Background
The Supplier of Last Resort (SoLR) process is one of two options available to Ofgem in the event that a licenced supplier fails, the other being the special administration regime (SAR) which was used for the first time in 2021, when Bulb was placed into SAR. Under the SoLR process other licenced suppliers bid for (or are directed to take on) a failed supplier's customers. The successful SoLRs may then be entitled to claim a SoLR Levy for their net costs of doing so. The cost of the SoLR Levy is mutualised across all energy consumers via gas and electricity transportation and use of system charges. During the interim period between the SoLR Levy costs being incurred and fully recovered - which can be months or even years - the SoLR has to finance these costs.
Until recently the volume of failed suppliers meant that the SoLR process largely functioned as intended. Suppliers would bid for a failed supplier's customers, and (incentivised to expand their customer base) suppliers would often waive their entitlement to SoLR Levy claims in order to succeed. However, the recent unprecedented and unexpected rise in gas and electricity prices has contributed to the failure of 26 suppliers in 2021 and reduced the ability or appetite of suppliers to act as a SoLR.
The proposed reforms
Ofgem is proposing energy licence reforms to facilitate the third party receivables financing of SoLR Levies in order to smooth the impact of current extraordinary SoLR Levy payments on 2022/23 consumer bills and enable greater ongoing competition in future SoLR processes, by increasing the availability of working capital for energy suppliers.
The proposed scheme would operate for both existing and future SoLR Levy Claims, and help achieve the above goals by: (1) enabling SoLR Levy costs to be recovered from consumers over a longer time horizon; and (2) increasing the ability of suppliers to act as a SoLR.
The consultation paper proposes that participating lenders would establish an insolvency-remote SPV, which would then purchase (or otherwise have transferred to it) from the relevant SoLR the right to receive the SoLR Levy payments directly from the network licensees. This purchase or transfer will be funded by the SPV raising debt from participating lenders. After adjustment to take account of any decrease in the SoLR's working capital costs and any increase in its financing costs, the SOLR Levy would be paid directly by the network licensees to a segregated collections account of the SPV. The debt raised by the SPV would then be repaid in accordance with its terms against this receivable.
Ofgem will retain the discretion to approve (or not) any particular purchase or transfer of a SoLR Levy by the SPV from the SoLR, on the basis of whether it considers it to be in the consumers' best interests. Ofgem may grant its consent subject to conditions, for example a requirement that the SoLR procures that the SPV enters into an agreement or undertaking relating to gainshare for consumers in future sales or refinancings or restricting subsequent assignment of the SoLR Levy.
Given certain financing costs, for example interest on the debt raised by the SPV, will likely fluctuate the consultation recognises that the proposed financing structure will need to include a mechanism by which these changes could be agreed and confirmed by Ofgem periodically (Ofgem's current expectation is this would happen yearly in advance). This mechanism could also adjust for any refinancing gains / costs in the relevant year. The consultation states that the risk of any 'true-up' costs under the current expedited SoLR Levy claim process would remain with the SoLR.
The proposed reforms are seeking to create a bankable receivable in the hands of the SPV over which lenders may take appropriate security. Among other aspects of the scheme and structure, prospective lenders will need to understand whether the receivable will constitute a direct payment obligation that is capable of being enforced by the SPV (and its lenders) against network licensees and, if not, how any alternate enforcement mechanism (eg via Ofgem) would work together with any other mitigations that may be available (such as over-collateralisation of the debt).
Assuming take-up in the market is good, the proposals should enable greater long-term price stability. They may also, depending on the relative financing costs of lenders versus working capital costs of suppliers, lead to a reduction in overall costs to consumers.
How to respond
Stakeholders have until 27 January 2022 to respond to the consultation, which can be found here Statutory consultation | Ofgem. Ofgem is particularly interested in receiving feedback on its proposals from potential finance providers.
Hogan Lovells has recent relevant experience of the SoLR and SAR regimes and would be happy to hear any thoughts you have on these proposals.
Authored by Alex Harrison, Stephen Foster, Nick Tidnam, Andrew Gallagher, and Mark Nash.
