Our response to Ofwat’s consultation on Strengthening the Interim Supply Process – Implementation of the Cost Recovery Mechanism and Cost Support Tool
We welcome the opportunity to submit our views on the proposals to amend the various codes in the business retail market to introduce a cost recovery mechanism and cost support tool into the Interim Supply Process.
General comments
Overall, we generally agree with the proposals for the Cost Recovery Mechanism (CRM) and the Cost Support Tool (CRT) to help incentivise retailers to opt in to the interim supply process. Strengthening the interim supply process to guarantee continuous services for business customers if their retailer exits the market is one of the recommendations in our review of the water retail market. Introducing a scheme that may lead to greater retailer participation in the interim supply process could reduce the risk of customers being left without a retailer.
While we generally support the introduction of these schemes, there is still a risk that the CRM and CST will not result in retailers opting in to the interim supply process. This means the risk to affected business customers will remain unresolved. Ultimately, we want the interim supply process strengthened so there is a mandatory supplier of last resort if there is an interim supply event. We remain committed to working with both Ofwat and Defra on how to achieve this to ensure the gap in protection for business customers is filled. It is vital that the retail services to business customers are not impacted in instances where their retailer exits the business retail market.
We support the proposed Principles and Criteria that would need to be met for a successful CRM claim. If business customers are required to cover the costs of a claim, it is important these are only costs that are unavoidable and have been efficiently incurred by the interim supplier. However, we expect the CRM to only be used when absolutely necessary to avoid imposing higher charges on business customers. Ultimately, customers are not responsible for an interim supply event, so they should be protected from the consequences of one as much as possible.
Even if an interim supplier’s CRM claim meets Ofwat’s proposed Principles and Criteria in the claims guidance, there is a risk that business customers of those retailers required to fund the claim could face an unreasonable financial burden if the cost was significant. In addition, if those customers were unable to pay, this could cause a financial risk to their retailer which could in turn disrupt the services they provide to the same customers. It is therefore important that Ofwat recognises these wider market impacts at the point of any retailer exit and reserves the right not to allow a CRM claim if this is likely to cause such a significant impact. If a claim is permitted, Ofwat should also have the right to cap the amount that can be awarded to mitigate the same risk for the market and business customers.
We generally support the introduction of the CST as this should help incentivise retailers to opt in to the interim supply process. However, there needs to be a limit on the amount of wholesale charges that can be deferred and the length of time Credit Support can be reduced. Both could create a financial risk for wholesalers that may impact the delivery of wholesale services or ultimately result in wholesalers recovering losses through the price controls. This could financially impact both business and household customers. We do not want to see any customers bearing unnecessary costs for a market failure, so the support options need to be limited.
If the proposals are implemented, we want Ofwat to monitor the impact of any CRM and CST claims to ensure the right limits have been set, that there are no unintended consequences, and no adverse impacts on business customers. This should be compared against the results from prior cost and benefit modelling
Response to specific questions
We generally agree with both the introduction of the CRM, and the changes to the Interim Supply Code (ISC) to implement it. The proposed changes are clear concerning the circumstances that interim retailers can make a claim, the steps that will be taken by Ofwat to assess the claim, and how any agreed funds will be collected and distributed by MOSL. It is important the process is clear and understandable for all, to the benefit of customers. A transparent process that is understandable to retailers may also encourage them to opt in to the interim supply process when needed.
While we generally agree with the CRM, we do not agree with permitting interim suppliers up to 2.5 years to submit a claim for costs incurred. Even if these costs are ‘qualifying costs’ (under proposed section 10.1.2), a balance needs to be struck between allowing full reimbursement of these and the impact on business customers’ charges. This could be significant if the exited retailer had a large number of customers, thereby potentially increasing the amount of unavoidably incurred costs. It is also important for the CRM to be accountable to businesses, who need to be able to understand the basis of which they are being asked to pay more. As such, it may be difficult to justify an increase in charges for an event that had potentially occurred a significant time ago. We believe a maximum timeframe of 12 months is more reasonable for a claim to be made. This lessens the impact on customer charges and should also mark the point where most interim suppliers have achieved a ‘business as usual’ position in respect of the onboarded customers. We expect the process to be efficiently managed to reduce any wider impact on business customers, and this includes a shorter timeframe for claim submissions under the CRM.
We also do not believe it is necessary for Ofwat to consult on their minded to position following a decision on an interim supplier’s claim for costs. The CRM should be sufficiently robust to deal with each claim without additional industry input. Allowing such input after a decision has been made elongates the time period, creates unnecessary uncertainty for interim suppliers and could disincentivise them from opting in to the interim supply process. Ultimately, delays in concluding the process could negatively impact business customers. In addition, trading parties and stakeholders have already had opportunities to provide views in this, and previous, consultation stages, on the design and implementation of the CRM.
We believe that most of the proposed changes to the Market Arrangements Code (MAC) and Wholesale Retail Code (WRC) will result in a transparent and understandable process for the collection and distribution of agreed costs, which is key. Similar to the proposed changes to the ISC, this should help incentivise retailers to opt in to the interim supply process as they will have the necessary clarity of what to expect. However, we have some concerns about the inclusion of the bad debt percentage allowance which we expand on below.
We understand the proposed bad debt percentage allowance is included to mitigate the risk of retailers being unable to fully recover their share of a CRM claim from their customers. However, the permitted charges for Group 1 customers under the Retail Exit Code (REC) currently include an allowance for bad debt. Therefore, this group of customers is already paying more to cover the risk of bad debt for the retailer regardless of what the charges are then used for. To ensure Group 1 customers are not effectively paying twice to mitigate the same risk, retailers should not be permitted to include the proposed bad debt percentage allowance in the charges being recovered from them to cover their share of a CRM claim.
We would also like further clarification around the permitted percentage of the proposed bad debt allowance. The draft Section 7.1.2 of the CSD0004 refers to “the permitted adjustment value”, but also, “the default rate for this adjustment shall be 2%”. The first statement implies there is scope for the adjustment to be higher than 2% in certain circumstances, but it is unclear how Ofwat would reach such a decision. To limit business customers exposure to higher costs arising from a bad debt allowance, we believe the percentage should be fixed at 2%. This aligns with the expected level retailers should plan to bear over the course of a business cycle (as determined by Ofwat when assessing retailer liquidity and bad debt challenges during the COVID-19 pandemic).
We agree with the proposed changes to the REC. As stated in our introductory comments, our preference is for an interim supplier not to use the CRM, particularly if the unavoidable, efficiently incurred costs are low. However, in the event of the CRM being used, the fairest option is for retailers to have the means to recover costs from all their customers, if they are unable to absorb the cost themselves. The proposed change will allow costs to be passed through to Group 1 and Group 2 customers, and we agree with Ofwat that retailers should be incentivised to amend customers negotiated contracts to enable costs to be passed through to them too. If a retailer chose to pass on costs, it is fair and equitable that this is passed on to all their customers.
In our response to the consultation on CPW153, we raised concerns that it may not be possible for costs to be recovered from customers on negotiated contracts, which could then result in customers on REC terms and conditions bearing the entire cost of their retailer’s share of a CRM claim. We therefore support the proposed amendment to the REC that makes clear the cost that can be passed through to Group 1 and Group 2 customers’ needs to be equal to the number of SPIDs held by that customer multiplied by the flat rate per SPID calculated by MOSL. This should ensure these customers are protected from paying more than they should. However, in terms of customers on negotiated contracts, we believe Ofwat should give a regulatory direction and that retailers are incentivised to amend negotiated contracts to ensure they can recover costs across their entire customer base.
While we agree there is no need for a customer to receive a separate bill for CRM costs, it is important that retailers are making clear what the extra charges relate to. This is particularly vital if these charges are significant in proportion to the rest of the customer’s regular bill. We therefore believe the amendment to the CPCoP needs to be expanded to require retailers to explain to customers in simple terms what the charges relate to and why they are being required to contribute. This will ensure the CRM is fully transparent to business customers and they are receiving a consistent message regardless of who their retailer is. We want to work with Ofwat on revising the proposed amendment as well as working with retailers on the most effective way to communicate the charges, should the need arise.
We support the proposed claims guidance and its content as it sets out clear expectations of what is expected from interim suppliers in terms of their reasons for applying to the CRM and the supporting evidence required. To protect business customers from unnecessary price rises, it is vital that interim suppliers are only awarded costs that are fully evidenced, were unavoidable, and were efficiently incurred. The process set out in the proposed claims guidance should achieve this.
As we stated in our answer to Question 1, we do not agree with allowing interim suppliers up to 2.5 years to submit a final ‘true-up’ claim for costs, and we urge Ofwat to amend this to 12 months for the reasons we have provided.
We agree both with the introduction of the CST in principle and the proposed drafting of the ISC. We particularly support the requirement that retailers must state whether they intend to use the CST if appointed as an interim supplier. Given the risk with allowing a deferral of wholesale charges and/or Credit Support, it is important that Ofwat knows the retailer’s intention in advance so this can form part of their decision on whether to appoint that particular party as an interim supplier.
We broadly agree with the proposed changes to the WRC as they clearly set out how the CST process will work, the requirements on interim suppliers in terms of repayment, and how this should be agreed with the relevant wholesalers. We also agree with the emphasis on interim suppliers securing alternative funding as soon as they can, thereby reducing the reliance on the CST. As stated in our introductory comments, we want the use of the CST to be as limited as possible to reduce the wider risk to the market and customers if wholesalers are negatively financially impacted.
In order to mitigate the wider risks to the market and customers, it is important there is a limit on the amount of wholesale charges that can be deferred and the amount of Credit Support that can be temporarily reduced. While the proposed changes to the WRC appear to confirm this is limited to 60% for the former and six months for the latter, we are unclear on the circumstances that may mean the parameters could change (as per the proposed section 8.3.1.). We do not support the limits potentially increasing as this will increase the risk to wholesalers’ financial security, which could then negatively impact all customers. In addition, it is important that the terms of the CST are clear at the outset to retailers in order to help incentivise them to opt in to the interim supply process. We, therefore, want the proposed drafting to be amended to rule out the possibility that the limits could be increased.