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

4 How IPART should address finaceability in the future?
Where overseas regulators have used a higher credit rating, the regulated businesses
are generally publicly-traded and so there is more information available to the
regulator to make an independent assessment on the appropriate credit rating.
Our preliminary view is that a benchmark credit rating of BBB+ to BBB remains
appropriate.
IPART seeks comment
3 Should we continue to use a credit rating of BBB+ or BBB as the benchmark for
passing the financeability test? If not, what benchmark should we use?
4.3 Should we use notional or actual gearing ratio for the financeability
test?
Using a notional gearing ratio in calculating the regulatory WACC is well-established
practice. For most of the utilities we regulate, we use a notional gearing ratio of 60%
for this purpose. This implies that, in our view, the efficient capital structure for a
typical Australian network utility consists of 60% debt and 40% equity. This gearing
ratio then feeds into several parts of our building block model and our financeability
assessment:
� the WACC used in calculating the allowances for a return on and of capital is
based on a constant 60% gearing level throughout the determination period
� the annual interest payments within our building block model are based on the
60% gearing level.
However, we used the actual gearing ratio in our financial ratio analysis in most of
our determinations (section 3.1). In a few cases, we used notional gearing and in one
case both notional and actual.
We have favoured using the actual over a notional gearing ratio in our financial ratio
analysis in the past because it reflects commercial practice more closely. It enables us
to assess the impact of our pricing decisions on the financial viability of the regulated
business over the determination period. In contrast, using the same notional gearing
ratio we use in calculating the WACC would place more weight on the long-term
viability of a business. While we consider this makes actual gearing more
appropriate for the financeability test, there are some problems with its use. For
example:
� using the actual gearing level in the financial ratio analysis is inconsistent with the
notional gearing (and the target debt margin) assumptions in the WACC, and
� using actual gearing means that businesses within the same industry are not
treated equally due to variations in actual gearing levels.
A highly geared business will have a lower credit rating than an equivalent business
with a lower level of gearing.
Financeability tests and their role in price regulation IPART 21