Ofwat offers wholesalers collateral cover – but retail risk remains

Retailers will have to provide 50 days of collateral cover to wholesalers in the business retail market under credit terms proposed by Ofwat last week, but wholesalers would not be able to seek price review reopeners or end of period true ups for additional debts in the event of a retailer’s default. The regulator scoped out seven credit options for the 50 days’ cover:

[if !supportLists]• [endif]Cash – the retailer placing funds equal to 50 days of supply into a secure bank account established by the wholesaler. In the case of default, the wholesaler could withdraw from the account.

[if !supportLists]• [endif]Letter of credit – from a bank, agreeing to make a payment to the wholesaler if certain contractual conditions are not met by the retailer.

[if !supportLists]• [endif]Third party guarantee – a guarantee of payment by a parent company or third party guarantor acquired before any service is provided by the wholesaler.

[if !supportLists]• [endif]Insurance – a surety bond issued by an insurance company on behalf of a retailer, guaranteeing the performance of the retailer’s obligations.

[if !supportLists]• [endif]Unsecured credit – an unsecured allowance as a proportion of otherwise collateralised charges and liabilities. The amount of the allowance would depend on the the creditworthiness of the retailer.

[if !supportLists]• [endif]Pre-payment – payment in advance by the retailer of the estimated cost associated with delivering one month of service by the wholesaler, plus a balancing payment once the actual cost of providing the service is known.

[if !supportLists]• [endif]Bilateral agreement – terms to be negotiated between a wholesaler and retailer on a bespoke basis and published.

Ofwat said: “We believe that this approach would a) provide an efficient balance of risk, b) promote competition in the retail market for the benefit of customers and reduce entry barriers to that market, c) avoid tying up capital in that market unnecessarily which would be inefficient and d) provide automatic cover for the majority of the risk associated with a retailer default.”

It said it did not consider that an additional wholesale risk sharing mechanism such as a reopener or true up would be required. It argued there would not be a material impact on wholesalers even in the event of a significant default, and that companies already have a number of re- opener mechanisms within the existing framework that they could use were an extreme event to occur. However it called for stakeholders to bring forward further evidence on this for consideration.

The consultation runs until 7 July. Ofwat intends to publish a decision document that month and to take the changes through the Interim Code Panel in August. If appropriate, changes would also be reflected in the methodology for PR19.

See the full consultation document here