Ofgem and BEIS join forces to set out long-awaited reforms to Energy Code Governance in latest consultation

On 20 July 2021, Ofgem and the Department for Business, Energy & Industrial Strategy (“BEIS”) published a joint Consultation on the Design and Delivery of the Energy Code Reform (the “2021 Consultation”) seeking views on a range of proposed reforms to a broad spectrum of energy codes[1].The 2021 Consultation followed on from a joint 2019 Consultation on Reforming the Energy Industry Codes (the “2019 Consultation”). The 2019 Consultation highlighted overarching challenges with the current code governance framework – that it is fragmented, reactive as opposed to forward-looking and overly complex. The 2021 Consultation echoes these criticisms and builds on proposals in the 2019 Consultation, putting forward two alternative reform models aimed at creating a more unified, coherent and dynamic approach. This article provides a high-level summary of those proposals.

Current challenges and areas for reform

Challenges identified with the current framework include:

1. Modifications are slow to implement, with lengthy modification processes. As an example, the 2019 Consultation cited that it takes on average 200 to 250 calendar days to make changes to the BSC, DCUSA and UNC.
2. Code changes tend to be reactive to existing problems, as opposed to forward-looking in preparing the energy system to meet future challenges. This is due in part to the lack of co-ordination between the large number of code panels and bodies with varying governance and ownership arrangements.
3. The industry-led nature of code governance creates potential for conflict of interest and lack of incentive to make changes in the interest of customers.
4. The codes are extremely lengthy and overly complex. This acts as a barrier both to participation in the industry and to code reform. Understanding the codes takes significant resources, which can disincentivise engagement from new entrants to the market, particularly smaller players.

Echoing the suggestions made in the 2019 Consultation, Ofgem and BEIS set out four areas for reform in the 2021 Consultation:

1. Providing strategic direction – to ensure that the regulatory system is forward-looking, with codes informed by the government’s overall vision for the energy system.
2. Empowered and accountable code management – incorporating mechanisms to ensure that appropriate code changes are implemented to deliver the strategic direction, and that these changes are progressed in a clear and logical manner.
3. Independent decision-making – rebalancing decision-making away from industry control.
4. Code simplification and consolidation – simplifying codes to ensure that they are suitably adaptive to a changing industry and more accessible to code parties.

Overview of proposals

The 2021 Consultation builds on the 2019 Consultation and sets out two alternative reformed governance models, summarised below.

Model 1 – (Ofgem and BEIS’ preferred option) a split strategic function performed by a separate ‘strategic body’, with separate code managers:

Ofgem as strategic body

In this role, Ofgem would develop and annually publish a strategic direction for all codes, to be implemented by the code managers. Ofgem would hold code managers to account via their licences. Specifically, a code manager licence and tender process would be developed to manage potential conflicts of interests. As the strategic body, Ofgem would grant licences and monitor and (where appropriate) enforce the licence conditions of the code managers. Ofgem would determine whether or not material code changes should be approved. Examples of Ofgem’s other code reform activities may include considering how to streamline the code change processes across codes and how codes could be digitalised.

Code managers

Code managers would be appointed via a competitive tender process and those with conflicts of interest would not be eligible. BEIS and Ofgem propose that primary legislation would set out the framework for tendering, including powers to make secondary legislation which would provide for the tendering process and selection criteria. Code managers would replace existing code administrators and take over the majority of roles currently performed by industry-led panels. Code managers would be responsible for developing annual delivery plans based on the strategic body’s overall plan.

They would also decide upon non-material code changes and make recommendations in respect of material code changes.

Process

Under Model 1, Ofgem as the strategic body would be able to directly develop or change codes. In addition, any interested person could suggest a change to the code manager. The code manager would then decide on the materiality of the change. For non-material changes, the code manager would manage the process, develop the code change and decide on the approval of the change. For material changes, the code manager would still manage the process and develop the code change but would make a recommendation to the strategic body instead of a decision. Ofgem (as the strategic body) would subsequently decide on the approval of the material change. See diagram below for a visual overview of the process under Model 1.

Model 2 - an ‘integrated rule making body’ (“IRMB”), where the strategic function and code manager function is combined.

IRMB

The Consultation states that if a Future System Operator (“FSO”) was appointed pursuant to the Energy Future System Operator consultation[2] (launched on the same day as the 2021 Consultation – see our commentary here), this body would be suitable to undertake the combined role of IRMB. One reason stated is that the FSO’s strong focus on whole system thinking and broader co-ordination roles would fit well with the IRMB’s function of providing long-term thinking and direction across the energy sector.

Under Model 2, the strategic function and code manager function would be combined, meaning that there would be no separate code managers. The IRMB would therefore hold most of the responsibilities outlined under Model 1, above. Ofgem would retain some oversight and decision-making in line with its duties as regulator.

Process

Under Model 2, any interested person could suggest a change to the IRMB. The IRMB would then decide on the materiality of the change. For non-material changes, the IRMB would manage the code change process with the support of an external administrative service provider and would decide on the approval of the change. For material changes, including in relation to retained EU law or the EU-UK Trade and Cooperation Agreement, approval from Ofgem would be required. See diagram below for a visual overview of the process under Model 2.

Appeals

The 2021 Consultation considers that regulatory accountability and the appropriate route of appeal for decisions (ultimately for both models) could fall in to one of two ways:

• Judicial Review only; or
• Combination of Judicial Review and CMA Appeal.

Judicial Review only

This route would mean all strategic body decisions on code changes would be subject only to judicial review, including where the decision of the strategic body aligns with the recommendations of the code manager. BEIS and Ofgem note that this would be simple to effect and be relatively future proof as it would avoid gaps emerging between legislation and the substance of the codes themselves as they are developed or consolidated. The 2021 Consultation acknowledges concerns that this option could weaken existing licensee protections because it provides a generally less intrusive standard of review and does not necessarily involve economic and other technical expertise. However, Ofgem and BEIS point out that judicial review applies to many code changes already and has been utilised in other areas, for example the retail price cap.

Combination of Judicial Review and CMA Appeal

Alternatively, a combination of judicial review and CMA appeals may be used. This would require CMA appeal timings to be aligned with the licence modification appeals process. The 2021 Consultation states that creating a route of appeal to the CMA for decisions made by the strategic body on code changes would need to be delivered through primary legislation. BEIS and Ofgem anticipate that judicial review rather than CMA appeal would be available for licence and code changes required to implement their proposals and the outcomes of any code consolidation.

Analysis of the proposals

Model 1 is stated to be BEIS and Ofgem’s preferred option, as they say it would result in a less complex governance landscape, build on the existing expertise of Ofgem and be quicker and easier to implement. Delivery of Model 1 could begin in 2024 and Model 2 in 2026, however both dates would be dependent on the availability of parliamentary time for the introduction of required primary legislation.

However, criticisms of Model 1 are likely to touch on the added layer of bureaucracy that results from separating a strategic body from the code managers, as well as the potential for the strategic body to be out of touch with the codes. The alternative Model 2 also presents challenges, as it gives wide power to one body which requires a more significant skills transfer and could lead to a lack of transparency. In both cases, the move away from industry involvement in the framework is significant.

It goes without saying that an overhaul of the codes and their governance is required to establish and support a system that is fit for purpose long term. In the Energy White Paper published in December 2020 (see our commentary here), BEIS committed to ensuring that the institutional arrangements governing the energy system were overhauled to achieve this. While the proposals in the 2021 Consultation are a positive next step, it remains to be seen which solution will strike the best balance of levelling the playing field for industry involvement and making the framework nimble enough to deal with the challenges of a transforming energy system.

Next steps

The Consultation is one of a flurry of publications issued by government during the month of July. The closing date for responses to the 2021 Consultation is 28 September 2021.

[1] These include the Connection and Use of System Code, Grid Code, System Operator – Transmission Owner Code, Balancing and Settlement Code, Master Registration Agreement, Distribution Connection and Use of System Agreement, Distribution Code, Smart Energy Code, Uniform Network Code, Supply Point Administration Agreement, Independent Gas Transporter Uniform Network Code and Retail Energy Code.

[2] A consultation on the establishment of an expert, impartial FSO with responsibilities across both the electricity and gas systems to drive progress towards net zero while maintaining energy security and minimising costs for consumers.