Does the introduction of PCDs mean we are regressing to prescriptive output regulation?

Published: 15 August 2024

As water companies continue to prepare for AMP8, starting April 2025, Ofwat is beginning to set Price Control Deliverables (PCDs) as part of the final determination process. As part of this process, Ofwat has proposed assurance requirements for delivery of enhancement schemes in its recent PR24 draft determinations. Independent assurance of PCDs will likely play an important role in Asset Management Plan 8 (AMP8) reporting, but there are concerns that overly prescriptive regulation may stifle innovation and be in tension with outcome-based regulation.

There is certainly merit for companies to starting thinking about this process now and using the PCDs that require assurance for Annual Performance Report 2025 (APR25) as a trial run of these new requirements. With a big step up for APR26 companies would be advised to put processes in place in good time if they wish to deliver this requirement effectively and efficiently throughout AMP8.

Shifting regulatory framework

The extensive adoption of PCDs at PR24 marks a significant shift in the regulatory framework, establishing a much stronger connection between revenues and the successful delivery of investments. A notable proportion of funding is now contingent upon achieving specified outputs. This change aims to ensure greater accountability and efficiency in investment projects, incentivising companies to meet their performance targets to secure the necessary financial resources.

Payment for delivery

While the stronger focus on payment for delivery is understandable, there is a risk that this approach could lead to a regression from outcome-based regulation to a more prescriptive, output-focused regulation. This shift might undermine the flexibility and innovation encouraged by outcome-based frameworks, as companies may prioritise meeting specific deliverables over achieving broader, long-term objectives. Balancing the need for accountability with the benefits of outcome-based regulation is crucial to avoid these potential pitfalls.

Lists of specific outputs that must be delivered feels like a step back to earlier price reviews where the emphasis for companies became ticking outputs off the list rather than striving to deliver the most effective solution or reflecting new information and changed priorities.

Although in aggregate many companies in recent years have been fully investing or investing more than the regulatory allowance there have been widespread concerns that companies have not always fully delivered the expected outputs.

Value for money for the customer

In the circumstances, it is not surprising that Ofwat felt it needed to respond to growing concerns that companies were under delivering investment or delivering late. Furthermore, faced with the largest ever investment programme and the inevitable increase in bills associated with this, Ofwat needed to demonstrate that customers would get what they were paying for in full and on time.

The result is a big increase in the use of PCDs to ensure that if the outputs are not delivered customers will get their money back, and if late they will be compensated.

Stifling innovation

However, the more prescriptive monitoring approach could stifle innovation in developing more efficient or greener solutions for the duration of the AMP. It may inhibit companies from being more flexible in their response to new information.

The devil is in the detail. It is hard to object to the argument that customers should get what they have paid for or with the principle of payment on delivery. However, it remains important not to constrain investment plans in such a way that innovation is postponed and responses to new information delayed.

Flexibility and transparency

More focus on how PCDs could be amended if necessary to meet changing needs or circumstances would be welcome. This should not involve 'letting companies off the hook' but should enable flexibility where this is demonstrably in the interests of customers. The regulatory approach to amending PCDs if required needs to be transparent and not so burdensome that companies decide it is not worthwhile and just keep ticking outputs off the list despite there being better alternatives.

Ensuring investment benefits the customer

PCDs are not novel, as they have been used successfully in the energy sector, and are an evolution of Ofwat's established approach to performance commitments. They create a stronger link between revenue and delivery which is important in the context of public concern that companies are 'pocketing the money but not delivering the investment'. These concerns may not be entirely valid but past performance of companies has nonetheless contributed to the concerns.

While it is delivery of outcomes which ultimately matter, there is not always a clear short-term link between large investment programmes and defined performance or outcomes. This makes it difficult to entirely avoid output monitoring. However, this needs to be done intelligently and with some flexibility.

So long as these remain the right outputs it is important to know that they are being delivered fully and on time. If alternatively specified outputs or entirely different solutions which offer better outcomes become available, it is important to ensure that investment programmes remain responsive and to keep in mind that the objective of investment is to meet customers' needs not simply to comply with the regulators' expectations.

Aqua Consultants have a proven track record, acting as expert assurers in previous AMPs. Our team understand Ofwat’s assurance requirements intimately and will implement best practice processes for your independent third-party assurance. Get in touch and one of our experts will get back to you within 24-hours to discuss your needs.