Interview: Cathryn Ross, Chief executive, Ofwat

“If companies don’t feel they can live with the determination, then it’s their call. Really, the ball’s in their court.”

The live interview with Cathryn Ross was the best bit,” said a delegate at a recent Utility Week conference. “She’s just so clear – such a great communicator.” It’s a good thing too, because one year into her tenure, the chief executive of Ofwat has a lot to communicate. Today, she’s speaking to Utility Week at the regulator’s Bloomsbury Street London office, over the road from the British Museum and just 400m away from the Competition and Markets Authority HQ – a proximity that may prove useful in the months ahead.

Just weeks before Ofwat’s final determinations on the 2014 price review, Ross has a lot on her mind. Not only will the December announcements put the seal on a historic review, ushering in a significant period of change; they will also mark the transition into the delivery stage of an asset management plan (AMP) cycle that will be every bit as complex and challenging. Then there’s the minor matter of the introduction of competition to the non-domestic market and the looming spectre of upstream reform. And all this on a budget decimated by the Comprehensive Spending Review, a reduced headcount and a new operational structure.

Luckily, Ross has got the brains for it. As the impressed conference delegate noted, she’s a great ­communicator – clear and concise while conveying complex ideas, without being showy or condescending. She returned to Ofwat in October 2013, having left her role at the regulator as director of markets and economics in 2011 for a relatively short stint at the rail regulator. “It’s flown by – but it’s absolutely lovely to be back. If someone had said, would you come back, I would have said yes, absolutely, but if someone had said, how long would it be, two-and-a-half years wouldn’t have been the period I would have given.”

She’s too diplomatic to say so, but chances are she wouldn’t have chosen the situation she walked back into, either. Her predecessor Regina Finn left the organisation unexpectedly in May 2013, just before the price review began in earnest, following a bruising row with the sector over the attempted introduction of modifications to the licence. Incoming chair Jonson Cox poured oil on those troubled waters, but when Finn departed at a crucial moment, and shortly afterwards a hole of £5.6 million was discovered in Ofwat’s budget, it looked as though the regulator was on its uppers.

Nevertheless, for Ross, when the advert came out, it was a “dream job”. “My husband saw the news that Regina was leaving and the advert came out and he said, ‘so you’ll be applying for this’,” she says, with customary rapid-fire delivery. “To which my initial response was, ‘I like what I’m doing, I’m just getting to grips with rail’ – but it lodges in your brain and niggles away. That was the job of a lifetime, that would be amazing – so I threw my hat in the ring, and here I am.”

The rest is history – 12 months of it now, which centres on the price review. For Ross, this was a return to familiar territory, as she had been heavily involved in drafting the initial principles that set the framework for the review. “When I was around last time I was playing quite a key role in putting together those principles and even at the time that I was working on those four years ago I was really conscious it was quite an ambitious agenda, some quite substantial changes, customer engagement and outcomes and rebalancing risk and reward and totex. It was all absolutely the right thing to do but it was quite ambitious, and honestly, I didn’t think that Ofwat would achieve as much as it has. That’s no credit to me at all, it’s all stuff that was happening while I wasn’t here. The highlight is coming back and living that review.”

It will reach its culmination in a few weeks – can Ross give us any clue as to what the final determinations will be? She laughs: “Honestly – no! I couldn’t, even if in ­principle I could, because we haven’t made the decisions yet. We’ve still got the board meetings to be had, conversations to be had, and decisions to be reached. There’s nothing to tell yet – watch this space ”

It’s been a tough price review, with the companies smarting under a reduced weighted average cost of capital (Wacc) as well as getting to grips with the introduction of four separate price controls. While some companies have flourished – notably South West Water and Affinity, both fast-tracked with “enhanced” status – ­others have struggled. Thames Water, United Utilities and Bristol Water are notable among them, with the regulator breaking with tradition to announce multi-million pound discrepancies between their sums and its own ahead of the draft determinations in August. Does Ross expect any of the companies to play their wild card option and refuse the final determination, effectively taking the regulator to the CMA? “Who knows? It’s part of the process, if companies don’t feel they can live with the determination, then it’s their call. Really, the ball’s in their court – it’s part of the process, and not something I’m particularly bothered about. Time will tell.”

She’s positive about the companies’ response to the new process. “This time we followed a much more consciously iterative process and if you think about the scale of the challenge that we’re putting on to the sector in terms of how we want the sector to engage with its customers, for example, conversations companies will be needing to have with their investors, it’s a big step up, a big change for people, and people don’t get their heads around a change of that magnitude coming to it from a cold start. So I don’t think we were going to deliver what we needed to deliver by following the old process with the big reveal in the draft determination. It’s been quite arduous, I think, for us and the companies because there’s been a lot more interaction. But it produces a much ­better outcome and frankly it goes to that maturity of relationship between the regulator and the companies that we’ve been looking for.”

She is also ready to learn from any mistakes: there will be a formal “lessons learned” exercise once the review is over. Any idea yet what could have been done differently? “One thing that springs to mind, and something I’ve heard from a lot of people, is that it has been a lot of change in a short space of time and it would have been nicer to have more clarity about the policy framework and the methodology in particular. I hear that, that would have been good for us too.”

It looks as though the fast-track model is here to stay: she thinks it has been a success, and it’s important philosophically. “As a regulator, I don’t think we should be intervening where we don’t have to intervene. I know that sounds really trite and self-evident, but I don’t think pre-2009, that was the model. Then we had a model that was blanket intervention, where we were telling the companies what to do, we were looking at whether they did it or not and we were stepping in. It was quite one size fits all, for good reason, we were trying to get the sector up to minimum standards, but I think the world has moved on.

“I think it’s generally a better thing to be very clear what’s expected of companies. But then if they do what they need to do and they do it well and, crucially, provide us with assurance that they have, then we don’t need to intervene. That’s better for everybody because that gets us to companies genuinely owning the relationship with their customers, genuinely driving their business from that relationship and, frankly, us not wasting our time and effort where it isn’t needed.”

With all the time and attention that’s been spent on PR14, it’s easy to forget that it’s just the prelude to AMP6. “That will be a completely different ball game, and it’s going to be a real challenge – particularly delivering outcomes and totex. If you put those two things together, and bear in mind those are the two things where I think people will really be able to make money and deliver outperformance, you have to run your business in a completely different way.”

Ross sees some companies preparing already for this brave new world – she namechecks Severn Trent for overhauling its management team and structures. “You can see already some of them beginning to grapple with what delivery in line with PR14 actually means, but it’s a tough ask, and if you think about, for example, the relationship with the supply chain, that’s really interesting. If you go back to PR09 and the last control period, a lot of the companies had alliancing agreements back through the supply chain, but alliancing agreements to deliver outputs on a capex project is a completely different ball game to delivery of outcomes on a totex basis – the risk sharing is much more complex.”

That differentiation is precisely what the risk and reward structures set up in PR14 aim to recognise. Despite media protestations over water company profits, and growing political scrutiny, Ross is happy to defend outperformance in the sector under the new arrangements “because we’ve actually aligned the incentives for companies and company management with those of customers”.

Moreover, PR14 is tough on the bottom line, with proposals to reduce the Wacc from 5.1 per cent in PR09 to 3.85 per cent already on the table, and the possibility this could be driven down even further. How likely is it the final Wacc will come out below 3.85 per cent? “Go and hire an economics consultant!” she bats back. “If you look at the way that the markets are moving and if you plug those observations into the sort of models that we use, there is an argument for a lower cost of capital. What we will do in making our final determinations is weigh everything in the round and make a judgement.”

The tough risk and reward guidance will put pressure on senior management. With Richard Bienfait’s surprise departure from Affinity already announced, will we be waving goodbye to any more chief executives? “I’ll be quite interested to see how particularly the investor community responds to a lot of the information we put out in PR14. We have done transparency like never before in this review, there are thousands of pages out there and a lot of what those pages are telling you is about the quality of company management.”

There are likely to be changes in market structure as well as leadership, with Ofwat having opened the door to mergers. Ross insists she “doesn’t have a model in her pocket” and laughingly declines to name a minimum number of companies the sector’s comparative regulation model requires, but says: “I’d be surprised if there were not changes in market structure… At the moment we have 17 water retailers – that’s a hell of a lot.”

There are changes afoot at Ofwat, too, as it gets to grips with a government-mandated cut in its budget from £31.5 million this year, at the height of the price review, to £21.5 million next year. “It’s not like for like [because of the review], but it’s still a hefty budget cut.”

To deliver to this tighter budget, Ross has run a “business transformation project”, which will see the headcount come down by about 45 – all through voluntary redundancies – and the workforce reorganised into “resource pools” from which project teams are drawn on a project-by-project basis.

The regulator’s strategy for the years ahead will be published early next year; its content has been heavily trailed. It’s all about trust and confidence – which Ross admits has been inspired by the experience of energy firms, which have lost public trust. “You’ve got to go back to first principles on this stuff – ask what do water companies do, what does the sector do, and it takes you about a nanosecond before you realise it provides one of the most vital public services to everybody in the country.”

This will be at the heart of the regulator’s approach as it oversees the introduction of competition to the non-domestic market in 2017 and, further ahead, to the upstream market. Ross acknowledges there’s “a lot to do” on competition, particularly on the cultural side: “It’s not so much the nuts and bolts that worries me, it’s just how different a mindset a competitive market requires on the part of companies who have just been so insulated from this for so long.”

As if that wasn’t enough for companies to grapple with, Ross says upstream reform is firmly on her agenda for PR19, talking enthusiastically about the “size of the prize” of introducing competition and driving efficiencies in the wholesale part of the value chain. Coming on the back of PR14 and retail competition, that will be a bitter pill for water firms to swallow. Does Ross feel the regulator has won back their “trust and confidence” following the Section 13 debacle? “It’s a difficult one for me because I can’t do the before and after comparison, but I think we’re in a good place, given the scale of changes we made in PR14. The sector has responded really well, the conversations have been incredibly constructive. Not everyone likes ­everything we do, but regulation is no popularity contest.”

You can’t get clearer than that.