The principles of regulation – Where the utilities industry is heading in 2019

Posted: 28th May 2019

Utilities providers have, historically, been held to a tight set of rules-based regulations that limit environmental impact and ensure both competition and access to supply.

Recent years, however, have seen a marked trend away from prescriptive, rules-based decision making within the utilities market.

Ofgem, the gas and electricity regulator, for example, began shifting to a principles-based approach to regulation in 2015, in line with the Financial Conduct Authority’s (FCA) approach to regulating the financial sector. Ofgem has always set pricing controls for the purpose of customer protection and competition but is now also ensuring that there is space for companies to experiment with processes and technologies.

A number of prominent figures from the FCA have moved across to the gas and energy regulator, suggesting a continuation in theme for the foreseeable future as Ofgem learns from the FCA’s successes (and their war stories).

The current principles-based model of regulation is an outcome-focused model centred on the end-customer, who, in principle, will benefit from providers being able to evolve in response to ongoing customer feedback, as well as the obvious market drivers.

Now, more than ever, we need innovative solutions to some of the most pressing issues of our time, and principles-based regulation provides some much-needed breathing room to allow for that.

THE CHANGING WORLD OF UTILITIES REGULATION

In late 2018, Ofgem published its final decision on domestic supplier-customer communications rulebook reforms, which will see greater responsibility placed on firms to communicate effectively, accurately and accessibly to their customers. Ofgem wishes that customers be totally clued-in to consumption, access and access options.

The final decision sees five new enforceable principles coming into play, meaning that firms will have to review their communication strategies and ensure they are in line with the regulator’s expectations. In other words: delivering the best customer outcomes possible.

Again, in late 2018, Ofwat, the regulator of water and sewerage firms, launched an investigation into its own principles, concerned by public outcry at the behaviour of some corporate entities and their senior management. The resulting report suggests that this regulator will be amending its Board leadership, transparency, and governance (BLTG) principle to ensure that senior managers, Boards and other executives within regulated firms act with the best interests of customers and markets always forefront in mind.

While this doesn’t represent a prescriptive set of new obligations like the Senior Managers and Certification Regime in financial services, the revised Ofwat BLTG principles do bear some similarities, namely in the expectation on boards to clearly outline their purpose, strategies and values and in encouraging a culture of compliance within the firm.

In general, this action can be seen as a streamlining of certain Ofwat principles, designed to provide more clarity around expectations of responsibility to firms within the regulator’s jurisdiction.

It is important to note that Ofwat will be shifting away from its standard measure of ‘quality of service’, known as the Service Incentive Mechanism (SIM) to a new customer-centric model referred to as the ‘customer measure of experience (C-MeX). This could have large ramifications for firms across the sector but should also serve to incentivise more ‘customer-first’ behaviour and pricing within water.

Since the SIM was introduced in 2010, overall customer feedback scores have improved, but the relatively simple equation behind it (calculated through number of complaints received and customer satisfaction with the handling of these) does not, perhaps, go far enough to ensure that customers are really receiving value for money and a good experience in general.

As such, C-MeX will dig deeper, made up of a ‘Customer Experience’ survey and a ‘Customer Service’ survey. The definition of a ‘complaint’ is also expanded alongside this change, widened to include those made via social media and other channels attributable to the customer. 

MAKING THE MOST OF A PRINCIPLES-BASED APPROACH

Of course, principles are harder to interpret, comply with and report against than set rules. Businesses must now work to a compliance bandwidth based on mutual trust between regulator, licensee and the public.

The financial services market, already seeing positive results after a shift from rules-based to principles-based regulation, has seen roles such as “Risk” and “Compliance” become professions in their own right. As the remit widens, specialists will have to step to the forefront of any regulated organisation to help ensure that they are delivering services in a compliant, de-risked and mutually beneficial manner with an increased onus on customer satisfaction and outcomes.

Firms without specialised risk and compliances officers, or even whole teams, will find themselves struggling to thrive in a less prescriptive and more competitive market or, worse, receiving penalties for failing to align with the regulator’s principles. In 2017 and 2018, for example, the FCA handed out over £250 million in fines relating to breaches of its core “principles for businesses”. In financial year 17 /18, Ofgem secured over £15 million worth of penalties related to principle breaches and wrongdoing in the utilities sector, almost all of which was either paid as compensation to affected consumers or as voluntary redress payments

As utilities firms begin bringing in new systems as a response to regulatory, market and environmental pressures, the challenge for suppliers will be finding and placing the right people in the new roles created around them.

The Big 6 utility companies and those smaller suppliers who are already well established in the UK market will have to ensure that their own staff are capable of dealing with change in a way that is fast enough to minimise losses to challengers. There are many young suppliers waiting in the wings with innovative solutions that could reshape the energy market as we know it.

As has already happened within the financial services sector, utilities providers will also likely find they have to take on both short-term and permanent resources to help deal with regulatory change and build fit-for-purpose business functions that will carry them forward. In this new landscape, businesses may find their small teams rapidly expanding, meaning that securing a relationship with trusted recruiters and consultants – those that truly understand your business – early on will certainly be a leap in the right direction.

The training or re-training of existing team members could also be a cost-effective solution that would set the business on the road to an adaptable, forward-thinking future. An external supplier offering fully tailorable learning solutions, in-depth assessment and a programme encouraging internal culture transformation will, again, put a provider ahead of the curve in delivering excellent customer outcomes.

Outsourcing of compliance functions could be a viable option for providers who wish to use liberated internal resources to focus on the areas in which their expertise truly lies. The key to getting the most from an outsourcing agreement is selecting the partner with the right specialism. There are countless nuances to regulated operations, not to mention the added layers of complexity inherent to utilities, so it will be vital to deal with specialists in compliance and customer outcomes.

In an increasingly competitive landscape, utilities providers will have to ensure that their existing teams are assessed and trained to ensure they have the tools needed to deliver constantly improving customer outcomes – the ultimate goal of principles-based regulation.

With the gradual decline of rules-based regulation, utilities providers will be able to deliver ever-bolder, ever-cleaner and ever-simpler solutions – and drive enhanced customer satisfaction at the same time.