Ring fence review: energy networks call for input
Issues identified
Summary
This section outlines issues we have already identified in other areas of regulation and within the licence conditions itself.
Known issues and proposed resolutions
Several issues with the ring fence licence conditions have already been identified through our initial assessment.
We proposed to amend some of our existing requirements in our RIIO-3 Sector Specific Methodology Decision which was published in July 2024.
The proposals included:
- amending the Availability of Resources requirement to require a certificate from the board stating that the network company has sufficient financial resources to cover the entire price control period or a minimum of 3 years ahead
- modifying the Credit Rating condition to require companies to maintain more than one investment grade rating
- strengthening the dividend lock-up trigger in the Restriction on Indebtedness condition from ‘BBB- with a negative outlook’ to the earlier of ‘BBB- with a negative outlook’ and regulatory gearing of 75% or greater
Read Chapter 6 of the RIIO-3 Sector Specific Methodology Decision Finance Annex for more details.
We have also introduced the following additional reporting requirements to the Regulatory instructions and guidance that network companies must follow when submitting their annual regulatory returns:
- increased disclosure around distributions along with narrative explanations
- disclosure around debt covenant trigger events
- disclosure around MidCo or HoldCo financing including any implications this may have on the network company
Read the Regulatory instructions and guidance on our Decision on 2024 modifications to the Regulatory Financial Performance Reporting (RFPR) for RIIO-2 page.
Further potential issues in the licence conditions
We have identified several areas for further improvement outside of what has been explored in the RIIO-3 Sector Specific Methodology Decision and set out examples.
Strength of dividend lock-up
The licence contains a dividend lock-up mechanism, which is triggered in the event of a material breach of covenant or where the network company is at risk of losing its investment grade credit rating, among other things.
However, the current conditions provide for numerous exceptions. For example, distributions made to repay interest on loans from intercompany entities, shareholders or related parties are exempt where the interest is on normal commercial terms. We want to better understand these exceptions and their relevance today.
Clarity of restrictions on disposals
Asset disposals represent another transfer of value from within the ring fence. If a network company transfers assets to a related party or another group entity, it may be incentivised to undervalue the asset at the point of transfer, which may be to the detriment of consumers.
In general, network companies are required to notify us of any asset disposals. However, there are numerous exceptions and the requirements and definitions used in the licence could do with clarification. This is particularly relevant in the context of net zero, where gas assets are likely to be repurposed and transferred to low carbon operators.
Inconsistencies across sectors
The Gas and Electricity Transmission licences contain an obligation for network companies to submit a Financial Resilience report if a rating agency downgrades or considers downgrading the network company’s credit rating. However, this obligation is not present in the Electricity Distribution licence.
Obligations may be open to interpretation
Some ring fence licence conditions contain limited guidance or there is no guidance. Neither the purpose of each ring fence condition nor the purpose of the ring fence itself are stated in the licence or in any relevant guidance.
We have also found that some terms lack clear definitions. They are open to interpretation which may result in activity that may follow the licence condition rules but act in a way that is not within the policy intent of the ring fence.
Before you give us your views
Read the issues identified chapter in our call for input (PDF).