Energy retailers to face financial stress tests

Energy suppliers are to be subject to financial stress testing from January as part of a raft of new measures being taken by the regulator in response to the fallout from high wholesale prices.

In an announcement on Wednesday morning (15 December), Ofgem also outlined potential adaptions to the price cap methodology as well as consultations on strengthening milestone assessments and potential short-term interventions to address risks to consumers from market volatility.

It comes as the regulator’s chief executive Jonathan Brearley admitted previous measures brought in by Ofgem were underdeveloped and “overtaken by the speed of change in energy markets”.

Ofgem said it envisages these initial stress tests will take the form of a number of “what if” scenarios which are likely to cover price volatility, differing levels of customer bad debt and significant acquisitions or loss of customers.

Suppliers will be issued with a request for information and Ofgem will then undertake stress testing on the data provided, test its results with the supplier and adjust the findings as appropriate.

Those who fail to cooperate with the process or provide inaccurate data will be subject to “robust enforcement action”.

Where any issues are raised from testing, Ofgem said it will identify a suitable improvement plan for the supplier to rectify them, with the possibility of enforcement action if this is not agreed or followed.

Ofgem said it anticipates this being the start of a series of stress testing exercises,  adding that it will learn from and adapt the design of the tests over time. Domestic suppliers will be prioritised and the regulator plans to consider the best approach to non-domestic retailers in the New Year.

Elsewhere, Ofgem has published a consultation on measures to strengthen requirements on suppliers with regards to financial risk management, with a particular focus on the risks associated with growth.

It will consult on temporarily pausing customer onboarding once suppliers reach the 50,000 and 200,000 domestic customer milestones, giving it time to complete any necessary assessments and the supplier sufficient time to complete any necessary actions.

It has also proposed to increase the flexibility of these assessments by either adding new milestones or adjusting existing ones.

There will be a temporary three month extension to the period of assessment of new supplier licences, meaning the current timeframe will be nine months.

Ofgem has additionally proposed to require boards to undertake self-assessments of their management control frameworks. Early next year the regulator will launch a self-assessment exercise for suppliers and Ofgem will request assurances from the board that risks are properly managed.

The plan further proposes to strengthen existing controls concerning “fit and proper” requirements and tighten rules around the protection of credit balances and renewables levies.

Ofgem chief executive Jonathan Brearley said: “Our intent is not to discourage well-financed new entrants, new business models, innovation or risk taking, but to reduce potential harm to energy consumers, in particular, to ensure that if suppliers do fail, the resulting costs to consumers are minimal, even in instances of high or volatile energy prices.

“These proposed reforms will strengthen risk management in the sector, protecting the interests of consumers, providing greater certainty for investors and strengthening the resilience of the sector. Our aim is to bring in these reforms as soon as reasonably practicable.”

Responding to the announcement, Energy UK chief executive Emma Pinchbeck said the industry has “long been calling” for a more sustainable regulatory and policy environment.

She added: “The energy industry’s priority is to support customers through these next months, but it’s right Ofgem is acting to ensure that in future all suppliers are equipped to cope with volatile costs, otherwise more will exit the market – ultimately leaving customers to pick up the bill.

“It is also right Ofgem look at what can be done in the short term to prevent further costs to customers and further fragility to a critical industry. We will look at the proposals in detail and look forward to discussing them with our members and Ofgem.”

Clare Moriarty, chief executive of Citizens Advice, said reform of the energy market is “urgently needed” and that Ofgem’s failure to adequately regulate the sector “left it vulnerable to recent price spikes”.

She added: “Ofgem is right to prioritise building sustainable and resilient business models that can withstand increases in wholesale gas prices. Everyone should be able to trust their energy supplier is fit to operate.”