On March 28, the Ontario Energy Board (“OEB”) issued its Draft Report on Corporate Governance Guidance for Rate-Regulated Utilities (the “OEB Draft Report”). The OEB Draft Report is another milestone in the OEB’s efforts to develop a “Guidance” on corporate governance for regulated utilities; specifically, Ontario Power Generation, electricity distributors and transmitters and natural gas distributors.
As noted in our previous article on the OEB’s Draft Corporate Governance Guidance for Regulated Utilities, the OEB intends that the Guidance will deliver outcomes established in the Renewed Regulatory Framework, and that it will generate a more consumer-centric regulatory framework by promoting better planning and more efficient performance by utilities.
The OEB Draft Report follows publication of the KPMG Report, dated April 29th, 2015, commissioned by the OEB, which contained a jurisdictional review of leading corporate governance practices in the energy sector, as well as release of the Elenchus Report, which provided the OEB with a set of recommendations on guidance regarding corporate governance.
The OEB Draft Report is intended to encourage quality decision-making and accountability in areas of the utility business that the OEB considers crucial for achieving regulatory goals essential to the Renewed Regulatory Framework, namely: (i) alignment of shareholder and customer interests; (ii) prudent decision-making with proper consideration of customer interests; (iii) spending and investment discipline (capital spend, OM&A, major transactions); (iv) suitable financing; and (v) excellence and continuous improvement in utility performance.
To this effect, the OEB Draft Report sets out preliminary recommendations on the following four aspects of utility governance:
1. Degree of Board Independence
The OEB expects utility boards to be made up of a majority of independent directors, based on existing Affiliate Relationships Code (“ARC”) requirements. The OEB’s view is that the quality of governance is likely to be improved if a majority (over 50 percent) of directors are independent, which contrasts with the current requirement established by the ARC that one-third of directors be independent.
Notably, the OEB believes that a minimum of 5 directors is required to provide a meaningful number of independent directors.
Further, the OEB is concerned that if shareholders retain significant decision-making authority, there will be less scope for the board of directors to exercise independent judgment, particularly where restrictions affect the ability of directors to act in the best interests of the utility and its customers. Accordingly, the OEB Draft Report recommends that the inclusion of such restrictions in shareholder declarations or similar instruments be avoided.
2. Director Skills
The OEB Draft Report states in respect of director capabilities that the boards of rate-regulated utilities as a whole must possess the range of skills required to execute their governance function and effectively discharge their duties. Moreover, the OEB Draft Report recommends that a matrix approach be used to compile an inventory of director skills, as “[d]irectors with appropriate skills and experience provide greater confidence in the board’s oversight of a utility’s financial viability, effectiveness, reliability and safety, as well as in its ability to deliver desired outcomes.”
3. Board and Committee Structures and Functions
The OEB Draft Report offers regulated utilities three recommendations regarding board and committee structures and functions: (i) boards should ensure that they are structured to provide oversight of key functions of the utility business; (ii) committees of the board are an effective means of achieving appropriate oversight of key functions; and (iii) committee members should possess the requisite skills to effectively discharge their responsibilities.
Based on the skills and functions highlighted in the KPMG Report and Elenchus Report, the OEB Draft Report recommends that utility boards be involved in the following key functions:
- Strategic planning;
- Asset planning;
- Health and safety functions;
- Executive compensation;
- Risk assessment;
- Regulatory and public policy activities;
- Customer relations and human resources; and
- Succession planning.
Although the OEB Draft Report does not provide specific guidance on governance structures, the OEB expects that utility boards will be able to demonstrate that the skill-sets of directors are adequate in accomplishing their roles and responsibilities. As well, the OEB expects that a utility board will be able to describe how it exercises oversight of each assigned committee.
4. Supporting Documentation and Practices
Lastly, the OEB Draft Report provides four recommendations in respect of supporting documentation and practices: (i) utility boards should have a written mandate and any committees of the board should have a written charter; (ii) the mandates of boards and any committees should be documented; (iii) boards should have a written code of conduct; and (iv) boards should provide orientation for new appointees and continuing education and/or other methods of enhancing the skills of all directors.
The OEB is confident that written definitions and expectations will provide clarity and a shared understanding of the roles and responsibilities of the board of directors, and will bring transparency to the utility’s corporate governance.
The OEB Draft Report is consistent with the G20/Organisation for Economic Co-operation and Development’s (“OECD”) Principles of Corporate Governance, particularly in respect of the responsibilities of boards in exercising independent judgment regarding corporate affairs. For instance, the OEB’s view that committees should be established to support the board in performing its functions echoes the recommendations of the OECD.
The OEB Draft Report also adopts the primary recommendations of the Elenchus Report. For example, the OEB Draft Report affirms the Elenchus Report’s suggestion that a utility board should have a majority of independent directors, as well as its recommendation that utility boards adopt a written mandate, along with a written code of conduct for directors, officers and employees.
The Elenchus Report provides detailed guidance on implementing its recommendations for utility governance, such as the content that should be included in a board’s written mandate and code of conduct, and which types of committees should be established. However, the OEB Draft Report provides high level recommendations without offering specifics.
In our view, the broad proposals set out in the OEB Draft Report are preferable from a stakeholder perspective, as they allow utilities to tailor the OEB’s recommendations on corporate governance to their particular needs and priorities, depending on their mandate, size and the area that they operate within. Although the OEB’s new reporting and record-keeping requirements will be mandatory for utilities, utilities will retain discretion over whether to adopt the OEB’s guidance in their governance architecture and functions.
Overall, the OEB Draft Report continues to swing the pendulum away from shareholder control and more towards directors’ independence. These guidelines do not distinguish between smaller utilities owned by a single municipality, larger utilities owned by multiple municipalities or, indeed, privately-owned but publicly-traded companies. Different balances between shareholder control and board independence may be appropriate in different contexts.
Finally, there is little discussion in the OEB Draft Report regarding the governance structures between the regulated utility, on the one hand, and its holding company and unregulated affiliates, on the other. It may be time to revisit the Affiliates Relationships Code to modernize the governance principles contained in it.
Following the OEB’s consideration of stakeholder comments on the OEB Draft Report, the OEB will develop its Final Report, and will issue detailed proposed amendments to the 3 Electricity Reporting and Record Keeping Requirements and the Natural Gas Reporting & Record Keeping Requirements: Rule for Gas Utilities, based on the Final Report.