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16 | 3rd - 9th OctOber 2014 | UtILItY WeeK Policy & Regulation Market view O n 16 September 2014, the Department of Energy and Climate Change (Decc) published proposals to amend the UK's implementation of the energy owner- ship unbundling rules, required by the EU Third Energy Package, to reflect the more lib- eral approach now being taken at European Union level. The European Commission's third pack- age requires structural separation between transmission system operator activities (onshore gas and electricity transmission systems, offshore transmission lines and interconnectors) on the one hand, and gen- eration, production and supply activities on the other. The directives prevent a company that controls a transmission system operator – or has the right to appoint the members of its supervisory board – from controlling or even exercising any right over a generation, pro- duction or supply business, and vice versa. The exercise of a right in this context includes the exercise of any voting rights and the power to appoint board members. The rules do not, however, prevent purely pas- sive minority shareholdings, where there are no associated voting or appointment rights. The rules are enforced through a certification process undertaken by Ofgem and overseen by the Commission. The purpose of these rules is to prevent conflicts of interest and opportunities to discriminate in favour of a company's own affiliated businesses and against third party network users. However, the directive's stringent word- ing has led to a number of apparently unintended and unanticipated limitations on portfolio investments. This is a particu- larly unfortunate result given the EU's rec- ognised need to encourage investment in infrastructure. The unbundling rules apply not only to shareholdings or influence within each of the electricity and gas markets but also across the two. Furthermore, the rules have no geographic limitations, such that conflict- ing interests in countries on different sides of the EU or even outside of Europe are tech- nically prohibited. There is also no account taken of the physical distance between the businesses required to be unbundled, or the lack of a physical connection. Nor are there any "safe harbours" built into the regime. The potential chilling effect on investment activity has not been helped by the absence of a speedy process for seeking certification clearance. These rules, when taken literally, have led to perverse outcomes, preventing investment in essentially unrelated activities, which even the European Commission did not wish to countenance in its transmission system operator certification reviews. Thus, in May 2013, the Commission pub- lished much-awaited guidance on this issue. The non-binding Staff Working Paper on unbundling recognised the difficulties that the rules have caused for holding compa- nies of transmission operators and financial investors such as pension funds, insurance companies and infrastructure funds, which would typically have diversified portfolios. In Staff Working Paper, the Commission confirmed the more pragmatic approach it has taken, in circumstances where the spirit if not the letter of the unbundling rules is satisfied – that is, where there is no risk of discrimination in practice. Three scenarios the Commission has been comfortable with are shown in figure 1. In the light of this, the UK government now believes that the UK's transposition of the directives into national legislation is unnecessarily restrictive – that it unduly constrains investment where there is no fore- seeable harm. The government therefore proposes to introduce further flexibility to the country's unbundling regime, in the form of a new discretionary power enabling Ofgem to cer- tify a transmission system operator as com- pliant even where one or more of the five ownership unbundling tests is not passed, provided that it does not consider there to be a risk of discrimination in the circumstances. The change, which should be widely wel- Unravelling unbundling There's good news for infrastructure investors as the government softens the energy unbundling rules handed down from European directives, say Mark Jones and Alex Olive. FiGURE 1: instancEs oF thE EURopEan commission's pRaGmatic appRoach to UnbUndlinG Swedish gas transmission system operator Swedgas 3xUK transmission system operators US generation asset National Grid Holdco Waste disposal company generating electricity in Denmark Spanish solar energy generation Italian gas transmission system operator Financial investor Holdco