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| Energy Currents: "The End of The Public Utility Holding Company Act of 1935 — Now What?" |
| August 8, 2005 |
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On August 8, 2005, President Bush signed into law the Domenici-Barton Energy Policy Act of 2005 ("Act"), completing the enactment of the first comprehensive piece of energy legislation in over a decade. Among the most important provisions is the repeal of the entire Public Utility Holding Company Act of 1935 ("PUHCA") or the ("'35 Act"). PUHCA repeal is effective six months after enactment, although state and federal regulators will be guaranteed access to the books and records of holding companies, affiliates, and holding company systems.
For 70 years, PUHCA has limited U.S. electric utilities and natural gas distribution companies to a single geographic region in which integrated operation is feasible. The '35 Act prohibited utility ownership of businesses not reasonably incidental or functionally related to the utility business. PUHCA also has been a significant deterrent to meaningful investment in utilities by financial institutions and foreign companies. Even the SEC's more expansive recent construction of PUHCA still required convoluted corporate structures and entailed regulatory risk. While the '35 Act still has defenders in Congress, PUHCA's repeal has long been considered a key component of a comprehensive energy bill. Despite this expectation, the delay of comprehensive legislation in recent years led to creation of numerous new registered holding companies as utilities proceeded with mergers despite PUHCA. The general consensus is that other consolidations would have occurred but for PUHCA. This view is reinforced by the return of utilities to their core business as many companies have found that a strategy to expand into unregulated operations has proven difficult to implement profitably.
PUHCA's repeal eliminates several major obstacles to utility consolidation. One is that utility operations will no longer need to be confined to a single integrated system. The integration requirement in PUHCA created a perverse incentive to merge adjacent systems, thus magnifying the horizontal market power concerns that have been the predominant concerns in merger review by the Federal Energy Regulatory Commission ("FERC") and the Department of Justice. Without PUHCA, geographically diverse companies may now merge. This possibility opens the way for combinations that will more readily avoid market power concerns.
The second major impediment removed is that non-utilities will now be able to directly own and control utilities. It is likely that private equity and other financial investors will enter and produce more diverse ownership in the sector. Not only will the complex ownership structures created to avoid PUHCA's impacts no longer be necessary, but also financial investors may elect to make shorter term, strategic investments in order to pursue the value that may be available in restructurings. Finally, without PUHCA, affiliate arrangements should become simpler, as should purchases and sales of utility assets and issuances of securities.
However, significant regulatory impediments to utility consolidation will continue to exist. The Act makes no changes in state regulation of the comprehensive or partial sale or purchase of utility assets. Also, in exchange for PUHCA repeal, the Senate supported certain enhancements to FERC's merger and acquisition review authority that were ultimately adopted in conference. For example, FERC now has explicit authority to review acquisitions of generation-only assets.
The more significant restraint will be review of transactions by the states. State commissions have traditionally conditioned their approval of mergers and asset transfers by requiring that the bulk of operational savings created by a transfer must be passed on to ratepayers. It may well be that the key to unlocking value in the industry may be through the acquisition of individual companies, disaggregating the functional components, and reassembling the components into functional units of broader scope. This is where the new feasibility of control by financial investors will likely be most significant. An example of such a corporate strategy is the creation of independent entities with one utility function such as transmission. The prime example of the value available in restructuring is the creation of an International Transmission Company through a complicated, PUHCA-protected leveraged buy-out and its recapitalization through an IPO. This effort has brought large returns to the purely financial investors and has produced a corporation with bright prospects. New corporations of this kind will be well positioned to capitalize on PUHCA repeal by assembling a large transmission-only entity. This investment strategy may now be pursued without the complicated corporate structure that was necessitated by PUHCA. Similar opportunities should exist to use the master limited partnership structure to assemble local natural gas distribution companies into larger units. Another possibility may be the emergence of entities of national scope to control electric distribution companies.
During the months before the repeal of PUHCA becomes effective, FERC and other agencies will be reaching conclusions as to whether, in their opinion, PUHCA repeal has opened any holes in key consumer protections. The Act specifically directs that FERC undertake rulemakings to determine the extent of access to the books and records of holding companies. The purpose is to determine the costs of doing business for regulated companies. The Act provides that state commissions are also to have necessary access to the books and records of holding companies that control state regulated retail entities. It can also be expected that FERC will be concerned with cross-subsidization within holding company systems and the potential for affiliate abuse. FERC will likely initiate rulemakings to address these concerns. Before year’s end, FERC will also be adopting rules governing exemption of certain companies from the access to books and records provisions and exemption of the single-state operations of a holding company system from the new requirements of the subpart altogether.
PUHCA repeal has brought the end of one era, and it also introduces new opportunities for regulators to act. The utility industry and the financial community must recognize that a proactive stance during the next year will be critical to ensure that the opportunities for more rational economic structures created by PUHCA repeal are realized.
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If you have any questions regarding Energy Currents, please contact Stephen Angle or Jim Hoecker.
Energy Currents is an online publication of the law firm of Vinson & Elkins LLP. It is intended to afford notice to our clients and friends of certain developments. It is not intended, nor should it be used, as a substitute for specific legal advice regarding particular factual situations. |
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