Ofwat rejects a call to suspend credit security for wholesalers with junk ratings, but commits to a wider review
Ofwat plans 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.
It announced this as it opened a consultation on its provisional decision to reject a code change proposed by Castle Water which sought to protect retailers and their customers from financial problems at wholesalers.
In a blog on the Castle website, chief executive John Reynolds said the change aimed 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, whose credit rating is now below investment grade, and to whom Castle provides the bulk of the £45m it pays in credit security against wholesaler charges. However 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.
In its provisional decision to reject the proposal (CPW132), which is open to consultation until 2 September, Ofwat said: there would be legal repercussions for a wholesaler which drew on credit without a legal basis to do so; 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.
Reynolds’ blog, Ofwat thinks you will be happy with providing financial support to Thames Water – do you agree? sought the views of businesses by 28 August to inform Castle’s consultation response. He asked for email responses to ceo@castlewater.co.uk especially on the following questions:
Do you, as a business (or public sector) water customer consider it appropriate that water retailers are required to provide credit security to a wholesaler who is in breach of licence requirements relating to their credit rating?
Do you think Ofwat is adequately prioritising/protecting business customers from the financial risks associated with the risk of wholesaler insolvency?
Regarding its decision to review market credit more widely, Ofwat noted Castle’s view that the existing arrangements are no longer fit for purpose, in light of developments in the sector and wider economy.
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