Utility Week

20 | JANUARY 2022 | UTILITY WEEK Regulation Comment What's the point of appeals? T here was an initial urry of interest at the start of the year when all transmission and gas distribu- tion networks appealed their RIIO2 price control determinations. However, the CMA's nal determination published at the end of October has prompted relatively little comment. In large part that re ects the fact that there were minimal changes from the provisional decision pub- lished in August. But the publication of the full text of the nal decision amounting to ve volumes and over 1,200 pages does give regulatory enthusiasts plenty to chew on. At the time of the provisional decision, I described the result as a victory for Ofgem but with companies having landed some punches. Ofgem won on the central issue of the cost of equity but lost on its attempt to apply a reduction to the cost of equity through the novel device of an "outperformance wedge". It also lost on the innovation upli‡ it had applied to the ongoing eˆ ciency rate and on the process around some of the key uncertainty mechanisms where Ofgem's approach would have le‡ companies without a right of appeal against signi cant decisions. While not huge in nancial terms these wins will have covered the com- panies' costs in lodging an appeal and have set down a marker for Ofgem about the level of evidence it needs if it wants to push out the regulatory envelope. However, at this stage, what is interesting is not so much the nal score but what all this says about the appeals regime overall, in particular when viewed alongside the earlier PR19 appeal in water. As a reminder, the appeals regime in energy requires appellants to demonstrate that Ofgem was "wrong" on a point of fact or law or on the weighting of its duties. In contrast, in water the CMA is carrying out a full re-determination – deciding what they would do if they were in Ofwat's shoes. Throughout the RIIO2 decision the CMA reiterates that this is not what they are doing here. What this means in particular is that they allow Ofgem a margin of discretion on issues which are a matter of judgement. Unsurprisingly, Ofgem argued that almost everything was a matter of judgment. If the CMA had accepted that, it would have made a mock- ery of the appeals process – but they didn't. However, there was lengthy legal debate on exactly how much discretion should be allowed to the regulator, with the companies noting that the CMA itself is an expert regu- lator with experience across sectors. In terms of overall approach, the CMA made clear that while Ofgem should be a' orded a margin of appreciation as an expert regu- lator, that margin of appreciation is not unbounded. Expanding on this the CMA set out a principle that the fact there were alternative approaches the regulator could have taken is only relevant if they were "clearly superior". This then takes us into some interesting territory in terms of the interplay with the CMA's decision on the cost of equity in PR19. Unsurprisingly one of the argu- ments mounted by the companies was that Ofgem's approach was wrong where it took a di' erent approach to the CMA in the way that it built up the cost of equity. For example, in PR19 the CMA had used AAA corporate bonds as a benchmark for the risk-free rate. However, in the RIIO appeal the CMA says that its own approach was not clearly superior and also describes its own decision as "novel in a regulatory context" and needing scrutiny. Ofgem was therefore not wrong to depart from the approach taken by the CMA. This line that the CMA's PR19 approach was not clearly superior appears several times in the decision. A‡ er a year of submissions and hearings on PR19, Ofwat must be wondering what the point of it all was. More generally there is no recognition of the value in consistency across regulatory regimes. The CMA plays down the relevance of the PR19 case arguing that this was a di' erent decision, in a di' erent sector under a di' erent regulatory framework. Never mind that they have some of the same investors and that one strength of the CMA is that it does look across sectors and should therefore be able to help drive greater consistency. Indeed, it explicitly rejected the companies' argument that Ofgem was wrong not to pay more regard to the CMA's PR19 decision in the round, dismissing the idea that this created regulatory uncertainty for investors. It did acknowledge the work of the cross-regulator group (the UKRN) but only to show that Ofgem's views were informed by wider practice (and hence not wrong). It does feel as if out of all this must come calls for a review of the appeals mechanism. It is not clear why the CMA "judgment" on subjective issues should be superior to Ofwat's and an approach, as on energy, that allows the regulator a margin of discretion (but not too much) feels more appropriate. However, on cost of equity, where the UKRN work was done in order precisely to try to pro- a point of fact or law or on the weighting of its duties. In contrast, in water the CMA is carrying out a full re-determination – deciding what they would do if they were in Ofwat's shoes. Throughout the RIIO2 decision the CMA reiterates that this is not what they What this means in particular is that they allow Ofgem a margin of discretion on issues which are a matter of judgement. Unsurprisingly, Ofgem argued that almost everything was a matter of judgment. If the CMA had accepted that, it would have made a mock- ery of the appeals process – but they didn't. However, there was lengthy legal debate on exactly how much discretion should be allowed to the regulator, with the companies noting that the CMA itself is an expert regu- Indeed, it explicitly rejected the companies' argument that Ofgem was wrong not to pay more regard to the CMA's PR19 decision in the round, dismissing the idea that this created regulatory uncertainty for investors. It did acknowledge the work of the cross-regulator group (the UKRN) but only to show that Ofgem's views were informed by wider practice (and hence not wrong). It does feel as if out of all this must come calls for a review of the appeals mechanism. It is not clear why the CMA "judgment" on subjective issues should be superior to Ofwat's and an approach, as on energy, that allows the regulator a margin of discretion (but not too much) feels more appropriate. However, on cost of equity, where the UKRN work was done in order precisely to try to pro- After the Competition & Markets Authority (CMA) published its fi nal determination on the RIIO2 appeals by transmission and gas distribution networks at the end of October, Maxine Frerk, director of Grid Edge Policy and a former Ofgem partner, asks whether the appeals processes in energy and water need to be reviewed to provide consistency within and across sectors.

• Cover