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Ofgem’s Supplier Licensing Review: ongoing requirements and exit arrangements

Posted: 08/07/2020

Between 2014 and 2019, the number of active domestic energy suppliers in the GB market more than doubled, from 27 to 64. During the same period, the proportion of customers served by small and medium sized suppliers grew to around 30%. However, the period has also seen an increase in the number of supplier failures, particularly amongst smaller suppliers. This has led to increasing concerns about supplier compliance, market risk and harm to customers, with vulnerable domestic consumers a particular cause for concern.

In July 2019, Ofgem tightened the conditions on new suppliers entering the market. Now the regulator is undertaking a statutory consultation on its detailed final proposals for additions and changes to the standard conditions attached to supply licences (SLCs). [1] Ofgem’s focus is ongoing obligations on suppliers operating in the market and exit arrangements as they leave. The deadline for any responses is 20 August 2020.

What is Ofgem planning?

Domestic and non-domestic supply

1. Ofgem’s proposals cover both domestic and non-domestic supply, save for the provisions on milestone notifications (SLC 28C) and administrators’ pursuit of debts (SLC 27.8A), which apply to domestic supply only.

Risk management

2. A new financial responsibility principle (SLC 4B) will require a supplier to responsibly manage, minimise and, ultimately, be able to meet customer credit balances and Government environmental and social scheme costs that could be mutualised amongst other market participants if that supplier failed.

Ofgem says it is expecting suppliers to have pricing and business plans in place, robust financial governance and effective processes for both setting direct debit levels appropriately and proactively returning credit balances to customers; however, this is not detailed in the drafting of SLC 4B.

Whilst SLC 4B is drafted with a high-level of generality, rather than specific requirements, it is likely to be used by Ofgem as a tool for intervention whenever it has concerns about the risks that a supplier poses. As with SLC 4A (discussed below), it will provide a mechanism by which Ofgem can seek to take action, including potentially with provisional and Final Orders compelling suppliers to take steps, whenever Ofgem perceives that a financial risk, but not necessarily any actual harm, is reasonably anticipated.

Ofgem also states that it is considering – and seeks thoughts upon - more prescriptive provisions in respect to suppliers’ management of credit balances and ability to meet environmental scheme obligations.

3. A new over-arching provision on operational capacity (SLC 4A) requires suppliers to maintain robust capability, systems and processes to efficiently and effectively serve customers, identify and mitigate likely consumer harm and to meet relevant regulatory and legislative obligations.

A key question for suppliers will be how this interacts with other obligations.

One reading of SLC 4A is that it adds an additional breach to the charge sheet for a supplier that fails to meet an existing obligation (the “relevant regulatory and legislative obligations”) and where that failure is because its capability to meet the other obligation was not sufficiently robust. An SLC 4A breach could be added if the supplier was not meeting other SLC requirements on billing, for example.

However, SLC 4A does not define which regulatory and legislative obligations it attaches to; it simply refers to “relevant” obligations (and it does not use the specific term “relevant conditions or requirements” which is used in the Electricity Act 1989 and Gas Act 1986 to define those obligations in respect to which Ofgem can use its “sectoral” enforcement powers).

The flavour of the consultation suggests that Ofgem’s concern here is that suppliers should be required to properly resource the meeting of their obligations towards consumers and the rest of the market. However, the risk is that SLC 4A could create liability whenever Ofgem decides a supplier is not robust enough in meeting any regulatory or legal obligation, even if it is not one over which Ofgem would normally have any powers (data protection, tax, etc).

As drafted, SLC 4A potentially also creates a standalone obligation to have operational capacity (judged by Ofgem) to efficiently and effectively serve customers and mitigate harm. This is an obligation that could be breached even if a supplier is otherwise meeting other obligations on such matters as billing, complaints handling etc. A supplier may be billing on time, but Ofgem may conclude that it nevertheless lacks sufficient robustness in capacity to do so.

SLC 4A could be used in circumstances where poor performance was not otherwise a breach of an existing obligation, because SLC 4A might effectively raise the bar on expectations of supplier inputs and at the same time cover areas of supplier performance not otherwise subject to other regulation. It requires robust systems delivering efficient and effective customer service, which may be more than just meeting existing obligations.

Importantly, SLC 4A also relates to risk, as well as actual performance. A supplier may be meeting other existing obligations, but if it lacks robust capacity for efficient and effective service, or mitigation of potential harm, it may be found in breach. In this vein, the interaction of SLC 4A with milestone and dynamic assessments (see below) is important: Ofgem is creating a potentially actionable breach where it sees a risk which, at present, it may not be able to respond to (Ofgem does have powers to impose provisional and Final Orders compelling actions to avoid or remedy actual or anticipated breaches, but these require a crystallisation of an actual or imminent breach of specific obligations; for example, on billing or complaints handling etc, not the more generalised risk of poor performance that SLC 4A will seemingly prohibit and thus make the subject of potential future provisional and Final Order decisions).

Since its introduction a few years ago, the Standards of Conduct (SLC 0 / 0A) has become a breach that is often turned to by Ofgem whenever there are issues of concern, even where there is a more specific regulatory provision dealing with the exact issue of concern; SLC 0 / 0A breaches are looked at in addition to breaches on complaints handling, billing, customer transfers and the like. SLC 4A is similarly likely to become a “go to” provision for Ofgem whenever it has any concerns about supplier performance or even just risk, in particular when it wants to intervene early.

4. The third element to Ofgem’s risk management proposals consists of milestone and dynamic assessments.

SLC 28C will have suppliers notifying Ofgem at “a reasonable time before” and when they first reach 50,000 and 200,000 domestic customers.

This is to enable Ofgem to carry out “milestone assessments”, in which Ofgem will decide (against criteria set out in appendix 3 of the consultation) whether (i) the supplier has appropriate operational and financial resources to manage its existing customers and planned growth and (ii) the supplier has sufficient plans to meet its regulatory obligations. The regulator will be looking at operational performance, customer services, planning, oversight and control of outsourced functions and budgeting for regulatory obligations.

Ofgem is also planning for “dynamic assessments”, which will be triggered by warning signs such as customer service difficulties, rather than customer number thresholds.

The assessments will not be pass/fail. Rather, they will identify potential issues for action, which could include enforcement action on suspected breaches (and note the interaction with SLCs 4A and 4B here).

The changes here are largely about Ofgem’s approach to monitoring risk and compliance: it is saying that against a revised set of SLC requirements (in particular SLCs 4A and 4B) it will be more systematic and structured in assessing the risk presented by growing suppliers and others showing particular “red flags”.

Ofgem is unlikely to be able to dig too deeply in assessing the materials it is provided with by a supplier. It does not have the staff to start second-guessing the detailed running of businesses. What it will be looking for are obvious risks presented by an apparent lack of planning (for example), which may need to be followed up with an audit (see below), enforcement or other compliance action.

Ofgem does not cite the powers it will use to gather the information it will analyse for the milestone or dynamic assessments. However, suppliers will often be incentivised to cooperate, since they will not want to escalate the engagement into enforcement action. SLC 5 already requires suppliers to provide information in response to requests from Ofgem. The new obligation at SLC 5A to be open and cooperative (see below) would also be relevant.

Governance and accountability

5. SLC 4C creates an ongoing obligation to ensure that those with significant managerial responsibility or influence are fit and proper. This captures anyone (not just employees) making decisions about or actually managing all or substantial parts of the supplier’s activities, and for most suppliers this is likely to be more than just the board and executive team. Because it refers to “the licensee’s activities” the drafting of SLC 4C also appears to be trying to regulate the employment of managers in parts of a supplier’s business that may not be related to energy supply; for example, if the same licensee has a diversified business and was also engaged in telecoms or broadband provision.

Fit and proper” is not defined, but a list of factors to consider include misconduct or mismanagement (whether unlawful or not), unspent criminal convictions, insolvency history, director disqualification, being subject to SOLR or other regulatory actions against the person or the business they were involved in. The supplier is required to have particular regard to any background in the GB energy sector and any actions that “resulted in or contributed towards significant consumer or market detriment”.

Ofgem states in its consultation that this is not intended to be a bar per se on future employment and it is not intended to discourage senior managers from trying to save failing suppliers. SLC 4C does create room for suppliers to exercise discretion. It is easy to see that SLC 4C is designed to make suppliers think hard about who they appoint to senior positions, with the intention to make regulatory compliance an important part of leadership appointments.

However, there is a risk that senior managers may be punished for actions that may not otherwise seem particularly egregious: even relatively well run businesses occasionally commit unintentional regulatory breaches and such breaches often turn on the contested interpretation of regulations decided by Ofgem. One consequence of SLC 4C may in fact be to discourage or complicate the early resolution of compliance and enforcement matters, if the senior leadership of the energy business under investigation fear being criticised and having their future employment prospects harmed.

6. SLC 5A introduces a requirement that the supplier must be “open and cooperative” with Ofgem. This is elaborated as a requirement to tell Ofgem, as soon as the supplier is aware of it, of any circumstance that Ofgem would reasonably expect notice of in order to perform its own functions, in particular where acts or omissions give rise to a likelihood of detriment to domestic customers. However, suppliers are not required to provide information that they could not be compelled to provide in court proceedings. Ofgem states that it is clear that requiring disclosure for regulatory purposes does not infringe the right against self-incrimination (although it does not provide the legal analysis behind this statement).

In principle it is a good idea for a well-run business to be open and cooperative with its regulator, and regulators will want to incentivise this. Ofgem already incentivises being open and cooperative. For example, its Enforcement Guidelines are clear that Ofgem is less likely to open an enforcement investigation if a supplier has been proactive in identifying and engaging with Ofgem on problems; in the event that Ofgem finds a breach, its Penalties Policy provides that open and cooperative engagement is a mitigating factor.

However, suppliers may still be concerned that in practical terms SLC 5A goes beyond requiring responses to Ofgem questions or incentivising cooperation through the enforcement process. The potential difficulty with SLC 5A is that it makes proactive openness and cooperation by the supplier something which Ofgem can take hard-edged enforcement action about: if Ofgem determines a supplier has not been sufficiently proactive in being open and cooperative, the supplier may be punished.

Suppliers should anticipate some difficult conversations, internally at least, as to what SLC 5A means in practical terms. Particular difficulties could arise where a supplier does not consider there to have been a breach or harm (often quite reasonably), but Ofgem takes a different view. What happens if the supplier only learns at a later date what Ofgem’s view on the matter is?

Market oversight

7. SLC 5B gives Ofgem the power to require a supplier to appoint auditors, at the licensee’s expense, to conduct an independent audit where Ofgem considers this necessary for the performance of any of Ofgem’s functions.

SLC 5B.1 is widely drawn in giving Ofgem this power. SLC 5B.2 goes on to say that the audit may cover financial stability, customer service or “where a licensee cannot provide adequate information under Conditions 28C”, which appears to mean that an independent audit could be ordered to check on domestic customer numbers. It is not clear whether SLC 5B.2 is intended to be an illustrative but non-exhaustive list of areas the audit might cover, or to set limits on what Ofgem can require the audit to cover. Ofgem’s policy document suggests the latter. It also suggests that the audits will be required where a supplier has not been able to satisfy Ofgem on financial stability, risk of harm to consumers, root cause analyses or in respect to milestone or dynamic assessments (see above); however, the drafting of SLC 5B does allow for wider application.

Audits have previously been required by Ofgem as part of the resolution of compliance matters or early settlement of enforcement cases – the supplier has agreed to them as part of whatever package has been used to avoid a continued contested case. They allow for issues to be examined at potentially greater speed, depth and specialism than Ofgem and perhaps the supplier itself may be capable of. However, SLC 5B is new in giving Ofgem the power to compel the audits even without any compliance or enforcement process being engaged.

8. Customer Supply Continuity Plans (aka “Living Wills”) (electricity SLC 19C / gas SLC 19E) is a short requirement to have in place an up-to-date and accurate plan, prepared with skill and care, setting out plans for safeguarding supply to customers in the event of market exit.

In its policy document Ofgem is more expansive on what it wants to see in these plans, including details of arrangements with third parties to ensure continuity of billing, payment processing and PSR, key contacts such as directors and heads of teams, customer account information, and plans for hand-overs.

This all seems like sensible information that a well-run supplier may want to have in its contingency plans and which mitigates consumer risk.

However, none of the detail of what Ofgem wants to see is contained in the enforceable requirements of SLC 19C. And as others have already commented, if a supplier is failing and exiting the market there would seem a high probability that compliance with a high-level SLC 19C will already have slipped so that whatever plan was in place may not be wholly reliable.

9. SLC 19AA is a list of additional reporting requirements. Suppliers will need to notify Ofgem when a trade sale/purchase has been agreed (and see below for more on trade sales), when there are changes in contact details, when a merger is planned, when there are changes of persons with significant control or significant managerial responsibility or influence, or significant changes in how the supplier operates (including supplying through a white label tariff).

Exit arrangements

10. SLC 19D (electricity) / SLC 19F (gas) prohibits suppliers from engaging in a trade sale/purchase that is likely to subvert or distort the SOLR process or make it more likely that costs will be mutualised. For a supplier that is exiting the market, the threat of enforcement action for an SLC 19D breach may not immediately seem sufficient to stop it from going through with a financially advantageous trade sale. However, so long as it holds a licence, Ofgem would still, in theory at least, be able to take enforcement action for example with a provisional or Final Order to compel compliance.

For the trade buyer, who will be planning to continue operating as a supplier, SLC 19D is likely to focus thinking on the impact of the sale, due diligence and potential SOLR positions.

11. In related amendments to existing licence conditions, SLC 8 is amended to introduce a requirement on the SOLR supplier to take all reasonable steps to honour any commitment made to Ofgem. SLC 7 is similarly amended so that the SOLR supplier honours commitments specifically on customer credit balances.

12. Ofgem’s policy concern on administrators adopting aggressive debt collection tactics and the gap as compared to protections for customers (particularly those in a vulnerable situation) engaging with a licenced supplier is more difficult to deal with.

Ofgem recognises that insolvency practitioners are beyond its regulatory remit and that the insolvency regime puts its own, different, requirements and priorities on its practitioners. Ofgem asserts that an administrator’s duties are not incompatible with also treating debtor customers with the same standards as if they were engaging with a compliant supplier and it says many administrators have managed this. But it is clear that reconciling the requirements of the insolvency and energy consumer protection regimes is potentially difficult.

Ofgem’s solution is to insert new provisions into SLC 27 requiring the supplier to import the operative SLC provisions on debt collection (SLC 27.5 - .8 and .17 and .18, SLC 28B.5 and .6, SLC 21BA.3) into its domestic and deemed supply contracts. This is intended to have the effect of contractually binding any administrator to continuing to offer protections, provided of course that the supplier has first complied with the new SLC 27.8A requirement to introduce the contractual terms.

Additional commentary

It seems unlikely that market participants will have fundamental objections to the principles of financial responsibility, operational capacity and reducing the risks of supplier failure leading to mutualised costs and consumer detriment. Broadly speaking, it is already in suppliers’ interests to engage well with Ofgem, whether as a question of regulatory compliance or simply good business practice. Ofgem reports that consultation responses were generally supportive when it trialled the ideas now contained in the present statutory consultation and proposed new SLCs.

Ofgem says throughout the present consultation document that it will be proportionate in its enforcement of the new obligations and that it does not expect that there will be significant new costs or administration attached to compliance. The larger part of what is being done by Ofgem is the introduction of requirements on suppliers to plan for growth and ongoing compliance, and to be open to escalating checks on this. Ofgem does not refer to hard-edged enforcement much and, where it does, it is to raise the possibility of preventing suppliers from taking on more customers where there are concerns about their ability to grow without unacceptable (in Ofgem’s eyes) risks.

Much of what will be required is likely to be within what a well-run supplier would be doing in any event.

However, it is hard to believe that there will not be additional burdens created and we have highlighted above some specific points that will need to be thought about by suppliers (and there will be additional practical points to consider about how suppliers ensure compliance with the new requirements).

Whilst there are some precise and specific requirements in the new SLCs, there are also some which are broadly drawn and potentially open to a range of interpretations; SLCs 4A, 4B and 5A being obvious examples. Provisions including SLC 4B and SLC 28C additionally require suppliers to have regard to any guidance that Ofgem may produce in the future.

This is important, because once licence conditions have come into force, they cannot be retrospectively challenged simply because a supplier does not like how Ofgem subsequently uses them. If suppliers do not like a new SLC then the time to challenge is now. If a supplier later finds itself in a dispute with Ofgem it is going to be limited to arguing that the SLC is somehow beyond what Ofgem had the powers to introduce or that Ofgem’s ultimate interpretation and enforcement of that licence condition (at the end of the formal enforcement process and arguments in front of the Enforcement Decision Panel) is unreasonable and beyond its powers, both of which are likely to be difficult to successfully argue in court.


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