Financeability tests and their role in price regulation - IPART - NSW ...

2 Why do IPART and other regulators test for financial
viability?
2 Why do IPART and other regulators test for financial
viability?
We generally assess financeability as part of our price determination process to
ensure that our pricing decisions will not threaten the regulated business’s financial
viability in the short to medium term. Assessing financeability is relevant to matters
required to be considered under Section 15 of the Independent Pricing and Regulatory
Act 1992 (IPART Act). While our overall approach to regulation and the building
block method we use in making price determinations are designed to ensure the
regulated business’s financial viability over the long term, it does not necessarily
ensure this viability in the shorter term. Further, while it may be argued that
financeability issues are less critical for government-owned businesses (which is the
case for most of those we regulate), we consider these issues are still important given
that our approach to regulating these businesses is predicated on a competitive
private business model.
In the building block model, prices are derived based on an assumed WACC which
is derived using an assumed cost of debt associated with a specified credit rating and
an assumed (notional) gearing ratio. When calculating the financial statements of a
utility, we can:
� use the notional gearing level used in the WACC, or
� use the actual level of debt of a utility divided by the value of the RAB to compute
a gearing level.
Financeability tests involve checking whether the time paths of particular financial
ratios which are outputs of the model are consistent with the assumed credit rating
used as an input by reference to standards used by the rating agencies. However, the
test involves some judgement because:
� rating agencies take additional factors into account, and
� the firm has flexibility in payout, capex and financing decisions which mean that
it is likely that its actual gearing ratio will deviate from the notional gearing ratio.
Other regulators assess financeability for similar reasons. However, the importance
of this assessment varies, depending on the legislative framework under which the
regulator operates.
The sections below discuss our legislative obligations in relation to assessing
financeability, and explain in more detail why we need to assess financeability even
when the building block model is used, and when the regulated business is
Financeability tests and their role in price regulation IPART 5