Legacy workshop Reconciling 2010-15 performance 9 April

Legacy workshop
Reconciling 2010-15 performance
9 April 2014
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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on a pre-efficiency basis as required by the guidance
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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
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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
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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
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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
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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)
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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
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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
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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
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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)
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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
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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
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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
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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.

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