Review Group 0221: User Commitment

1. Review Group 0221: User Commitment Best Practise guidelines for Gas and Electricity Network Operators Credit Cover (2005)

2. Introduction • February 2005Ofgem 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

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