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legal and practical impact of the Ofgem consultation on NIA and NIC

23 January 2018

The Office for Gas and Electricity Markets (Ofgem) has recently reviewed the governance arrangements for the gas and electricity Network Innovation Allowance (NIA) and Network Innovation Competition (NIC), as well as a number of other arrangements relating to holders of gas transporter or electricity transmission/distribution licences (licensees). The NIA Governance Document is the authority for the regulation, governance, and administration of the allowance and the NIC Governance Document addresses the regulation and governance of the competition awards.

In general, Ofgem have introduced a host of changes, some unique to each strand of funding and some that affect both the NIC and NIA, but one can’t help noticing the result is likely to yield increased costs for the licensees who wish to make NIC bids going forward, or to simply use their NIA.

Set out below is a detailed analysis of the changes and interpretation of the impact but before going into the detail, a short recap of the frameworks might be beneficial for those that aren’t aware of the structures, or are a little rusty.

Contents

  1. Background to NIA and NIC
  2. Sharing of trial data
  3. IP clarification
  4. Removal of requirements for Customer Engagement and Data Protection Plans
  5. Reporting
  6. Project eligibility
  7. NIC cost claim changes
  8. Increased partner involvement
  9. Changes for the better?

Background to NIA and NIC

The NIA and NIC both provide funding to licensees to incentivise them to develop innovative research and development projects (projects).

With this funding, licensees are expected to embark on projects with third party partners, such as independent network operators, small and medium-sized enterprises (SME’s), universities, or any energy producers (partners). Successful projects are to be implemented, enabling them to become an everyday part of the licensees’ business and thus allowing customers to benefit from efficiency savings. Even if the project is not successful, Ofgem believe that valuable lessons can be learned that could potentially result in future efficiency savings.

The NIA provides a set amount of annual funding to licensees to fund small scale projects. The amount of NIA a licensee is due is calculated using the formulae in the NIA Licence Condition – a document which has also received slight amendments by Ofgem recently.

The purpose of the NIC is to encourage licensees to “innovate to:

  • address issues associated with the move to the low carbon economy; and 
  • deliver wider environmental benefits to customers” (according to version 3 of the Gas NIC Governance Document).

Both the NIA and NIC are successors to the Low Carbon Networks (LCN) Fund, and the NIC in particular seeks to partially replicate the second tier of the LCN - an annual competition between licensees and partners for funding towards particular projects.

Unlike the NIA, the NIC is focussed on larger scale projects which are more complex and, in theory, more innovative. The key differentiator with NIA is that the projects have to be focussed towards driving low carbon and / or environmental benefits to gas and electricity customers. NIA was originally much easier to use on a variety of projects, although this is set to become ever so slightly more difficult, due to the latest changes.

Before the changes, the Gas NIC awarded up to £20m of annual funding, whilst the electricity NIC awarded up to originally £90m per annum and now £70m per annum. The NIC began in 2013 and will run until at least 2021

Sharing of trial data

This change impacts both the NIA and NIC routes to funding. To encourage greater collaboration, licensees will soon need to have systems in place to be able to share data with other licensees. Ofgem recognise that projects involve gathering significant amounts of data, some of which may be useful in a number of contexts. To this end, licensees, by the 30 September 2017, needed to have in place publicly available data sharing policies which set out the terms on which data will be provided to those who request it.

Whilst in theory the benefits of this idea seem clear, some licensees may feel the burden of complying, particularly those who do not already have data sharing policies that can be used. In their absence, clear and compliant data sharing policies will need to be drafted. What complicates this task is that no clear guidance has been given on the limits on data that should be shared and may be retained, despite feedback in the consultation explicitly requesting this.

Ofgem envisages all data shared under this new requirement will be anonymised prior to sharing so licensees need to have an efficient and cost-effective way of anonymising any personal data they may come to hold through certain projects. Indeed, the handling and anonymising of personal data brings with it data protection concerns, particularly as the General Data Protection Regulation (GDPR) comes into effect next year (discussed further below). The upshot of this for licensees and partners is that all parties will require robust advice around the new GDPR regulation to ensure compliance and to not subject themselves to excessive potential fines.

IP clarification

A change, which the vast majority of those consulted welcomed is a production of a ‘plain-English’ guide to intellectual property rights (IPR) arrangements for projects funded through the NIA and NIC.

IPR have historically been a tricky area for licensees to navigate through, and the broad guidance currently contained in the governance documents provides little assistance on the best approach, with many inconsistent provisions. Unfortunately, the ‘plain English guide’ will likely only result in a list of examples of arrangements that are considered ‘default IPR arrangements’, and a non-exhaustive list of alternative arrangements that are not considered default, but which Ofgem may consider due to the circumstances. Rather than being an attempt to rectify some of the problems licensees encounter with IPR arrangements, this update merely seeks to rephrase the existing problematic guidance. Unhelpfully, at the time of writing, the guide has not yet been drafted, making its use impossible to assess.

It seems likely that the problems that licensees currently encounter will persist. For example, the NIA Governance Document states that “Relevant Foreground IPR ” must be made available freely to other licensees. Relevant Foreground IPR is described as “Foreground IPR that other Network Licensees need to utilise in order to implement the method being developed or demonstrated in the Project”. Aside from being horribly ambiguous, the problems with these requirements are vast. For example:

  • the licensee’s partners might be unwilling at the contract stage to allow other licensees to use any of its Foreground IPR at all, if, in fact, some of it will ultimately be deemed 'Relevant Foreground' and require free of charge sharing
  • above is further exasperated by the Governance Document stating that the licensee and partner may own the IPR in shares (depending on who creates what – not always an exact science), problematic because one party will always require the consent of the other to share any details ‘freely’ plus distinguishing what is in fact ‘relevant’ may be challenging
  • projects don’t always include ‘methods’ and ‘processes’ but instead the development of new technologies capable of patent protection. In such cases what would be considered ‘relevant’?

It is therefore crucial that at the outset, the contract states that all Foreground IPR that is not solely owned by the licensee is at least licensed to the licensee, and that the use of this licence is clearly defined allowing any sharing required. Of course, partners are less likely to be enticed by this prospect, most enter into such projects for commercial gain of some description.

There are further inconsistencies in the governance documents surrounding access to Background IPR, that being IPR in existence prior to the project owned by a collaborating party. How do parties access this when it is required to use the Foreground IPR? Can partners hold licensees ‘over a barrel’ and demand high fees meaning the project has delivered no cost savings? This is exacerbated further by unclear wording surrounding what is considered a ‘commercial product’. All of the uncertainty in the IPR provisions remains despite the consultation and is wide open to interpretation.

Complicating matters further are the Utilities Contracts Regulations 2016, which governs how licensees may procure services. These regulations, which are often forgotten about at the early stages of research and development (R&D) negotiations due to R&D activities being exempt from a procurement process, mean that licensees need to tender for the industrial production of successful products that arise as a consequence of a project. Not only does this mean that partners cannot automatically be awarded a supply contract (even though they often may be best placed to act as a supplier for the product they helped develop), but it also means that partners’ background IPR may need to be used by the licensees in order to complete a successful tender. This is understandably something few partners are unwilling to agree to at the contract stage and can act as a blocker to successful projects.

A way around this issue has been to tender for services before the project has actually been carried out, but suppliers are understandably less enthusiastic about competing for the production of a product that they know very little about and is at research stage, and licensees are reluctant to invest resources in tendering for a product which has no guarantee of success. Perhaps the future is to consider setting up innovation partnerships following the Utilities Contracts Regulations 2016 procurement process. No doubt this will lead to delays in delivery and further incurred costs of upfront processes.

There is no obvious solution to these problems, but by ignoring the opportunity for reform, Ofgem have ensured that licensees will need be on their toes when it comes to interpreting the Governance Document, as well as being clear on the oft forgotten effect of competition law and the Utilities Regulations when it comes to implementing the fruits of a project into ‘business as usual’.

Removal of requirements for customer engagement and data protection plans

Many licensees will be relieved to hear that, under NIA and NIC, the requirement to draw up and submit to Ofgem for approval customer engagement and data protection plans, at least two months before a project was due to begin, has been scrapped. The plans had to contain details of how the licensee planned to engage with customers and manage any personal data obtained during a project.

Ofgem reason that they are not best placed to review customer engagement plans, and believe there is ample incentive within price controls to effectively engage customers/stakeholders. The removal of the data protection plan requirement is likely a nod to the fact that, on 25 May 2018, the GDPR will come into effect. Companies across all industries are gearing up - some better than others - in time for the GDPR, which imposes far greater controls on handlers of personal data than the current Data Protection Act regime. Falling foul of the GDPR can result in fines of up to EUR 20 m, so whilst licensees will no longer have to submit data protection plans, they will likely find that much more time and money is spent ensuring compliance with the GDPR in any event. This is a regulation that all collaborating parties are going to need to ensure compliance with.

Reporting

More minor changes see the annual reporting of NIA being merged with the NIC report. Ofgem believe this will prevent duplication and increase visibility through a central document. However, in response to feedback that certain NIC projects require more regular reporting, Ofgem have not precluded more frequent NIC reporting, should a licensee wish to continue to do this.

A new ‘business as usual’ report will also be required for both NIC and NIA projects. Ofgem intend to establish a working group to create two new templates for this reporting requirement in an attempt to ensure that reporting is proportionate and consistent. One template will deal with the actual benefits of rolling out innovative solutions into business as usual (relative to the costs of former methods) whilst the other will require an assessment of innovative solutions and their forecast of the possible benefits they will deliver. Understandably, stakeholders are concerned at the extra resource required to comply with this new obligation, but it is difficult to assess whether these fears are justified until the templates are published later this year.

Project eligibility

Ofgem’s final policy decision, published on 31 March 2017, included a ‘telling off’ to certain licensees who are using both NIA (and to a lesser extent NIC) funding for projects that lacked innovation or failed to directly benefit networks (as opposed to the pure production of electricity and gas).

In this context it is not surprising that Ofgem, in addition to promising to get in touch with licensees whose use of NIA funding they are concerned about, are now requiring licensees to explain how their proposed project meets the NIA eligibility criteria. This explanation will be required in the Project Eligibility Assessment (PEA); in particular the licensee needs to demonstrate why:

  • the project is innovative and has not been tried before
  • the licensee will not fund the project as part of its business as usual activities
  • the project can only be undertaken with the support of the NIA.

The assessment then needs to be signed by the “senior person responsible for implementing NIA Projects”.

The reception on consultation to this change was mostly neutral, with a dissenting few questioning the need for it when they already have robust internal authorisation processes for innovation projects. For those that don’t have such internal processes, this change has the potential to add an administrative burden considering the previous requirement was merely to state that the project was eligible. This is particularly the case if licensees have to invest time in discovering whether a project has “not been tried before” – are licensees necessarily in a position to know this? If they aren’t, are they expected to find out before completing the PEA? Ofgem clarified by explaining that licensees will only need to explain the steps they have taken to confirm whether or not a project has been tried before. This may slightly lessen the burden, but there has been no change in the wording of the governance documents to reflect this clarification; potentially leaving unprepared licensees confused at what is expected of them.

Ultimately, this change will require licensees who currently use the NIA to fund business as usual activities to find the funding and resource from elsewhere to undertake such activities, as well as dedicating resource to determine whether or not a project has been tried before. A great example of this is where the only step remaining is technology readiness sign off under safety codes; this presumably now must be funded by the licensee.

NIC cost claim changes

There is a removal of the ‘10% successful delivery award’, which historically allowed licensees and third parties to recover the 10% contribution towards the project costs that they initially make, provided the project was successful and delivered in an efficient manner. A second change is the removal of the provision that allows licensees and third parties to recover NIC bid preparation costs. Previously, licensees were able to recover the greater of £175k or 5% of the funding requested for a bid provided it passed the initial screening process.

The vast majority of stakeholders consulted were predictably opposed to these changes. They argued that they would discourage riskier, more adventurous projects and would focus licensees’ minds on delivering projects which were more about driving network benefits rather than consumer ones, as well as stripping away a motivating factor for delivering projects efficiently. Many also pointed to the financial burden this would place on smaller third parties, to the extent that they may be put off approaching licensees with ideas.

Ofgem, perhaps understandably, responded to the feedback of these two proposals by commenting that the NIC was created to incentivise innovative ideas where there were previously none, and to provide double incentive on this front would be inefficient. More particularly, it argued that licensees and their partners should not be rewarded for good project management, and that the quality of bids will likely increase if the bidders know that it is their capital that is also at stake. However, there is no denying that these changes will squeeze smaller partners in particular, an odd move considering Ofgem’s general push for greater partner involvement.

Increased partner involvement

Ofgem have sought to ramp up partner involvement in NIC projects as there is a concern that innovative ideas are not put forward by licensees because they aren’t a good fit with that licensee’s business model, rather than them being poor ideas.

To rectify this, Ofgem put forward three proposals for consultation:

  • a requirement that licensees issue an annual call for ideas from third parties
  • a requirement on the licensees to respond to all proposals publicly
  • to increase the number of projects a licensee can put forward as full submissions from two to four where additional projects involve the network company partnering with third parties on the latter’s idea.

The majority of those consulted were positive about a requirement for an annual call to third parties, as they believed it would deepen the pool of ideas and experience. There was some disparity though when it came to whether the annual call should be a single industry wide call (and thus benefitting from reduced administrative burden) or whether the requirement should be more flexible. Ofgem decided to take the flexible approach – the Governance Document now requires an annual call “either individually, collectively with other Network licensees or through organisations such as the Energy Networks Association…” - however this does not specify who exactly the call needs to be issued to, how many third parties need to be reached and whether the call needs to be on a national scale or whether a regional call suffices. These are points that haven’t been clarified in the consultation and may lead to some teething problems when the first annual call is due this year (2017/18 regulatory year).

Stakeholders rubbished the idea that licensees should be required to give publicly available feedback to third party responses to the call, due to the commercially sensitive nature of some of these responses.

However, there was unanimous support for increasing the maximum number of bids a licensee can make in a year from two to four, provided the latter two of those bids are ‘third-party led’. This proposal can be praised for incentivising licensee’s co-operation with a potentially diverse range of partners - but could the term ‘third-party led bid’ be any vaguer? Many stakeholders thought this too, and Ofgem has since clarified the wording in the Governance Document to state that a licensee must:

“confirm its intention to implement the proposed Project in partnership with the Non-Network Licensee which submitted it.”

‘Partnership’ is not defined anywhere and this is again something which is likely to experience early stage problems when it is rolled out in practice, and this lack of clarity provides scope for licensees to take advantage of the wording by, for example, involving small partners on a minimal and token scale, so that they may submit extra bids throughout the year.

Attempting to engage third parties and encourage them to participate in the NIC process is admirable, and likely would encourage a greater diversity of ideas receiving funding. But there is no getting around the fact that the removal of the successful delivery award and the ability to recover bid preparation costs sees Ofgem give with one hand and take away with another. It is also questionable how the IPR challenges are compatible with third-party led projects.

Changes for the better?

The amendments to the governance documents, on the face of things, appear to make projects more expensive for licensees. Coupled with the failure to alter the IPR arrangements in a meaningful way, it is difficult to identify any substantial benefit for licensees as a result of these changes.

The counter argument to this would be that the intention of both NIA and NIC was to imbed innovation as a cultural change in the sector. By pulling back some of the recoverable costs and ensuring that licensees have “skin in the game” this may be considered a half-way house to the end of the Revenue Incentives Innovation Outputs (RIIO) period when it is uncertain what, if any, funding will be available for innovation. Ultimately, it is best licensees get used to funding and managing their own innovation without relying on Ofgem.

Needless to say, the next 12 months will be interesting times in the world of NIA and NIC projects. The most hotly awaited document set to be the IPR plain English guide….

 

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