London, 26 November 2012 -- Moody's understands that a majority of the incumbent water companies in England and Wales have declined to accept, in their current form, proposals by the Water Services Regulation Authority, Ofwat -- the economic regulator for water companies in England and Wales, to modify companies' licences. If implemented, the proposals would provide the regulator with flexibility to move activities accounting for up to 40% of companies' total revenues outside of the established price control framework. The non-acceptance, together with the possibility of the regulator now referring the matter to the Competition Commission (CC), sustains uncertainty which is credit negative.
Ofwat's proposals were made in the context of its continuing review of the way in which it will set future price limits and the draft Water Bill published in July 2012. Proposed licence amendments would allow the regulator to implement changes that it is planning from the start of the next regulatory period, beginning in April 2015, with segmental price controls and targeted incentives to achieve, according to Ofwat, better outcomes including retail choice for business, better allocation of treated water resources and different approaches to sludge treatment.
Following consultation with companies and other stakeholders, Ofwat has committed to maintain wholesale price controls linked to the Retail Price Index (RPI), to allocate companies' Regulatory Capital Value (RCV) to the wholesale function and to continue to calculate an RPI based return on the RCV as the main cost recovery mechanism for the monopoly network activities. The regulator has also highlighted the important regulatory safeguards that will continue to apply, including its duty to finance functions for the entire business as a whole, companies' ability to appeal any price control and a commitment to no changes for the natural monopoly.
Companies' non-acceptance of the licence amendments, as drafted by Ofwat, is related to the future flexibility the regulator is seeking. Ofwat considers it important that the services and activities covered by the proposed wholesale controls can be adjusted over time, so that it can create the right incentives and adjust the framework as appropriate. To provide this flexibility, the regulator has proposed that in any price control it would be able to move activities accounting for up to 20% of total revenue outside of the wholesale price control. There would also, it is proposed, be a further cumulative cap on activities moved outside of the wholesale business set at 40% of total revenue.
Ofwat indicated in October that if companies did not accept its proposals then it would likely refer the matter to the CC. We note, however, that Ofwat also said in a note published on 21 November that it would welcome responses that set out companies concerns and how they might be addressed; this together with company responses may open the door to a further period of discussion between the companies and regulator. Both sides will be keen to avoid a time consuming and costly CC referral if at all possible.
Moody's has previously said that we would not ordinarily view a CC referral as credit negative; the Commission is an integral part of the regulatory framework in the UK and an important risk mitigant. However, a referral would sustain current uncertainty and the perception of increased regulatory risk in the sector and that is credit negative.
Neil Griffiths-Lambeth Senior Vice President Infrastructure Finance Group Moody'sInvestors Service Ltd. One Canada SquareCanary WharfLondon E14 5FA United Kingdom JOURNALISTS: 44 20 7772 5456 SUBSCRIBERS: 44 20 7772 5454 Monica Merli MD - Infrastructure Finance Infrastructure Finance Group JOURNALISTS: 44 20 7772 5456 SUBSCRIBERS: 44 20 7772 5454 Releasing Office: Moody's Investors Service Ltd. One Canada SquareCanary WharfLondon E14 5FA United Kingdom JOURNALISTS: 44 20 7772 5456 SUBSCRIBERS: 44 20 7772 5454 (C) 2012 Moody's Investors Service, Inc. and/or its licensors and affiliates (collectively, "MOODY'S"). All rights reserved.
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