Review Group 0221: User CommitmentBest Practise guidelines for Gas and Electricity Network Operators Credit Cover (2005)

2

Introduction

February 2005 Ofgem issued, ‘Best Practise Guidelines for Gas and Electricity Network Operators Credit Cover Conclusion document’ (BPG).

The BPG consultation was initiated, in September 2004, following Ofgem concerns that, “various credit cover arrangements in regulated areas of the industry, which are designed to mitigate the risk of exposure to bad debt, have not been consistent and/or appropriate”

Ofgem’s proposals sought to establish best commercial practices with reference to comparable commercial industries, taking into account the nature of gas and electricity transportation and all regulatory and legal issues.

The BPG sets out Ofgem’s conclusions on best practice, “for gas and electricity network operator credit cover and criteria for pass through of bad debt for gas and electricity network operators”

3

Ofgem preferred approach for management of credit risk going forward;

Incentives placed upon Network Operators (NwOs) to manage debt

efficiently.

Credit must not unduly discriminate or prevent the promotion of competition

Credit arrangements should provide a secure and stable business

environment.

Ofgem should take measures to protect consumers from loss of supply, in

the event of shipper or supplier failure to maintain adequate levels of cover or

default on payments due.

4

Post Ofgem BPG conclusions - Going Forward

Ofgem stated that it expects the NwOs and Users to ‘take steps’ to

bring their credit arrangements in line with the approaches set out in

the BPG.

‘Steps’ may take a number of forms; raising Code Modifications (for

key arrangements), amending bilateral agreements and changing

internal working practices.

BPG did not seek to provide best practice credit cover arrangements

for Energy Balancing credit arrangements.

5

Areas proposed to be addressed as part of the BPG

Identification and Assessment of Credit Exposures

Protection of Credit Exposures

Payment and Billing and Collection Procedures

Remedies for Payment default

6

Identification and Assessment of Credit exposures

- Approach to setting unsecured credit limits

Unsecured Credit Limit to be set as a proportion of each NwO’s max

credit limit.

Max credit limit should be based on 2% of the NwO’s Regulatory Asset

Value (RAV).

NwO’s “who seek other levels of risk may not obtain full pass through..”

UNC V3.1.5 National Grid Transmission and Distribution are construed as

one Transporter for Transportation Credit Arrangements under the UNC.

Mod 0031 – ‘Re-Assessment of User Unsecured Credit Limits’ -

implemented Jan 2006

7

Identification and Assessment of Credit exposures

- Credit Ratings

Credit rating to determine the percentage of unsecured credit available to the User is set using Credit Ratings (Moodys or Standard and Poors)

Where a Qualifying Company or Parent Company (Security Provider) provides a Guarantee to a User, the Security Provider’s Approved Credit Rating can be used in place of the Users to calculate User’s Unsecured Credit.

Unrated Users and Users below BB- unsecured credit allowance can be based on payment history, allowance set at 0.4% of the 2% of RAV per year climbing to a max of 2% of the 2% of RAV after five years of perfect payment history. ( Mod 0113 – Availability of unsecured Credit based on a User payment record history or Independent Administration – May 2007)

So an NwO with a RAV of £1bn = after 1 years perfect pay record Users would have access to £80,000 of unsecured credit. Rising to £400,000 unsecured credit, after 5 years perfect payment history, from that NwO.

8

Identification and Assessment of Credit exposures

- Independent assessment

Through an Independent assessment, Ofgem stated that unrated company should be able to achieve 20% of the NwO’s maximum credit limit of 2% of RAV.

The BPG states that an unrated User may increase its unsecured credit by submitting an independent assessment of its credit worthiness.

The assessment would replace the allowance for payment history record as the assessment may include this measure.

The NwO can select one of a panel of three assessment agencies and an annual assessment could be paid for by the NwO if requested by the counter party.

Mod 0147 – Administration of Unsecured Credit Afforded on the basis of Payment History and Independent Assessment – Imp Sept 2007

9

Identification and Assessment of Credit exposures -Unsecured Credit Allowances

BPG states that the following percentage of the unsecured credit limit (2% of

the NwO’s RAV) may be applied to rated entities as follows:

Standard and Poors or Moodys

10

Protection of credit exposures

The following tools should be available to allow Users to cover their

exposure beyond the unsecured allowance.

The Users may use the following tools or any combination of them;

11

Protection of credit exposuresTools available

Users may extend their exposure beyond its Unsecured Credit Limit by

providing surety or security in one or more of the forms set out below;

Bilateral Insurance: and/or

Letter of Credit; and/or

Guarantee; and/or

Deposit Deed; and/or

Prepayment Agreement

12

Protection of credit exposuresTools available (2)Bi-lateral insurance

A policy of insurance

Is Unconditional in order to attain 100% of its face value

Provided by a Qualified Company with a debt rating of at least A by Moodys or equivalent Standard and Poors if registered in England or Wales, and equivalent for companys’ registered elsewhere; and

An approved LoC or equivalent bank guarantee

Is an unconditional irrevocable standby letter of credit

Payment must be made at a UK branch of such issuing bank

Bank must be rated A (Moodys rating or equivalent Standard and Poors);

13

Protection of credit exposuresTools available (3)

Guarantee

Is an irrevocable Guarantee or Performance bond that is enforceable

Parent Company Guarantee Must have greater than BB- rating in registered in Wales or England, and equivalent for companys’ registered

elsewhere.

A Performance Bond provided by Qualifying company. Must have greater than A rating in registered in Wales or England, and equivalent for companys’ registered

elsewhere.

Deposit Deed

An Enforceable agreement

Cash Deposit (payment made before the delivery of the service) (any interest credited back to User on a 6 monthly basis through a credit invoice which may be offset against subsequent invoices);

Advance payment (payment made after the delivery of a service but before contract settlement);

Pre-Payment agreement

An enforceable agreement for the User make payment of amounts calculated on a monthly basis

Transporter estimates charges which will become due in a charging month using accrual methodology .

14

Security and Surety ToolsAlignment of UNC with the BPG

Mod 0024 – Independent Security provision by an entity with an Investment

grade rating of ‘A’ or above - Imp Dec 2005

Mod 0146 - Acceptable Security Tools available to Users for Transportation

Credit Arrangements – imp Oct 2007

15

Comparing Transportation and prevailing Long Term Capacity Credit Arrangements

Transportation Credit Requirements Prevailing Long Term Entry Capacity

Requirements

Indebtedness calculated based on a dynamic VaR. Indebtedness assessment based on relevant

indebtedness + the sum of the registered

quarterly firm Entry capacity charges for next 12

calendar months.

Unsecured credit based on max of 2% of the RAV of the NwO. The same

Unsecured credit allowance based on percentage of the 2% of RAV NwO’s dependent

on credit rating or payment history or forms of independent assessment.

The same

Beyond its unsecured credit limit, the User may choose acceptable forms of Secured

Credit from the acceptable tools.

The same

Where the User VaR exceeds 80% of its Code Credit Limit the User will be required to

take steps to reduce the risk, within prescribed timescales.

Where the Users Relevant Code Indebtedness

(RCI) plus the relevant Quarterly System Entry

Capacity (QSEC) for the following 12 calendar

months exceeds its 85% of Code Credit limit

based on RCI the User will be required to provide

additional Security.

Where the VaR exceed 100% of the Code Credit Limit the User will be required to

reduce VaR through increasing security or taking steps to reduce VaR, where the Users

fails to take steps to reduce the risk within the prescribed timescales, the User will be

sanctioned (unable to increase its level of risk further than existing position on the

system). Where the User fails to pay the NwO may issue a termination notice.

Where the User fails to put in place the required

security within the prescribed timescales the

User’s Registered QSEC for each relevant

calendar quarter will lapse and the User will cease

to be treated as holding the registered QSEC.

16

Identification and Assessment of Credit exposures

- Value at Risk (VaR)

The amount of credit deemed to be taken at any time is the VaR from trading with a counterparty.

The VaR for Use of the System (UoS) charges shall be equal to the sum of;

(a) the aggregate value of all charges which at that time have been billed to such counterparty (but not necessarily due) but remain unpaid; and

(b) a deemed amount equal to the aggregate value of all UoS charges that would be incurred in a 20 day period at the same average daily rate implicit in billed charges under (a).

The NwO should make reasonable VaR calculations based on a dynamic assessment of VaR.

The VaR exposure arising from long term connection and capacity contracts to be based on payments billed but unpaid plus the difference (if any) between the recoverable value of the reversionary interest held by the NwO in the contracted capacity and the contract value.

Mod Proposal 0144AV – Quantification of Value At Risk- Imp Feb 2008

17

Identification and Assessment of Credit exposures

- Relevant Code Indebtedness

Relevant Code Indebtedness - Is the aggregate amount other than Energy

Balancing charges which a User is liable at any time. Determined on the

amount accrued, irrespective of whether amounts have been invoiced or due.

and;

Users liability for capacity charges in respect of B shall be treated as accruing

on the following Day.

18

Payment and billing and collection procedures

Mod 034 – netting off of payment and Credits relating to Transportation

Charges – Imp Dec 2005

Mod 0076 - Right to Off Set under Uniform Network Code – Imp Sep 2006

19

Remedies for payment default

Mod 0026 – Application of Charges consistent with late payment of

commercial Debt (interest) Act 1998 - Feb 2006

Mod 0077 – Notice Period for Code credit Limit Revision (as a consequence

of credit rating downgrade ) and remedies for non-compliance with a request

for provision of additional security - Implemented Sept 2006

Mod 0145 - Management of Users Approaching and Exceeding Code Credit

Limit – Feb 2008