FERC’s proposed rule to limit intra-corporate cash transfers, although a step in the right direction, does not provide a regulated energy subsidiary with a sufficient amount of “insulation” from its cash-strapped parent company to justify awarding the regulated entity a separate credit rating, according to Standard and Poor’s (S&P) credit analyst Todd Shipman. Even if it did provide the insulation, the Commission’s past record of “sluggish response” doesn’t instill much confidence that the agency will actively enforce the rule, he said last week.

The Commission’s proposed cash management rule is “obviously more stringent” than its existing regulations, but it would “still fall short of providing the requisite insulation to justify a ratings separation for [a] regulated pipeline” or a public utility subsidiary from its corporate parent, Shipman noted. In August, the Federal Energy Regulatory Commission proposed a number of restrictions on regulated subsidiaries’ involvement in cash management programs, or cash pools, after it raised concerns about the propriety of $1 billion in loans that Northern Natural Gas and Transwestern Pipeline secured to help bail out their ailing parent, Enron Corp., just prior to its filing for bankruptcy last year. The agency took this action to safeguard regulated companies’ future cash transfers to parents.

In a notice of proposed rulemaking (NOPR), the Commission proposed that FERC-regulated subsidiaries (public utilities and oil and gas pipelines) be required to maintain a minimum common equity balance of 30%, and that their parent firms possess an investment grade credit rating, as preconditions to a regulated subsidiary’s involvement in a cash management arrangement.

When assessing corporate credit ratings, S&P reviews the credit profile of the “entire enterprise,” including the parent company, all subsidiaries, divisions and affiliates. But it also looks to see whether factors exist that would allow it to view a subsidiary as sufficiently “insulated” from the rest of the corporate organization to merit a separate credit rating, Shipman said. If such factors are present, a subsidiary’s corporate credit rating (CCR) can be higher than that of its parent, assuming its stand-alone credit quality justifies it.

“Regulation is the factor most frequently invoked to show insulation,” he said. “But with regulators’ changing role and the move toward deregulation, we are seeing fewer and fewer instances where the regulatory oversight is comprehensive and protective enough to support higher ratings” for individual regulated subsidiaries.

The strongest case for “regulatory insulation is when there are tight, statutory-based restrictions on cash or asset transfers with real consequences for violations, coupled with active, preemptive oversight by the regulatory body,” Shipman noted. FERC and its cash management proposal fail on both counts, he believes.

The 30% minimum equity balance proposed by FERC “is not particularly protective because it would not support even an investment-grade rating at a typical pipeline business risk score.” While the minimum credit rating requirement is “more stringent,” the “actual consequences for violating the rule in either instance are negligible, in that the pipeline company would only lose the ability to participate in the parent’s cash-management program or a similar joint money pool,” Shipman said. And, “by the time the violations would have occurred and [been] detected, the financial damage will have been already done and would be of little consolation to the creditors of the pipeline.”

The degree of oversight by FERC “has traditionally been viewed as less than sufficient to justify insulation, and it does not appear that anything has changed because of the proposed rule,” he noted. The Commission’s “sluggish response” to the actions of Northern Natural and Transwestern “indicates that timely intervention that would protect bondholder interests is not likely when a regulated utility’s parent is experiencing credit problems.”

Still, FERC’s effort to “take some steps to address the issue is duly noted…, and could be a harbinger of stricter oversight to come.”

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