Trends in regulation

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Our Global Assurance Power & Utilities Leader, Charles-Emmanuel Chosson, says understanding regulatory trends can help power and utility companies (P&Us) manage the burden and prepare for change.

Charles-Emmanuel Chosson, who works with some of the world’s largest utilities, says current regulatory trends have created a critical time for the sector.

US GAAP and IFRS variances

One of the biggest regulatory issues of recent times is back on the agenda at the International Accounting Standards Board (IASB). The IASB is considering possible resolutions to the accounting variances between US GAAP and Europe’s IFRS that burden global utilities and have hindered Canada’s transition to IFRS.

Charles-Emmanuel, who is part of our team involved in the talks, says it is a simple – but critical – issue.

“Should regulatory assets and liabilities — that is, those costs or revenues that the regulator permits a utility to defer to its balance sheet — be recognized in the accounts under IFRS rules?”

“If yes, they will be included in a P&U’s balance sheet, which, considering the size of the assets on these balance sheets, may have a significant impact for some companies,” he continues. “If they are not recognized, they will continue to be handled as off-balance sheet items.”

The IASB is reactivating its rate-regulated activities research project. In April, it launched its “Regulatory Deferral Accounts” exposure draft in an attempt to resolve the variances between the two frameworks.

While he does not anticipate a speedy resolution, Charles-Emmanuel says the IASB’s decision will be felt across the sector.

Moves toward convergence

Charles-Emmanuel says the lack of development of a single European regulatory model to date is surprising but believes some points of convergence are arising due to the regional focus on efficiency, cost reduction and quality of service.

“Europe’s regulators are looking for opportunities to benchmark performance, which leads to a form of convergence in the rate-setting mechanisms,” he says. “Nevertheless, we will not see a single European model any time soon as regulators keep their own local specificities.”

“This is a challenge for utilities, as operating a regulated business requires having a perfect understanding of specific local regulation,” he continues.

While regulation will remain “above all, of a national nature,” the trend toward convergence on some matters is a step in the right direction.

“It is helping utilities anticipate how the regulatory system may evolve,” he said. “Now is the opportunity to start a discussion with regulators and acquire some bargaining power, by using what is done in neighboring countries as a benchmark.”

A broader approach

Charles-Emmanuel says today’s regulatory trends are particularly interesting because of regulators’ focus on efficiency and their broader approach to the development of quality targets and incentives for utilities.

“Regulators are encouraging a more balanced approach to cost reduction,” he explains. “They are prepared to offer companies a fair return on investments, but want to ensure that financial objectives do not harm the overall quality of the operations.”

This trend is highlighted by the UK regulator’s introduction of its new RIIO (Returns = Incentives + Innovation + Outputs) price control framework. It incentivizes regulated utilities through quality and performance indicators focused on six outputs:

  • Safety
  • Environment
  • Customer service
  • Connecting customers
  • Social obligation, in particular to vulnerable customers
  • Reliability of the network

“RIIO probably represents the clearest example of how regulatory systems are likely to evolve in the future,” Charles-Emmanuel says.

“Regulated companies will still be in a position to post good returns on investments but only if they achieve the targets set by the regulators,” he continues. “The old cost plus regulation will disappear, and companies will have to be efficient to improve their results.”

Charles-Emmanuel says utilities will be challenged to monitor an increasing number of variables.

“They will need to extend their operational targets beyond economic angles, requiring a coordinated effort from various functions, including finance, operations, supply and quality management.”

Anticipating change

While keeping an eye on trends can help companies better manage their compliance and performance, Charles-Emmanuel cautions that utilities will “never be in a position to know with certainty how regulatory models will evolve.”

“External factors will always influence regulators,” he says, “particularly regarding remuneration rates, which are impacted by the financial market and the level of risk premium assigned to regulated activity, which can evolve over time.”

The best approach is vigilance. “Keep comparing what is happening across Europe and not only in your primary geographies,” he says. “What is going on in other countries may represent what you will have to live within a couple of years. Be proactive and try to anticipate how regulators may make changes.”

“Reacting too late is always expensive.”