Canada: Governing The New Hydro One: "Striking The Right Balance"

Last Updated: April 28 2015
Article by Ian A. Mondrow

On April 16th, the Ontario Government released what may be the most public “unreleased” government report in recent times. Various details of the sell-down of Hydro One, and the merger of Hydro One Brampton with other GTA area electricity distributors, had already been well reported by the press when the Premier’s Advisory Council on Government Assets report on unlocking the value of Hydro One was published. Aptly named “Striking the Right Balance,” the report describes a very thoughtful assessment of how to balance the commercial drivers and public policy concerns associated with the future of Hydro One.

At the same time as Striking the Right Balance was released, the Ministry posted an information release on Hydro One Oversight.

The Advisory Council suggests in its report that its recommendation that the government sell its interest in Hydro One down to 40% as a combined electricity distributor and transmitter, together with its recommendations on governance of the new Hydro One, will strike an appropriate balance between the “policy objectives” of continued government ownership of Hydro One and the imperative given to the Advisory Council to monetize the value of the business. (The Advisory Council’s initial, interim view was that Hydro One should be split into its transmission and distribution components, the latter sold off and the former held. The Council’s thinking has evolved to a sensible conclusion that the enterprise has more value, and that this value will be easier to monetize, if these two businesses are held together.)

Governance of the new Hydro One is an important issue, not just for regulatory geeks, but for the financial markets as well. As already noted in some of the post-release press reports, and as discussed in the press and financial circles following the release of the Advisory Council’s initial report in November 2014, one of the problems inherent in the “balance” which the Council is hoping to strike is the reticence of investors to commit to a business where control remains with the government. Particularly in the electricity sector, and in no place more than in Ontario, government management of the electricity file, often through government-owned electricity companies, has been characterized by an intense focus on public policy and political agendas, with less attention paid to commercial considerations and the efficient operation of a large “essential service” utility.

From a governance perspective, one of the most important passages in Striking the Right Balance is recommendation that: “The Province, in its capacity as a shareholder, should engage in the business and affairs of the company only as an investor, and not as a manager”. The Council aptly observes that the government will have to adjust its approach to Hydro One in order to “provid[e] assurance to investors that the new company will have sufficient autonomy and flexibility to operate effectively in the private sector”.

Some of the Council’s recommendations should assist in this respect:

  • The Province should approve initial governance standards, which should be consistent with “best practices” in Canada for public companies.
  • Governance should then be ceded to a new board of directors, which should have full authority to approve the strategy and annual business plan and budget for the company, and to hire, direct, and oversee the company’s management.
  • All members of the Board should be high-quality, reputable business leaders with the requisite skills, board experience, time and motivation for an operation of the new company’s size and scope.
  • All directors would be “independent” (that is, not employed by the Government) and owe a duty as a director to the company. (The Province would be entitled to nominate directors in proportion to its shareholding, to a maximum of 40%. Moreover, all directors of Ontario business corporations such as Hydro One, already owe expressly statutory fiduciary duties of this nature)
  • The Chair of the Board should be elected by the Board. (Again, this is a typical element of corporate governance in any case.)

So far so good, but there are some recommendations which could be perceived as compromising the general principle that the government should get out of the way and let this new, recapitalized company get on with the business of running and growing the utility. For example, the Council has included recommendations that:

  • The government could retain a right to remove the entire board of directors, including those which it has appointed.
  • The Chair of the Board and the CEO of the new Hydro One would be confirmed annually by two-thirds of the Board. Given that the government will continue to hold at least 40% of the shares of the new Hydro One, and thus hold the right to appoint at least 40% of the Board, this could at least be perceived as institutionalizing the potential for continued political interference in the affairs of the utility. The Council specifically notes that this measure would “ensure that both the Chair and the CEO, who are critical to the direction and management of the company, must be satisfactory to the Province’s nominees”. Put another way, the government can in effect, annually unilaterally dismiss the Chair and the CEO of Hydro One, if it so chooses. While both Chairs and CEOs do typically serve a the pleasure of a board of directors, is unusual to have this type of provision in a corporate charter.

Review of the Government’s companion Hydro One Oversight information release does nothing to allay creeping concerns regarding these notable departures by the Council from otherwise sound commercial governance recommendations. In particular, the Government’s release:

  • Emphasizes the Government’s intended power to remove all of the members of the Board.
  • Signals an intent to reserve the power to remove the Chair of the Board at the Government’s discretion.
  • Further signals the Government’s intent to reserve the power to reject non-provincial Board nominees if the government determines that they do not meet pre-defined qualifications. (Although these pre-defined qualifications are supposed to be focussed on independence and commercial experience, the details have yet to be fully defined).

The Government’s “de facto control” over the new Hydro One is also emphasized in the information release.

Neither these reserved powers nor the Government’s emphasis on its ongoing control will add any comfort that the Government will be disciplined enough to act as an owner rather than a manager going forward.

Beyond corporate governance, both the Advisory Council’s report and the Government’s information release refer to other governance changes that will attend the transition of Hydro One to a broadly publicly held company:

  • The Ontario Ombudsman’s oversight would cease. The government will require that the new Hydro One appoint its own Ombudsman (a good governance practice for a corporation of this size, scope and importance in Ontario).
  • The Freedom of Information and Protection of Privacy Act would no longer apply to Hydro One, nor would oversight by the Ontario Auditor General.
  • The Ontario Energy Board (OEB) would continue to set rates that are “just and reasonable”, in the legal sense, and to otherwise govern the service standards and service quality provided by Hydro One to Ontario’s electricity consumers. (Independent economic and service regulation of Hydro One has been the case in Ontario since 1998, and would continue to be the case. Previous, politically motivated or ill informed “hues and cries” regarding rising electricity rates were always misplaced.)
  • The Ontario Securities Act would also continue to apply to the new Hydro One, which provides for continuous disclosure standards and requirements regarding financial, management and compensation information.
  • General corporate legislation would also continue to apply to the new Hydro One, providing for financial statement audit, public disclosure and management certification requirements, and shareholders meetings with attendant information circular obligations.

The Advisory Committee report also refers to enhancements of OEB oversight of the new Hydro One. The Government’s information circular provides a bit more information regarding legislative changes to enhance the OEB’s ability to:

  • Increase compliance penalties;
  • Ensure reliability and continuity of electricity service in the face of licensee mismanagement of its obligations (an event that is highly unlikely for any regulated utility of the size, scope and importance of Hydro One, under any ownership structure); and
  • “Enhance oversight for ensuring best practices on utility consolidation activities.” This is an odd one, and appears to be aimed more broadly at electricity distributor consolidation than the specific transactions related to the monetization of the value of Hydro One.

Finally, the Government’s information release refers to an OEB initiative “to increase consumer advocacy by giving consumers a direct voice in OEB hearings and proceedings”. Right on cue, the OEB then released a letter indicating that it is proceeding with a second phase of a policy review of the role of intervenors that it began last year. This new phase of the policy review will focus specifically on alternatives for the funded consumer group regulatory intervention structure currently in place in Ontario. This is properly the topic of a separate comment. Suffice it to say for now that in Striking the Right Balance the Advisory Council recognized that rate applications to the OEB are already public, and consumer and industrial groups already have an opportunity to review costs and question rates being requested by regulated distribution and transmission companies (like the new Hydro One). These intervenors are sophisticated, broadly representative of ratepayer concerns, properly funded through an OEB-controlled cost eligibility system, and have a very “direct voice” in OEB hearings and proceedings. There is nothing apparent here that needs fixing, either generally or in the particular context of governance of the new Hydro One.

We will see whether the foregoing set of recommended and proposed measures will, in fact “strike the right balance” with investors who will be looking for a commercially oriented company rather than a vehicle for execution of the government policy of the day. We are encouraged by the balanced report of the Advisory Council. We are hopeful that the Government will take a commercial view of the path towards monetization of the value of Hydro One. We are somwhat concerned with the political statements indicating the Government’s intention to retain authority to nullify a functioning board of directors and replace the CEO at will, and signalling that the government will retain de facto control of the new Hydro One.

Private investment and government control do not often mesh easily, and a perception of continued government management of the business of Hydro One could reduce the value of the upcoming public offering.

The market will ultimately determine whether the right balance has been struck.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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