that is based on the highest percentage of applicable turnover ever imposed by Ofwat.” While comparisons are drawn with previous cases the reason for arriving at 6.7% of turnover is not explained.

4.7 Ofwat says that “We would have been minded to impose a penalty significantly greater than 6.7% had Southern Water not taken the necessary steps to bring itself back into compliance and had it not engaged with us on settlement.” We would point out that the reparations package is largely made up of rebates that customers were due to receive under the regulatory incentive mechanisms. It could be argued that the retrospective payment of incentive penalties (under the Outcome Delivery Incentives process Ofwat introduced at PR14) is simply backdating penalties that the company would have received since 2015 anyway if Southern Water had accurately reported data. In this context it should not be seen as an additional punishment or reparation for the company’s failure to report accurate information to its regulator.

4.8 While the co-operation of the current Board and senior management, and the planned actions to address the findings from the investigation to bring the company back into compliance are to be welcomed, as we have said before – these are what we would expect a responsible company to already have in place. We would therefore suggest that the £34.7m going back to customers seems to be insufficient to fully, or fairly reflect the particular circumstances of this case. It leaves us with the unanswered question - just what company failures and behaviours would warrant a penalty of 10% of turnover?

4.9 We have already started to receive complaints from Southern Water’s customers regarding the proposed arrangements for rebating customers’ accounts. The key concerns relate to:

- The length of time over which the rebate is being repaid. - The lack of rebate for those who are moving out of Southern Water’s area this year given repayments do not start until 2020. - Lack of clarity over where this money will be coming from.

4.9 While we accept that there may be funding issues to consider given where we are in PR19, spreading repayment over 5 years could mean that many customers may not receive their full entitlement. Those moving out of the region this year will currently not receive any rebate even if they have been longstanding customers paying wastewater charges throughout the entire period in question (2010 – 2017). See the company’s explanation of how rebates will be applied and FAQs HERE. We think any customers who have paid wastewater charges during this period that contact the company because they are moving outside of the company’s wastewater area this financial year should receive a pro-rata rebate based on the number of years they have paid Southern Water’s wastewater charges. After all, these are customers that have been misled and let down by the company.

4.10 Finally, we note that Ofwat intends to work with the company on setting out these rebates clearly on customer bills with wording being approved by Ofwat. We would ask that accompanying explanation is provided on where the money is coming from. This should seek to reassure customers that they are not somehow funding the rebates or that the company will be redirecting funds away from future investment into customer priorities like the environment or service resilience.

Enquiries

Enquiries about this consultation response and requests for further information should be addressed to:

Steve Hobbs Senior Policy Manager Consumer Council for Water Tel: 0777 817 5006 E-mail: [email protected]