UK Utilities regulation: a brave new world?

This:

• presents new opportunities to engage and influence the development of the model; and
• promises new investment and business opportunities that the new approach will deliver.

Since the UK left the EU, leveraging the flexibility in policy development that has provided, the Government has issued a slew of consultations on how the UK should now approach regulation.  During the course of 2021, the Government consulted on the UK regulatory framework for financial services, medical devices and transport (flight and rail), among others, and last year’s consultation on “Reforming the Framework for Better Regulation”, suggested five principles that should underpin the Government’s approach to regulation.  These included adopting a less codified approach to regulation, adopting high standards, and encouraging innovation.  The consultation also included some practical steps that the Government would take in order to enshrine these principles within the Better Regulation framework.  One of these steps was there should be a review of the role of regulators, especially around competition and innovation.

Hot on the heels of that commitment to review the role of regulators, we now have a much-anticipated policy paper on the economic regulation of the “utility¹ ” sectors by Ofwat, Ofgem and Ofcom.  The consultation promises that:

refreshing our approach to economic regulation will help the UK to build back fairer, faster, and greener, and help foster an enterprising and innovative economy which promotes growth,

at the same time as promoting broader policy objectives, such as:

reaching Net Zero, protecting and enhancing the environment, and increasing digitalisation.

This represents a welcome opportunity for businesses to participate now and moving forwards in a fundamental resetting of the web of regulation that has grown in and around the utilities sector, and to address the following problems in particular.

• Complexity and response to broader policy goals: as new and broader policy goals have been layered on top of each other, the complexity of regulation has become a huge challenge for companies, investors and regulators alike.  
• Difference of approach: while there are often good reasons for the approach to regulation in each sector, there is less justification for the resultant divergence. A more homogenous set of objectives applied equally to all the sectors would bring enormous benefits in terms of efficiency and understanding by companies and the investor community.
• Politics: the politics of the privatised utility model in the UK have in recent times been complicated with the model routinely challenged. The policy paper provides a welcome recommitment from the Government to the economic regulatory model and a reassertion of the benefits of private investment into the utility space.

The policy paper focuses on four areas, all of which are going to be critical in ensuring that the issues above are addressed. 

• Regulator duties: the paper recognises it is vital that utilities regulators have appropriate and coherent duties covering price, quality, resilience, the environment and net zero.  Simplifying and refreshing these duties should allow the regulators a greater ability to balance key trade-offs and take decisions that will ensure the broader policy goals are delivered.  The paper also confirms that the Government does not plan to create a “super regulator”, ending the debate on that idea for the time being.  In general, this is reflective of the market view, which welcomes the expertise that each of the regulators has developed.
• Clear strategic direction: the paper recognises that effective economic regulation requires strategic leadership both from regulators and Government. In particular, the Government remains committed to providing more transparent strategic guidance and context to ensure all regulators can support effective long-term investment.  Whilst transparent policy direction is welcome, the elevation of the importance of policy direction in the regulatory toolkit can complicate both perceptions of independence of regulators and provides a risk of less stable long term horizons and needs to be approached in a considered manner.  This underlines the need for regulatory engagement to go hand-in-hand with political engagement.
• Greater competition in strategic investment: the paper recognises that real competition can lead to increased innovation, greener solutions, and provide savings to consumers. Continuing the ongoing trend to introducing greater competition in the water and energy sectors (as we have seen with the introduction of New Appointments and Variations , Thames Tideway, the imminent Direct Procurement for Customers market in the water and sewerage market, and Offshore transmission in energy, for example), the paper suggests that regulators should harness competition to unlock opportunities for strategic investment.  The Government has both: (a) asked for a refresh on the areas of infrastructure that could be separately regulated (in water this is likely to continue the trend towards regionalisation and shared infrastructure across incumbents); and (b) indicated support for removing strategic investments from the standard price control process and opening them up for competition where appropriate.
• Transparency and consistency: the regulatory model must provide a stable and predictable environment for investment to thrive, while protecting consumers. The paper focuses on two areas in which it considers transparency and consistency to be particularly important:
  • the possibility of greater consensus on price control methodology (on which a taskforce supported by the UK Regulators Network will report later this year); and
  • regulatory appeals, in particular the function of the CMA in considering appeals against regulators’ price control decisions.  The policy paper does confirm, however, that merits-based reviews will be preserved.

Perhaps the most notable proposal in the paper, however, is the suggestion that there should be greater potential for consumers to challenge regulators’ decisions. While the importance of consumer interest has been at the centre of the regulatory models, we anticipate there will be nervousness among industry participants about the threshold test for these challenges, as well as the resources that they may require. 

The next steps for the Government include the launching of the formal review of regulators’ statutory duties, as well as a specific review by Ofwat of competition for the provision of infrastructure in the water sector.  The Government is also planning to develop proposals that will align the appeals processes more closely.  Businesses with interests in the utilities sector must act now to understand these proposals so that they are ready to engage in the specific reviews which will shape the future of these markets.

Hogan Lovells has deep experience of working with public and private sector clients on the creation and design of economic regimes, including regimes designed to facilitate investment, and advising on appeal mechanisms.  We frequently assist investors and market participants in navigating complex regulatory regimes, including direct engagement with Government, as well as acting when matters turn contentious.  We are therefore uniquely well-placed to support businesses’ engagement with this resetting of regulation, helping them shape the resultant regulatory regimes and enabling them to make the most of the opportunities, and mitigate the risks, arising from involvement in these critical sectors. 

If you would like us to help you to understand the aspects of these proposals that are likely to be most critical to your business, so that you are prepared for engagement, please do get in touch.