Ofwat accepts retail penalty recycling plan as an interim solution

Ofwat has agreed an interim solution regarding what to do with charges wholesalers and retailers pay for underperformance against Market Performance Standards (MPS).

In a decision to be implemented on 29 March, the regulator approved a revised CPM008 Panel recommendation to redistribute the penalties as follows.

• 2018/19: MPS charges for retailers and wholesalers to be ring fenced into two separate pots. In each case, half is to be redistributed to trading parties in the same proportions as they share market operator charges (as set out in the Market Arrangements Code) and the other half is to be allocated on a performance basis (using an algorithm which is designed to return greater monies than paid in MPS charges to those who performed better against MPS metrics, and less or none to those who performed worse, relative to other trading parties).

• 2019/20: MPS charges for retailers and wholesalers to be ring fenced into two separate pots, with all the funds in each pot shared according to performance as above.

However, Ofwat said it had “significant reservations”, on the following principal grounds.

• Diluted incentives – the revised proposals could result in a poor performing trading party paying no net charges, provided others are performing worse. Ofwat said: “We find it difficult to reconcile such diluted incentives against the need to ensure that end customers, as well as effective market functioning, are well served by good performance – in absolute terms – of those in the market. They will be best served where, among other things, trading parties who fail to meet required standards face appropriate financial penalties.”

• Non-redistribution: “The Market Performance Committee (MPC) and Panel has in our view given insufficient consideration and provided insufficient evidence to the question of non-redistribution, which may be a method for avoiding undue dilution of incentives under the MPS regime.” Non redistribution could, for instance, involve the creation of some kind of central fund for innovation or market improvement.

Consequently, Ofwat agreed the revised proposal only on the grounds that it is a transitional arrangement. It told the Panel and MPC to submit a revamped plan which addresses the weaknesses identified by October 2019, to apply from 2020/21 onwards. It set out some detailed views on non-redistribution that it wants considered. The regulator cautioned: “If we consider that the Panel and MPC has failed to adequately take these factors into account, then we are likely to propose an Authority Timetabled Change Proposal.”

Ofwat rejected the original charge redistribution plan put forward by the Panel in March 2018 in May that year, on grounds which included the incentives for trading parties to improve performance were too weak. It told the MPC to reconsider and resubmit a new plan, which it did in autumn, and which has now been temporarily approved.