In order to ensure non-discriminatory access to the network and avoid conflicts of interest it is necessary to separate the network business which is generally seen as a so-called natural monopoly from those activities of vertically integrated companies which compete on the market, namely production and supply.

The purpose of the unbundling provisions in the Second Electricity and Gas Directives, which are considerably strengthened in comparison to the First Gas and Electricity Directives, is to achieve this separation. As a minimum requirement, articles 10 and 15 of the Second Electricity Directive and articles 9 and 13 of the Second Gas Directive provide that the TSO and the DSO must be independent of a vertically integrated energy undertaking in terms of its legal form, organisation and decision-making from other activities not relating to transmission/distribution. The basic elements of the new unbundling regime are the following: 

  • legal unbundling of the TSO and DSO from other activities not related to transmission and respectively distribution 
  • functional unbundling of the TSO and DSO, in order to ensure its independence within the vertically integrated undertaking 
  • possibility of exemptions from the requirement of legal and functional unbundling for DSOs 
  • accounting unbundling requiring companies to keep separate accounts for their TSO and DSO activities

Legal unbundling

The fundamental concept underlying the unbundling provisions is that transmission and distribution have to be carried out by separate network companies. It is not necessary for the network company to own the relevant network assets but it must be able to exercise “effective decision making rights” in line with the requirements of functional unbundling

The obligation to create a separate company only concerns the core network business, ie, the natural monopoly. All other activities, such as supply and production, can continue to be operated in one single company. The vertically integrated company is in principle free to choose the legal form of the (new) network company, provided that the type of company selected provides for sufficient independence of the management of the TSO/DSO from the parent company.

Functional unbundling

The provisions as to the functional unbundling requirements are contained in article 15(2) of the Second Electricity Directive and article 13(2) of the Second Gas Directive. They provide that, in order to achieve functional unbundling, the following minimum criteria apply:

  •  those persons responsible for the management of the DSO may not participate in company structures of the integrated electricity undertaking responsible, directly or indirectly, for the day-to-day operation of the generation, transmission and supply of electricity 
  • appropriate measures must be taken to ensure that the professional interests of the persons responsible for the management of the DSO are taken into account in a manner that ensures that they are capable of acting independently 
  • the DSO shall have effective decision-making rights, independent from the integrated undertaking, with respect to assets necessary to operate, maintain or develop the network

In order to ensure the implementation of these provisions in the individual network companies, DSOs are under the obligation to establish a compliance programme, which sets out measures to ensure that discriminatory conduct is excluded. The compliance programme has to set out the specific obligations of employees to meet this objective.

This does not prevent the existence of appropriate co-ordination mechanisms to ensure that the economic and management supervision rights of the parent company over a subsidiary in respect of the return on assets, regulated indirectly according to article 23 (2) of the Second Electricity Directive and article 25 (2) of the Second Gas Directive, respectively, are maintained.

In particular, parent companies are still able to approve the annual financial plan, or any equivalent instrument, of the DSO and to set global limits on indebtedness levels of its subsidiary. Parent companies are not permitted to give instructions regarding the day-to-day operations, or individual decisions concerning the construction or upgrading of distribution lines not exceeding the terms of the approved financial plan, or any equivalent instrument.

The Notes expressly point out that the provisions as to the management separation require that the management staff of the network business do not work at the same time for the supply/production company of the vertically integrated company. This applies to both the top executive management and the operational (middle) management. This implies that, for example, an executive director of the network company may not at the same time be an executive director of the related supply/production company, and vice-versa. The Notes state, however, that it is possible for an executive director of the holding company to perform a supervisory function in the relevant network company, without being involved in day-to-day decisions.

Accounting unbundling

The provisions as to accounting unbundling are contained in article 19 (1-4) of the Second Electricity Directive and in article 17 (1-4) of the Second Gas Directive. In particular, companies are required to maintain accounts for each of their transmission and distribution activities as they would be required to do if the activities in question were carried out by separate undertakings, so as to avoid discrimination, cross-subsidisation and distortion of competition. Revenue from ownership of the transmission/distribution system must be specified in the accounts. Consolidated accounts are possible for all other activities, including the remaining gas and electricity activities not relating to transmission/transportation and distribution activities.

Until 1 July 2007, companies have to keep separate accounts for supply activities for eligible customers and supply activities for non-eligible customers, in order to avoid cross-subsidisation of the former by the latter. Where appropriate, companies must keep consolidated accounts for other, non-electricity/gas activities. The internal accounts must include a balance sheet and a profit and loss account for each activity.

Exemptions from the unbundling regime

Member States cannot legislate to exempt vertically integrated energy companies from the obligation to maintain unbundled, separate company accounts. However, Member States may legislate to exempt smaller DSOs (undertakings serving less than 100,000 households) from the requirements of legal and functional unbundling. In the case of all other DSOs (ie, DSOs serving more than 100,000 households), the requirement of legal unbundling may be postponed until 1 July 2007. This exemption is not available with regard to functional unbundling.