Additional regulation for electricity companies with ‘systemic importance’?

In the wake of the energy crisis, the Federal Council has presented a draft for the regulation of electricity companies with ‘systemic importance.’ This proposal takes its cues from banking regulation, and it is the only one of its kind in the world. Misguided requirements could hamper the competitiveness of Swiss electricity producers and impede investment in renewable energy in Switzerland. An overview.

The consultation on a draft that would impose new standards on electricity companies with ‘systemic importance’ concluded on 14 June. The Federal Council’s bill would classify eight major electricity producers as systemically important, and the regulator EICom would be able to add more Swiss companies to the list. These companies would have to meet requirements related to their organisational structure and would be obligated to have ‘appropriate’ liquidity and ‘appropriate’ equity for ‘all relevant’ scenarios. Both an external audit company and EICom would review this annually. Along with the audit of internal models, the authorities would be able to demand models in the form of standard scenarios or stress tests. The Federal Council would also be authorised to impose specific liquidity and equity quotas. Major infringements would be met with heavy sanctions and several years’ occupational ban.

The only one of its kind in the world

Electricity producers with international trading operations are subject to EU regulations, which they observe. In response to the energy crisis, the EU has just updated its regulation of energy and finance markets but hasn’t introduced comparable provisions. By introducing special regulations that would impose considerable competitive disadvantages on Swiss producers operating internationally, the federal authorities would be entering unfamiliar territory by international standards. And it is not at all clear what would happen in the event that an electricity agreement with the EU is concluded – presumably, the conditions would need to be amended.

But there is also potential for unfair competition domestically; few companies would be subject to the provisions, yet other actors, intermediaries and foreign suppliers active in Switzerland that are just as important for security of supply (at least locally) would be fully exempt.

Hedging potential losses

The draft focuses on liquidity, an understandable move given that the energy crisis of 2021/2022 saw liquidity shortages among electricity producers in numerous countries. The cause was the hedging of electricity production facilities. To hedge against falling electricity prices, producers sell part of their electricity in the future. In order to do this, they need collateral – not just for exchange transactions, but for bilateral sales as well. This prevents credit risk and domino effects, with the collateral ensuring the resupply (or sale) of the electricity with no loss in the event of counterparty default. When electricity prices rise, the collateral for existing advance sales has to increase as well. The unprecedented, rapid increase in electricity prices during the energy crisis – up to 20 times historical levels – required collateral worth billions, which had to be provided almost immediately. Yet the resulting liquidity shortages were temporary, as money flowed back once the electricity was supplied. The high price of electricity meant revenue prospects for production facilities were extraordinarily good. This means it’s not a situation you can compare with the liquidity problems of banks, where a rapid withdrawal of customer funds can lead to emergency liquidation. Electricity production facilities can generally continue to operate even in the event of a liquidity shortfall; the workforce doesn’t simply cease working.

Implementation questions regarding liquidity

Nonetheless, this raises the question of exactly how high ‘appropriate’ liquidity would be if the bill were implemented. Companies have learned from the crisis. They don’t hedge production as much as they used to, which generally reduces the liquidity risks associated with collateral. And risk models have improved as liquidity reserves have increased. There has also been a change in European regulations in this area: as well as accepting cash as collateral, in future exchanges will also accept bank guarantees. 

If the federal authorities introduce regulation that imposes more stringent, potentially inefficient liquidity provisions on top of this, it would ultimately block funds for investment in the expansion of renewable energy.

Misguided focus on equity

The bill’s planned provisions on equity are less comprehensible. Such provisions have their place in the banking world: it takes a certain degree of equity to maintain the stability of banks and so increase trust in them. This reduces the potential for bank runs (i.e. the withdrawal of customer funds/debt capital) and ensures there are enough funds to protect customer investments in the event of insolvency.

But this is where the business activities, asset structures and risk situations of electricity producers differ completely (refer to the comments on hedging of production above). Equity is primarily an accounting figure, one which actually says very little about the risk situation of the company. It also fluctuates wildly with the changing valuation of trading transactions and production facilities, and is not comparable across individual electricity producers. Regulating equity would have arbitrary and unpredictable consequences. This could in turn limit the companies’ scope for action (for example, by forcing them to raise additional debt capital to cover collateral) or impede investment in renewable energy.

While the federal government’s bill may aim at preventing excessive debt, profits cannot simply be regulated into existence. Nor would the insolvency of a single electricity producer jeopardise security of supply. It would be a protracted process starting with attempted restructuring, which would allow enough time for a transfer of production facilities. A liquidator would have no incentive for shutting down facilities in this process.

Alternative: transparency rather than risk management intervention

In the wake of the crisis it is understandable that the federal government wants a better view of the risk situation of companies, but there are more efficient approaches than what’s being proposed here. For example, a company could directly supply information on its available liquidity and risks, without a complex audit of its models. These audits require extensive additional effort – for the companies as well as the authorities – and their strict formalisation also restricts flexibility in developing the models further.

Liquidity and equity provisions imposed by the authorities would have to reflect not just the company’s specific situation, but also the complexity of risk management and the electricity market. In any case, this comes with the potential to unnecessarily restrict the company’s risk management and ultimately weaken security of supply.

More articles for you

Show all

Renewable energy

‘Humans remain the deciding factor’

The Mauvoisin power plants were also severely affected by the storms

Read more

Renewable energy

‘It all happened so fast’

Misox: The effects of the storm can still be felt today – including at the Axpo power plants.

Read more

Renewable energy

‘How can we better protect our installations?’

The Saas Valley in the canton of Valais was hit by two severe storms this summer

Read more

Renewable energy

Does the new Electricity Act provide a suitable framework for the integration of solar energy?

Grid stability as a challenge

Read more