European Regulators’ WACC Decisions Risk Undermining Investment Decisions

Fri Mar 06 09:59:16 EST 2015
By James Grayburn and Tomas Haug

The allowed rate of return is one of the most important yet contentious aspects of setting regulated companies’ allowed revenues. To be able to attract capital at an efficient cost, it is important that regulators adopt an objective approach to setting the allowed return. Where regulators do not adopt objective methods, financing costs can increase, or capital investment tail off, with eventual increases in customer bills or poorer levels of service.

In this article published in Energy Regulation Insights, NERA Associate Directors James Grayburn and Tomas Haug discuss the decline in European regulators’ decisions on allowed cost of equity on the back of declining sovereign yields following the global financial crisis. They show that the decline in the allowed cost of equity reflects at least in part, a failure by European regulators to consider the interactions between the different elements of the CAPM formula. They then provide evidence from the US where, in line with financial theory, US regulators have increased the ERP when bond rates are lower than normal, and so regulated returns have been relatively constant in the face of falling sovereign yields.