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After PUHCA Repeal: The State Response

Will the industry be able to meet capital investment and growth expectations?

Fortnightly Magazine - May 2006

possesses unclear or ambiguous legal authority to impose conditions, promulgating a rule relying on such authority will likely be challenged on appeal. The commission thus runs the risk that a court may find it acting beyond the scope of its authority, and prevent the commission from imposing such conditions in future contested cases. If, however, a commission refrains from adopting a rule, it may continue to leverage its assertion of this authority in specific cases so long as the question of legal empowerment remains open.

But not acting now to adopt specific measures leaves unclear what type of conditions the commission may impose in future merger applications if the commission has a sparse or nonexistent track record. Fox opts to remove this uncertainty: “It is far more preferable for us to adopt rules for transparency’s sake so that companies know beforehand what’s required. The alternative is to rely on a ‘who-happens-to-be-in-office, who-do-you-know’ system. Administrations change, but you don’t want the rules to do likewise.”

2. Measures Adopted By Other States.

Although state commissions are independent from one another, they typically look for guidance from practices in other states in shaping policy. One oft-cited practice has been the adoption of “ring-fencing” measures embodied in state law or imposed in rate or merger approval proceedings by state commissions when exercising authority to protect ratepayers from holding company risks. According to Fitch Ratings, “The aim of a ring-fence is to insulate an issuer [ i.e., the utility] from the credit risks of its holding company and affiliate companies.” 12 Ring fencing could consist of any one of the following measures: 13

  • Dividend restrictions
  • Equity ratio requirements
  • Unregulated investment restrictions
  • Maintenance of stand-alone bond ratings
  • Collateralization requirements
  • Working capital restrictions
  • Prohibitions on inter-company loans
  • Prohibitions on utility asset sales
  • Independence of board members.

While various commissions previously have employed ring- fencing measures, one of the most notable instances occurred when the Oregon Public Utility Commission approved Enron Corp.’s acquisition of Portland General Electric Co. (PGE). The case illustrated administrative ring-fencing’s general merit in protecting the utility from the bankruptcy exposure of its holding company parent.

The Oregon commission approved a stipulation and agreement that provided, among other things, that: (1) PGE maintain separate debt and preferred stock ratings; (2) PGE not make any distribution to Enron causing PGE’s equity to fall below 48 percent of total PGE capital without the commission’s approval; and (3) Enron notify the commission in advance of payment of upstream dividends from PGE. Although these conditions were sufficient to enable PGE to maintain its financial integrity upon Enron’s bankruptcy, it did experience a temporary loss in credit quality of its unsecured debt, and constrained access to capital in the commercial paper market. 14

Notwithstanding the virtues of ring-fencing, not all measures are without cost. A February 2005 report by the staff of the Maryland Public Service Commission, which evaluated various forms of ring-fencing, noted that the thickened equity ratio imposed by the Oregon commission on PGE had two downsides. It could: (1) raise the cost of capital since equity cost exceeds