Ofwat looks to remove barriers for new water entrants

Ofwat has laid out plans to introduce a set of regulated credit and collateral arrangements to support the retail market, to prevent wholesale incumbents creating barriers to entry.

The regulator is consulting on its proposed approach to the credit and collateral arrangements between wholesalers and retailers in the new business retail market.

It said such credit terms are an important aspect of the new market arrangements, which seek to manage the financial risks of retailer default in the new market.

“In an effectively competitive market where multiple buyers and sellers exist, we would expect some risk sharing to be agreed between the two parties. We want to try and mimic this competitive market arrangement and provide an efficient allocation of this risk,” the regulator said.

In order for the market to be effective, the regulator said there was a need to ensure that the credit terms promote competition in the new retail market for the benefit of customers, whilst allowing wholesalers to remain financeable and mitigate undue costs from misallocation of risk.

In UK electricity and gas distribution, retailers provide 60 per cent of the collateral arrangements and wholesalers are subject to 40 per cent of these risks.

Ofwat said this is an efficient balance of risk, and is proposing that retailers provide 50 days of collateral to wholesalers to cover the risk of retailer default – which represents around 60 per cent of the total risk exposure under our modelling approach.

The regulator is seeking responses to its consultation by 7 July.

It said it would “carefully consider” respondents’ views before setting out its proposed approach in a decision document in late July.

The document will set out the proposed credit arrangements for the codes that it intends to put before the Interim Code Panel for consideration and ratification; and whether the arrangements will include a wholesale risk sharing mechanism.