Ofgem publishes consultation into the future of retail market regulation

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Ofgem to make suppliers responsible for their own regulatory compliance

On 18 December 2015, Ofgem issued a retail energy consultation which set out how it intends to re-shape retail energy market regulation (the Consultation). Ofgem’s Consultation outlines how it wants to move away from detailed rules by replacing them with a high level principles-based approach.

Boards will be empowered and expected to “self-regulate” compliance with the principles.  Companies who are proactive in embedding the principles within their business, and can demonstrate such compliance to Ofgem, should benefit from less onerous scrutiny than companies who fail to do so.

This marks a significant departure for Ofgem, which will have ramifications for firms’ approaches to regulatory compliance. However, in addition to potentially increasing regulatory burdens, the Consultation offers energy suppliers a good opportunity to help shape the future regime.

Stakeholders have until the 31st March 2016 to comment on the proposed approach.

Why has Ofgem changed its approach?

The Consultation puts the nail in the coffin for Ofgem’s historically prescriptive approach to regulation.  This “traditional” approach peaked in 2013 following the Retail Market Review, which launched in late 2010 amid concerns that the energy market was not working effectively for consumers. Following the Retail Market Review, Ofgem introduced several prescriptive obligations by way of a detailed set of licence modifications. Key changes included:

  • Enhanced Standards of Conduct which required the energy suppliers to treat their customers fairly in all interactions;
  • Restrictions on energy suppliers which limited them to offering a maximum of four “core” tariffs per fuel (electricity and gas); and
  • Requirement on energy suppliers to give all their customers personalised information on the cheapest tariff they offer for them, with this information appearing on each bill and on a range of other customer communications.

The Consultation comes in the context of the Competition and Markets Authority’s (CMA) energy market inquiry.  The market inquiry entails a comprehensive review of the energy sector to determine whether competition is working effectively.

The CMA published its provisional findings on 10 July 2015, in which it was highly critical of Ofgem’s prescriptive approach to regulation, particularly the complex suite of measures introduced as part of Ofgem’s Retail Market Reforms.  The Consultation marks Ofgem’s clear response to the CMA’s criticisms.

What does the consultation say?

The reforms are focused on the standard licence conditions of electricity and gas (SLC). These form the primary means by which Ofgem regulates the relationship between suppliers and consumers and they serve as the foundation for other forms of regulation.

The aim is to reformulate the SLCs into principles where appropriate and to reduce the number of detailed rules which Ofgem argues can lead to an increasingly complex regulatory framework for suppliers to navigate.  For example, the standard conditions of electricity supply licences have expanded from 64 pages in 2007 to 465 pages today.

Despite the broader shift to a principles-based approach, Ofgem acknowledges the continued need for prescription to provide clarity and manage risk, and in particular to deliver:

  1. Specific minimum standards which all suppliers should adhere to, for example, specifying that customers should be billed at least twice a year;
  2. Prohibition of specific practices in order to protect consumers, for example, prohibiting disconnections in winter for certain categories of customers in vulnerable situations; and
  3. Standardisation across the market to ensure the market functions effectively, for example, by specifying requirements relating to the Advanced Domestic Meters.

Ofgem guidance will be essential in helping achieve compliance

Ofgem aims to publish a limited amount of written guidance to  aid relevant parties in understanding the rules and their obligations. Ofgem is mindful to avoid reintroducing prescription through guidance as this would undermine the principles-based approach.

Non-compliance with guidance would not generally constitute a breach and may not therefore trigger automatic compliance or enforcement action. However, if a supplier does not have regard for the guidance, particularly where published guidance indicates expectations to achieve positive consumer outcomes, this could potentially indicate a breach. A supplier’s regard for the guidance may also be a factor Ofgem considers when deciding whether to impose a penalty and the level of such a penalty.

Ofgem acknowledges that suppliers may deliver positive outcomes in different ways and has stated its willingness to get “comfortable” with this more flexible regulatory dynamic. Nevertheless, Ofgem has stated that the reliance on principles will mean an increased focus on engagement and monitoring, especially early on.

Ofgem encourages proactive implementation of the new rules

Ofgem is mindful to ensure that monitoring is proportionate and does not present a an undue financial burden on suppliers. Companies who are proactive in embedding the principles within their business, and can demonstrate such compliance to Ofgem, should benefit from less onerous scrutiny than companies who fail to do so.

Ofgem believes that cooperation between itself and suppliers is crucial to the successful shift to a principles-based approach. Suppliers will be encouraged to share potential compliance issues with Ofgem at an early stage, building a transparent and trustworthy relationship. Nevertheless, Ofgem notes that while the self-reporting breaches may count in a supplier’s favour, Ofgem will not hold back from enforcing where appropriate.

Ofgem acknowledges that the provisional decision on remedies and the final decision of the CMA’s energy market investigation, both due in 2016, will influence the final form of the reforms.

What does this mean for regulated suppliers?

Ofgem’s move to principles-based (and risk-based) regulation mirrors a general trend away from the prescriptive regulation prevalent in other regulated sectors such as water. If (as is likely) the proposed new approach is implemented, energy suppliers will have greater obligations to determine on their own account how to operate their retail business in order to comply with their duties.

Financial services firms in particular are used to complying with regulatory principles and are likely to be useful comparators for energy suppliers to learn from.

Getting in touch

We regularly advise clients on energy regulation and competition issues, including advising on implementing Ofgem’s Retail Market Reforms. If you have any questions, please get in touch with one of the authors.

 

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