Yes, if the switch is in the negative wire, the switch will disconnect the second battery from the first, but not necessarily the loads from the second battery. However, the same would be true if the switch was in the positive wire... there's no difference.
Water is not a particular problem, 12v wiring is on the whole not going to short out just because it's under water.
The cable to the starter/alternator isn't fused on standard vehicles, as i said before, the fuse would have to be rather large to allow normal operation, so it will have much less affect in terms of protection. a fuse the size you would require wouldn't cost 25p either!!!
Every load running off the battery should be fused, correctly for the load in question, as near to the battery as possible.
A better approach is to stop shorts in the first place, use heat-shrink on open connectors and run cables through gromets rather than through sharp edged metal holes.
Why is the battery between the seats? you can fit two batteries in the battery box.