Castle Water seeks CMA permission to appeal Ofwat credit ruling on fragile wholesalers

Castle Water has applied to the Competition and Markets Authority (CMA) for permission to appeal Ofwat’s decision to reject CPW132 – a change to the Wholesale Retail Code that Castle proposed in light of wholesaler financial resilience jeopardy.

The change sought to temporarily stand down the requirement for credit security to be provided by a retailer to a wholesaler if the wholesaler’s balance sheet falls below the credit rating required by Ofwat in the wholesaler’s licence. This is immediately relevant to Thames Water, to whom Castle provides the bulk of the £45m it pays in credit security against wholesaler charges. However, in a blog last year on the Castle site, chief executive John Reynolds pointed out “there are probably at least five other water wholesalers with a level of financial stress”.

He argued that credit security is normally a good idea in reducing the risk of failure of a retailer. “However, to me it is obvious that if the wholesaler is at risk of failure, then it actually creates risk (including market wide systemic risk) rather than reducing it.” Potentially the credit posted could be vulnerable to being drawn upon beyond the sums due from the retailer to the wholesaler, and potentially, banks issuing letters of credit for retailers may refuse to do this (or charge a premium for higher risk) if the recipient wholesaler is a failure risk.

Ofwat issued a ‘minded to’ reject decision on CPW132 last August, which it confirmed on 5 February. It reasoned there would be legal repercussions for a wholesaler which drew on credit without a legal basis to do so; that the market codes already offer retailer protections; and that credit would be transferred to the new wholesaler in the event of special administration.

Ofwat also said it had not seen evidence to warrant the argument that the availability or cost of credit to a retailer would be affected by the wholesaler’s financial position. And that the CPW132 could contribute to deterioration in a wholesaler’s financial metrics, weakening its financial resilience.

Nonetheless, Ofwat said it planned to review wholesaler / retailer credit arrangements – including the extent to which the allocation of risk between the parties in the business retail market remains appropriate –  in light of increased wholesaler financial fragility and the current economic environment.

The CMA will decide whether to grant or reject permission for Castle to appeal Ofwat’s decision by 12 March. If permission is granted, the CMA has 30 working days (with a possible extension of ten days) following the date it receives Ofwat’s reply, to determine the appeal.

Castle wants to see Ofwat’s decision quashed and CPW132 approved, relieving retailers of the obligation to provide credit support to wholesalers who do not have a stable credit rating of BBB/Baa2 or higher.