Review points to possible cheap credit advantage for incumbent retailers

Ofwat, in a recent report, has warned that new entrants to the business water retail market could be hindered by lower credit costs available to players that were subsidiaries of incumbent water wholesalers.

The regulator said also it “could look at a recommendation in the report to ” consider the sufficiency of the gross margins,” in a future review .

Retailers have to offer collateral to wholesalers to enter and operate in the market. In an Ofwat-commissioned review of credit arrangements in non-household retail, consultancy, KPMG said it had found that many associated retailers received credit from their wholesaler parent companies at “low or zero cost” Such parent company guarantees (PGCs) are permissible under the current codes. “Such arrangements raise concerns as to whether the associated retailer is genuinely bearing 60% of credit risk as per the requirements of the code,” said Ofwat.

Ofwat said the KPMG review showed that new entrants, were typically unable to access PCGs and tended to use more expensive options such as cash credit, which made up a “significant proportion of all retail level costs for new entrant retailers.”

The regulator added: “Ofwat will be seeking reassurance that associated retailers have been pricing in a way that fairly reflects their access to PCGs and has asked the Codes Panel to improve transparency of PCGs and consider whether changes to the rules are required to ensure a level playing field for all retailers.”

Ofwat agreed with KPMG’s conclusion that intervention specifically to help new entrants was currently unnecessary as market-based provisions “appear to be providing benefit to a number of retailers including smaller new entrants.” The regulator was also “keen” to see a KPMG recommendation that unsecured credit arrangements were improved to better reflect the reduced risk associated with retailers with a strong payment history. It proposed the addition of an unsecured credit allowance based on credit rating agency reports and scores. It emphasised the prospects for a “pooled” credit scheme where all retailers would be covered by a single financial instrument.

Ofwat’s senior director of Market Outcomes and Enforcement, Emma Kelso said: “We would like to see the industry pick-up the baton in leading the work to improve the functionality of the credit arrangements. For example, we are keen that the industry Codes Panel takes forward work looking at the use and transparency of Parent Company Guarantees and alternative credit arrangements.”