Are current approaches to ensuring company financeability incentivising short-term thinking and are current regulatory frameworks fit for purpose? In the first of a series of articles, Sam Williams, director of Economic Insight and a member of the CMA’s Cost of Capital Panel, explores these questions and outlines his vision of the financeability blueprint.
The issue of company financeability has always been central to regulation (both in the energy and water industries, and more widely). Put simply, it is vital that efficient companies are able to finance their functions, so that customers, taxpayers, wider society and the environment are protected from the harm that arises from: (i) underinvestment; and (ii) paying for company inefficiency. Consistent with this, economic regulators have statutory duties relating to financeability.
Over the course of my career, however, the ‘in practice’ interpretation and application of those duties has evolved considerably, to the extent that there is a risk they are not meeting their intended aims. Most obviously, there is a growing perspective that there has been underinvestment in vital UK infrastructure (including, but not limited to, regulated industries).
A related issue I am increasingly concerned by is whether current approaches are incentivising short-termism, whereby firms appear financeable over a short window of time, but – fundamentally – are not investable in the long-run. There certainly seems to be relatively little attention paid to trends in opex/capex splits, depreciation rates and capital maintenance (and the reasons for those trends). This raises the obvious question of how financeability duties should evolve going forward, both in their form and interpretation.
To this end, over the next six months, Economic Insight will be taking forward work to develop a ‘Financeability Blueprint’, intended to be the gold standard in how stakeholders think about, and assess, the financeability of regulated companies. In doing so, we will be drawing on input from a diverse set of experts, including investors, leading finance academics, economists, corporate finance professionals and ratings agencies. We’ll arrive at our final blueprint by addressing six questions:
- Why do we care about financeability and what problems should financeability duties (and the assessment of) be targeted at addressing, particularly given the UK’s economic performance?
- What does it mean for a company to be financeable and what are the implications of this for financeability duties and the assessment of financeability?
- What is the distinction between a company being financeable on an actual, versus a notional, basis and what purposes do these two perspectives serve?
- What are the challenges with the assessment of financeability on a notional basis? What are the consequences of not meeting these challenges?
- Are there ways of mitigating any identified challenges in determining notional financeability; and what are the implications of this for the assessment of financeability?
- When assessing financeablity from a debt perspective, what methods and metrics should be used; how prescriptive should these be; and how can we ensure internal consistency?
Rather than waiting until the end and delivering an uber-technical and long report we will instead develop a range of targeted analyses and outputs around the above as we go. These will include peer-reviewed journal articles, standalone think pieces and published reports. We’ll also be establishing a panel of experts, who we will periodically ‘tap into’ on these matters. As our outputs emerge, we’ll make summaries exclusively available to Utility Week readers.
In Spring time, once we’ve reached our conclusions, we’ll be hosting an event in London setting out our findings. This will coincide with the publication of our Financeability Blueprint, which will be a short, and easily-digestible, document.
Sam Williams is a director of Economic Insight and a member of the CMA’s Cost of Capital Panel, and the Bar Standard Board’s Advisory Panel of Experts.