In utility regulation, the Ring-Fencing Certificate (RFC) certifies that in the opinion of the Board of Directors the company has sufficient resources to enable it to carry out its regulated activities for at least the 12 month period ahead. As part of its work to ensure the UK utility sector has a resilient labour market, Energy & Utility Skills studies the ongoing Ofwat review of the RFC and the case for increased inclusion of human capital in the regulatory framework.
Just prior to the COVID-19 pandemic, the Office for National Statistics (ONS) had reported the tightest constraint ever recorded in the UK labour market. At the same time, every major business sector in England, Scotland, Northern Ireland and Wales was reporting workforce shortages and material skills gaps. The human capital constraint issues facing the economy were material enough for HM Treasury to declare that the UK was at economic ‘full employment’.
Come the start of the pandemic the situation tightened greatly, with utility companies quickly recognised as ‘critical industries’ under civil contingency planning processes, resulting in them having to assess the risks to workforce from maintaining vital services under social distancing, self-isolation and cases of infection. This was followed by totally modified capital and operational activities and the associated impacts on the workloads for the direct and indirectly employed workforce.
For the indirect workforce who operate as much as 60% of utility projects in some areas, the major partners experienced stretching emergency demand from many of their utility clients at once, and from right across their infrastructure portfolio. Concurrently, many hundreds of their workers had to be moved onto the government Job Retention Scheme, or ‘Furlough’, because of the fast collapse of the planned programme of capital and non-emergency maintenance work.
Within infrastructure planning, the HM Treasury National Infrastructure Plan for Skills had fallen totally out of alignment with both the ONS labour market evidence and central and devolved government ambitions for infrastructure growth. Sir John Armitt, the Chair of the National Infrastructure Commission, advised the All Party Parliamentary Group for Infrastructure that “At present, there is an insufficiently joined-up approach to infrastructure skills development in the UK, with a wide range of responsible bodies operating across different geographic and political boundaries. The human capital aspects of the National Infrastructure Plan for Skills need to be refreshed to help ensure our pipeline of future workers is adequate for the challenges ahead.”
In other vital areas of capital where core resilience and sustainability are at such explicit risk, regulators can require companies to include it in their RFC. This includes water and wastewater companies in England and Wales, where preparing a Ring-fencing Certificate (“RFC”) or “certificate of adequacy” is part of conditions within some licences.
The RFC – This is published annually alongside other main performance reports, and each water and wastewater company delivers it to Ofwat with a copy of the regulatory accounting statements. The RFC and the wider regulatory ring-fencing framework provides an important protection for companies and their customers. Ofwat set out its latest approach in February 2020 and has been explicit that the subject remains under review.
Each company’s regulatory ring-fence consists of licence conditions which place specific obligations on it. These obligations include requirements for the company to produce and submit to Ofwat, an annual Auditor-assured RFC that will ensure that it is able to carry out the regulated activities. They include testing a range of financial aspects, and already consider core workforce resilience and resilience measures such as:
- Systems for maintaining supply / business continuity, stated action plans
- Long-term viability statements
- Management skills, experience and relevant qualifications
- Recruitment processes and staff engagement
- Succession planning for key management and staff
- Quality of management and staff inductions and other training and development
- A process for ensuring diversity of perspectives
Where a company is known to be facing significant challenges with its business, Ofwat already expects to see clear explanations to justify why resources are “nonetheless sufficient to sustain the business including actions that the company is taking to address those challenges.”
The guidance advises; “If the business has faced significant challenges in the past or if adversities are expected in the future, it is important for the company to include factors covering the activities that they are undertaking to solve or mitigate the issues.”
Ofwat has advised they are planning to monitor the RFCs that are published for future years and review their approach to monitoring and assurance in the future. This will ensure the framework remains effective and continues to deliver desired outcomes, including meeting the Ofwat duty to further the resilience objective.
Resilience is defined as the ability of companies to cope with, and recover from, disruption and anticipate trends and variability, in order to maintain services for people and protect the natural environment now and in the future.
Workforce resilience is already a stated requirement within the Ofwat ‘Resilience in the Round’ approach, and human capital issues are contained in the requirements for two out of the three main resilience categories – Operational and Corporate Resilience. Workforce resilience is also a requirement of PR19 business plan submissions, requiring companies to think for the five years of the price review period, plus 10 years out and do so for both the direct employees and those supply chain partners that enable their business model to be delivered successfully.
Energy & Utility Skills Chief Executive, Nick Ellins, commented;
“The pandemic has brought a new global awareness and respect for the role of the workforce in the core operational resilience of companies, and the strategic role that these critical industries play for the economy, their communities and customers during major extraneous events. As Ofwat increasingly tests the robustness of the RFC, and the leading companies seek to increase their transparency regarding key risks, adding human capital and workforce resilience would seem a logical next step.”
“The existing approach already requires a number of workforce tests and none of the respondents to the Ofwat consultation had any issue with this being included in the statement, which is reassuring. At this stage however, Ofwat does not know if a company can even value its human capital effectively or know the resilience or sustainability of that value.”
“To be deficient in human capital is now widely recognised as being as high a risk, or potentially even a higher risk, to that of deficient financial or natural capital. It therefore fits well with ensuring that Better Regulation principles apply, avoiding fears of micro-management and unnecessary regulatory burden in non-material areas. Having workforce resilience as part of Board discussions should now be a standard approach, and quantifying human capital risks and remedies would sit well within key Board risk mitigation statements, such as we should see in water with the RFC.”
“With institutional investors and ratings agencies now scanning human capital risk closely through companies’ ‘Integrated Reporting’ plus their own ESG reporting and initiatives such as the major ‘Workforce Disclosure Initiative’, we are quickly moving away from company workforce resilience tests only being a quick check as to whether it is spending enough on training. This is now a core test of whether a company has the thinking, systems and processes needed to ensure its very operational and corporate sustainability and can deliver innovative, efficient and resilient services to customers. It also seems logical that with investors and other shareholders seeking more transparency on human capital risks, and the UK Chancellor seeking to put a value on the UK’s human capital in order that policies and funding can be aligned to enhance it, major infrastructure businesses and their regulators will follow.”
“In some areas this is already a well-established approach, with the investment in human capital judged as also meeting important social value tests, by contributing to economic and business growth for the benefit of employees, employers and the wider economy.”
Human capital reporting is already part of the successful ‘Integrated Reporting’ model, with some utilities already reporting annually against the ‘six capitals’ approach. Under the model, the human assets are judged as a key driver of organisational success with an increasing importance being placed on understanding its role. It can often be the most significant asset an organisation has as business models become ever more centred on people, intellectual capital and technology.
In energy, SSE valued its human capital at £3.4bn, and set out an evaluation framework to target its Board discussions and internal investment at raising that value. The study also concluded that £4.29 of economic value came from every £1 invested in human capital.
Workforce related corporate reporting is a standing recommendation by the ‘Financial Reporting Council’ following their major report, with their strategic questions on behalf of investors in January 2020. This required companies to state their position on such areas as whether their workforce viewed as a strategic asset, the composition of the workforce e.g. does it include contractors, franchisee staff, supply chain, employees etc. and how the workforce helps generate or preserve value in the company.
The International Standard Organization (ISO) recently published ‘Guidelines for Internal and External Human Capital Reporting’, as it aspires to place people at the centre of organisations. The World Economic Forum has advised that human capital reporting and the new international standards will disrupt the way companies think, value and report on their human capital, and deliver what investors look for; sustainable growth and returns. They advised “This will provide urgently needed transparency on measures such as leadership competencies, dependencies on external workforce, employee engagement and commitment, and workforce productivity to name a few. Investors, rating agencies, governments and potential employees will really benefit from this. Having rules and comparable data provides stakeholders with another way of evaluating and understanding companies better.”
In conclusion, to not have a business critical asset such as human capital in an organisation’s formal statement of resilience to its regulator would appear a less than prudent approach. Governments, investors, ratings agencies, wider stakeholders and employees all already explicitly advise that increased transparency in this area has high value. With existing human capital reporting and evaluation well established, it is a small step to take the existing human resource related questions in the current RFC and modify them to become a formal Board statement of strategic workforce resilience, in line with the current water regulatory model in England & Wales.
Read more on Energy & Utility Skills’ work for the utility sector’s approach to building sustainable human capital.