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Changes in the pipeline for the water sector - Part 2

August 17, 2018

Contacts

Partners Matt Conway, Sally McKechnie, Padraig McNamara, Jonathan Salter
Special Advisors Chris Browne

Water management Government reform and public policy Local government

The release of Local Government Minister Nanaia Mahuta's Cabinet paper Review of Three Waters Infrastructure: key findings and next steps indicates significant changes to water regulation in New Zealand are coming.

In this FYI we look at some of the regulatory options and pose some key questions about what a new regulatory regime for water might look like.

Background

Both the Government Inquiry into Havelock North Drinking Water (the Inquiry) and the Three Waters Review identified a range of challenges facing the water sector. Concerns have been raised about the effectiveness of the current regulatory regime for the three waters (drinking water, wastewater and stormwater). The issues include how best to provide for safe drinking water, environmental compliance and enforcement, a lack of independent economic regulation, minimal central oversight, and relatively light transparency and accountability compared with other core infrastructure sectors.

Cabinet paper proposal for regulation

In response to these concerns Minister Mahuta's Cabinet paper proposed a review of three waters infrastructure and regulation via four, interconnected workstreams. Workstream 1, to be led by MBIE, will provide options for new regulatory arrangements. It will comprise three main components:

  • Policy oversight: There needs to be clarity about who is responsible for the development of three waters policy. This component could result in the appointment of a lead government agency, and Ministerial accountability for the three waters sector.
  • Regulatory oversight: This component involves identifying and assessing potential mechanisms for better regulating the three waters. Options include an industry regulator, environmental regulator and/or economic regulator.
  • Regulatory compliance and enforcement: This component involves strengthening the monitoring, compliance and enforcement of rules and standards in the three waters sector. The goal includes ensuring land use controls and resource management planning regimes implemented by local authorities are adequate to protect drinking water quality.

Workstream 1 has links to Workstream 4, which aims to identify options for ensuring accessible, robust and consistent information on the performance of three waters services for consumers.

The timeframe is ambitious. Minister Mahuta intends to report back to Cabinet in October 2018 with proposals for all the workstreams. These proposals will likely be important inputs to the Government's budgets in 2019 and 2020.

The Havelock North Drinking Water Inquiry recommendations

This reform was prompted by the findings of the Inquiry. As part of its review, the Inquiry made a number of recommendations about three waters regulation.

A key recommendation of the Inquiry is that a dedicated drinking water regulator be established to focus on the quality of drinking water and the safety of all elements of the water supply chain. The Inquiry considered such a regulator, if properly resourced, would be the best vehicle for bringing about the necessary improvements to drinking water in New Zealand.

As well as providing leadership for drinking water initiatives, the Inquiry envisaged the new regulator having responsibility for drinking water assessors, samplers and laboratories, monitoring compliance with and enforcing water quality standards, and approving and monitoring compliance with water safety plans. These responsibilities are currently spread across District Health Boards and the Ministry of Health in what the Inquiry considered to be an unhelpfully fragmented way. The Inquiry noted the water industry comprises many disparate elements and a firm and effective regulator that can act decisively and promptly is necessary.

The Inquiry did not make detailed recommendations about the structure of the regulator, as this was beyond the Inquiry's scope. However, the Inquiry did say the regulator would need to operate independently of drinking water suppliers (mostly territorial authorities) and other water industry participants.

Other amendments needed?

The Inquiry also recommended changes to the Resource Management Act 1991, National Environmental Standards for Sources of Human Drinking Water, and Health Act 1956.

The Inquiry identified there is currently no specific reference in the Resource Management Act to the protection of drinking water sources. The Inquiry recommended the Act be amended to expressly recognise the protection and management of drinking water sources as a function of regional councils, and to make the management and protection of drinking water sources a matter of national importance. One aim of these suggested amendments is to keep the protection of drinking water sources at front-of-mind for local authority policy makers.

The Inquiry’s comments on the drinking water quality compliance provisions in the Health Act are disparaging. The Inquiry concluded “that the weak state of the [the Health Act] is inappropriate and unacceptable” and “that current knowledge and circumstances call for a much greater level of accountability for drinking water suppliers.”

We expect to see wider legislative changes in these areas as part of the Government’s reforms.

Water regulation: what should we have in New Zealand?

In completing this policy work, there are a range of very complex issues that will need to be addressed. This includes the form the regulator will take.

LGNZ’s co-regulatory proposal

As part of the Inquiry, the proposal by LGNZ for an industry co-regulator was considered.

The LGNZ proposal consisted of an industry body with a board comprising a majority of independent members as well as industry representatives. The regulator would be funded by a sector levy, have a statutory objective and be subject to some form of direction through Government Policy Statements. The regulator would have limited (if any) rule-making authority and enforcement powers. This is similar to the gas industry co-regulator in New Zealand, the Gas Industry Company.

The Inquiry doubted an industry co-regulator model would meet the needs the Inquiry identified for the future regulation of the water industry. However, the Gas Industry Company has been successful, so a water industry co-regulator should not be ruled out.

An industry co-regulator model requires a relatively high level of voluntary co-operation by the regulated parties, backed up by the perceived threat of an independent regulator with greater powers.

In New Zealand, the electricity industry has an independent regulator in the form of the Electricity Authority. The Authority is an independent Crown entity and its board is fully independent. The Authority is funded by a sector levy, has a statutory objective and is subject to light-handed direction through Government Policy Statements. The Authority has rule-making powers, monitors compliance with the rules, and plays a role in enforcing them together with the Electricity Rulings Panel. Independent regulators such as the Authority can be more expensive to set up and operate than industry co-regulators, which is one of the reasons the industry co-regulator model is preferred by LGNZ.

Multiple regulators? The model in England and Wales

The Cabinet paper flags the possibility of multiple regulators, specifically an industry regulator, environmental regulator and/or economic regulator. This approach is common overseas and New Zealand may look to these for guidance on the best approach.

An example is the regulatory system in England and Wales, which consists of both a water quality regulator and an economic regulator:

  • The Drinking Water Inspectorate is responsible for providing independent assurance that public water supplies in England and Wales are safe and drinking water quality is acceptable for consumers. It carries out a range of functions including assessing incidents potentially affecting drinking water quality or sufficiency, investigating consumer complaints about drinking water quality, and taking enforcement action.
  • The Water Services Regulation Authority (known as Ofwat) is the body responsible for economic regulation of the privatised water and sewerage industry in England and Wales. It is primarily responsible for setting limits on the prices charged for water and sewerage services, taking into account operational and capital expenditure plans and expected efficiency gains. It also licenses suppliers of drinking water and sewerage services.

The Inquiry heard expert advice on how active and effective enforcement of drinking water quality in England and Wales has led to better compliance, better standards and a high level of certainty within the industry.

Issues for future Three Waters regulation

The Cabinet paper does not expressly adopt any pre-existing model in its recommendations. Rather, the work streams require a more clean-slate assessment of New Zealand’s needs. We consider that there are a number of fundamental regulatory issues officials will need to grapple with in this work. Some of the key issues include:

  • How many new regulators will there be?
    Indications are there will at least be a new drinking water regulator focussing on drinking water quality, but the extent to which that regulator will also have responsibilities for wastewater and stormwater is unclear. The Cabinet paper conflates drinking water with wastewater and stormwater, although the Inquiry and its recommendations only related to the former.

It is also unclear whether the drinking water regulator will have any economic regulatory functions or if those functions (if any are implemented) will go to a new, separate regulator or to an existing body such as the Commerce Commission.

We expect any new environmental regulation will be implemented through existing legislation and administrative structures. However, there are significant overlaps between the sectors which will need to be considered.

  • What powers will the water regulators have?
    At one end of the spectrum is a regulator that monitors compliance with rules and standards set by someone else and provides policy recommendations. At the other end, there is a regulator with full information gathering, rule-making and enforcement powers, operating largely independently. If there is more than one water regulator they may not all be at the same place on that spectrum.

A related issue is how independent from the Government the water regulators should be. We expect the Government will wish to retain the power to direct the regulators through Government Policy Statements, at least in a light-handed way.

  • How will the water regulators relate to each other and the regulated parties?
    This will be a particular issue if there are separate industry and economic regulators as both will have an interest in the quality of the services provided by the regulated parties. Also, if economic regulation is introduced, how will the regulator interact with local authorities when they make decisions about their three waters investments, develop their infrastructure strategies and long-term plans, and set their rates and charges? This will depend on whether the economic regulation is based on expenditure control, revenue control, price control or a combination of those, and on how much appetite there is for disrupting established local government processes and rules.
  • Will there be a water services licensing regime?
    In England and Wales, Ofwat licenses suppliers of drinking water and sewerage services. New Zealand does not have a licensing system for three waters services.

The Inquiry recommended the introduction of a licensing system for all existing and future drinking water suppliers as soon as practicable, which would include mandatory qualifications for the suppliers and their staff.

  • How will the water regulators be funded?
    Regulators in New Zealand are typically funded through sector levies and service-based fees, sometimes with a contribution from the Crown. We expect the water regulators will be at least part-funded by sector levies paid by relevant industry participants, and the bulk of those will come from territorial authorities (and presumably be recovered through rates).

There are several options that could form the basis for the levies. They may be linked to industry participant type, regulator activity type, water volumes, network connections, size of asset or rating base, events, or a combination of those things. There are precedents for all of those approaches in the levy regimes for the New Zealand electricity and gas industries, Financial Markets Authority and Commerce Commission. Some more granular approaches to setting levies for the water industry will be out of reach in the medium term, due to the lack of universal metering.

  • What will the transition look like?
    There will need to be a period of transition to the new regime, especially if economic regulation is introduced. The different types of regulation may not all be introduced at the same time, and may not be applied at the same time to all types of industry participant. The transition may also have a geographical dimension. If an industry co-regulator model is chosen it is possible the enabling legislation will foreshadow the potential introduction of an independent regulator if co-regulation fails, as the Gas Act 1992 currently does for the gas industry.

The policy direction on these and other issues should become clearer when Minister Mahuta reports back to Cabinet (scheduled for October 2018).

This is the second FYI that has focussed on the significant changes which may be on the way for the water sector in New Zealand. Our previous FYI discussed the issue of aggregated, dedicated water suppliers and can be viewed here.

If you would like to discuss these matters and how they may directly affect your organisation, please contact our public law, regulatory or local government and environment experts.