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

2 Why do IPART and other regulators test for financial
viability?
For example, financeability is relevant to the payment of dividends (see Sections
15(c) and 15(g)), borrowing and capital requirements (Section 15(g)), and the capacity
to fund assets (Section 15(g)). In the longer term if new investment cannot be funded
the quality, reliability and safety of the services may ultimately suffer (Section 15(l)).
Therefore, indirectly, financability may be considered in having regard to many of
the matters listed in Section 15.
Tests of financeability assess the capacity to pay dividends and fund new investment
from capital and borrowings from current and future cash flows. Given the
commercial and regulatory precedents for testing financeability it may be seen as a
useful metric for assessing the extent to which we have taken into account the
financial considerations of Section 15. However, these financial factors have to be
considered alongside other factors in Section 15. Our legal obligations on IPART in
regard to the consideration of financial issues differ from those in the UK where
much of the discussion of financeability has occurred. Finally, it should be noted that
financability requirements may be less relevant to those businesses that rely upon
large general subsidies or direct government funding such as CityRail. In these cases
it is harder to directly link commercial tests of viability to the requirements of Section
15, such as the funding of new investment or dividend and capital or borrowing
requirements.
2.2 Why we need to assess financeability when building block method is
used
We usually base our pricing decisions on an estimate of the revenue the regulated
business will require to meet its full, efficient costs over the determination period.
We use the building block method to calculate these costs, which include operating
and maintenance costs, plus allowances for returns on and of its assets. In
calculating these allowances, we determine the appropriate rate of return on the
business’s regulatory asset base (RAB) by calculating its WACC using the capital
asset pricing model.
This approach should allow the regulated business to recover all its efficient costs
over the life of its assets, and thus should ensure its long-term financial viability.
However financeability problems can arise due to:
� poor financial management and/or excessive costs
� a mismatch between revenues and costs under the building block method.
Financeability tests and their role in price regulation IPART 7