Background
The current regime requires any supplier applying for a licence to provide relatively basic information, including the applicant’s insolvency status and history; major shareholders and controlling persons; disqualification and criminal offences of its directors; and key dates for when the applicant expects to commence licensable activities.
In its final proposals, Ofgem notes that competition in the retail energy market has increased significantly in the last five years. Although this has brought benefits to consumers, through increased price competition and pressure on incumbent suppliers to improve customer service, there has been an increase in supplier failures, which has undermined consumer confidence in the market. It is notable that, since the beginning of 2018, 10 energy suppliers have collapsed. The collapse of an energy supplier is always of concern to the market as a whole, but particularly to end-user consumers, who risk not having an electricity or gas supply.
As a result, several suppliers have demanded that more rigorous, qualitative assessments of an applicant’s fitness to operate as a supplier should be introduced, including financial testing.
New market entry requirements
Ofgem’s final proposals conclude that the existing regime should be strengthened, in order to mitigate the risk of supplier failures and increase standards in the sector, while still promoting innovation and competition in the supply market.
Ofgem has confirmed that the following four principles have guided the supplier licensing review and the final proposals:
- suppliers should adopt effective risk management, be adequately prepared and resourced for growth, and bear an appropriate share of the risk;
- suppliers should maintain the capacity and capability to deliver a quality service to their customers, and foster an open and constructive dialogue with Ofgem;
- Ofgem maintains proportionate oversight of suppliers, and effective protections for consumers exist in the event of failure; and
- Ofgem’s licensing regime facilitates effective competition and enables innovation.
New market entrants will now need to provide increased information to Ofgem on their market entry plans. Ofgem will undertake a qualitative assessment of this information based on the following three application criteria:
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Criteria
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Practical requirements set out in Draft Regulations
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1. The applicant has the appropriate resources for their proposal to enter the market.
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Applicants will have to demonstrate to Ofgem that they have planned their financial and operational resources for entry into the supply market and that they are prepared to meet the costs of entry, for example,the costs of complying with applicable government and environmental obligations.
The Draft Regulations suggest that applicants will be required to provide financial projections, funding arrangements and their risk management strategy for the first two years of operating in the supply market.
Ofgem will not prescribe a minimum level of capital for new suppliers but will instead consider whether applicants’ resources are reasonable.
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2. The applicant understands their regulatory obligations, and has appropriate plans in place to meet these.
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Applicants will need to provide a statement of intent in respect of compliance with their licence obligations, detailing in particular how they will comply with their customer service obligations.
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3. The applicant is fit and proper to hold a licence.
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Ofgem will enhance its suitability assessment of applicants by enforcing ‘fit and proper’ disclosure requirements.
This will include the provision of statements in regard to insolvency, supplier of last resort events,3and compliance history, and details of any actions against the applicant by other regulators.
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Under the Draft Regulations, Ofgem is entitled to assess all applications on a case-by-case basis. It is expected that there will be a teething period, during which time the industry and Ofgem will become accustomed to the new requirements.
The enhanced licensing requirements also come with an increased cost. Under the Draft Regulations, the application fee will be increased from the current £450 per application to £2,150.
Timing and practical implications
Ofgem has proposed that the supply licence application process should take place after market entry testing has commenced but before controlled market entry. In practice, this means that applicants should apply for a licence after having commenced initial entry testing, which will take approximately six to 12 months to complete. Ofgem considers that it is possible for licensing to run concurrently with the later stages of market entry testing, provided that the applicant is capable of meeting Ofgem’s criteria.
This will likely end the practice of operators purchasing ready-made supplier companies (often referred to as ‘supplier in a box’ companies), as the ultimate operators will be forced to engage with Ofgem at an early stage.There is a possibility that there will be fewer suppliers in the market and suppliers will start to consolidate. In 2018, some of the smaller suppliers that collapsed were taken on by other suppliers, in order to ensure continuity of supply to customers. While this is potentially detrimental from a competition perspective, it could mean that there is less risk of a supplier collapsing, meaning that there is a decreased likelihood of customers (particularly individuals) being without a gas or electricity supply.
Finally, as well as Ofgem’s rules becoming stricter, suppliers may face stricter requirements from their market access providers. A number of suppliers enter into market access arrangements with banks and large-scale traders, in order to hedge their exposure when supplying to customers. The access providers are now imposing stricter credit terms and default provisions into their access arrangements, in order to ensure that they do not suffer a loss in the event of a supplier ceasing to trade.
Conclusions
Under the new licensing regime, Ofgem will not require suppliers to undertake and report ongoing suitability assessments and compliance with the new criteria. Consequently, Ofgem will be unable to monitor a supplier’s ongoing compliance with the new suitability criteria set out in the Draft Regulations. As a result, Ofgem will not have contemporaneous information regarding the suitability of a supplier, and whether its circumstances have changed. Therefore, although the new licensing regime makes positive and much needed changes to the market entry requirements for new suppliers, there is potential scope for further improvement.
Ofgem’s aim is that, subject to the consultation on the Draft Regulations, the new licensing regime will be in place from June 2019. If you would like to discuss your obligations under the new regime, please contact the authors of this article.
- www.ofgem.gov.uk
- www.ofgem.gov.uk/publications-and-updates
- The supplier of last resort process occurs when Ofgem revokes a failing supplier’s supply licence and appoints another gas or electricity supply licensee (the supplier of last resort) to take over the failed supplier’s customers.
Client Alert 2019-153
