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Legacy workshop Reconciling 2010-15 performance 9 April 2014
1 Water today, water tomorrow
Agenda 1
About this workshop
2
Introduction
3
Service incentive mechanism
4
Revenue correction mechanism
5
Opex incentive allowance (OIA) Break
6
Change protocol and serviceability
7
Capital expenditure incentive scheme
8
Financial modelling impacts, RCV midnight adjustments and tax
9
Closing comments
10
Questions and answers
11
Next steps 2 Water today, water tomorrow
About this workshop Following the announcement of the risk based review results, we are holding a series of workshops across the elements of the business plan The purpose of these sessions is to provide companies with the opportunity to raise questions with the Ofwat team. We are doing this in a workshop format to allow us, and companies, to use time effectively and efficiently Our objective is to support companies to understand our approach and our requirements. We want to help companies to improve aspects of their plans, to address any gaps identified during the risk based review, and to continue to take ownership and accountability of their plans The workshop materials will be put on our website, along with the main points/questions and answers, without attribution. There will be no detailed meeting note 3 Water today, water tomorrow
Agenda 1
About this workshop
2
Introduction
3
Service incentive mechanism
4
Revenue correction mechanism
5
Opex incentive allowance (OIA) Break
6
Change protocol and serviceability
7
Capital expenditure incentive scheme
8
Financial modelling impacts, RCV midnight adjustments and tax
9
Closing comments
10
Questions and answers
11
Next steps 4 Water today, water tomorrow
Context In the final methodology, we said that we would adjust 201520 price controls to reflect company actual performance during the 2010-15 price control period We said that adjustments would be made in line with the 201015 incentive tools, which were designed to manage the risks to customers and companies from uncertainty, and to encourage efficiency and outperformance in the delivery of FD09 commitments Delivery tools are SIM, RCM, OIA, change protocol and CIS We also said we would make adjustments to: Account for differences between the RCV projections we made in 2009 and companies’ outturn positions Recover any assumed costs at the 2009 price review of issuing new equity Recover any tax benefits arising from in-period changes in capital structures Water today, water tomorrow
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Objectives At the end of today’s session companies should have an understanding of: Our expectations for how companies should calculate and evidence their proposed adjustments, drawing on the risk based review The steps companies must take ahead of draft and final determinations How performance in 2013-14 and 2014-15 will be taken into account in 2015-20 price controls, including how we will deal with performance in 2014-15 for price controls that come into force in April 2020
6 Water today, water tomorrow
Agenda 1
About this workshop
2
Introduction
3
Service incentive mechanism
4
Revenue correction mechanism
5
Opex incentive allowance (OIA) Break
6
Change protocol and serviceability
7
Capital expenditure incentive scheme
8
Financial modelling impacts, RCV midnight adjustments and tax
9
Closing comments
10
Questions and answers
11
Next steps 7 Water today, water tomorrow
Risk-based review feedback In the risk-based review we considered the evidence that companies used our methodology and guidance to estimate their relative SIM position and legacy adjustments We looked at the value of adjustment included in company plans Examples of good practice Easy to see what value had been included in business plans and how adjustments had been calculated and included in plans. We could easily recreate values from SIM % adjustment and 2014-15 Companies provided reasoned logical arguments Either a penalty or reward is applied to represent the companies’ view of how they performed The basis for the reward or penalty is explained, including how it relates to guidance on the SIM, companies’ performance, and the company’s assumptions on the industry average Calculations correctly reflect our methodology 8 Water today, water tomorrow
Next steps – companies All companies Submit fully assured 2013-14 SIM performance data by 2 May Q – why 2 May for all companies? A – to allow us to do June draft determinations Q – what about assurance? A – full assured required. We appreciate it is close to year end so make it clear what level of assurance you have achieved For June or August draft determinations Include SIM adjustment predictions within updated business plans (as specified in appendix 7 and table guidance S20/W20) Q – why bother with a SIM prediction when Ofwat will do it? A – business plans should be as complete as possible, to give the best indications to your customers and other stakeholders Water today, water tomorrow
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Next steps – Ofwat Ofwat Three sets of draft determinations. All company SIM on 29 August Q – why 29 August (why not June?) A – to allow any company specific sensitivities to be explored in context of each business plan (we won’t be able to do this in June for all companies)
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Agenda 1
About this workshop
2
Introduction
3
Service incentive mechanism
4
Revenue correction mechanism
5
Opex incentive allowance (OIA) Break
6
Change protocol and serviceability
7
Capital expenditure incentive scheme
8
Financial modelling impacts, RCV midnight adjustments and tax
9
Closing comments
10
Questions and answers
11
Next steps 11 Water today, water tomorrow
Risk-based review feedback (1) In the RBR we considered the evidence that companies used our methodology and that their proposed RCM adjustments fairly reflected their performance in 2010-15. We assessed whether companies adopted fair and appropriate forecast data assumptions.
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Risk-based review feedback (2) Examples of good practice Populated RCM models – using the latest versions and correct input data – which demonstrated the RCM adjustment amounts claimed for Consistency between the data used in the company’s populated RCM model and business plan tables. Detailed supporting commentary that explained the approach to abating K in 2014-15 Demonstrating how the RCM was used to deal with the revenue variances in 2014-15 Revenue forecasts for 2013-14 and 2014-15 are consistent with the trend for the remainder of the period and fully explained. Such forecasts are justified, fair and reasonable Detailed commentary to explain revenue variances (FD vs actual) in AMP5, including fully explaining variances between actual revenues and forecast revenues from 2010-11 to 2012-13 13 Water today, water tomorrow
Next steps In revising their business plan submissions, companies should: 1. Set out updated actual revenue data for 2013-14 and updated revenue forecasts for 2014-15 and provide new populated RCM models to reflect this data 2. Provide a commentary to explain revenue variances (FD vs actual) in AMP5 3. Provide a commentary to explain the basis of the revenue forecasts for 2014-15 4. Ensure that data used in the RCM model is consistent with what is provided in business plan tables, namely W17, S17 (if applicable), R3 and A9
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Agenda 1
About this workshop
2
Introduction
3
Service incentive mechanism
4
Revenue correction mechanism
5
Opex incentive allowance (OIA) Break
6
Change protocol and serviceability
7
Capital expenditure incentive scheme
8
Financial modelling impacts, RCV midnight adjustments and tax
9
Closing comments
10
Questions and answers
11
Next steps 15 Water today, water tomorrow
Risk-based review feedback In the RBR we considered the evidence that companies used our methodology and whether the value of their proposed opex incentive adjustments was fair and reasonable, reflecting their performance in 2010-15. Examples of good practice The incentive allowance was calculated correctly and in accordance with PR09/04 using the 2013-14 year to constrain outperformance Companies confirmed the basis of their logging up/down and shortfall adjustments to opex Companies included their actual effective tax rate for 2012-13 as required by the updated guidance Ofwat issued September 2013 We were able to understand how a company had calculated its pension adjustments, and these adjustments were appropriate 16 Water today, water tomorrow
Next steps In revising their business plan submissions, companies should: Use the actual outperformance achieved in 2013-14 as the constraining year Adjust the opex incentive revenue allowance by the actual effective tax rate for 2013-14 Review their pension adjustments and be satisfied that these are fair and appropriate for the purposes of calculating any outperformance incentive allowance due to them Explain their pension adjustment calculations in their commentaries Ensure logging up, logging down and shortfall adjustments are post efficiency, having been derived using FD09 assumptions adjusted for FD09 opex efficiency improvements 17 Water today, water tomorrow
Agenda 1
About this workshop
2
Introduction
3
Service incentive mechanism
4
Revenue correction mechanism
5
Opex incentive allowance (OIA) Break
6
Change protocol and serviceability
7
Capital expenditure incentive scheme
8
Financial modelling impacts, RCV midnight adjustments and tax
9
Closing comments
10
Questions and answers
11
Next steps 18 Water today, water tomorrow
Agenda 1
About this workshop
2
Introduction
3
Service incentive mechanism
4
Revenue correction mechanism
5
Opex incentive allowance (OIA) Break
6
Change protocol and serviceability
7
Capital expenditure incentive scheme
8
Financial modelling impacts, RCV midnight adjustments and tax
9
Closing comments
10
Questions and answers
11
Next steps 19 Water today, water tomorrow
Risk-based review feedback – change protocol (1) In the RBR we considered the evidence that companies used our methodology and their proposed adjustments fairly reflected their performance in 2010-15. We considered whether assumptions for forecast data were fair and appropriate.
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Risk-based review feedback – change protocol (2) Examples of good practice Comprehensive information and supporting evidence on all FD09 outputs. For example, a report on actual and forecast performance against all the individual outputs stated in the supplementary report tables. Individual logging up/down claims had evidence to support the need/basis of efficient costs But, some company business plans included a lack of information on the delivery of PR09 outputs % water outputs reconciled 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% A
B
C
D
E
F
G
H
I
J
K
L
M
N
O
P
Q
R
S
T
U
Some companies did not provide confirmation that adjustments were derived 21 on a pre-efficiency basis as required by the guidance Water today, water tomorrow
Next steps In revising their business plan submissions, companies should: Provide a separate, easily identifiable, chapter or annex on AMP5 delivery Provide commentary confirming whether outputs have been delivered, are delayed or are no longer required Provide information explaining any differences between the PR09 determination and actual performance – identify if trivial or not Differentiate outputs between different requirements as set out in their supplementary report table (for example, differentiating between internal, 1 in 20 and external outputs and net reductions for the sewer flooding programme) Explain any differences from previously submitted data in tables W13 and S13 – for example, new claims, changes in costs Confirm the net adjustments are derived on a pre efficiency basis Amalgamate claims by investment driver 22 Water today, water tomorrow
Risk-based review feedback – serviceability (1) Examples of good practice Sections clearly identified for serviceability – for example, in historic performance; AMP5 serviceability All indicators actual and forecast data and relevant commentary included on performance and reasons for failure in delivery Provided serviceability assessment based on actual and forecast data, with evidence to support serviceability assessment Properly applying toolkit and FD09 supplementary report to the assessment – serviceability is a long term trend and performance should oscillate the reference level not just close to the upper control limit (for example, one year of apparent recovery is not sufficient)
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Risk-based review feedback – serviceability (2) Examples of good practice Provided commentary where shortfall adjustment identified Provided value of the shortfall adjustment and commentary on the determination of size of this shortfall Assessment and shortfall adjustment is in agreement with Ofwat’s assessments
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Next steps In revising their business plan submission companies should: Provide a section clearly marked as ‘serviceability 2010-15’ discussing actual (2010-14) and forecast (2014-15) performance including the end of AMP expectations where applicable (tables W21 and S21 are new tables created specifically to support serviceability draft determinations) Provide a commentary to explain the serviceability judgements for the whole 2010-2015 period given the actual performance data for 2013-14 (through the application of the serviceability toolkit and guidance provided in section 2 of the FD09 supplementary report) Where serviceability is less than stable, companies should determine the size of any shortfall and set out in their commentary their justification for this being fair and reasonable Water today, water tomorrow
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Agenda 1
About this workshop
2
Introduction
3
Service incentive mechanism
4
Revenue correction mechanism
5
Opex incentive allowance (OIA) Break
6
Change protocol and serviceability
7
Capital expenditure incentive scheme
8
Financial modelling impacts, RCV midnight adjustments and tax
9
Closing comments
10
Questions and answers
11
Next steps 26 Water today, water tomorrow
Risk-based review feedback (1) In the RBR we considered the evidence that companies used our methodology and that their CIS assessment and proposed adjustments fairly reflected their performance in 2010-15. We considered whether assumptions for forecast data were fair and appropriate.
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Risk-based review feedback (2) Examples of good practice Provided a populated version of the published model A full CIS true-up assessment is completed and submitted, and for merged companies the CIS true-up is assessed for each of the former operational areas Clear evidence of how the revenue adjustments have been derived and profiled over the period. Where the CIS revenue adjustment is spread beyond 2015-16 the profiled adjustments are equivalent (in net present value – NPV – terms) to the single-year adjustment Commentary clearly sets out the scale of any reward or penalty due on the performance and the scale of the revenue adjustments 28 Water today, water tomorrow
Risk-based review feedback (3) Examples of good practice CIS calculations consistent with figures submitted elsewhere in the plan, including capital expenditure and inflation assumptions: Actual capital expenditure to 2013-14 (and 2014-15 forecasts) match table W15 and S15. The price base in these tables is ‘outturn’ and projected 2014-15 figures reflect the inflation assumptions used in table A9 Logging up/down inputs within the CIS true-up models reflect items identified in table W13 and S13 RPI and COPI details in section 4.1 match table A9
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Next steps In revising their business plan submission, companies should: Use the CIS published on our website which applies Ofwat methodology as intended Include a commentary on their CIS analysis setting out the scale of any reward or penalty due on the performance, the scale of the revenue adjustments arising and how these are applied in the company’s modelling of the 2015-20 allowed revenues and the scale of any RCV adjustments Ensure, where the revenue adjustments are spread over the 2015-20 period, that the profiled amounts are equivalent (in NPV terms) to the single year adjustment; Provide separate business plan tables and CIS models for the former areas where companies have merged since 2009 (where appropriate) 30 Water today, water tomorrow
Agenda 1
About this workshop
2
Introduction
3
Service incentive mechanism
4
Revenue correction mechanism
5
Opex incentive allowance (OIA) Break
6
Change protocol and serviceability
7
Capital expenditure incentive scheme
8
Financial modelling impacts, RCV midnight adjustments and tax
9
Closing comments
10
Questions and answers
11
Next steps 31 Water today, water tomorrow
Feeder models RCV midnight adjustment feeder model Incorporates all adjustments needed to move RCV to 1 April 2015 position The components are: a. b. c. d.
Land sales CIS RCV impact 2009-10 outperformance adjustment Water: wastewater ratio adjustment
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Tax impact of revenue from legacy tools There are five legacy tools: a. b. c. d. e.
SIM RCM Opex incentive allowance Change protocol (incl serviceability) CIS
RCM can be further divided into the PR09 ‘true-up’ element, the billing incentive and the back-billing incentive
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Tax impact of revenue from legacy tools There are two significant differences between the nature of the legacy tools: 1. An ‘incentive’ type adjustment – where revenue is either added or deducted from the following price review 2. A ‘true-up’ adjustment – where assumptions made at the previous review are considered against actual performance in order to ‘re-set’ the start point for PR14
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Tax impact of revenue from legacy tools General view is described in the PR14 financial model rule book section 22 ‘Legacy performance and delivery incentive adjustments’
22.11 The change in tax that results from the post-financeability adjustments are calculated and included in the allowed revenue requirement This ensures that if an incentive is intended to be, say, £10 million, then a company will be allowed an additional revenue amount to offset the tax payable on this revenue (so £12.5 million at a rate of 20% in this example) However some legacy tools have a taxation adjustment which gives an additional impact on the final result
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Tax impact of revenue from legacy tools Tools that are an ‘incentive’ (which includes BI and BBI) are generally deemed to include a taxation effect included within the value of the incentive given – so no specific adjustment is needed. The OIA is however an exception to this, where the full value of the incentive is reduced by a tax amount However, the allowance under 22.11 still remains. So in overall terms the absolute value of the incentive is preserved, albeit with companies bearing the tax ‘cost’ of this revenue Step 1: Opex incentive allowance is calculated as £100. This is reduced in the calculation by the effective tax rate (say 20%) to give a net incentive of £80 Step 2: £80 is entered into the financial model, which, as part of the tax computation, grosses up the amount by 20/80 So £80 x 100/80 = £100 Water today, water tomorrow
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Tax impact of revenue from legacy tools Tools that are a ‘true-up’ adjustment will include components of the price control which would have had a second order effect on the amount of tax actually paid by the company. Therefore, there will be a difference between that and the amount forecast in the determination The RCM tool calculates the amount of tax that arose due to the difference between the actual and expected revenue. So this part of the calculation reflects the true impact, in cash terms, of the over/under collection of revenue This amount is then carried forward to the next AMP and the rule described in 22.11 ensures that this impact is included in the control, even after allowing for tax
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Agenda 1
About this workshop
2
Introduction
3
Service incentive mechanism
4
Revenue correction mechanism
5
Opex incentive allowance (OIA) Break
6
Change protocol and serviceability
7
Capital expenditure incentive scheme
8
Financial modelling impacts, RCV midnight adjustments and tax
9
Closing comments
10
Questions and answers
11
Next steps 38 Water today, water tomorrow
What are we aiming to achieve Highlight good practice, drawing on the risk-based review Set out the steps companies must take ahead of draft and final determinations Explain how performance in 2013-14 and 2014-15 will be taken into account in 2015-20 price controls, including how we will deal with performance in 2014-15 for price controls that come into force in April 2020
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Forward timeline Date
Enhanced companies
Companies seeking June draft determinations Companies submit revised business plan – including : • SIM data (A24) • 2010-15 adjustments – water data set – A7, A9, W3a, W13, W14, W15, W16, W17, W20, W21 • 2010-15 adjustments – wastewater data set – A7, A9, S3a, S13, S14, S15, S16, S17, S20, S21 (Fully assured data required 2013-14 actuals and updated 2014-15 forecasts)
Companies seeking August draft determinations
2 May 2014
Companies submit SIM data set A24 (fully assured)
27 June 2014
Companies submit assured 2010-15 information including: • 2010-15 adjustments – water data set A7, A9, W3a, W13, W14, W15, W16, W17, W20, W21 • 2010-15 adjustments – wastewater data set A7,A9,S3a,S13,S14,S15,S16,S17,S2 0,S21 (Fully assured data required 2013-14 actuals and updated 2014-15 forecasts)
15 July 2014
Companies publish risk and compliance statements, performance reports and regulatory accounts
Summer 2015
Companies submit assured full 2010-15 information including: • 2010-15 adjustments – water data set (A7, A9, W3a, W13, W14, W15, W17, W20, W21) • 2010-15 adjustments – wastewater data set (A7, A9, S3a, S13, S14, S15, S17, S20, S21)
Autumn 2015
RCM reconciliation, change protocol and serviceability adjustments for 2014-15 variations
Summer 2016
CIS reconciliation of rewards and penalties (to be reconciled at the next price review if material)
Water today, water tomorrow
Companies submit SIM data set A24 (fully assured)
Companies submit revised business plan including: • 2010-15 adjustments – water data set – A7, A9, W3a, W13, W14, W15, W16, W17, W20, W21 • 2010-15 adjustments – wastewater data set – A7, A9, S3a, S13, S14, S15, S16, S17, S20, S21 (Fully assured data required 2013-14 actuals and updated 2014-15 forecasts)
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Reconciling 2010-15 performance – tables All services
Water service
Wastewater service
A7 – Adjustments to RCV from disposals of land
W3a – Water service transition investment
S3a – Wastewater service transition investment
A24 – SIM legacy performance
W13 – Water service logging up, logging down and shortfalls
S13 – Wastewater service logging up, logging down and shortfall
A9 – Inflation measures
W14 – Water service overlap programme
S14 – Wastewater service overlap programme
W15 – CIS reported and projected actual expenditure for water service
S15 – CIS reported and projected actual expenditure for wastewater service
W16 – Opex outperformance
S16 – Opex outperformance
W17 – Revenue correction mechanism for the water service
S17 – Revenue correction mechanism
W20 – Water service legacy reconciliation table
S20 – Sewerage service legacy reconciliation table
W21 – Water service serviceability
S21 – Sewerage service serviceability
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Agenda 1
About this workshop
2
Introduction
3
Service incentive mechanism
4
Revenue correction mechanism
5
Opex incentive allowance (OIA) Break
6
Change protocol and serviceability
7
Capital expenditure incentive scheme
8
Financial modelling impacts, RCV midnight adjustments and tax
9
Closing comments
10
Questions and answers
11
Next steps 42 Water today, water tomorrow
Questions and answers
43 Water today, water tomorrow
Agenda 1
About this workshop
2
Introduction
3
Service incentive mechanism
4
Revenue correction mechanism
5
Opex incentive allowance (OIA) Break
6
Change protocol and serviceability
7
Capital expenditure incentive scheme
8
Financial modelling impacts, RCV midnight adjustments and tax
9
Closing comments
10
Questions and answers
11
Next steps 44 Water today, water tomorrow
Next steps As noted earlier, today’s workshop materials will be put on our website, along with the main points/questions and answers, without attribution. There will be no detailed meeting note Companies wishing to receive an early draft determination in June now need to prepare a ‘gap analysis’ by 17 April – see ‘Setting price controls for 2015-20 – policy and information update’. We are keen to ensure that companies are in the best possible position to complete their gap analyses so we are open to having further working-level meetings to discuss issues related to the gap analysis, if that would be helpful for companies. Once we have received the gap analysis, we will meet with all companies as part of the draft determination process Please continue to liaise with your portfolio lead if there are further queries after today Thank you for attending Water today, water tomorrow
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Questions and answers on legacy Q1. Confirmation of the service incentive mechanism (SIM) approach Company submissions should include their own decisions for SIM adjustments and set out their reasons within commentary. All companies are required to submit SIM 2013-14 performance data on 2 May. Q2. Points of clarification on the revenue correction mechanism (RCM) Companies were asked to provide information on the reasons for any large differences between forecast and actuals. Actuals for 2013-14 should now be included with forecasts for 2014-15. Companies should clarify the basis for 2014-15 forecasts particularly if the trend varies from the remainder of the period. Q3. Points of clarification on assessing serviceability performance Companies should provide an explanation of the reasons behind their assessment of serviceability, and if appropriate, their calculation of the shortfall and why this is considered fair to customers. Q4. Question on logging up/down, shortfalling Could Ofwat please clarify what an investment driver is for the purposes of amalgamating claims and testing triviality? An example would be a specified series of outputs that are contained under one investment driver in the FD09 supplementary report – for example, nitrate removal. Logging up/down claims should be amalgamated by driver before the 2% triviality threshold is applied. Companies were asked to provide details of their performance for the AMP5 period referenced to the outputs set out in the tables specified in their FD09 supplementary report. The 2% triviality threshold applies to all logging up/down adjustments.
Q5. Question on logging up/down and shortfalling Will efficiencies be applied twice if adjustments are entered in tables W13/S13 post efficiency? Yes. The logging up/down and shortfall model applies efficiencies. Therefore companies must enter the net change in costs in tables W13 and S13 preefficiency. Q6. Question on serviceability performance How will Ofwat treat companies that get better or worse serviceability in the final true-up in 2015? Companies with a marginal (or worse) serviceability performance in 2014-15 are at risk of being shortfalled at the next price review. If a company is shortfalled at PR14 based on marginal serviceability performance up to 2013-14, but improves its performance in 2014-15, it may propose amendments at the next price review. These proposals will be considered as part of any true-up (as deemed appropriate) at the next price review. Note, however, that the shortfall with regard to 2013-14 performance may still be deemed appropriate. Q7. Question on discount rates There are a variety of discount rates used across legacy tools. Would it be sensible to have a uniform approach across them all? The discount rates are different across the legacy tools to reflect the specific regulatory policies that each tool is dealing with. Q8. Question on the capital expenditure incentive scheme (CIS) The CIS true-up does not consider the impact of the expenditure variations on tax within the financing costs considerations. Is this what Ofwat intended? Yes. The CIS model is performing the true-up as we set out in our working spreadsheet model. This does not include a tax related adjustment.
Q9. Question on the financial model There are two financial years with the same discount year setting on the profiling sheet. What is the rationale for that? The columns for the years up to 2014-15 are not used on the profiling sheet. The year settings shown in these columns are relevant to the future value discounting used on the Calc sheet for the purpose of establishing the value of the revenue adjustment as at end of 2014-15. The columns for 2015-16 to 2019-20 are used in the profiling sheet to preserve the present value where the revenue adjustment is not applied in full in the first year of the period. If the adjustment is applied in full in the first year then no discounting is required. Q10. Question on the financial model The updated version of the financial model now allows the post financeability revenue adjustments to flow through the tax computations. Does Ofwat require the companies to report the iterative tax impact of applying the revenue adjustments in tables the other tax adjustments line on tables W20 and S20? No. We do not require details of the iterative tax impact arising from the post financeability revenue adjustments.
