On 9 June 2021, Ofgem published a consultation (the “Consultation”) proposing a range of modifications to its Enforcement Guidelines (the “Guidelines”) and statement of policy with respect to financial penalties and consumer redress (the “Sectoral Penalty Statement”).
Having a duty to regulate the conduct of persons operating in the energy sector, Ofgem’s Guidelines and Sectoral Penalty Statement collectively outline the procedures and considerations that the regulator must take into account when deciding whether and how to use some of its statutory enforcement powers. Following a review of its approach to enforcement and market developments, the Consultation sets out Ofgem’s proposed changes to make allowance for the evolving nature of the energy market and enforcement landscape.
In this article, we summarise some the main proposals, and what these might mean for regulated energy companies.
Ofgem (acting on behalf of the Gas and Electricity Markets Authority, “GEMA”) is entrusted with statutory enforcement powers that enable it to respond to conduct that is unlawful, anti-competitive or detrimental to consumer interests. These formal regulatory enforcement powers include:
imposing financial penalties and issuing orders to require compliance, compensate consumers or remedy a harm where certain licence conditions and certain legislative requirements have been breached, including requirements specified in the Gas Act 1986, the Electricity Act 1989 and the Electricity Capacity Regulations 2014 (the “Sectoral” powers);
issuing infringement decisions, accepting commitments and imposing directions and penalties for breaches of the prohibition on anti-competitive agreements and abuses of a dominant position in the Competition Act 1998;
applying to the court for an order to stop breaches of certain consumer legislation, including under the Enterprise Act 2002, the Consumer Rights Act 2015 and the Business Protection from Misleading Marketing Regulations 2008; and
- imposing financial penalties, making restitution orders, or issuing statements of non-compliance where there has been a breach of certain legislative requirements set out in the Electricity and Gas (Market Integrity and Transparency) (Enforcement etc.) Regulations 2013 (the “REMIT civil enforcement”).
In addition, Ofgem may use less formal “Alternative Action”, such as accepting non-statutory undertakings or conduct audits, to remedy a matter of non-compliance.
Ofgem has issued various policy documents which seek to explain how it will approach enforcement in practice. Specifically, the Enforcement Guidelines provide a detailed framework describing how Ofgem will use its enforcement tools, provide redress for consumers and address infringing behaviour. The Guidelines also aim to enable Ofgem to deliver on its enforcement objectives, which include providing credible deterrence, enabling competition and innovation, and ensuring that the consequences for non-compliant businesses are visible and meaningful. A variety of factors must be taken into account by Ofgem when considering whether to impose a financial penalty or consumer redress order, and to what extent – these factors are outlined in the Sectoral Penalty Statement.
Ofgem’s Guidelines were last revised in October 2017, and the Sectoral Penalty Statement in November 2014. Since then, the energy sector has advanced significantly, and will continue to evolve as the transition to net zero progresses. In addition, the proposals take account of new licence requirements brought in under the Supplier Licensing Review.
It is worth noting that Ofgem also has separate powers to investigate and prosecute certain criminal offences under legislation including the Gas Act 1986, the Electricity Act 1989 and the Electricity and Gas (Market Integrity and Transparency) (Criminal Sanctions) Regulations 2015. Ofgem’s approach to criminal enforcement and REMIT civil enforcement is subject to separate guidelines and policy statements, which are outside the scope of the current Consultation. It is, however, mentioned in the Consultation that Ofgem intends publish a separate consultation in respect of proposed changes to its Statement of Policy on Financial Penalties and Restitution under REMIT and the REMIT Procedural Guidelines in July 2021.
Updates to the Settlement Process
Some of the main proposals outlined by Ofgem in the Consultation relate to the settlement process for Sectoral cases, being cases where enforcement action is taken against regulated persons for breaches of relevant licence conditions or requirements under the Gas Act 1986 or the Electricity Act 1989 (in other words, not as part of Ofgem’s competition or consumer law remit). The Guidelines set out a process for reaching settlement, whereby the investigated business must voluntarily admit to the breach, resulting in a formal finding of breach, and agree not to challenge or appeal Ofgem’s finding or resultant penalty or order.
Under the present guidelines there are three settlement windows (early, middle and late), whereby a sliding scale of percentage discounts is offered to the non-compliant person if settlement is reached within a specified time period. Whilst this incentive mechanism is designed to save resources and secure customer redress at an earlier stage, in practice, Ofgem maintains that settlement is a lengthy and resource-intensive process. Accordingly, it proposes to remove the ‘middle’ and ‘late’ settlement windows and retain only one settlement window at a 30% discount, equivalent to the prior ‘early’ window, unless there are exceptional circumstances. This window will open when the settlement offer, draft penalty notice and/or redress order and press notice have been provided to the regulated person, and close after a ‘reasonable period’, likely to be 28 days. By reducing settlement discount to a single (early) window, Ofgem hopes to continue to incentivise businesses that are willing to settle, but also make findings of breach closer to their time of occurrence and achieve redress for consumers as early as possible. Simplification of the settlement windows is also said to be of benefit where businesses are not willing to settle; the expectation is that it will result in quicker resolution as the case will instead move forward to the contested process without prolonged settlement periods running in parallel.
In addition, Ofgem proposes to change the decision-making entity for settlements. Currently, a Settlement Committee makes settlement decisions. Settlement Committees are made up of one Ofgem Director and two members of the Enforcement Decision Panel (itself made up of dedicated specialists employed only for enforcement duties and who are independent from Ofgem’s investigation teams). Ofgem is seeking views on its proposal to allow the Ofgem Director responsible for enforcement (or another Ofgem Director nominated on their behalf) to be the decision maker for settlement cases, with the Settlement Committee being retained as an alternative option where the Enforcement Decision Panel’s expertise may bring benefit. The Ofgem Director would be able to issue a settlement mandate, approve or issue a settlement penalty notice and approve final settlement decisions. Ofgem maintains that this change is aimed at addressing the concern that Alternative Action, with no formal finding of breach, is less of a deterrent, yet it is increasingly used as a quicker way to secure customer redress and resolve concerns.
Provisional and Final Orders
Pursuant to the Gas and Electricity Acts, Ofgem (on behalf of GEMA) may:
make a provisional order where it appears that a regulated person is contravening or likely to contravene a relevant condition or requirement and the order is required before a final order can be made; or
make a final order or confirm a provisional order, if it is satisfied that a regulated person is contravening or is likely to contravene a relevant condition or requirement and where that order is required to bring the breach(es) to an end.
Certain procedural requirements must be followed to make these orders. Citing the increased use of provisional and final orders to address non-compliance, Ofgem is proposing to update the Guidelines to provide greater clarity on: (i) the order framework and (ii) the process for imposing penalties/redress orders following the making of a final order or confirming a provisional order.
Section 7 of the updated Guidelines, annexed to the Consultation, is now dedicated to enforcement orders, and delineates when and how the authority may make (or revoke) a provisional or final order. Among other things, it now clarifies that if the regulated person fails to comply with the final order within 3 months, a final 30-day notice may be issued explaining that their licence may be revoked after expiry of the notice if non-compliance persists. The revised Guidelines also now include a dedicated sub-section explaining Ofgem’s approach to issuing financial penalties and/or redress orders following the making of a final or provisional order.
The Sectoral Penalty Statement
In essence, Ofgem states in the Consultation that it is seeking to simplify and clarify the Sectoral Penalty Statement. This statement, required pursuant to the Electricity and Gas Acts, sets out a number of factors that the authority must take into account when determining (i) whether or not to impose a financial penalty and/or consumer redress order as a result of a contravention; (ii) the amount of any financial penalty; and (iii) the requirements of any consumer redress order.
Following the Supplier Licensing Review in January 2021, several new licence requirements were introduced for suppliers. This has resulted in certain conduct becoming a form of breach in itself, rather than a factor that might be considered when imposing and calculating financial penalties and consumer redress orders. Further, certain behaviours will no longer be considered as mitigating factors as they are now required by the new licence conditions. The Consultation presents the new supply licence requirement to self-report breaches as an example of this, which was previously a mitigating factor. To take account of the outcomes of the Supplier Licensing Review, the Consultation proposes to include a statement (currently at paragraph 4.2 of the revised Sectoral Penalty Statement, annexed to the Consultation) which highlights that conditions and requirements are regularly updated, and the authority does not have to take a particular kind of conduct into account when deciding whether to impose a penalty or order where such conduct may amount to a contravention itself.
Lastly, Ofgem proposes to simplify elements of the process used to calculate financial penalties and consumer redress orders. Currently, two elements must be considered:
the gain made by the contravening entity and the detriment suffered by consumers as a result of the breach (known as the “gain and detriment element”); and
the seriousness of the breach, including aggravating or mitigating factors (known as the “penal element”).
To address the complexity of calculating gain and detriment, and the significant resources required to do so, Ofgem is suggesting that these components will only be calculated where proportionate, reasonable and practical to quantify. Where this is not the case, unquantified gain or detriment is to be considered qualitatively as part of the seriousness assessment noted above.
For the penal element, Ofgem is proposing to simplify and condense the number of aggravating and mitigating factors used to determine this by moving to a more high level principles-based approach. The principles that are replacing the aggravating/mitigating factors include (but are not limited to):
the seriousness of the contravention;
the impact of licensees’ behaviours, including whether the contravention damages the interests of consumers or other market participants; and
how necessary the penalty is to deter future contraventions.
The theme underpinning Ofgem’s proposals is the stated desire to increase flexibility, free up resources, and speed up enforcement. While regulated persons would of course welcome a more streamlined, efficient and simplified approach to enforcement cases, this has to be balanced against the substance of the proposed changes.
On closer inspection, the majority of the proposals appear to reduce the burden on Ofgem, while changing very little (if anything) that achieves the same for regulated persons. Moreover, it seems that the desire to increase simplicity and speed has effectively removed valuable safeguards. More specifically:
the presence of Enforcement Decision Panel (“EDP”) members in Settlement Committees provides valuable assurance that settlement offers and decisions are fair and balanced. Removing the role of independent EDP members is unlikely to be seen as a change that improves the settlement process;
similarly, while Ofgem notes that the “middle” and “late” settlement windows have not yet been used, it is difficult to understand why this is a valid justification for removing them entirely. This is particularly true in circumstances where (as Ofgem acknowledges) settlement and contest currently move in parallel. In our experience many breaches are involuntary, and businesses often need time to gather information and understand whether to settle or contest enforcement decisions. Depriving them of the opportunity to settle at a later stage may have the opposite effect of increasing the length and complexity of the process through protracted contest;
the proposal that Ofgem will, in most cases, no longer calculate the “detriment and gain element” of penalties/redress orders is capable of causing some concern. While lengthy and complex, the detailed quantitative calculation supporting the quantum for penalties allows both regulated persons and consumers to ensure that these accurately reflect the gain and detriment; and
finally, moving to a more principles-based approach when calculating the “penal element” for penalty/redress orders appears positive in principle, allowing greater flexibility in unforeseen circumstances. It remains true, however, that Ofgem will interpret and apply those principles, while prescribed factors can sometimes provide a more objective basis for assessing the seriousness of a contravention.
This is not to say that there are not positive elements in the proposals. In this respect we note Ofgem’s intention that the changes will reduce the scope for Alternative Action, which is sometimes perceived as a more discretionary and nebulous process with fewer embedded protections and safeguards. The improved clarity surrounding timeframes and consequences where there is non-compliance with enforcement orders, as well as the process for imposing financial penalties in those circumstances, is similarly an improvement.
It cannot be discounted, however, that the proposed changes presage an increased momentum for enforcement action. The proposals come against the backdrop of Ofgem increasingly using its enforcement powers and market players would be well advised to ensure that regulatory compliance functions are sufficiently resourced and alive to new licence and statutory requirements. It is also possible that a more assertive enforcement posture on Ofgem’s part will be “priced in” by market players, to account for the additional resources committed to dealing with investigations, which can therefore increase regulatory costs that are ultimately borne by consumers.
Regulated persons wishing to respond to the consultation should do so soon as the deadline for responses is 4 August 2021.