An Ounce of Prevention or a Pound of Cure?

Context

(Source: Ofgem)

Earlier this week, Ofgem announced a review of its approach to licencing suppliers.

Since 2011, there has been a marked increase in the number of active domestic suppliers. At the end of 2017, there were almost 70 suppliers in the market. This has brought increased competition and greater consumer choice, but has also introduced risks:

– The bottom 10 companies in Citizens Advice’s latest customer satisfaction ratings are all small or medium sized suppliers.
– Ofgem has opened an enforcement investigation into Iresa’s customer service processes and has temporarily banned the company from taking on new customers. In addition, there are open investigations of Utility Warehouse, Ovo, Economy Energy and Extra Energy.
– Ofgem has issued a ‘statement of objection’ alleging that two small suppliers breached competition law by agreeing not to target one another’s customers for some sales activities and by sharing commercially sensitive information.
– Two small suppliers, GB Energy and Future Energy, ceased trading after financial difficulties, requiring Ofgem to step in and appoint a supplier of last resort.

These concerns have led to calls from consumer bodies and the press for Ofgem to increase the scrutiny applied to applicants during the licensing process.

What might Ofgem do?

Ofgem’s current approach – minimising the regulatory burden

Ofgem’s current approach to reviewing licence applications is relatively light-touch, using a risk-based approach and focusing mainly on whether details provided by the applicant can be verified and checking financial information. For example, Ofgem checks whether the applicant been declared insolvent and whether it is a registered company. The process also requires an applicant to demonstrate they are in the process of becoming a signatory or party to relevant industry codes. Ofgem typically uses its information gathering powers to target specific issues separately from the licensing process.

One of Ofgem’s stated aims is to minimise the regulatory burden for applicants. This aim was emphasised when Ofgem decided it’s previous, more detailed approach was too burdensome. However, Ofgem’s forthcoming review provides an opportunity to consider whether priorities should be changed, to reflect the circumstances of the modern supply market.

Ofgem’s ability to act and impose checks in the licensing process may be partly limited by the framework for licensing set out in legislation. It could also be affected by Brexit, if there are changes to rules on authorisation schemes arising from directives on the internal market.

Ofgem is likely to consider the approaches adopted by other regulators. The differences between them are illustrated by the disparity in fees and timescales:

What lessons can be learnt from other regulators?

Ofwat – a thorough but not overly burdensome assessment of competency

Since retail market opening in 2017, the non-domestic retail market for water and wastewater is competitive. Ofwat reviews applications for Water Supply and Sewerage Licences (WSSLs), using a process that it states should be thorough but not overly burdensome. A little over a year since market opening, there are 34 licensees.

Applicants must be able to satisfy the regulator that they understand the business retail market. Ofwat highlight managerial competency, financial stability and technical competency as three themes for their assessment of prospective licensees. Information is also shared with the Drinking Water Inspectorate (DWI), Environment Agency (EA) and Natural Resources Wales (NRW) to enable them to assess the technical competency of the applicant.

Applicants also require a separate ‘Market Entry Assurance Certification’, which provides assurance that they have the required systems, processes and capabilities to become a trading party.

Prudential Regulation Authority – a review of business plans, funding and control frameworks

The Prudential Regulation Authority, in collaboration with the Financial Conduct Authority, run an in-depth process to assess and authorise new banks. The assessment includes four phases and several meetings and interviews, starting with expectation-setting and then progressing to feedback and challenge before the application is finally submitted. There is an option for a partial ‘mobilisation’ route to allow the prospective bank to start setting itself up, albeit with limitations on the business it can perform.

Assessment of an application includes a detailed challenge of applicant’s business plans and funding models. It also looks at risk management and control frameworks and sets capital and liquidity levels. Outsourcing arrangements, IT systems and business continuity plans will also be considered.

The entire process can take up to 40 months. This reflects the higher level of scrutiny and supervision financial services regulators impose on companies.

Ofcom – a light touch to secure a wide range of providers

Under Ofcom’s General Authorisation Regime, companies don’t need a licence or permission to operate an electronic communication networks and services. There is a set of general conditions similar to licence conditions, which automatically place obligations on companies providing the relevant services. Some specific conditions are placed on particular companies, for example to provide universal service or address concerns over market power. (Note that licences are required for other activities Ofcom regulate, television broadcast is one example).

This is consistent with one of Ofcom’s statutory duties, which is to secure that there are a wide range of electronic communications services available. This approach represents the opposite extreme from the approach in financial services, since there is no review process and no fees need to be paid for authorisation.

Implications for Ofgem

These three examples show that there are a wide range of alternative approaches that Ofgem can draw upon for its review of the licensing regime.

Our prediction is that Ofwat’s model provides the best indication of the direction Ofgem could move in. Ofwat’s system does not seem over-burdensome, given the rapid increase in licensees since market opening in 2017, and it would address the challenges Ofgem currently face. However, presuming no changes to primary legislation are planned, there may be some limits to what this review can achieve.