Regulation & Resilience

Climate change, growing demand and increased digitalisation is putting more pressure on the country’s infrastructure systems, and strategic, long term investment across water, energy and telecoms is needed to enable them to adapt.

In its report Strategic investment and public confidence, the Commission recommended that the government sets out a long term vision for each of these sectors and give regulators new powers. This will enable companies to invest in sustainable infrastructure to reduce emissions, ensure reliable digital connectivity and build resilience to floods and drought, while still protecting consumers’ interests.

The high levels of investment will come from the private sector, but is ultimately funded by consumers and businesses, so they need to have confidence that their money is being spent on the right things and that they are not being exploited. Investors benefit from a regulatory system that is trusted by the public and government, so the Commission recommends that an updated regulatory system should more fairly balance the risk and reward between investors and consumers and work for all groups of consumers.

The Commission also recommended a move away from monopoly providers to a greater use of competition, where appropriate, in the design and build of infrastructure service networks.

The nation’s energy, water, digital, and transport systems are vulnerable to shocks and stresses such as those caused by heatwaves, accidents, surges in demand or flooding. Many risks are exacerbated by climate change.

With infrastructure systems increasingly interconnected, the knock-on effects of any failure can have major impacts on the economy and people’s lives. Our study Anticipate, React, Recover: Resilience infrastructure systems explored how the country needs to prepare better for the future and manage for uncertainty.

This means government setting clear resilience standards every five years, and infrastructure operators stress testing their systems to demonstrate they can meet resilience standards and address vulnerabilities. Infrastructure operators should maintain long term resilience strategies, and regulators should account for these when making their price determinations.

Government, regulators, and operators all have a role to play. The resilience framework the Commission recommends seeks to improve how infrastructure systems anticipate, resist, absorb, and recover from shocks and stresses, while valuing resilience properly and driving adaptation and transformation to meet the needs of the future.

Climate change increases the likelihood of flooding. UK cities, towns and villages must adapt and improve their resilience to its impacts: currently, about five million homes are at risk.

A new long term funding strategy delivering a national standard for resilience to flooding is needed to better prepare and protect all parts of the country. The National Infrastructure Assessment set out the case for this nationwide standard of resilience to flooding, with catchment based plans. These plans should evaluate the full range of options including traditional flood defences, ‘green infrastructure’, individual property measures and spatial planning.

In November 2021 the government asked the Commission to undertake a new study into ways to reduce the risks from surface water flooding, which will report in November 2022.

Climate change and population growth puts increasing pressure on England’s water: there is a one in four chance of a serious drought before 2050. Boosting resilience, the Commission showed, is almost half as expensive as relying on emergency measures in times of drought (saving up to £20 billion over the next 30 years).

A twin-track approach of managing demand and enhancing supply is needed to deliver by 2050 an extra 4,000 mega litres of water every day to reduce the risk of drought – the equivalent of well over 22 million bath tubs of water. This can be achieved by the government, regulators and water companies working together to deliver a national water transfer network and additional supply by the 2030s, halving leakage by 2050 and better managing demand.

The Commission has welcomed draft plans announced in January 2022 by five regional water resources groups in England for water companies to collaborate in order to improve the management of the country’s water resources, in line with an approach recommended by the Commission in the first National Infrastructure Assessment.

Government should introduce a statutory requirement by 2022 for Secretaries of State to publish:

• clear, proportionate and realistic standards every five years for the resilience of energy, water, digital, road and rail services
• an assessment of how existing structures, powers and incentives enable operators to deliver these standards or where changes are needed.

Regulators should introduce obligations on infrastructure operators to meet these resilience standards by 2023.

Regulators should require a system of regular stress testing by 2024 for energy, water, digital, road and rail infrastructure operators, to ensure that infrastructure operators’ systems and decision-making can credibly meet resilience standards for infrastructure services.
Regulators should introduce obligations by 2023 on infrastructure operators to require them to participate in stress tests and to require remedial action in case of failure of stress tests.

Energy, water, digital, road and rail infrastructure operators should develop and maintain strategies to ensure infrastructure services can continue to meet resilience standards in the long term. To ensure this, regulators should:

• introduce obligations by 2023 on infrastructure operators to require them to develop and maintain long term resilience strategies (where there is no current requirement)
• set out, in future price reviews, how their determinations are consistent with meeting standards of resilience in both the short and long term.

Forward looking regulation, by independent regulators, remains the best approach to balancing the needs of consumers and investors, whilst incentivising efficiency. However, this should be embedded in a clearer strategic framework for the long term investment needs of the country:

• The government should introduce legislation by 2021 to fulfil its previous proposal that regulators have regard to endorsed recommendations from the Commission
• The government should set out a long term strategic vision for each of the regulated sectors, through strategic policy statements, within the first year of each Parliament, to support lasting plans and stable funding.

Regulatory frameworks should reflect the devolution of powers within the UK:

• Ahead of the next price controls, regulators should put in place formal mechanisms, such as advisory committees, to ensure they have regard to the strategic vision set out by devolved administrations, where devolved and reserved powers interact
• In future price controls, regulators should demonstrate how they have taken consideration of the strategic vision of metro mayors and relevant local government, within devolved powers, where this has material impacts for network investment
• Regardless of specific devolved powers, regulators should engage with the views of elected representatives, alongside other sources of insight into consumers and the public’s preferences.

Regulators’ duties need to be coherent, covering price, quality, resilience and environment. Government should introduce legislation by 2021 ensuring that, where they are currently missing, Ofwat, Ofgem and Ofcom have duties to require them to seek to:

• Ensure their decisions promote the resilience of infrastructure systems
• Ensure their decisions are consistent with, and promote the achievement of, the government’s legislated greenhouse gas emissions targets, currently achieving net zero greenhouse gases by 2050
• Collaborate with other regulators, where relevant, to avoid contradictory regulation and promote efficient outcomes for consumers on cross-sectoral issues.

The use of competition should be enhanced as the most reliable means of supporting innovation, particularly where there is rapid technological change:

• Regulators should focus ‘standard’ periodic price controls on the maintenance of existing networks and marginal enhancements
• Ofcom should continue to promote infrastructure competition for fibre and mobile networks
• Government should introduce legislation, ahead of the next price controls, to remove any barriers to the use of competition in the provision of strategic enhancements to water and energy networks
• For future price controls, Ofwat and Ofgem should separate consideration of strategic enhancements from the ‘standard’ periodic price control. Ofwat and Ofgem should develop tendering processes for strategic enhancements, with a clear, public justification required where tendering is not used
• Government should ensure that regulators have the resources they need to carry out competitive tenders for transformational investments.

Regulators should be more proactive in addressing financial risk and corporate governance, to ensure that rewards reflect performance and risks that are genuinely taken by investors:

• In future price controls, regulators should take direct account of information asymmetries in assessing the weighted average cost of capital and total expenditure allowances, ‘aiming off’ to ensure a fair outcome for consumers and investors
• In future price controls, regulators should introduce outperformance sharing mechanisms to allow consumers to share in the benefits that equity investors achieve from high gearing, where companies have gearing levels which significantly exceed the level assumed by the regulators
• For natural monopoly companies, regulators should evaluate the case for an absolute cap on gearing
• For firms with a natural monopoly, regulators should ensure executive salaries are demonstrably linked to long-term performance for consumers and the public.

Regulators should be able to prevent companies from engaging in price discrimination that does not provide an overall benefit to consumers:

• Regulators should require companies to report annually on which groups of customers are paying more for the same service; companies should be required to publicly justify their price discrimination policies or rectify them
• Regulators should be able to require companies to change their price structures where price discrimination cannot be justified by benefits to consumers
• Government should introduce legislation, by 2021, to replace the current court-based enforcement of consumer law with an administrative compliance and enforcement model, subject to appropriate scrutiny by the courts.

Government and regulators cannot rely on a flawed assumption that market design and distributional consequences can be separated. For future regulatory proposals with significant distributional consequences:

• Regulators should publish an analysis of the distributional consequences for consumers and businesses of their proposals, and of the impact of possible mitigations for significant adverse effects
• Regulators’ boards should be given the power, by 2021, to seek explicit guidance from ministers on strategic policy direction and distributional choices, against a menu of feasible options provided by the regulator and within a fixed three-month period

The UK Regulators Network should have a stronger role, supported by an independent chair:

• By the end of 2020, the UK Regulators Network should appoint an independent chair
• By the end of 2020, the government should review data sharing powers by regulators to ensure they can develop a ‘whole customer view’
• By the end of 2021, regulators, with the support of the UK Regulators Network, should develop joint data sets to enable whole customer analysis
• By July 2021, the independent chair of the UK Regulators Network should publish a business plan setting out how the network will support collaboration on the achievement of common goals; coordination to avoid contradictory regulation and inefficiency; data and knowledge sharing, including supporting the regulators to improve their data management capability; improved performance reporting by regulators.