Ofwat tables cost recovery mechanism for when retailers fail

Ofwat is looking to implement a cost recovery mechanism to protect customers and suppliers when a retailer unexpectedly exits the market.

The regulator said that the current arrangements “are not sufficiently robust” and that there are “significant costs, risks and process that a retailer may face in the event of taking on the customers of a failed retailer”.

In particular, Ofwat said that “there are risks that too few retailers would elect to become an interim retailer in the event that one or more other retailers exit the market in an unplanned manner”.

Consequently, the water regulator is consulting on proposals to determine who would cover the costs, how costs will be recovered and how interim suppliers are selected.

Since the retail market was established in 2017 there have been two unplanned retailer exits. In both instances, Ofwat and the market operator MOSL have successfully reallocated affected customers to an alternative retailer using the market’s existing interim supply arrangements.

However, the current interim supply arrangements are voluntary, which means that unless a retailer chooses to ‘opt in’ to supply customers of a failed retailer, Ofwat currently has no legal means to direct retailers to supply these customers.

“Whilst customers would experience no disruption to the physical supply of water and sewerage services, this could potentially cause customers to experience delays to billing,” Ofwat’s consultation document states. “Any protracted disruption to settlement of bills would lead to knock-on effects for the flow of money within the market, impacting other trading parties.

“Furthermore, the existing arrangements remain untested at scale if a large retailer, or a number of smaller retailers, unexpectedly exit the market.”

To minimise barriers that may otherwise discourage retailers from opting-in to the interim supply arrangements, Ofwat is proposing the introduction of a cost recovery mechanism.

It has outlined several possible mechanisms, however its preferred option is to implement an ex-post levy arrangement, similar to what exists in the energy retail market.

It adds: “This option would take the form of a charge levied on retailers after an interim supply event and subsequent appointment of an interim retailer.

“The amount of the charge would be calculated on the basis of the costs claimed by the interim retailer and assessed as being reasonably and efficiently incurred.”

The consultation document adds: “We consider that this option should provide a reasonable degree of certainty for retailers that (efficient) additional costs incurred in taking on the customers of a failed retailer can be recouped. This in turn should minimise uncertainty for retailers and so encourage opt-in to the interim supply process.”

Ofwat added that this mechanism would be available to retailers of all sizes and noted that a similar mechanism has operated successfully within the energy market for two decades.

The consultation will run until 1 November.

Ofwat’s recent review of the business retail market concluded that it is still “not functioning as effectively as it needs to”. In particular, the water regulator ruled that market frictions including poor quality data and wholesaler underperformance are impeding the retail sector, in its annual ‘state of the market’ assessment.