A renewed capital investment structure is required for long-term investment in power infrastructure.
The bank markets and the long-term fixed income markets, or...
Business & Money
with a separate corporate identity and an appropriate capital structure the parent. The utility should be, at the very least, a separate subsidiary, with its own accounting system, separate debt and preferred stock ratings, its own cash-management system, and operations financed separately from its parent. Optimally, a special-purpose entity or limited-purpose operating entity would be created that would achieve almost complete credit isolation and bankruptcy remoteness. Finally, the parent must guarantee that it will not include the utility in a petition for bankruptcy protection.
While structural ring-fencing is a necessary antecedent to effective insulation of a utility, it alone is insufficient unless coupled with operational ring-fencing policies. These policy tools are more of an administrative burden for PUCs because they require active oversight of: (1) affiliated transactions; (2) dividend policies; (3) securities issuances and financings; (4) ownership changes; (5) diversification investments; and (6) asset transfers.
The power of PUCs to provide the necessary operational ring-fencing varies significantly. The New Jersey Board of Public Utilities, for example, has expansive ring-fencing powers, while other PUCs do not. At the federal level, provisions in the Public Utility Holding Company Act (PUHCA) allow for various operational ring-fencing for companies under its purview. For example, PUHCA prevents cross-subsidization of non-regulated businesses by registered utilities. In addition, FERC policies prevent companies from borrowing money against utility assets to finance non-utility activities. FERC jurisdiction is limited, however. This operational oversight not only helps to protect the financial health of a utility, but it also helps to protect ratepayers by making cost-based regulation more accurate financially.
Most structural and operational ring-fencing mechanisms are derived from specific statutory powers granted to PUCs, although commissions lacking these may be able to impose ring-fencing under general regulatory powers via settlements in rate cases and mergers, for example. Irrespective, utility commissions should anticipate resistance from holding companies, particularly if the authority is derived from general powers instead of specific statutory language.
A careful legal analysis of existing powers to ring-fence should be initiated before embarking on such policies. Both Fitch and Regulatory Research Associates have recently completed major studies on ring-fencing that may provide some insight into what statutory and regulatory powers are needed for effective ring-fencing.
Moreover, if PUHCA is repealed, that would leave a gaping hole in the supervision of holding companies, so state legislative action may be necessary. At the federal level, there is growing support for an amendment to the Federal Power Act that would enable state and federal regulators to ring-fence utility subsidiaries.
In conclusion, ring-fencing holds out the prospect for insulating regulated utilities from the traditional failed diversification investments of the parent holding company. There always will be incentives for holding companies to seek out higher risk/return opportunities in related markets and industries. Absent a blanket prohibition of these activities and forced divestitures, holding companies will to varying degrees expose their regulated subsidiaries to potential harms from failed investments.
Successful ring-fencing is even more critical considering that state regulators are facing the challenges created by failures of corporate governance, accounting scandals, and in some cases alleged criminal conduct