- The practice of lobbying used by some North American regulated utilities to advance certain legislation or other policy initiatives can expose these utilities to governance risks, including the risk that the policies and procedures designed to effectively monitor lobbyist activities may be insufficient.
- On July 23, 2020, we placed our ratings on FirstEnergy Corp. (FE) and its subsidiaries on CreditWatch with negative implications based on the criminal complaint filed against the former Ohio Speaker of the House, Larry Householder, and four associates for allegedly participating in a $60 million racketeering scheme, in connection with passing and upholding House Bill (HB) 6, legislation designed to financially support two nuclear plants in Ohio.
- During the same month, we lowered our long-term issuer credit rating on ComEd by one notch to 'BBB+' from 'A-'. The U.S. Attorney's Office for the Northern District of Illinois (USND) filed a bribery charge against Exelon Corp.'s subsidiary Commonwealth Edison Co. (ComEd) that demonstrates corrupt conduct by several of ComEd's former officers over a sustained period and insufficient internal controls to proactively identify such violations.
- These actions highlight the significance of our assessments of management and governance (M&G) for regulated utilities, which we typically view as either strong, satisfactory, fair, or weak, with the vast majority receiving an assessment of satisfactory.
- A satisfactory or better M&G assessment typically has no impact on credit ratings, including for investment-grade regulated utilities. In contrast, an assessment of fair or weak M&G can result in our lowering credit ratings by one or more notches, consistent with our criteria.
- We expect governance to remain an essential component of our ongoing credit surveillance, the effect of which may occur in hindsight but can have lasting implications on credit ratings.
Effective regulatory risk management entails several activities, some of which include working to advance policies that support favorable legislative, regulatory, or policy outcomes. They include working to advance legislation, litigating through judicial dockets, or simply filing for general rate cases using the regulatory rules that already exist, some of which are done for the benefit of the company and its investors, including bondholders. To that end, common and legal tactics some utilities use, such as lobbying to advance certain legislation or other policy initiatives, can expose utilities to governance risks if internal controls and transparency standards are lacking. As the Illinois and Ohio case studies show, allegations of inappropriate activity, whether they ultimately are proven or not, can potentially have tangible consequences on the credit quality for the utilities involved. But beyond the headlines and reputation risks, the scandals reveal something more worrisome--the potential that some utilities' policies and procedures designed to effectively monitor lobbyist activities may be insufficient in identifying warning signs of any ethics violations, or worse, possible criminal activity whether intended or not.
Some North American regulated utilities use lobbying as a way to manage regulatory risk
Some utilities engage professionally registered lobbyists to support their legislative or regulatory activities. Other utilities join industry trade associations such as the Edison Electric Institute (EEI), American Gas Association (AGA), the Nuclear Energy Institute (NEI), and others. These trade associations also engage lobbyists to advocate for policies that support the industry. These forms of lobbying are legal as long as the lobbyists comply with all applicable rules and disclosure requirements. Over the past several years some North American regulated utilities have turned to legislation as a means to effectively manage regulatory risk, including on a variety of issues ranging from storm cost recovery to stranded asset recovery. And while our ratings typically reflect a utilities' ability to effectively manage regulatory risk, we leave the methods used to manage such risk up to the utilities to navigate. Lobbying remains a key aspect of how some utilities seek to advance a variety of issues, including on legislation, regulation, or other policy matters.
…But the Ohio case potentially raises fresh questions regarding utilities' ability to monitor how lobbying dollars are spent
First then is the question of whether adequate due diligence was performed prior to engaging with Generation Now. In addition, were there specific ethical standards, guidelines or restrictions that should have been clear to Generation Now? Furthermore, was there sufficient ongoing oversight over Generation Now's lobbying and political activities? At this point we still do not know. The criminal complaint shows a pattern of several monetary transfers being made from a "Company A" to Generation Now. We placed our credit ratings on FirstEnergy Corp. and its subsidiaries on CreditWatch with negative implications based on the criminal complaint. FE has not been directly implicated in this scandal, and the investigation is ongoing. However, if subsequent investigations directly implicate FE, we believe it could reflect a material deficiency in the company's governance, and may weaken what we assess as the company's management of regulatory risk. We expect to resolve this CreditWatch in the coming months.
Our assessment of management and governance for North American regulated utilities is evidenced based
For these utilities, we assess their management and governance (M&G) as either strong, satisfactory, fair, or weak. We assess the vast majority of the utilities' M&G as satisfactory (see chart).
When assessing a company's M&G, our analysis includes a review of the following:
- Management, which includes strategic positioning, risk management/financial management, and organizational effectiveness.
- Governance, which covers a number of risk factors relating to how an enterprise is managed, and how its internal procedures, polices, and practices can create or mitigate risk. In addition, our analysis of governance incorporates our view of board effectiveness, including whether the board provides sufficient oversight and scrutiny of management.
In general, an assessment of satisfactory means that we view three of the eight subfactors designed to assess an entities' strategic positioning, risk management, and organizational effectiveness as at least positive, with none of the other subfactors considered negative. In addition, for an assessment of satisfactory, we will also have to conclude that none of the seven subfactors designed to assess governance is negative. A satisfactory or better M&G assessment typically has no impact on credit ratings, including for investment-grade regulated utilities. In contrast, an assessment of fair or weak M&G can lower credit ratings by one or more notches, consistent with our criteria.
The CreditWatch placement on FE and its subsidiaries
This rating action reflects the increased probability that we will lower our issuer credit rating on the companies by one or more notches. Although FE is not named as a defendant in the criminal complaint, we believe the severity of the charges outlined in the criminal complaint and the allegation that the bribery payments began as early as March 2017, prior to Energy Harbor Corp.'s emergence from bankruptcy under its new ownership, could possibly implicate FE in some manner. If subsequent investigations directly implicate FE, we believe that it could reflect a material deficiency in the company's governance, insufficient internal controls, or could result in a weakening of the company's management of regulatory risk. Any of the above determinations would likely cause us to downgrade the company by one or more notches.
Potential fallout from the ComEd bribery scandal could hurt its credit quality
We lowered our ratings on Exelon Corp.'s subsidiary Commonwealth Edison Co. (ComEd) following the U.S. Attorney for the Northern District of Illinois's (USND) bribery charge against ComEd, resulting in a deferred prosecution agreement with the government, and a payment of $200 million in fines by ComEd. In September 2020, a former ComEd executive pleaded guilty to one count of bribery conspiracy, and agreed to cooperate with investigators. At least four others have also been implicated in the bribery scandal, but not yet charged. Two are former executives of ComEd, and one is a former lobbyist for the utility. That the company wasn't able to proactively identify such gross violations demonstrated, in our view, a material governance deficiency. As such, we revised our M&G assessment for both ComEd and its parent to fair from strong, which resulted in the downgrade of ComEd to 'BBB+' from 'A-'. These developments also resulted in a revision of our view of the rating outlooks, which we revised to negative from stable. The negative outlook reflects the current minimal financial cushion at consolidated Exelon for its current rating and the prospect of increased business risk that could result from the USND's charge against ComEd.
ComEd accounts for about 25% of Exelon's consolidated EBITDA. As such, the duration and extent of ComEd's former officers' inappropriate conduct could lead to a weakening of ComEd's management of regulatory risk or potentially increase business risk at any of Exelon's other businesses. The company is currently pursuing a fixed resource requirement (FRR) program in Illinois, a move that will most likely require legislation before it can be implemented. In addition, ComEd is also trying to extend use of its formula rates in Illinois, which terminates at the end of 2022, and will also likely require legislation to implement. And so the revelation of this bribery scandal comes at an inopportune time for Exelon, as the company works to re-establish trust and advance this FRR process, and to extend its formula rates in Illinois. Separately, the Illinois governor has recently called for ethics reform and a strengthening of utility company transparency as part of a new energy policy proposal. Overall, we expect that these processes will become more challenging and have a lower probability of success, possibly leading to higher business risk.
What do these governance case studies mean for North American regulated utilities' credit quality going forward?
The recent scandals involving ComEd and possibly FE underscore the importance of effective governance and internal controls highlighting ways in which a potential deficiency in a utility's governance can weaken credit quality. We suspect these high-profile scandals have prompted utilities to reexamine or reaffirm their internal controls, including as they relate to lobbying expenses, and political contributions to guard against this type of negative development. We continue to believe that the vast majority of the utility management teams we interact with are credible and use appropriate tactics to advance their interests. That said, governance covers a broad spectrum of risk factors relating to how an enterprise is managed, including how its internal procedures, policies, and practices can create or mitigate risk. In addition, the board plays a key role in overseeing management and holding it to account. As such, any finding of a governance deficiency could dim our view of an otherwise strong utility management team or its board, resulting in an M&G assessment of less than satisfactory for affected utilities, the effect of which may occur in hindsight and have lasting implications on credit ratings. To that end, we expect governance to remain an essential component in our ongoing surveillance of credit risk for North American regulated utilities.
- Research Update: FirstEnergy Corp. And Subsidiary Ratings Placed on CreditWatch Negative On Potential Implication In Ohio Bribery Case, July 23, 2020
- Research Update: Exelon Corp. Outlook Revised To Negative On Bribery Charge; Subsidiary Commonwealth Edison Co. Downgraded, July 21 2020
- Criteria: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012
This report does not constitute a rating action.
|Primary Credit Analyst:||Obioma Ugboaja, New York + 1 (212) 438 7406;|
|Secondary Contact:||Sloan Millman, CFA, New York + 1 (212) 438 2146;|
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