Supplier Licensing Review—ongoing requirements and exit arrangements

Supplier Licensing Review—ongoing requirements and exit arrangements

Energy Law analysis: Ofgem has been reviewing its approach to supplier licensing, with the aim of improving suppliers’ financial resilience and enhancing customer protections. Having consulted on the proposed changes earlier this year, Ofgem confirmed on 26 November 2020 that it would introduce a package of reforms relating to energy suppliers’ ongoing regulatory requirements and arrangements for their exit from the energy supply market. In this analysis, Louise Dalton and Thomas Forman of CMS Cameron McKenna Nabarro Olswang consider the key principles of the package of reforms and what these mean for energy lawyers.

Original news

Ofgem releases its decision on the new approach to supplier licensing, LNB News 27/11/2020 15.

The Office of Gas and Electricity Markets (Ofgem) has published its decision regarding the new approach to undertake for supplier licensing. The reforms aim to encourage further responsible risk management, to enhance governance and accountability, and to improve market oversight. It follows two consultations, one undertaken in October 2019 on the requirements for active suppliers and exit arrangement and another one held in August 2020 on Ofgem’s policy proposals. The new requirements are to take effect from 22 January 2020, and the Customer Supply Continuity Plans requirement on 18 March 2021. Views can be submitted until 22 January 2021 on the Financial Responsibility Principle guidance found in the Appendix 3 of the decision.

What are the key principles of the reforms?

These reforms will take effect through changes to electricity and gas supply licence conditions. The changes are intended to promote more responsible risk management, improve governance and accountability, increase Ofgem’s ability to oversee energy supply markets effectively and reduce the cost burden and disruption caused when suppliers exit the market. Guidance has been published to accompany two of the proposals, the Financial Responsibility principles and milestone assessments. Ofgem is also considering further reforms on other aspects of market regulation in 2021. The reforms put forward by Ofgem should be considered together as a package and will function together.

Financial Responsibility Principle

This will be a new Condition 4B in the licence. The obligation is on the licensee to manage responsibly costs that could be Mutualised (including Customer Credit Balances and costs incurred under government environmental and social schemes) and to take appropriate action to minimise such costs. It is required to have adequate financial arrangements in place to meet those costs at risk of being Mutualised. Ofgem has published draft guidance alongside this licence condition that it is consulting on. It may revise this guidance from time to time.

Ofgem is also considering further reforms to deal with cost mutualisation. A key area of this is costs relating to the Renewables Obligation. Changes to this process would, however, require legislation and Ofgem is working closely with Business, Energy and Industrial Strategy to consider all options in the round.

Operational capability principle

There will be a new Condition 4A in the licence. Licensees are required to ensure that they have and maintain robust internal capability, systems and processes to enable it to (1) efficiently and effectively serve each of its customers, (2) efficiently and effectively identify and mitigate risks of consumer harm and (3) comply with relevant legislative and regulatory obligations.

Milestone assessment

A new Condition 28C means licensees will need to give Ofgem notice when a licensee reaches 50,000 and 200,000 domestic customers. This will be combined with the introduction of dynamic assessments, allowing Ofgem to conduct assessments on licensees.

Ongoing fit and proper requirements

A new licence Condition 4C is being introduced to regulate the management of energy suppliers. The licensee must not appoint or have in place a person in a position of Significant Managerial Responsibility or Influence who is not a fit and proper person to occupy that role. Regular assessments of such persons to ensure that they remain fit and proper to occupy that role are required. There are a number of factors that the licensee must have regard to, including whether they have been engaged by a current or former energy supplier that has been involved in a Supplier of Last Resort process. A person of Significant Managerial Responsibility or Influence means where a person plays a role in (a) the making of decisions about how the whole or a substantial part of a licensee’s activities are to be managed or organised, or (b) the actual managing or organising of the whole (or a substantial part) of those activities.

This follows closely with the position taken in financial regulation.

Principle to be open and cooperative with the regulator

New licence Condition 5A is a condition requiring the licensee to be open and cooperative with Ofgem. This puts an obligation on the licensee to disclose any circumstance relating to the licensee of which the Authority would reasonably expect notice in order to perform its statutory functions. This disclosure requirement is subject to the licensee not being compelled to produce or give the information if it would not be compelled to do so in civil proceedings before a court. This disclosure should be given as soon as the circumstance arises, or the licensee becomes aware of it.

Customer Supply Continuity Plans

The new Condition 19C/19E obligates licensees to ensure they have prepared and have in place at all times a customer supply continuity plan. This is a strategy for safeguarding the continuity of supply for its customers in the event of its exit from the market. It must be kept up to date at all times.

Independent audits

Under Condition 5B Ofgem can request and the licensee must carry out an Independent Audit on one of more of the following aspects: (1) financial stability, (2) customer service systems and processes, or (3) an audit where the licensee cannot provide adequate information under Condition 28C (new Milestone Assessments). As above, the licensee will not be compelled to produce or give the information that it otherwise would not be compelled to give in civil proceedings before a court.

Monitoring and Reporting requirements

A new condition dealing with additional reporting requirements is being introduced. Ofgem is expecting that suppliers promptly report to them any significant changes that may affect their operations. This will further Ofgem’s ability take action on issues related to customer service and standards and financial stability, as it will be aware of these issues earlier. The matters referred to in the new licence condition include: (1) whether the licensee is entering into a binding agreement for a trade sale or purchase (such notification should take place before any such agreement is entered into), (2) whether a Relevant Merger Situation has arisen in respect of the licensee (as set out in section 23 of the Enterprise Act 2002), (3) changes to those persons with Significant Control or Significant Managerial Responsibility or Influence in respect of the Licensee, (4) whether the licensee supplies through a White Label Tariff, and (5) any significant changes that may affect how a licensee operates.

Customer interactions with administrators

A new condition is being inserted into the licence that makes it a requirement for suppliers to include references in customer contract terms and conditions to the effect that activities relating to debt recovery will be executed as set out in the licence condition. These conditions are that charges may not be demanded or recovered unless and until it can be established that the corresponding contractual terms have been complied with, and that the customer has the right to offset any amount owing to it under the contract against any amounts owed by the customer under any other contract for the supply of gas or electricity to the premises. These provisions must be noted to continue to bind the licensee after the termination of the licence. This is intended to introduce consistency with the way a supplier could pursue debt after a supplier becomes insolvent.

Customer book sales

Suppliers will now be required to notify Ofgem when entering into a binding agreement for a trade sale or a trade purchase. This notification should come before the licensee enters into such agreement. The new Condition 19 also prohibits a licensee undertaking a trade sale or trade purchase where it will (1) subvert or distort, or is likely to subvert or distort the Supplier of Last Resort process, or (2) make it more likely (in Ofgem’s opinion) that costs will be Mutualised.

SoLR commitments

A new licence Condition 8 obligates licensees to take all reasonable steps to honour any commitments made to Ofgem before Ofgem gave it a Last Resort Supply Direction. This is coupled with a new Condition 7 which requires that Deemed Contracts contain terms that reflect this and require the licensee to honour Customer Credit Balances to the extent the Deemed Contract arose from a Last Resort Direction and the licensee committed to the same before Ofgem appointed them Supplier of Last Resort.

What does this mean for Energy Lawyers?

The principles-based approach to the majority of these changes leaves flexibility for suppliers in the implementation of the licence changes, allowing different approaches to be taken. It does, however, also give Ofgem flexibility in its interpretation. This should be considered carefully when implementing changes to terms and conditions and business processes based upon the new conditions. The key themes throughout the changes are (1) protecting customers and (2) ensuring a more stable energy supply market, with fewer exits due to financial instability. Having systems, processes and plans in place to meet each principle will be key and suppliers should be ready to evidence this at the request of Ofgem. It is also clear that the approach to regulating those who run energy suppliers is shifting towards the position adopted in financial services. Energy suppliers should be ready to demonstrate the processes they went through to vet persons holding a position of Significant Managerial Responsibility or Influence and should have steps in place to deal with a situation where they are no longer fit and proper to occupy the role.

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