Business owner looking at company books

We welcome the opportunity to submit our views on the proposals to introduce a cost recovery mechanism to help strengthen the Interim Supply Process in the business retail market.

General comments

Overall, we agree with the proposal for a cost recovery mechanism to help ensure that the interim supply process works as it should. Strengthening the interim supply process to guarantee continuous services for business customers if their retailer exits the market is one of the recommendations in our review of the water retail market. Introducing a scheme that may lead to greater retailer participation in the interim supply process could ensure the risk of customers being left without a retailer is reduced.

We want to see the following from the strengthened interim supply process, to ensure it delivers the best outcome for customers:

  • The fairest option is a cost recovery base that does not discriminate against a particular group of business customers, and is funded by all business customers;
  • An Ex-Post Levy option will introduce a levy after an interim supply event has occurred, based only on those costs specifically linked to that event, and giving greater transparency in the process;
  • A balance needs to be struck between encouraging greater retailer participation in the process and protecting customers by limiting their exposure to higher prices. Therefore, only those costs that are unavoidable, and have been efficiently incurred by retailers in the process of onboarding affected customers should be claimable and capped, in order to protect customers from bearing undue costs;
  • The maximum cost recovery period, and time in which to submit a claim, should be no longer than 12 months to protect customers from higher price increases than they would otherwise have to bear;
  • The cost recovery mechanism must operate in a way that business customers understand, and where the necessity of the scheme is clear. The need for clarity and fairness extends to how any price rises are communicated to customers if costs are being recovered in an interim supply event;
  • It is important that Ofwat commits to strengthen the interim supply process further, if necessary, while it remains voluntary for retailers to opt into the process; and
  • We do not consider it fair that we may have a situation where retailers’ reasonable losses are recoverable, while any affected customers’ losses remain unrecoverable. To increase customer protection in this area, we urge Ofwat to address our change request to the Customer Protection Code of practice for annual credit refunds as soon as possible, as well as continuing to explore how we could further protect customer losses caused by an interim supply event.

Our views are set out in more detail in our responses to the consultation questions below.

Responses to specific questions

We support the aim for a cost recovery mechanism, as this is intended to encourage retailer participation in the interim supply process, and therefore lessen the impact on business customers of an exiting retailer who may face disruption to their retail services if there is no interim supplier. The risk of business customers being adversely affected by an interim supply event is something we highlighted in our response to Ofwat’s consultation on amending the interim supply process in August 2020. In that we called for reforms to the process that would make it easier for retailers to opt in as interim suppliers. We, therefore, welcome the proposals to encourage greater participation in this process.

We agree with the proposed criteria, particularly that the mechanism is cost effective and efficient. Given how it will be business customers who ultimately fund this, we do not want to see inefficient retailers effectively being compensated for participating as an interim supplier. A balance needs to be struck between encouraging greater retailer participation in the process, which may benefit all customers, and protecting the same customers from bearing undue costs.

We accept that business customers will ultimately have to fund the proposed cost recovery mechanism, but this should be limited to those incurred efficiently, and only borne by those customers who may be affected by a retailer failure. As households are not eligible for the business retail market, we agree that costs should be ring-fenced in the way described, thereby protecting them from being exposed to these costs.

Protecting the interests of customers should not only include preventing them from bearing undue costs, but also should include an emphasis on simplicity and transparency. For the cost recovery mechanism to be effective, it is important that it is simple to administer, and that customers understand how it works, and how they benefit from the scheme.

We consider that all the options available have been considered by Ofwat in this consultation. With regards to the options, we would not support a funding model that effectively discriminates against a particular subset of business customers, particularly where the group in question is already disempowered within the market, and also less financially secure than others. Therefore, we do not support options 1 to 4.

Typically, customers subject to the REC price controls are smaller businesses that can ill afford to see a price increase, so would be disproportionately impacted as a result. In addition, it would be unlikely that any price increase would motivate many of those customers to engage in the market to try and seek a better price, given their lack of time and resources to explore their options, as our ‘Testing the Waters’ 2022 research highlighted.

As all business customers in the water retail market could potentially be affected by an interim supply event, the fairest option is for all business customers to pay towards a funding model. Therefore, we believe that Ofwat’s proposed option – a recovery from all business customers via an uplift to wholesale charges – is the fairest.

We believe that the levy should be based on a flat fee rather than one based on consumption, as there is no compelling reason why a customer’s level of consumption should determine how much they contribute. Level of consumption does not necessarily correlate with a businesses’ financial position, so there is also a risk that struggling businesses with higher consumption may be disadvantaged under this model. In addition, a levy based on a flat fee will minimise the risks of a fee based on consumption which subsequently proves to be inaccurate due to continuing problem of poor data quality in the market.

We recognise that a cost recovery mechanism would have to be in-period, which means these recovered costs would not form part of those considered in the five year price determinations.

We would like transparency on what the cost recovery mechanism does, and how it impacts customers, so making it part of the charges approval process annually could achieve this. Wholesalers would have to show what (if any) provision has been made for the recovery of a proportion of interim supply costs as part of the wholesale charges following a retailer exit.

There is also a risk that the additional costs being collected by wholesalers could be taken into account in the revenue ‘true-up’ process under the revenue correction mechanism. To safeguard against this, these costs would need to be ring-fenced to ensure this risk is removed.

We agree that doing nothing regarding the interim supply process is not an option. Ensuring that customers are not adversely impacted by an interim supply event is vital and it is something we continue to campaign for. We, therefore, support strengthening the interim supply process so customers do not experience any disruption to the provision of retail services if a retailer exit occurs.

We support Ofwat’s views on the use of an auction to select an interim supplier and, therefore, do not consider this to be the appropriate option for the cost recovery mechanism. As there needs to be an enduring process created that does not reward inefficient costs, we believe there is a significant risk that an auction could not guarantee this, which could inadvertently result in inefficient costs being passed on to customers.
The option for retailers to defer wholesale charges is also undesirable, as a significant cost impact on wholesalers may affect both provision of services to household customers, and the associated charges. We do not want to see households affected by an issue that does not affect them.

Out of the remaining options, we consider that the Ex-Post Levy option is preferable to the Ex-Ante Levy. This is because an Ex-Ante Levy could build up costs that may not be required, placing an unnecessary financial burden for customers. We also agree that the Ex-Ante Levy would not achieve its objective if there were insufficient funds at the point of a retailer exit.

We believe it is in the best interests of customers to introduce a levy after an interim supply event has occurred. As such a levy would be based only on those costs specifically linked to that event, the approach should be fully transparent. In addition, this should also make it easier to ensure that only those costs efficiently incurred and evidenced will be paid through the cost recovery mechanism.

We agree that there has been a comprehensive assessment of each option, which has resulted in a proposed cost recovery mechanism, and method of funding, that is the fairest option for all business customers. However, the extent to which we can agree that the aims and criteria have been met can vary depending on the option. For example, with both the Ex-Ante and Ex-Post levies, whether or not they are truly cost effective and efficient will depend on how robust Ofwat’s assessment process is for determining whether or not an interim retailer’s claim for excess costs is acceptable. Similarly, while we agree that whether or not each option is in the customers’ best interest has been explored, ultimately there is no guarantee that this will lead to greater customer protection if retailers remain discouraged from opting in to the interim supply process if they believe the risk of an unsuccessful claim for costs is too great. We, therefore, expect Ofwat to closely monitor the implementation of the cost recovery mechanism and introduce further measures, if needed.

We believe there has been careful consideration of each option, and customers’ interests have formed a key part of this assessment. Therefore, we do not consider that any factors have been missed.

As we stated in our introductory comments, and under further comments at the end of our response, a cost recovery mechanism could also be used to ensure customer credit, that would otherwise be lost in an interim supply event, is covered too. While there is nothing to prevent an interim retailer voluntarily covering affected customers credit, it is unclear whether this would result in a successful claim for reimbursement under the cost recovery mechanism, if the retailer could not absorb this cost. We would welcome further clarity on whether such a claim could meet the existing criteria, and for this to be made more explicit in Ofwat’s subsequent decision. If the proposed criteria does not currently support such a claim, we suggest that the mechanism could potentially be expanded in future to ensure that any losses that customers of a failed retailer have suffered could be recovered.

Claimable costs need to have been incurred as a direct result of the retailer’s role as an interim supplier to ensure customers do not end up paying more than they should. However, it is difficult to suggest a time period for this as the cost and timeframes for onboarding affected customers will differ depending on the number of customers involved. To ensure customers are shielded from significant price increases, this needs to be set at a level that is more weighted towards limiting this, which may also have the effect of further encouraging retailers to manage costs more efficiently. We would, however, not want the period to be too elongated as this could cause uncertainty for customers and disincentivise retailers.

We are not sure what the benefits of a minimum time period would be, but we agree there should be a maximum time limit for submitting a claim, and that this should be no longer than 12 months. While an interim retailer should be permitted a reasonable period to calculate a claim for excess costs, it would be difficult for Ofwat to accurately assess whether the costs were directly linked to the interim supply event if the claim was submitted significantly after this had taken place. It is also very important for the cost recovery mechanism to be accountable to customers, who need to be able to understand the basis of which they are asking to pay more. As such, it may be difficult to justify an increase in charges for an event that had potentially occurred a significant time ago.

If retailers choose to opt in as an interim supplier, they should have a reasonable expectation that they will face some additional costs of taking on customers of a failed retailer. It is, therefore, important to distinguish between additional costs (which retailers should be taking steps to absorb), and those that were unavoidably incurred despite the retailers best efforts to manage them efficiently. Ensuring that only those costs that are unavoidable and efficiently incurred are considered part of a claim will mean that customers are only subject to price increases in specific and reasonable circumstances.

Even where additional costs have been deemed to have been efficiently incurred, we want to see a cap on the amount that can be claimed to limit the impact on customers. A balance needs to be struck between ensuring efficient retailers are not unduly impacted by unavoidable costs, and protecting customers from significant price increases for events outside of their control.

We agree with the level of scrutiny that Ofwat have outlined in step 5 of the proposed assessment process, as this provides a clear direction to retailers as to the type of evidence they would need to provide. As a minimum, we would expect retailers to be able to evidence where they have incurred additional costs, that these costs relate to the customers they have taken on through the interim supply process, and where they have attempted to mitigate the cost impact, either through making financial savings, or raising additional capital.

In the best interests of customers, only allowing reimbursement of excess costs that have been efficiently incurred should be a key principle of the proposed cost recovery mechanism. In an individual case, a retailer’s claim for costs that are deemed inefficient should be refused by Ofwat. Therefore, we support step 6, which allows Ofwat to disallow the claim or require the retailer to revise its plans to reduce these costs.

If such actions were occurring too frequently, we urge Ofwat to review the assessment process to ensure it is not causing any confusion which could be inadvertently causing retailers to submit such claims. If claims for inefficient costs continued despite a process review, Ofwat should be ultimately prepared to bar retailers either from opting in as an interim supplier, or from submitting a future claim for excess costs. While we do not want to see retailers discouraged from opting in, it may be undesirable for inefficient retailers to be permitted to participate, particularly with a lack of understanding of the regulatory framework.

We agree with the introduction of a materiality threshold as there is a need to minimise claims for fairly insignificant amounts, so the operation of the mechanism does not become overburdened. However, whether an amount is significant or not will depend on factors such as retailer size and turnover, so this should be set as a proportion of this rather than an absolute amount.

As stated in our answer to Q10, we also believe there should be a cost threshold that cannot be exceeded, to limit the impact on customers. Given how the intention of this is to protect customers from excessive price rises, there is merit in setting this as an absolute amount, so there is certainty in terms of the maximum increase that customers would be exposed to, rather than linking this to a retailer’s size and turnover, which would not be primary considerations in this case.

We do not consider there is a need for Ofwat to consult on each claim submitted, as this would be onerous on market participants and Ofwat, as well as it potentially being inappropriate for other retailers to see the details of the interim supplier’s claim. The cost recovery mechanism should be sufficiently robust to deal with each claim without additional industry input. In terms of establishing confidence that the mechanism works as it should, trading parties and other interested parties have opportunities to provide views, and scrutinise the proposals, at this consultation stage.

In the event that Ofwat wish to make significant changes to the cost recovery mechanism, then we would expect further industry consultation at that point.

There is merit in limiting the claim to one per interim supply event so the assessment process is easier to manage. In the second scenario, we see no reason to impose such a restriction as long as the claim meets the criteria we have outlined earlier in our response.

We believe Ofwat’s proposal for a 12 month recovery period may strike the reasonable balance that is being sought. While retailers need to have assurance that costs will be repaid within a reasonable time, the proposed period would mean customers facing a higher price increase, which may be difficult for a large number of them to bear. It, therefore, strikes the right balance to spread the recovery period over a longer period of time to ensure this impact is mitigated, and protects the interests of customers.

It is right that Ofwat is seeking to address any factors that may continue to discourage retailers from opting in to the interim supply process. However, we do not want to see any weakening of the proposals if retailers raise concerns that the proposed criteria is too stringent. While there will be benefits for customers if retailers are encouraged to opt in to the process, this would be negated if they were paying higher charges to cover costs incurred inefficiently, or ones that could have been avoided, by the interim supplier.

We also do not want to see any of the customer protection provisions in the Interim Supply Code, diluted or removed, in response to any feedback. It is vital that customers onboarded during an interim supply event are not discriminated against in terms of pricing by the interim retailer, and that they are not restricted from switching away if they so choose. We believe these protections should remain in place, and if any further changes are made to interim supply arrangements, these should be increasing protection for customers, and not weakening it.

We agree with Ofwat’s comments that there may be additional industry processes created as a result of the cost recovery mechanism, but we do not consider these to be unintended consequences, and instead something that market participants can expect as part of the proposal.

Further comments

It is important that any cost recovery mechanism operates in a way that business customers understand, and that the necessity of the scheme is clear. This is vital given businesses will be paying higher charges for an event that was outside of their control. The need for clarity and fairness also extends to how any price rises are communicated to customers if costs are being recovered in an interim supply event. We therefore expect the cost recovery mechanism, and its associated communication, to be in the best interests of customers, and we will work with Ofwat and retailers to ensure this objective is met.

Given how this proposal means the interim supply process will remain voluntary, it is important that Ofwat commits to strengthen this area if necessary. We would like to work with Ofwat on this to ensure the best outcomes are achieved for business customers.

It is positive that Ofwat has recognised there is a gap in customer protection, and that a proactive approach is needed to address this before any detriment may be experienced. This is the same principle that underpins our previous request to change the Customer Protection Code of Practice, to require retailers to annually refund customer credit. A loss of credit in an interim supply event is as great a risk as the one Ofwat is seeking to mitigate by encouraging participation in the process. While we support strengthening the interim supply process, we do not consider it fair that we may have a situation where retailers’ reasonable losses are recoverable, while any affected customers losses remain unrecoverable. To increase customer protection in this area, we urge Ofwat to address our change proposal as soon as possible, as well as continuing to explore how we could go even further in protecting customer losses caused by an interim supply event.