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Rate-regulated activities — Research project

Date recorded:

Preliminary analysis of asset and liability definition

The project manager introduced the paper by explaining that it focuses on one of the specific features of rate regulated activities which is the true-up adjustments that are applicable in circumstances in which there is no competitive market. The purpose of the true-up adjustment is to ensure that the entity is able to earn the amount of revenue permitted by the rate regulation during the regulatory period.  The objective of this agenda paper is to consider whether a rate-setting mechanism that incorporates a true-up adjustment could result in the existence of assets and liabilities.

The research was based on the existing and new draft conceptual framework that defines assets and liabilities. The objective of this session is to take the initial views from the Board members. As part of this project, the staff held recently a meeting with the consultative group and the feedback obtained consisted of (i) the description that the adjusting mechanism is not quite refined enough and (ii) the research is too narrowly focused. Nevertheless, the staff believe that it is appropriate to keep the project narrowly focused.

One Board member questioned why there is an asset in a rate regulated environment raised from a true-up adjustment while there is no asset in a competitive market environment.

One Board member expressed that in general the utilities industries operate in very competitive markets; the chairman replied that this is not in general the situation in Europe.

Another Board member explained that in general there is a monopoly for the generation of electricity and there is a competitive market for the distribution market.

The project manager explained that some aspects of the market are regulated, in addition, regulation is changing and some countries are becoming more de-regulated. Some jurisdictions still are heavily regulated and the objective of this research is to capture this piece of the market.

One Board member expressed agreement with the project although is concerned about whether this true-up adjustment is not a general issue for estimates that applies to regulated and non-regulated markets.

The project manager responded that the regulated market is different in the sense that the regulator’s objective is to make sure that utility companies can survive and also that customers obtain good services. In addition, the regulations are enforceable by law and companies can go to court to enforce the adjustments. In some cases, governments implement other measures if customers cannot cope with the price increase (for example by providing subsidies or tax reductions).

One Board member mentioned that the revenue recognition project requires performance for revenue recognition; it has to be very clear in the rate regulated paper that there is no contradiction with that.

Another Board member indicated that in some cases it takes years for the regulators to approve a true-up adjustment because this is also a political issue.

The project manager responded that the focus of the project is very narrow and the true-up adjustment has to be legally enforceable and it focuses on the existence of the asset and not on the measurement. The asset derives from a right to earn a particular amount of revenue which is set in the contract between a regulator and the company.

Another Board member requested that the paper should also consider de-recognition and impairment of the assets derived from the true-up adjustment.

Another Board member inquired as to how this interacts with business combinations.

The project manager explained that based on their research they find that in a business combination the acquiring entity will have to go to the rate regulator to obtain the approval, nevertheless the true-up adjustments are considered in the valuation of the companies.

One Board member requested that the paper should also discuss the liability side. According to the paper, when a company overcharges there is a liability because it will be required to reduce prices in the future to compensate customers. That member is concerned whether a future reduction of profit is a liability. Other Board members responded that it is a liability because it relates to a past event.

Next steps

The project manager explained they will take the feedback obtained from the conversations with the consultative group and from the Board members and they will provide a new paper with further analysis and clarification in January 2014.

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