The European Commission (the "Commission") has released a document setting out interpretative notes as to the application of the unbundling regime in relation to cross-sector investments in European energy assets by financial investors (the "Interpretative Notes") .

This is an important and long-awaited document aimed at providing clarification of the EU unbundling regime for financial investors who hold or intend to hold shares in both transmission and generation assets in the electricity and gas sectors.

The Interpretative Notes are of particular significance to financial investors (such as pension funds, insurance companies or infrastructure funds) who hold diversified portfolios with stakes in energy transmission, generation, production and/or supply activities spread across different regions, countries or continents and as such have been facing increasing uncertainty over the impact of the unbundling rules on their investments.

Whilst the Interpretative Notes fall short of providing clear-cut set of maximum shareholdings or similar thresholds, they provide some helpful clarification of how the Commission will assess concurrent shareholdings in transmission and generation and/or supply assets by financial investors.

Yet, while the Commission, in the cases cited in the Interpretative Notes, has taken a pragmatic effects based approach, it is not clear where the boundaries actually lie and this will only become apparent once certification of a TSO has been refused.

1. Background to ownership unbundling

One of the main aims of EU's Third Energy Package was to remove any conflict of interest between generators/producers/suppliers, on the one hand, and transmission system operators, on the other. Accordingly, Article 9 of the Electricity and Gas Directives1 prohibits the same person, at the same time, to 'control'2 generation, production and/or supply activities and 'control' or exercise 'any right'3 over a TSO or a transmission system. In addition, the same person is prohibited from being a member of the board of both a TSO and a generator, producer or supplier.

The ownership unbundling provisions apply across the gas and electricity markets so that no entity can have influence over both (1) an electricity generator or supplier and a gas TSO; or (2) a gas producer or supplier and an electricity TSO. Further details can be found in the European Energy Handbook from page six onwards.

2. Application to financial investors

The Interpretative Notes aim to clarify the application of rules on ownership unbundling to situations where a shareholder in a TSO also owns stakes in generation, production and/or supply activities. To this end, the Commission has indicated that in specific circumstances (set out below) where the relevant shareholder is able to demonstrate that it has no incentive to influence the decision-making process of the TSO in order to afford preferential treatment to its generation, production and/or supply activities to the detriment of other network users, it is possible that no conflict of interest arises and the relevant TSO will consequently not be deemed to breach the unbundling rules.

The Commission has acknowledged the important role of financial investors in the energy sector given that in many cases they enable TSOs to raise the capital required for the realisation of necessary investments in the EU energy network infrastructure. Accordingly, the Interpretative Notes set out the distinguishing characteristics of the type of financial investments which would fall within the scope of the Interpretative Notes:

  • The strategy of the relevant investor frequently involves investments in both renewable energy generation assets and transmission infrastructure, with a view to benefit from regulated income (eg, feed-in/network tariffs);
  • the investments are typically made with a long-term perspective;
  • the individual share in the energy production may remain minor compared to the overall available production capacities;
  • the assets are generally operated on a stand-alone basis;
  • the operational management of the generation and transmission assets is handled by separate teams and is not coordinated ;and
  • the participation in a TSO is often in co-operation with other financial and/or strategic investors.

3. TSO certification

The Interpretative Notes illustrate the Commission's approach to interpreting and applying the rules on ownership unbundling in the context of the certification procedure of TSOs.

Given that such certification can only be granted if any conflict of interest is clearly excluded, the Commission has attempted to identify certain circumstances that would render parallel investments (ie investments in both transmission and generation or supply assets) permissible.

According to the Commission, the particular facts of each case will determine whether simultaneous participation in transmission activities as well as generation, production and/or supply activities give rise to any potential conflict of interest or incentive to exploit it and consequently risk having negative impact on the independent management of the TSO.

The Commission has based its reasoning on five case studies:

  1. National Grid

The certification of National Grid was referred by Ofgem to the Commission as the UK TSO had also generation interests in the US and Australia. On this occasion, despite the fact that the ownership unbundling rules are not restricted to EU assets, the Commission found that in the absence of any connection or interface between the energy systems in question there was no risk of a conflict of interest arising.

  1. Swedegas

The Commission has taken the view that, on the facts, it was impossible for EQT Infrastructure Fund, the ultimate parent of both Swedegas and a Danish waste disposal company, to use the gas transmission activities of Swedegas in a manner so as to favour the generation interests (ie, limited quantities of electricity sold at pre-established prices) of the waste disposal company in Denmark. Thus there was no risk of discrimination of other network users which could preclude certification.

  1. Red Electrica de Espana & Enagas

The Commission acknowledged that where an investor owns cross-sector assets (shares in a gas TSO and in electricity generation activities), the scope for affording preferential treatment to its electricity generation activities by influencing the gas transmission may, under certain circumstances, be somewhat more limited than where the transmission and generation interests are both in electricity. On the facts, the Commission found that as long as the coal-fired generation activities are performed under a regulated framework, can benefit by law from priority dispatching and remain small in size, it is beyond the realms of possibility that the investor would be able to influence the transmission activities of the TSO in a manner that would favour its generation activities and hinder other network users.

  1. 50 Hertz Transmission

IFM Global Infrastructure Fund had a controlling stake in a German TSO as well as several interests in generation and supply activities including a supplier of heat on the regulated district heating market in Poland. The by-product of heat production was generation of limited quantities of electricity. In this case, there was no incentive to influence the decision-making process of the TSO with a view to favour the generation interests as the decisions regarding the operation of the Polish heating plants were taken on the basis of the heating needs of the consumers connected to the district heating network rather than the needs of electricity generation. In addition, the Polish company was a price taker on the Polish electricity market.

  1. Societa Gasdotti Italia

Eiser Global Infrastructure Fund in addition to owning an Italian TSO had interests in two Spanish companies producing electricity from solar energy. The Commission found that the interface between the Spanish electricity market and the Italian gas market was limited. Also, it was important that the generation activities were performed under the Spanish regulated framework with a regulated price, benefited by law from priority dispatching and were small in size.

The fund also had an interest in a waste management company in the UK that generated electricity from waste and biogas through two production units of relatively small size. Here, the most significant factor was the geographical distance between the origin of electricity and the gas transmission network of the TSO that effectively precluded any conflict of interest.

The fund's interest in a waste management company in Italy was also found not be an impediment to certification as the renewable electricity produced from waste was a by-product of the main operations, its size was small, it was sold at a regulated price and the production units were not located in the area where the gas network of the TSO was situated.

Generally, the Commission has indicated that refusing a certification of a TSO where it can be clearly demonstrated that due to the existing circumstances there is no incentive for a TSO shareholder to influence the TSO's decision-making process in order to afford preferential treatment to its generation, production and/or supply interest to the detriment of other network users would be disproportionate and go beyond the remit of the rules.

4. Case by case approach

The Interpretative Notes are not legally binding and have, as previous interpretative notes issued by the Commission, the status of a staff working document only.

The Commission has made it clear that each case will be subject to an in-depth analysis and will be assessed on its own facts. To this end, any TSO awaiting certification should provide a complete file containing all the relevant facts and circumstances, together with a clear argumentation on whether other interests of its shareholders in generation, production and/or supply give rise to a potential conflict of interest and an incentive to exploit it. The burden of proof will always lie with the TSO and its shareholders.

On the basis of the decisions listed above, it is likely that the Commission will judge each case against the following criteria:

  • the geographic location of the transmission activities and the generation, production and/or supply activities concerned (including the presence or absence of any interface/connection between the energy systems);
  • the value and the nature of the participations in these activities (whether electricity generation is a mere by-product of other activities; whether the sale of electricity is performed under normal commercial terms or under a regulated scheme with pre-established prices and with priority dispatching)4;
  • the size and market share of the generation, production and/or supply activities (whether the generator has any influence over the electricity price or is a price-taker);
  • whether wholesale price evolution of the commodity would have consequences for the emergence of a conflict of interest; and
  • access to confidential information (even if there is no incentive to influence the decision-making in the TSO, the access the investor has to confidential information may still give him an advantage over its competitors on the generation, production and/or supply market).

The Commission has emphasised that these criteria are indicative and not exhaustive, and none of these elements is necessarily decisive on its own.

The Interpretative Notes stress the need for continued monitoring by the national regulators following the certification decision to ensure that no new facts or circumstances arise that could alter the initial assessment made (such as, for example, opening more generation units in the vicinity of the TSO's network that would interfere with the transmission business).

The Commission has reiterated that a certification decision may contain a condition requiring the TSO to regularly report to the regulator on the relevant circumstances and that TSOs must notify any material changes that may trigger a re-assessment to the national regulator failing which any national regulator has the authority to initiate a new certification procedure if it has acquired knowledge of a material change (or any such plans to this effect) in rights or influence over a TSO that may lead to a breach of the ownership unbundling rules. Alternatively, the Commission may request the national regulator to open a new certification procedure.

The Commission has also clarified that if a conflict of interest does arise, the shareholder with a participation in generation, production and/or supply interests would be allowed to maintain a stake in the TSO as long as it is a passive minority shareholding without an entitlement to directly or indirectly exercise voting rights or to appoint board members in the TSO. Any financial rights in relation to such shareholding, in particular the right to receive dividends, would remain unaffected in such case.