Resilient and sustainable energy businesses: preparing for new regulations

As the cost-of-living crisis endures and energy companies continue to experience a volatile and uncertain environment, their ability to be resilient in providing essential services has never been more important. The conduct and culture within companies has been under the microscope, with findings from Ofgem's Market Compliance Review last week naming and shaming those companies who have not supported vulnerable customers in line with their expectations. Ofgem’s Statutory Consultation - Strengthening Financial Resilience proposal tackles the on-going work needed to strengthen financial resilience within the industry following a series of failures and what the regulator calls excessive risk-taking behaviour.

The consultation document acknowledges that the regulator had been slow to act around the energy crisis and that consumers need a better functioning energy market as well as more resilient firms to avoid the on-going issues with ability to withstand shocks, pricing strategies, and hedging. Proposals outlined include the enhanced financial responsibility principle, market-wide capital requirements and treatment of renewable obligation receipts, and customer credit balances.

1. An enhanced financial responsibility principle (enhanced FRP)

The aim is that the enhanced FRP will embed the minimum capital requirements for domestic suppliers and introduce a positive obligation on all supply licensees to evidence that they have sufficient business-specific capital and liquidity to meet liabilities on an ongoing basis.

2. A market-wide capital requirement

This will be closely informed by the level of capital employed on which suppliers receive a return under the EBIT allowance. It is proposed a shorter-term target is set for domestic suppliers to have £110-220 per domestic customer in net assets but the end of March 2025. Suppliers will be required to submit a transition plan showing clear staging posts or increments as to how they intend to reach that target.

3. Ringfencing of renewable obligation (RO) receipts to domestic supply

This will ensure that suppliers are not reliant on money not intended to fund operations. Ofgem are proposing this requirement begins from 1 April 2023 to coincide with the 2023/24 RO scheme year, with the obligation ramping up quarterly in arrears. The proposal sets to amend the price cap allowance to account for the additional capital required to implement this.

4. Consumer credit balances

The proposals put forward do not go so far as to ring-fence consumer credit balances as some respondents to the consultation called for but affirm that business models should not rely on the collection of consumer credit balances to provide working capital. Ofgem analysis (see figure 1) shows that average customer credit balances make up a much higher proportion of forecast total assets amongst failed suppliers Ofgem will monitor credit balances and act if suppliers reach a trigger point. The first step will be engagement but, if the regulator isn’t satisfied with supplier compliance, they can take further assessment action including requesting an independent audit, and ultimately, enforcement action.

These proposals are significant, and the changes required to design and embed them will be a challenge to firms.

As well as articulating new principles for all companies, Ofgem has also made explicit its proposed expectations for directors and, in particular, CFOs (or equivalent). They must approve the directors’ declaration of financial and operation adequacy set to accompany the self-assessment report assuring that the directors have a reasonable expectation that the licensee meets its financial responsibility principal obligations.

The approach taken to driving good customer outcomes within a sustainable market and resilient industry mirrors a number of approaches taken in the financial services industry following the 2008 financial crisis. These range from minimum capital requirements, enhanced accountability for senior management and safeguarding of customer balances and renewable obligation subsidies. The regulators approach to monitoring and engaging with firms – and the ability to request an independent audit where there are concerns about a particular issue – also mirrors the approach of financial services regulators. Whilst Ofgem propose a self-assessment of appropriate financial and operational resources to meet the business requirements, suppliers seeking to address these new proposals and establish good practice from the start can benefit from our insights and experience of working across a variety of regulated sectors. Boards and non-executives may also seek an independent view of how well prepared the business is to meet the new requirements and where more work is needed.

Benefits of assurance

We have a deep understanding of how to approach new regulatory requirements.

We are able to leverage knowledge, understanding of good practice, and lessons learned, having supported financial services and other sectors with the challenges the faced in the adoption and continued compliance with similar or equivalent regulatory requirements.

Our expert teams can help you approach the governance, culture, conduct, and prudential aspects of regulation and give confidence to boards, regulators, and broader stakeholders that your company is appropriately approaching new regulations through and assurance readiness assessment and gap analysis, and then through the provision of robust, independent assurance. We are also experienced in supporting firms subject to review by the regulator and with their data and documentation submissions and ongoing interactions.