Ofgem/Ofgem E-Serve 9 Millbank, London SW1P 3GE www.ofgem.gov.uk Promoting choice and value for all gas and electricity customers GD1 Price Control Financial Handbook This handbook and the constituent methodologies are early working draft copies. The copies provided are internal working drafts, under development and should be regarded very much as a work-in-progress, subject to change. Reference: Contact: Ofgem Regulatory Finance Team Publication date: XX XXX 2013 Tel: 020 7901 7000 Email: [email protected]Overview: This is the GD1 Price Control Financial Handbook which forms part of Special Condition GDC 57 (Governance of Price Control Financial Instruments) of the Gas Transporter Licence held by gas distribution network operators. This document consists of: a) a description of the GD1 Price Control Financial Model (PCFM) and the Annual Iteration Process for it, used to update licensees‟ base revenue allowances during the course of the RIIO-GD1 price control period; b) an overview of the GD1 Price Control Financial Methodologies under which revisions to the variable values in the PCFM are determined for the Annual Iteration Process, in accordance with the special conditions of the Licence; and c) a series of chapters containing the detailed methodologies relating to PCFM Variable Values. The procedures relating to modification of this Handbook and the PCFM are contained in Special Condition GDC 57. An up to date version of this Handbook and the PCFM (in Microsoft Excel® format) can be accessed on the Ofgem website.
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Ofgem/Ofgem E-Serve 9 Millbank, London SW1P 3GE www.ofgem.gov.uk
Promoting choice and value
for all gas and electricity customers
GD1 Price Control Financial Handbook
This handbook and the constituent methodologies are early working draft copies. The copies
provided are internal working drafts, under development and should be regarded very much as a
places more emphasis on incentivising network owners and managers to achieve the
outputs needed to deliver sustainable energy networks at value for money for
existing and future consumers.
The RIIO-GD1 price control is longer than the previous gas distribution price controls
(known as GDPCR), running for eight years instead of five. This provides for a longer
period of settled price control arrangements and should facilitate improved strategic
planning and a long term approach to gas distribution infrastructure management.
However, the RIIO price control mechanisms are also more dynamic. Under the
GDPCR price controls, base revenue allowances typically representing over 80% of
network operation revenues, were set up-front for the whole of the price control
period, changing only with RPI indexation. A number of significant adjustments to
reflect activity levels and varying financial conditions were necessarily left in
abeyance until the subsequent five-yearly review. Under RIIO-GD1, comprehensive
adjustments to base revenue will be made each year in respect of the licensee‟s
network business.
This more sophisticated approach involves an annual iteration of the GD1 Price
Control Financial Model (PCFM) using updated variable values. This gives rise to a
requirement for licence conditions and methodologies to govern the determination of
revised PCFM Variable Values and the Annual Iteration Process.
This Handbook (which forms part of Price Control Licence Condition GDC 57) sets out
the required processes and methodologies. To promote transparency, up to date
copies of both the Handbook and the PCFM will be maintained on the Ofgem website.
Associated documents
a. GD1 Price Control Financial Model
[Hyperlink]
b. RIIO-GD1 Price Control Final Proposals
[Hyperlink]
c. Statutory Consultation on RIIO-GD1 licence conditions
[Hyperlink]
GD1 Price Control Financial Handbook
3
Contents
Introduction 6 Terms used in this handbook 7
1. The GD1 Price Control Financial Model and the Annual Iteration Process 8
Overview 8 Price base 8 Temporal convention 9
The Price Control Financial Model and the Annual Iteration Process 9 State of the GD1 Price Control Financial Model 11
The GD1 Price Control Financial Model Working Group 12 Terms of reference 12
2. The GD1 Price Control Financial Methodologies 14 Methodologies in this handbook 14 Processing of different types of PCFM Variable Value under the Annual Iteration
Determining PCFM Variable Value revisions for the GD1 Price Control financial
Model 22 Revisions to pension scheme established deficit allowed expenditure („EDE‟) 22 The first review 23 The second review 23 Revisions to values pension scheme administration expenses and Pension
Protection Fund levy allowed expenditure („APFE‟) 24 Notification of the PCFM Variable Value 25
Mains and Services Replacement – allowed expenditure 46 Temporal convention 46 Determination and direction of revised RE values 47 Processing of RE values under the Annual Iteration Process 47
9. Innovation Role Out Mechanism 49 Main Heading 49
Sub-Heading 49
10. Legacy price control adjustments 50 Overview 50 Main Heading 50
Sub-Heading 50 Main Heading 50
Sub-Heading 50
Appendices 51
Appendix 1 - Glossary 52
GD1 Price Control Financial Handbook
5
Introduction
The GD1 Price Control Financial Handbook (this handbook) is one of the Price Control
Financial Instruments referred to in Special Condition GDC 57 of the Gas Transporter
Licence held by gas distribution network operators. It describes the GD1 Price
Control Financial Model („PCFM‟) and the Annual Iteration Process for it, by which
annual adjustments to licensees‟ base revenues will be calculated. It also contains
the Price Control Financial Methodologies („the methodologies‟), specified in relevant
price control licence conditions, which will be used to determine appropriate revisions
to the variable values contained in the PCFM to facilitate calculations under the
Annual Iteration Process. The methodologies also describe the intent and effects of
revising the various revised PCFM Variable Values.
This handbook, the constituent methodologies and the PCFM (together the Price
Control Financial Instruments) form part of Special Condition GDC 57. The Financial
Instruments are subject to a formal change control process set out in that condition.
The PCFM Annual Iteration Process approach has been adopted because:
it is consistent with the aims of the RIIO price control, embodying more „real
time‟ adjustments to financial allowances;
it handles complex computational interactions between financial adjustments
without the need for unwieldy algebra on the face of price control licence
conditions;
it provides for consistent treatment of the Totex1 aspects of the price control;
it maintains transparency on adjustments to base revenues, since the licence,
methodologies, PCFM and variable values will be published; and
it allows stakeholders to keep abreast of allowed revenue levels and to carry
out business sensitivity analysis.
In any case of conflict of meaning, the following order of precedence applies:
(i) the licence,
(ii) the methodologies, and
(iii) the PCFM.
1 Total Expenditure – see Glossary
GD1 Price Control Financial Handbook
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Terms used in this handbook
References to the Authority and Ofgem
The Gas and Electricity Markets Authority (“the Authority”) is established by section
1 of and Schedule 1 to the Utilities Act 2000. The Authority‟s staff are based at the
Office of the Gas and Electricity Markets (“Ofgem”)
In this handbook the text refers to:
„the Authority‟ when an action or decision must be taken by the Authority
itself as a “reserved matter” (or by a committee or individual with delegated authority to so act on its behalf); and
„Ofgem‟ when an action or decision relating to a “non-reserved matter” is to
be taken by one or more of the Authority‟s staff under delegated authority or
a regime or protocol approved by the Authority.
Other terminology
Throughout this handbook:
„the licence‟ means a Gas Transporter Licence containing special conditions;
references to „the licensee‟ include each gas distribution network operator that
holds a Gas Transporter Licence containing special conditions;
„this handbook‟ means the GD1 Price Control Financial Handbook;
„Special Condition‟ means one of the special conditions contained in the Gas
Transporter Licences held by gas distribution network operators; and
„price control period‟ means the RIIO-GD1 price control period which runs from 1 April 2013 to 31 March 2021.
Where the meaning of other terms used in this handbook is not clear from the
context, they will either be defined/explained in the chapter concerned or in the
appended Glossary.
GD1 Price Control Financial Handbook
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1. The GD1 Price Control Financial Model and the
Annual Iteration Process
Overview
1.1. The special conditions specify the Transmission Owner (TO) and System
Operator (SO) opening base revenue2 levels for the licensee for each relevant year of
the price control period, reflecting the Authority‟s final proposals for the RIIO-GD1
price control settlement.
1.2. The GD1 Price Control Financial Model (PCFM) has been designed to calculate
incremental changes to the licensee‟s opening base revenues for each relevant year
so that the updated base revenue allowances reflect the adjustment schemes
specified in the licence and detailed in the methodologies in this handbook. The
adjustments fall into three broad categories:
legacy price control adjustments – the close out of schemes and mechanisms from preceding price control periods;
financial adjustments covering tax, pension and cost of debt issues; and
adjustments relating to allowed Totex3 expenditure and the Totex incentive
mechanism.
1.3. The calculations take place under the Annual Iteration Process for the PCFM
described below and are manifested as a PCFM output value for the term „MOD‟
which is then applied as shown in the simplified formula below:
Base Revenue for year t = opening base revenue for year t + MOD for year t.
Price base
1.4. The model works predominantly in a constant 2009-10 price base. This is
consistent with the opening base revenue values set down in the licence. The value
of the term MOD is calculated in 2009-10 prices. Indexation is provided for in the
base revenue formula set out in the special conditions.
1.5. Some tax calculations internal to the PCFM use nominal prices, based on
embedded RPI forecast data. Interest cost and tax allowance calculations relate to
the licensees accounting profit and loss position. Since, for regulatory purposes, this
2 Base Revenue is the largest component of the licensee‟s overall Allowed Revenue 3 see Glossary
GD1 Price Control Financial Handbook
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is considered in nominal prices, the use of nominal prices in the PCFM tax
calculations ensures that revenue allowance calculations more accurately reflect the
profile of tax expenses of the licensee.
Temporal convention
1.6. As indicated above, the MOD term is used to adjust the opening base revenue
figure for each relevant year t during the price control period4. References in this
handbook to relevant years are made relative to that usage. For example, in a
context where MODt applied in the formula for base revenue in 2015-16, a reference
in the same context to relevant year t-1 would mean 2014-15 and so on.
The Price Control Financial Model and the Annual Iteration
Process
1.7. The PCFM exists as a constituent part of Special Condition GDC 57
(Governance of GD1 Price Control Financial Instruments). It has an input area for
each licensee containing both fixed values and a PCFM Variable Values table. The
base revenue figure for each licensee for each relevant year of the price control
period is calculated using the fixed values, the PCFM Variable Values, and the
formulae and functions embedded in the PCFM.
1.8. At the outset of the price control period, the base revenue figures calculated
by the PCFM, using the variable values subsisting at that time, constitute the opening
base revenue values for each licensee. Before the calculation of opening base
revenues are performed, Ofgem will commission an external audit of the functionality
of the PCFM.
1.9. By 30 November in each relevant year t-16, Ofgem will determine whether any
PCFM variable values for the licensee should be revised in accordance with the
special conditions and methodologies referred to in chapters 3 to 10 of this
handbook.
1.10. The Authority will give licensee at least 14 days notice of any revised PCFM
Variable Values in accordance with requirements in the licence to allow for any
representations or objections. The Authority will then (by 30 November in relevant
year t-1) specify any PCFM Variable Value revisions in a formal direction to the
licensee. The direction will also include a „screenshot‟ of the PCFM Variable Values
table for the licensee, showing the state of all variable values after the directed
revisions, with revised values emboldened.
4 In 2013-14, the first year of the price control period, the licence specifies that the value of MOD is zero.
GD1 Price Control Financial Handbook
9
1.11. Ofgem will then carry out the Annual Iteration Process:
directed revisions to PCFM Variable Values will be inputted in the appropriate relevant year column of the PCFM Variable Values Table for the licensee;
the PCFM calculation functions will be re-run;
all calculated values within the PCFM will be updated, including:
- the base revenue figure for each licensee for each relevant year of the price control period, and
- the modelled RAV balance for each licensee;
the PCFM will output the value of MOD for relevant year t for each licensee.
1.12. The output value of MODt for the licensee will reflect the difference between
the most recently calculated base revenue figures for the licensee held in the PCFM
before the Annual Iteration Process and the most recent base revenue figures for the
licensee held in the PCFM after the Annual Iteration Process recalculations. The
PCFM calculations will apply appropriate time value of money5‟ adjustments to the
calculation of MODt, so that the licensee will be in the same position as if
adjustments to base revenue for years prior to relevant year t had been notified to it
in the relevant year concerned.
1.13. Changes to base revenue figures calculated under the Annual Iteration Process
may be upwards or downwards and, accordingly, the value of MODt may be positive
or negative. A key point to note is that once the value of MOD has been directed for
a particular relevant year, it is not retrospectively changed as a result of a
subsequent Annual Iteration Process – the value becomes a matter of record
alongside the opening base revenue value for the same year.
1.14. The steps of the Annual Iteration Process are specified in Special Condition
GDC 26 (Annual Iteration Process for the GD1 Price Control Financial Model).
1.15. The Authority will issue a direction to the licensee giving the value of MODt by
30 November in each relevant year t-16. In practice, it is expected that the value of
MODt will be included in the direction of revised PCFM Variable Values referred to in
paragraph 1.9. The value of MOD in the direction will be stated in £m to one decimal
place.
1.16. The deadline of 30 November in relevant year t-1 for the direction of PCFM
Variable Value revisions and for the value of MODt reflects:
5 See Glossary
6 The first such direction will be given by 30 November 2013.
GD1 Price Control Financial Handbook
10
the deadline of 31 July in relevant year t-1 by which the licensee must submit
its price control information returns (covering activity in relevant year t-2) to Ofgem; and
the need for the licensee to have confirmation of its allowed base revenue in
time to calculate and issue its indicative use of system charges by 31
December in relevant year t-1.
1.17. In the unlikely event that the Authority does not direct a value for MODt by 30
November in relevant year t-1, paragraph [•] of Special Condition GDC 26 specifies
that the value must be directed as soon as possible thereafter and that, in the
meantime, the value of MODt shall be held to be equivalent to the value of
MODt-1.
State of the GD1 Price Control Financial Model
1.18. As mentioned in paragraph 1.7, the PCFM exists as a constituent part of
Special Condition GDC 57 and will be maintained by Ofgem in its official records.
The state of the PCFM remains constant unless and until changed by either:
a) an Annual Iteration Process - which will change PCFM Variable Values and
recalculated values which are directly or indirectly dependent upon them; or
b) a modification of the PCFM under the procedures set out in Special Condition
GDC 57 (Governance of GD1 Price Control Financial Instruments).
1.19. Ofgem will keep a log of modifications to the PCFM.
1.20. A copy of the PCFM in its latest state will be maintained on the Ofgem website.
This will allow licensees and other stakeholders to make copies of the PCFM so that
they can:
use their own forecasts of PCFM Variable Value revisions to forecast base revenue positions and to conduct sensitivity analysis; and
reproduce the calculation of MODt by 30 November in each relevant year t-1.
The model is designed to be as „user friendly‟ as possible for this purpose.
1.21. An updated copy of the PCFM will be uploaded to the website by 30 November
each year (after each Annual Iteration Process) and the file will be named “GD1 Price
Control Financial Model 20XX-XX”.
GD1 Price Control Financial Handbook
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Error of functionality in the PCFM
1.22. In the unlikely event that an error of functionality is discovered in the PCFM,
the following procedures would be followed:
the issue would be considered at the earliest opportunity by the GD1 Price
Control Financial Model Working Group (see next section) and a corrective modification determined by Ofgem;
if the functional error had distorted the calculation of a previously directed
value of the term MOD, the determined modification would include any
adjustments necessary to correct for that distortion on an NPV neutral basis in the next calculation of the term MOD;
the procedure in Special Condition GDC 57 for modifications to the PCFM would be followed;
The GD1 Price Control Financial Model Working Group
1.23. Ofgem will facilitate an industry expert working group to review issues arising
with respect to the form or usage of the PCFM. The terms of reference for The GD1
Price Control Financial Model Working Group („the working group‟) are set out below.
1.24. In accordance with the provisions of Part A of Special Condition GDC 57
(Governance of GD1 Price Control Financial Instruments), the Authority will have
regard to any views expressed by the working group when assessing whether any
proposed modification of the PCFM would be likely to have a significant impact on
licensees or other stakeholders.
Terms of reference
Purpose of the working group
1.25. The purposes of the working group are:
(i). to review the ongoing effectiveness of the PCFM in producing a value for
the term MOD for each relevant year that appropriately adjusts the
licensee‟s opening base revenue so that its allowed expenditures and
performance under incentive schemes are properly reflected;
(ii). to provide, when requested by the Authority, its views to the Authority on
the impact of any proposed modifications to the PCFM in accordance with Part A of Special Condition GDC 57; and
(iii). to provide such views or recommendations to the Authority with regard to the PCFM as it sees fit.
GD1 Price Control Financial Handbook
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Composition
1.26. The composition of the group will be:
Ofgem (chair);
Ofgem (secretary);
one representative per licensee;
ENA representative (optional).
Timing and duration of the group’s work
1.27. The working group‟s incumbency will run from 1 April 2013 to 31 March 2021.
1.28. The group will meet at least once between 1 January and 31 July during each
calendar year, but may meet more frequently if required, in particular in relation to
the provision of views on the impact of proposed PCFM modifications (see paragraph
1.25(ii)).
1.29. Representatives may attend meetings in person, or at the discretion of the
chair, through video or telephone conferencing facilities.
1.30. A meeting of the working group will be quorate, for the purpose of expressing
a view or recommendation in respect of the PCFM, if at least one representative from
Ofgem, and at least two licensee representatives (each from a different licensee) are
present.
Resources
1.31. Meeting facilities will be provided or coordinated by Ofgem. Ofgem will keep
notes of key points of discussion and views expressed at meetings, and of any
recommendations made by the working group with respect to the PCFM.
GD1 Price Control Financial Handbook
13
2. The GD1 Price Control Financial Methodologies
2.1. The GD1 Price Control Financial Methodologies set out in this handbook
describe the basis for a range of annual adjustments to the licensee‟s opening base
revenue allowances for the purposes of the RIIO-GD1 price control arrangements.
2.2. The main purpose of each methodology is to set out the way in which one or
more PCFM Variable Values are to be revised for the purposes of the Annual Iteration
Process for the GD1 Price Control Financial Model under which values of the term
MODt are calculated (see chapter 1). Any revised PCFM Variable Values determined
under the methodologies will replace (over-write) the existing values contained in
the PCFM Variable Values Table as part of the Annual Iteration Process.
2.3. The methodologies are presented in chapters 3 to 10 of this handbook, and
are referenced in the associated special conditions of the licence. As constituent
parts of this handbook, the methodologies are part of Special Condition GDC 57
(Governance of GD1 Price Control Financial Instruments) and are subject to the
modification provisions set out in that condition.
2.4. The methodologies are subordinate to the special conditions of the licence. If
there is any inconsistency between a licence condition and a methodology, then the
licence condition takes precedence.
Methodologies in this handbook
2.5. The PCFM Variable Values to be determined under the methodologies in this
handbook are listed in Table 1 below.
Table 1
No
PCFM Variable
Value
Special Condition
Description Type of variable value
Specified financial adjustments
1 EDE 27/65 Pension scheme Established
Deficit
revenue allowance
2 APFE 27/65 Pension scheme
administration and PPF levy
revenue allowance
3 TTE 27/65 Tax liability – tax trigger events
revenue allowance
4 TGIE 27/65 Tax liability –
gearing/interest costs
revenue allowance
GD1 Price Control Financial Handbook
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No
PCFM Variable
Value
Special Condition
Description Type of variable value
5 CDE 27/65 Allowed percentage cost of
debt
Percentage
Totex incentive mechanism
6 ALC
47 Actual load related capex
expenditure
actual expenditure
7 AOC
47 Other actual capex
expenditure
actual expenditure
8 ACO
47 Actual controllable opex actual expenditure
9 ARE 47 Actual mains and services
replacement
actual expenditure
10 ACC
47 Contributions received actual revenues
(negative value)
Allowed Totex expenditure adjustments
11 IAE 28 Uncertain costs (site security
and flood/erosion protection)
allowed expenditure
12 RE 39 Mains and services
replacement expenditure
allowed expenditure
13 IRO 9 Innovation roll out
mechanism
allowed expenditure
Legacy price control adjustments
14 PAR 64 Pension true-up true-up revenue
allowance
15 TAR 64 Tax claw back true-up revenue
allowance
16 CAR 64/tbc Capex incentive scheme true-up revenue
allowance and RAV
additions
17 FAR 64 Non gas fuel poor network
extension scheme
true-up revenue
allowance and RAV
additions
18 MAR 64 GDPCR1 Mains and services
replacement arrangements
true-up RAV additions
GD1 Price Control Financial Handbook
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2.6. Specified financial adjustments (numbers 1 to 5 in Table 1) relate to the
adjustment mechanisms set out in the „Finance Supporting Document‟ in the RIIO-
GD1 Final Proposals. Overviews of the adjustments and the methodologies for
determining revisions to the associated PCFM Variable Values are contained in
chapters 3 to 5 of the handbook.
2.7. The Totex incentive mechanism (number 6 in Table 1) applies to any
overspend of underspend by the licensee against its RIIO-GD1 Totex expenditure
allowances. An overview of the mechanism and the methodology for determining
revisions to the associated PCFM Variable Values is contained in chapter 6 of this
handbook.
2.8. Allowed Totex expenditure adjustments (numbers 7 to 15 in Table 1) cover a
range of Totex adjustment schemes under which allowed expenditure can be
adjusted under a specified formula or through an application and assessment
process. The methodologies for determining revisions to the associated PCFM
Variable Values are contained in chapters 7 to 9 of the handbook.
2.9. Legacy price control adjustments relate to activities which took place in the
price control period prior to RIIO-GD1 but in respect of which a financial adjustment is required because:
the outturn data for relevant year 2012/13 was not available when opening base revenue for the RIIO-GD1 price control; or
it is possible for pre-RIIO-GD1 expenditure allowances to be adjusted under
the terms of a RIIO-GD1 special condition.
Processing of different types of PCFM Variable Value under the Annual
Iteration Process
2.10. In general terms, the different types of variable value specified in column 5 of
Table 1 are processed under the Annual Iteration Process for the PCFM in the
following ways:
Allowed expenditure
These amounts are modelled, subject to the regulatory capitalisation rate, as:
- fast money – flowing directly to the base revenue figure for the
relevant year to which the allowed expenditure relates; and
- additions to the licensee‟s RAV in the relevant year to which the
allowed expenditure relates, generating a slow money adjustment to
allowed revenues through the cost of capital return, depreciation and
Totex incentive mechanism.
GD1 Price Control Financial Handbook
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Revenue allowance
These amounts flow directly to the base revenue figure for the relevant year
to which the adjustment circumstance relates.
Percentage
This type of variable value applies to the cost of corporate debt only and
revised values for relevant year t will flow into calculations of the return on
RAV component of slow money.
Actual expenditure
This type of variable value applies to the Totex incentive mechanism only and
revised values affect fast and slow money calculations for the relevant years
concerned. These values will be obtained from the licensee Regulatory
Reporting Pack relating to relevant year t-2. Since the RRP contains values in
nominal prices, these will be deflated to a 2009-10 price base using published
RPI data so that they are consistent with the 2009-10 price base used in the
PCFM.
True-up revenue allowance
These amounts will usually flow directly to the base revenue figure for
relevant year 2013-14, because they relate to activity levels or outturn values
for the price control period prior to RIIO-GD1.
True-up RAV additions
These additions to the licensee‟s RAV will usually apply to relevant year
2013-14, because they relate to activity levels or outturn values for the price
control period prior to RIIO-GD1, and generate a slow money adjustment to
allowed revenues through the cost of capital return, depreciation and Totex
incentive mechanism.
2.11. During the Annual Iteration Process, appropriate automatic adjustments are
also made as a consequence of revised PCFM Variable Values and the treatment
summarised above. For example, increased levels of allowed Totex expenditure may
result in an increased allowance to cover the licensee‟s notional equity issuance
costs, in accordance with RIIO-GD1 Final Proposals.
GD1 Price Control Financial Handbook
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Atypical revisions
2.12. The GD1 Price Control Financial Methodologies describe the normal timing
sequence for sequence for each PCFM Variable Value. For example, in relation to the
driver for mains and services replacement expenditure (item 12 in Table 1) the
normal sequence would be:
activity level takes place in relevant year t-2;
activity level reported to Ofgem by 31 July in relevant year t-1;
revised PCFM Variable Value used in Annual Iteration Process to take place by
30 November in relevant year t-1 (the variable value in the column equating
to relevant year t-2 on the PCFM Variable Values Table is the one which is
revised, since that is when the activity level took place);
incremental change to recalculated revenue position for relevant year t-2
flows through to value of MODt i.e. it affects base revenue in relevant year t.
2.13. A number of the special conditions provide for PCFM Variable Values to be
directed for relevant years outside the normal sequence. Where this is the case, the
procedures are explained in the relevant methodologies in this handbook.
GD1 Price Control Financial Handbook
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3. Pensions – allowed expenditure financial
adjustment methodology
Overview
Pension allowances
3.1. The opening base revenue allowances („PU‟ values) for the licensee set down
in the table at Appendix 1 to Special Condition GDC 20 (Restriction of revenue in
respect of the Distribution Network Transportation Activity) includes allowances for:
(a) pension scheme established deficit allowed expenditure („EDE‟); and
(b) pension scheme administration expenses and Pension Protection Fund
(PPF) levy allowed expenditure („APFE‟).
3.2. Opening EDE and APFE allowances are denoted in £m (in 2009-10 price base)
and are based on modelling assumptions and parameters applicable at the outset of
the price control period consistent with our pension principles. The EDE and APFE
values include and true-up amounts for the RIIO-GD1 period although these will be
zero initially. True-up amounts relating to previous price controls are dealt with as as
set out in chapter 10.
3.3. Licensees actual pension deficit funding amounts are likely to change during
the price control as the result of the triennial formal valuations and changes in
market conditions. PPF levies may change based on the Pension Protection Fund
published methodology and its future funding requirements. Both of these allowances
will be updated on a triennial cycle commencing with formula year 2015-16.
Allowances will also be adjusted to true-up for any differences between the
allowances provided and the actual payments made into the pension scheme, subject
to being efficient, applicable to the regulatory business and in accordance with our
pension principles.
3.4. A materiality threshold is applied to changes in and true-up of both pension
scheme administration expenses and Pension Protection Fund levies. The threshold
for both individually was set at Final Proposals at £1m per annum for each
licensee/distribution business.
Temporal conventions
3.5. For the purposes of Special Condition GDC 27, Special Condition ETC 65, and
this chapter, “relevant year t” means the relevant year in which a value for the term
GD1 Price Control Financial Handbook
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MOD, calculated through a particular Annual Iteration Process, is used in the formula
for the licensee‟s base transmission revenue7.
Annual Iteration process
3.6. The updating of allowances for funding the established pension deficit, scheme
administration costs and PPF levies is carried out through the Annual Iteration
Process of the RIIO-GD1 Price Control Financial Model. The Variable Values Table for
the licensee contained in the RIIO-GD1 PCFM contains rows for PCFM Variable Values
for pension deficit funding and separately for scheme administration and PPF levies.
3.7. As at 1 April 2013, the values for each relevant year will be as determined at
Final Proposals. Part B of Special Condition GDC 27 (Specified financial adjustments)
provides for any revisions to EDE and APFE values to be directed after determination
under the methodologies set down in this chapter.
3.8. Revisions to EDE and APFE values feed directly into the recalculated base
distribution revenue figures (PUt plus MODt) for applicable relevant years through
the annual iteration Process of the RIIO-GD1 PCFM. Incremental changes to
recalculated base revenue figures for years earlier than relevant year t will, subject
to a time value of money adjustment, be brought forward and reflected in the
calculation of the term MOD to be directed for relevant year t. For the avoidance of
doubt, such a revision will not have any retrospective effect on a previously directed
value of the term MOD.
Pension Principles
3.9. Our pension principles set out some important principles that apply to our
approach for setting pension related allowances and these are attached as annex 1
to this chapter. These include:
Customers should expect to fund the efficient cost of providing a competitive
employment package including pensions costs in line with comparative
benchmarks
Customers should only fund the portion attributable to the regulated business
Customers should not fund costs arising from a material failure of stewardship
Pension costs should be assessed using actuarial approaches using reasonable
assumptions in line with current best practice
Under or over funding in prior period should be reflected subject to being
economic and efficient
7 See Special Condition ETC 20 (Restriction of Transmission Transportation Activity Charges).
GD1 Price Control Financial Handbook
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Customers should not fund pension cost arising from severance that have not
been fully matched by contributions
Timetable
3.10. Applying the triennial update cycle, EDE and ADFE values will be updated
twice during RIIO-GD1 as set out in column D of table 4.1 below.
Table 4.1 Triennial reporting cycle
A B C D
Actuarial pension scheme valuation as at:
Pension reasonableness review completed no later than:
EDE and ADFE values directed no later than:
Date EDE & ADFE revised allowances applied during RIIO-GD1:
31 March 2013 30 September 2014 30 November 2014 1 April 2015
31 March 2016 30 September 2017 30 November 2017 1 April 2018
31 March 2019 30 September 2020 30 November 2020 RIIO-GD2
3.11. The timetable for updates to allowances for EDE and APFE is predicated on
licensees pension schemes meeting the Pension Regulators requirement for
valuations to be completed within fifteen months of the valuation date and
completion of the reasonableness review by the dates set out in table 4.1 above.
Where this is not achieved revised allowances will be applied in the following formula
year.
3.12. Column A of table 4.1 above sets out the date of the valuation to be used for
each revision of EDE and ADFE allowances. Not all licensees have a formal triennial
valuation as at those dates. Where this is the case the last formal valuation prior to
this date will be used, rolled forward to the valuation date set out in the column A in
table x for changes in asset values and market conditions.
Reasonableness review
3.13. The Authority will commission an independent review of the reasonableness
with which any established deficit position has been managed („pension
reasonableness review‟). That review will assess the current position and
reasonableness of the methods and assumptions used to determine pension costs of
all network operator (NWO) pension schemes and to understand the differences
between individual NWOs‟ pension costs; and the pension principles. It will be based
on their full triennial actuarial valuations at 31 March 2013, 31 March 2016 or 31
March 2019. Where the full triennial valuation is not concurrent with the review
timetable, the latest full valuation (that has been the subject of a prior
reasonableness review) will be used, updated for movements in asset values and
market conditions to 31 March in 2013, 2016 or 2019.
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3.14. Prior to making any revisions to EDE values, the valuations used to inform
any revisions will be subject to a reasonableness review in accordance with the
timetable set out in table 4.1. The review will commence as soon as practicable and
when sufficient pension schemes have concluded their formal valuation, but not later
than 15 months after the above dates.
Deficit allocation methodology
3.15. As set out above only the portion of a scheme‟s deficit that is attributable to
the regulatory business will be included in setting allowances. At Final Proposals the
published regulatory fraction is basis for determining this value. For allowances
following the first reset of allowances with effect from April 2015, the deficit
allocation methodology, attached as appendix 2, will be the basis for determining the
regulatory portion for the established deficit, ie with the 31 March 2016 valuations.
Discount rate
3.16. In calculating the annual amounts to be provided as allowances for deficit
funding, the deficit amount is spread evenly over the 15-year notional deficit
recovery period (or the remaining portion of that period) using a discount rate.
3.17. The rate of return is equal to the median pre-retirement real discount rates
applied by network company pension schemes at the respective valuation date. The
median discount rate will be compared to applicable UK pension data for
reasonableness. The discount rate will be recalibrated as at the date of the initial
actuarial valuation, that is as at 31 March 2013, and then subsequent valuation
dates, ie 31 March 2016 and 31 March 2019.
3.18. The first review funding discount rate will be based on the formal valuations
as at 31 March 2013. The second review funding discount rate will be based on the
formal valuations as at 31 March 2016.
Determining PCFM Variable Value revisions for the GD1 Price
Control financial Model
Revisions to pension scheme established deficit allowed expenditure („EDE‟)
3.19. EDE values will be revised at the commencement of Formula Years 2015-16
(the first review) and 2018-19 (the second review) of the RIIO-GD1 price control
period. A third review will also take place during RIIO-GD1 but its outcome will be
reflected in revenues in RIIO-GD2.
3.20. The following adjustments to EDE values are dependent on whether the
relevant pension valuation is reporting an established deficit which the licensee is
required to fund. If either the valuation or the application of the pension deficit
allocation methodology reports a surplus for the scheme or established deficit then,
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in accordance with our pension principles, we will review the future EDE values and
true-up adjustments at each review point.
The first review
3.21. At the first review, the EDE value relating to 2013-14 and 2014-15 will be
restated. The restatement will be subject to the outcome of the reasonableness
review on the valuation as at 31 March 2013, the application of the regulatory
fraction as set out at Final Proposals and the first review funding discount rate. This
will be used to determine the revised deficit funding amount which recovers the
established deficit over the 15-year notional recovery period in equal annual
amounts from 1 April 2013. The values for 2013-14 and 2014-15 will be the revised
EDE values for the GD1-Variable Values Table (VVT) in 2013-14 and 2014-15 for the
GD1 Financial Model. The values for 2015-16 and subsequent formula years through
to 2020-21 will equal the revised deficit funding amounts.
3.22. At the time of the first review the actual deficit funding amounts for 2013-14
will be known and reported as part of the annual Regulatory Reporting cycle in
accordance with standard special licence condition A40 Price Control Review
Information. Subject to the outcome of the reasonableness review, this amount will
be compared to the revised EDE values as calculated in paragraph 4.21 above. The
difference whether positive or negative will be a true-up amount and be spread over
the remaining years of the 15-year notional recovery period in equal annual
instalments using the first review funding discount rate.
3.23. The revised EDE values for entry into the VVT for years 2015-16 will be the
sum of the revised deficit funding amounts as calculated in paragraph 4.21 and the
true-up amounts calculated in paragraph 4.22.
The second review
3.24. At the second review the revised EDE value relating to formula years 2018-
19, 2019-20 and 2020-21 will be restated plus any true-up amounts relating to
2014-15 through to 2016-17.
3.25. The restatement will be subject to the outcome of the reasonableness review
on the valuation as at 31 March 2016, the application of the deficit allocation
methodology (for the first time) and the second review funding discount rate. This
will be used to determine the revised deficit funding amount, which recovers the
deficit over the remaining period of the 15-year notional recovery period in equal
annual amounts. The values for 2018-19, 2019-20 and 2020-21 will equal the
revised deficit funding amounts for those years.
3.26. At the time of the second review the actual deficit funding amounts paid by
the licensee for 2014-15, 2015-16 and 2016-17 will be known and reported as part
of the annual Regulatory Reporting cycle in accordance with standard special licence
condition A40 Price Control Review Information. Subject to the outcome of the
reasonableness review, this amount will be compared to the deficit funding
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allowances provided for those years (excluding any true-up amounts). The
difference whether positive or negative will be a true-up amount and be spread over
the remaining years of the 15-year notional recovery period in equal instalments
using the second review funding discount rate.
3.27. The revised EDE values for entry into the VVT for years 2018-19, 2019-20
and 2020-21 will be the sum of the revised deficit funding amounts as calculated in
paragraph [1.25] and the true-up amounts calculated in paragraph 4.26.
3.28. The Authority will direct revised EDE values no later than 30 November in
each relevant Year t-1 (that is 30 November 2014 and 30 November 2017,
respectively). The Authority will direct revised EDE values for Formula Year 2021-22
of RIIO-GD2 no later than 30 November 2020.
Revisions to values pension scheme administration expenses and Pension
Protection Fund levy allowed expenditure („APFE‟)
3.29. APFE values will be revised at the commencement of Formula Years 2015-16
(the first review), 2018-19 (the second review) and 2020-21 (the third review) of the
RIIO-GD1 price control period.
3.30. Licensee actual costs in respect of scheme administration costs and PPF
levies will be reported in compliance with the annual Regulatory Reporting cycle in
accordance with standard special licence condition A40 Price Control Review
Information.
First review
3.31. At the first review for 2015-16 actual costs will be compared against the
allowances set at the outset of the price control in Final Proposals. If actual reported
costs in 2013-14 and 2014-15 are equal to or less than the threshold set out in
paragraph 4.4 then there will be no true-up adjustment. If actual reported costs
exceed the de minimis threshold, then they will be subject to review as to whether
they are economic and efficient in accordance with our pension principles. This may
include a review for reasonableness against other licensee costs and the Pension
Regulator and industry information. If assessed reasonable, revised APFE values will
be set based on the latest actual cost information plus any true up amounts.
3.32. True-up amounts, subject to the threshold, will be obtained by comparing
the actual payments reported as part of the annual Regulatory Reporting cycle in
accordance with standard special licence condition A40 Price Control Review
Information for 2013-14 and 2014-15 to the allowance set at Final Proposals for
those years and computing the difference. The difference (subject to the outcome of
the reasonableness review), in excess of the threshold, will spread over the following
three Formula Years commencing 1 April 2015 of the price control in equal
instalments and be made net present value neutral using the vanilla WACC for each
year.
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3.33. The annual allowance for the remaining years of the price control will be
reset based on average actual costs for 2013-14 and 2014-15, subject to the
outcome of the reasonableness review.
Second review
3.34. At the second review for 2018-19 actual costs will be compared against the
allowances set at the outset of the price control in Final Proposals. If actual reported
costs in 2015-16, 2016-17 and 2017-18 are equal to or less than the threshold in set
out in paragraph 4.4 then there will be no true-up adjustment. If actual reported
costs exceed the de minimis threshold, then they will be subject to review as to
whether they are economic and efficient in accordance with our pension principles.
This may include a review for reasonableness against other licensee costs and the
Pension Regulator and industry information. If assessed reasonable, revised APFE
values will be set based on the latest actual cost information plus any true up
amounts.
3.35. True-up amounts, subject to the threshold, will be obtained by comparing
the actual payments reported as part of the annual Regulatory Reporting cycle in
accordance with standard special licence condition A40 Price Control Review
Information for 2015-16, 2016-17 and 2017-18 to the reset allowances set at the
First Review for those years and computing the difference. The difference (subject to
the outcome of the reasonableness review), in excess of the threshold, will spread
over the following three Formula Years commencing 1 April 2018 of the price control
in equal instalments and be made net present value neutral using the vanilla WACC
for each year.
3.36. The annual allowance for the first three years of the next price control will be
reset based on average actual costs for 2015-18, subject to the outcome of the
reasonableness review.
Notification of the PCFM Variable Value
3.37. The Authority will direct revised APFE values no later than 30 November in
each relevant Year t-1 (that is, 30 November 2014 and 30 November 2017,