Watchdog uncovers water profits misuse

Ian Byatt, the water industry regulator, yesterday revealed damning evidence showing for the first time how the 10 privatised water companies have used their profits to subsidise hundreds of millions of pounds of activities by a web of non-regulated businesses.

The extent of the conflicts of interest and cross-subsidies only emerged after six months of investigation by independent inspectors appointed by Ofwat, the industry watchdog. They uncovered huge discrepancies between different companies in the scale of trading between the main regulated water operation and unregulated subsidiaries set up after privatisation such as engineering consultancy, contracting and computer support.

The research suggested some of the companies had ignored guidelines published more than two years ago by Ofwat imposing a statutory duty to keep the regulated water businesses at arm's length from the quoted parent group.

Problems highlighted included cash paid by the regulated water operations to the parent company which was not directly linked to specific services; contracts awarded to in-house subsidiaries which were not put out to competitive tender and potential conflicts of interest where directors of the water divisions were also directors of the non-regulated businesses.

Mr Byatt said despite some changes made by the water companies since the investigation began, he remained concerned about a situation where they did a lot of their business with subsidiaries of the parent group.

The findings were seized upon by Labour, which said they vindicated warnings that privatised water companies were creaming off money to finance other activities. Frank Dobson, the party's environment spokesman, said: "It shows that the present regulatory arrangements are not up to the task of tracking what is actually going on."

However, Ofwat blamed the companies' auditors for not spotting their lack of compliance with the guidelines. He said: "It is not the regulator's job to audit company procedures ... the reviews have shown the need for improved scrutiny of company compliance in this area by their auditors."

According to the regulator, the 10 privatised companies had non-regulated operations with sales of more than pounds 300m in 1994/95. In the case of five of the 10 companies, these subsidiary businesses derived more than a third of their business from the main water division.

Southern Water, which has since been taken over by Scottish Power, came off particularly badly, with 58 per cent of its non-regulated income derived from the water business. Southern also disclosed that not one of its contracts had been put out to competitive tender.

Southern said it was "benchmarking and market testing" some of its non- regulated operations, but still had 25 subsidiary companies which derived some or all of their work from the water business.

The inspectors found Southern's consultancy business, called McDowells, did the majority of the feasibility studies, design and supervision work for the regulated water company at prices in excess of market rates. These charges have since been reduced.

Five other water firms put less than 10 per cent of contracts out to tender: Welsh Water, Northumbrian, North West, Severn Trent and Yorkshire.

Action taken by the companies in response also varied widely. Thames Water and South West Water had removed all cross-directorships, whereas North West Water said in such situations directors would abstain from voting on decisions where conflicts of interest could occur.

Northumbrian, Southern and Severn Trent had since agreed to market test only "a proportion" of such services.

Separately figures published yesterday showed water bills this year have risen by twice the rate of inflation. The consultancy firm NUS said water prices in the UK had gone up by 4.9 per cent in 1996.

Comment, page 19

Companies' trading with subsidiaries (1994-95)

Trade with % of associates' Contracts with

associates as turnover associates:

% of regulated derived from not let by

turnover regulated competitive

business tender as %

(by value)

Anglian 4 35 58

Welsh Water 15 34 99

Northumbrian 9 20 97

North West 3 7 97

Severn Trent 6 23 92

Southern 19 58 100

South West 16 41 74

Thames 6 26 59

Wessex 2 1 34

Yorkshire 5 41 99