Notice of appeal (38 pages, 3.7M scanned PDF) to the Competition Appeal Tribunal by a specially-constituted Merger Action Group against Lord Mandelson's decision to clear the proposed HBOS / Lloyds TSB merger.

The grounds of appeal are expressed as:

• Unlawful fettering of discretion: because of media statements (that the merger would be cleared regardless) made at the time of the initial Government announcement of a new public interest ground.
• Wednesbury unreasonableness and error of law: over-reliance on the FSA's “inexpert competition views” that a stand-alone HBOS would not be an effective competitor, rather than on the OFT's competition analysis which found that a stand-alone HBOS would be a significant competitor. The minister's reliance on the FSA's views is said to be contrary to both reason and the rule in the Enterprise Act 2002 that the minister must accept the OFT's conclusions on competition issues. The FSA's views themselves are said to be based in part on a mistaken understanding of EC State aid law and policy.
• Breach of the EC law principle of proportionality, by “excluding other less anti-competitive outcomes” from consideration.

Update. An accelerated timetable has been set, with a CAT case management conference scheduled for Wednesday 3 December 2008, 2 pm. See http://www.catribunal.org.uk/.

Comment. The criticisms of the ministerial decision are well made in the notice of appeal, and the group has a good website. But newspaper reports on the action so far seem rather poorly informed. Franck.

HM Treasury press notice (about 1 page) that it will hold its shareholdings in bailed-out banks through a limited company, UK Financial Investments Limited (UKFI).

UKFI is intended to have full ownership or substantial stakes in Royal Bank of Scotland, Lloyds (if it merges with HBOS), Northern Rock and the Bradford & Bingley mortgage business. Whilst these banks will retain their own boards “determining their own strategies”, UKFI will eventually own Northern Rock and the B&B business, and will be responsible for enforcing the bail-out conditions on the others, including their promise to maintain “the availability and active marketing of competitively-priced lending to home owners and small businesses at 2007 levels”.

There is no mention of any merger control procedures for this restructuring. The shareholdings and extent of influence involved seem greater than for Sky's investment in ITV, which was found to be subject to UK merger control (independently of any media public interest considerations).

The press notice does not give enough information to determine whether UKFI should be seen as an enterprise (rather than part of public administration) and therefore subject to merger control for its acquisition of each bank shareholding. Even if UKFI is not an enterprise, its existence and shareholdings may establish sufficient structural links between the banks that it invests in to warrant a merger investigation by the OFT and Competition Commission. This would be most obviously the case between the Royal Bank of Scotland and a merged Lloyds/HBOS, which would be major competitors in both personal and business banking.

Comment: I can see two ways in which the Government could prevent merger control investigations:

• Strip UKFI of any commercial freedom: its role would be purely to enforce ministerial decisions, which might be deemed to have been made on political rather than commercial grounds. But this conflicts with the press notice's statement that UKFI will be a “arm’s-length company” and its “overarching objectives will be to protect and create value for the taxpayer as shareholder”. And what would be the point of the new organisation then?
• Use the financial stability public interest grounds. But I was not convinced by the way in which this was done in the HBOS/Lloyds TSB decision, and using it to justify structural links between an enlarged Lloyds Bank and the Royal Bank of Scotland would seem harder (and even more likely to be appealed and quashed).

Neither way sounds good. Franck

Ministerial decision (9 pages, PDF) not to refer the merger of Lloyds TSB and HBOS to the Competition Commission, despite the risk of a substantial lessening of competition identified by the OFT.

Under the Competition Appeal Tribunal rules, interested parties probably have four weeks to challenge the decision under section 120 of the Enterprise Act 2002.

Comment: This decision does not look robust to me. The grounds for clearing the merger seem to be that:

12 ... the Secretary of State considers that the merger will result in significant benefits to the public interest as it relates to ensuring the stability of the UK financial system and that these benefits outweigh the potential for the merger to result in the anticompetitive outcomes identified by the OFT.

But whether the benefits “outweigh” the risks is not the relevant test in my view. I think that the minister had to ask himself whether it was necessary to expose bank consumers to the risk of a lessening of competition in order to preserve the stability of the UK financial system. The ministerial decision contains nothing to rebut the proposition that the OFT's counterfactual — the continuation of temporary public ownership of HBOS for a few more years, followed by a non-anticompetitive sale — would have delivered sufficient stability of the UK financial system, without the risk of lessening of competition associated with the merger with Lloyds TSB. In my reading of The Enterprise Act 2002 (Specification of Additional Section 58 Consideration) Order 2008 and section 45(6) of the Enterprise Act 2002, the Government cannot legitimately rely on any alleged additional benefits over and above the basic stability of the financial system as a whole to justify an anti-competitive merger. Franck.

Ofgem proposals (74 pages, PDF) to direct electricity distribution network operators through new licence obligations (12 pages, scanned PDF) to implement specific methods for setting the structure of access charges to their networks.

The main proposals are:

• Access for EHV demand and EHV generation should be priced using WPD's long-run marginal incremental cost modelling method, with an increment size of 100kW for both demand and generation.

• In estimating long-run marginal incremental costs, a notional demand growth rate of 1 per cent a year should be used, irrespective of actual or prospective growth rates for a distribution network area or the relevant network elements. This global assumption is only said to be appropriate if “applied in a modelling context of a long run charging model”.

• The long-run marginal incremental cost should be converted into an annual charge using a 40-year annuity, irrespective of when the notional incremental investment expenditure is estimated by the model to be required.

• In estimating the notional costs of meeting the notional 1 per cent demand growth and the notional increments, network capacity should be calculated by reference to thermal constraints only. Costs associated with fault-level constraints should be recovered through connection charges. But “this is an area we would expect DNOs to keep under review”. The document does not say what happens to the new “common distribution charging methodology” if such reviews conclude that fault levels are important in some companies' networks and not in others.

• If applying Ofgem's model and assumptions “is considered to produce 'excessive' charges that are considered to be in breach of competition law”, distribution companies should “discuss the matter with [Ofgem]”, and (unless the common methodology is fixed) “propose suitable alternative arrangements ... based on their best assessment of the long run incremental cost of providing capacity at that point on their networks”.

• The 1 per cent notional growth figure is set by Ofgem, but “distributors should keep this growth rate under review” and it should be reset at each quinquennial price control review. The document does not say on what basis these reviews should take place, given Ofgem's decision to ignore companies' information on actual or prospective growth rates in setting a global notional number, or what should happen when different distribution companies' reviews find that different growth rates would be reflective of their circumstances.

• For HV and LV network elements, unit costs should be based on a bottom-up cost model for a 500 MW increment covering all aspects of its HV/LV network that are not covered by connection charges. The cost should be allocated between classes of customers on the basis of estimated peak-time load.

The main missing elements are:

• “[Ofgem] encourage[s] DNOs to develop a common methodology for IDNO charging as soon as possible” and “requires DNOs to work with IDNOs on this area of work”. But “given [Ofgem's] concurrent powers under competition law” Ofgem does not think that it would be “appropriate” for it to “determine the methodology”. According to Ofgem, “there is clearly need for further industry debate and discussion before [Ofgem] can make a decision on a common IDNO charging methodology”.

• “[Ofgem's] decision is for common tariff structures from 2010” (subject to potential derogations) but “the details of tariff structures is to be developed by DNOs”.

• Modification and governance arrangements are referred to in the proposed licence conditions but are not specified. Ofgem expects distribution companies to work together to develop theses arrangements, and put forward a document for approval by 1 September 2009. And proposals from Ofgem's review of governance for charging methodologies “may supersede the governance arrangements [whose core features only are] set out in this document”.

Companies have until Wednesday 29 October 2008 to decide whether to accept the licence obligations to implement these proposals. Unless three or more licence holders object (i.e. EDF or any two ownership groups), Ofgem has powers (presumably subject to judicial review) to impose the licence obligations without a Competition Commission inquiry.

Quick comment. The document contains (Appendix 3) some terms of reference for consultants. It seems that Ofgem would like DNOs to procure (and pay for) these services, but the terms of reference envisage most reporting to be to Ofgem. The document also says that Ofgem has “committed to help DNOs develop” some spreadsheets which seem to overlap with those specified in the terms of reference. All very strange. Message to the person in charge of procuring this work: Reckon is interested in making an offer. Contact Franck.

Update, November 2008. Proposals rejected.

UK Government notice (2 paragraphs) stating that the Government intends, subject to Parliamentary approval, to add something related to the “stability of the UK financial system” to the list of grounds under which ministers can intervene in the merger control process and take the final decision instead of the OFT or Competition Commission. The Government intends to invoke these new provisions in relation to the possible merger of HBOS with Lloyds TSB.

There would still be an independent review of the transaction by the OFT and, if referred, by the Competition Commission, with a published report advising ministers on both competition and public interest aspects.

There is no reason to doubt that the ministerial decision would be subject to judicial review (at the Competition Appeal Tribunal) under section 120 of the Enterprise Act 2002, in the same way as a merger control decision made by the independent competition authorities. The only ministerial decision that has been made under the Enterprise Act 2002's public interest regime for mergers (which the new proposals would extend) is the order for Sky to reduce its shareholding in ITV, and this is currently under appeal at CAT.

The right of appeal ensures that, if the grounds for the eventual ministerial decision are not clear and well reasoned, any aggrieved customers or competitors will be able to overturn the decision, or to force the Government to establish publicly its exact purposes about financial stability and the proportionality of any decision that it might make to allow a lessening of competition in order to meet these purposes.

Comment. There is a big gap between this proposal and the Chancellor's statement (or audio from BBC radio, 5:07-5:20) that the Government “will waive the competition requirements in relation to these two banks”. This discrepancy does not reflect a difference between Government departments: HM Treasury's press notice is consistent with the announcement reported above, not with the Chancellor's words. Franck

UK Government announcement (8 pages, PDF) of a plan to “propose legislation requiring energy suppliers and electricity generators to contribute an estimated additional £910 million” towards a “Home Energy Saving Programme”. This cost estimate relates to the period to March 2011.

According to the Government, these compulsory contributions from energy companies would not amount to a windfall tax.

Energy retailers would be required to fund more home insulation measures under the Carbon Emissions Reduction Target (CERT) programme (formerly known as the energy efficiency commitment), at an estimated additional cost of £560 million. The other £350 million are to be spent on a new “Community Energy Savings Programme” which would be “funded through a new and additional obligation on the energy suppliers and electricity generators”.

Under sections 7 and 8 of The Electricity and Gas (Carbon Emissions Reduction) Order 2008, the basis for allocating the burden of the £560 million between retailers seems to be the average number of customers supplied at 31 December 2007, 31 December 2008 and 31 December 2009 (except for new entrants where different rules apply). The basis for allocating the burden of the £350 million is not disclosed.

There are also some plans for future consultations or reviews on surcharges for non-direct-debit payments or pre-payment metering.

The possibility of charging electricity generators for more of the carbon emission permits issues within the current phase (2008-2012) of the EU emissions trading scheme was rejected on the grounds that it was not explicitly permitted in the relevant EU directive.

Comment. Assuming effective competition in retail supply, at least some of the £910 million is likely to be passed through to customers through bills, since the extent of each supplier's overall obligation under CERT will depend on its future market share. In other words, the additional compulsory contributions announced today make it more costly for retails to retain energy customers, and this additional marginal cost on retailers will presumably be reflected in their prices. Given the reliance on customer numbers rather than amounts of energy supplied as the basis for allocating the obligation, the burden of the scheme may be as great on low-consumption households as on high-consumption households. For the Community Energy Savings Programme, the charging base for the new obligation or tax is not disclosed, making it impossible to judge how much of the cost is likely to be passed through to consumers. Franck

Ofgem decision (15 pages, PDF) to prohibit SP Energy Networks' G3 proposals for a new method for determining use of system charges on the SP Distribution electricity distribution network. A similar decision (14 pages and 1 blur, PDF) was issued in respect of SP Manweb.

Ofgem considered that it had powers to prohibit on the grounds that some aspects of the proposals were worse than the current arrangements. Specifically, it states that:

We do not consider it appropriate to approve a methodology which includes a generation model which produces counter-intuitive results. We also consider some of the input data to the model to be too subjective to produce cost reflective charges.

The first point is a reference to SP Energy Networks' proposal to use a test-size generator and probability as a way of calculating the expected level of investment required to accommodate lumpy and unknown future generation. Whilst Ofgem abandons the calculations in its consultation paper on this point, it states that it re-ran the analysis with more realistic assumptions and still considered the results to be counter-intuitive. The new analysis is not disclosed in the decision.

The second point is a reference to SP Energy Networks' proposal to use unit cost data reported to Ofgem (instead of internal management projections) as the basis for costings in the HV model.

On the basis of these alleged adverse effects of the proposal, Ofgem apparently concluded that the proposal would not better achieve the relevant objectives, and that it could take account of its wider regulatory duties in reaching a decision. One factor in support of prohibition appears to have been the prospect of implementation in 2010 of an Ofgem-mandated method, and a desire to avoid frequent changes of approach.

Despite this prohibition and the prohibition of SP Energy Networks' IDNO proposals, SP Energy Networks' combined IDNO/G3 proposal is still apparently under consideration and due to be consulted on (according to the last paragraph of the document, page 15).

Comment. I commented on Ofgem's seemingly defective intuition on the test size generator point at paragraphs 84-89 of Reckon's consultation response (22 pages, PDF). Ofgem maintains its reliance on a "counter-intuitive results" claim in the decision. I still fail to understand what Ofgem's reasoning is, or even why the results obtained by Ofgem should cause any surprise at all. And I cannot check the reasonableness of Ofgem's calculations and supposedly corrected assumptions since they are not disclosed. Franck.