Public energy company: strategic outline case

Appendix D – ESA 2010 entity classification principles and SG funding implications

All UK Government departments (including SG) must manage their spending under the HMT Consolidated Budgeting Guidance (CBG) which applies in turn the UK Government's Fiscal Framework. This Framework applies European System of Accounts 2010 (ESA 2010). The EUROSTAT Manual of Government Deficit and Debt (MGDD 2016) provides guidance on demarcation of the public and private sectors. There is a chance that the UK Government will no longer apply the above information post Brexit, which may take place prior to the establishment of the Energy Co. However we are not aware of the Government's intentions for its Fiscal Framework post Brexit and so assume that the requirements do not change while highlighting the possibility that they will change.

This Appendix describes how we expect the Office of National Statistics to apply ESA 2010 and MGDD 2016 in classifying the Energy Co., and then summarises how this classification affects its impact on SG budgets.

Classification process summary

ESA 2010 classifies economic entities into one of the following:

• Private sector
• Public sector – and one of:
  • General Government
  • Public Corporation
  • Financial Corporation; this classification applies to entities that practice specific banking activities and this Appendix assumes that it is not relevant to the Energy Co.

MGDD I.2 sets out stages that a classification process must follow:

• Is the entity a separate body (MGDD I.2.2)?
• Does a public body control the entity (MGDD I.2.3)?
• Is the entity a market body (MGDD I.2.4 and VI.1.3)?
• Does the entity fulfil a specific narrow role for Government (MGDD I.6)?

Any entity that behaves as a market unit is private sector, while any non-market entity that a General Government unit controls is a General Government sector body.

Is the entity a separate body?

MGDD I.2.2 states that a separate body ('institutional unit') must be able to:

• Own and exchange ownership of goods and assets with other institutional units
• Be legally accountable for economic activities and decisions
• Enter into contracts that result in it incurring liabilities and costs
• Maintain standalone financial statements summarising the results of all of its transactions during an accounting period as well as a balance sheet of its assets and liabilities.

Does a public body control the entity?

ESA 2010 states that an entity controls another entity if it defines that entity's general policy and programme (MGDD I.2.3) and sets out three situations, any one of which normally indicates control:

• A right to appoint, veto or remove most key officers or board of directors
• A right to appoint, veto or remove most appointments to the unit's key committees, or
• Ownership of more than 50% of the unit's voting rights or equivalent if it does not issue shares.

Statisticians consider each of these situations in aggregate such that if several General Government units' rights sum to a majority, the situation applies. MGDD I.2.3 then states that if none of the above situations conclusively applies the analysis must assess a further six criteria. If then none of these additional six criteria apply, considering them collectively may still indicate control. The table below summarises these additional criteria:

ESA 2010 additional criteria

Criterion	Comments
Can government appoint, remove or veto key personnel?	Refers to determining general policy through influential Board members
Does Government hold special or "golden" shares?	Depends on whether the rights are contingent or time-restricted
Can Government control through contract?	If Government is exclusive customer of outputs, may indicate dominant influence over strategy
Can Government control borrowing and use of funds?	Government may veto borrowing or control how body uses funds it borrows
Does Government control through excessive regulation?	Tight regulation (e.g. utilities, rail) may restrict body's ability to set policy because it is set up for Government purpose
Other factors	Control dividends, start or end of activities

Source: MGDD

Is the entity a market body?

MGDD I.2.4 states that the entity will be a market unit if it passes the MGDD's 'Market Test'. This assesses whether the entity does or will meet more than 50% of its costs (including financing and depreciation) from revenues that arise from sales at prices that are economically significant.

MGDD VI.1.2 and VI.1.3 consider specific circumstances and state an underlying principle that revenue is sales at economically significant prices if the body provides a service specifically to the entity making the payment, and the charge for the service is similar to its underlying cost. We expect that the ONS will assess this criterion on a long-run basis because a new body may fail this test in its first years of operation as it builds demand for its services. This assessment will therefore need a robust business plan that demonstrates how this demand is likely to grow.

Does the entity fulfil a specific narrow role for Government?

MGDD I.6 considers entities that Government sets up to fulfil a specific role. These bodies may meet all other criteria for private sector classification but in substance may not be autonomous or have no autonomy of action. Instead, the entity would be a Special Purpose Entity' (SPE) and part of the General Government sector because it in effect implements Government policies.

ESA 2010 (2.17) states that SPEs usually fulfil narrow, specific or temporary objectives and isolate a financial risk, a specific taxation or a regulatory risk. Paragraph 2.18 of ESA 2010 states that there is no common definition of an SPE but that a Government will classify an SPE as for other entities if and only if it is sufficiently independent. The MGDD states that an SPE governing board's sole purpose is to ensure that the SPE implements a legal contract effectively, and has no autonomy to direct the SPE to enter into other business activity.

Classification outcomes summary

These are:

• If a public body does not control the entity under any of the criteria under "Does a public body control the entity?" above, the entity is a private sector body
• If a public body does control the entity and the Market Test applies, it is a public corporation
• If a public body does control the entity and the Market Test does not apply, it is part of General Government.

Budgetary impact summary

CBG paragraphs 11.13 and 11.14 summarise the budgetary impacts of public corporations. In summary:

• Any General Government body's costs, revenues and borrowing will score directly against the relevant sponsoring department's C-DEL' and R-DEL or (Annual Managed Expenditure) AME depending on its type
• Any net impact of a subsidy paid to and dividends received from a public corporation, and borrowing by a public corporation scores against the relevant sponsoring department's C-DEL, R-DEL or AME, depending on its type.

This means that a public corporation's revenue budget impact is likely to be lower and less volatile than that of a General Government entity, while there will be no significant differences in C-DEL impacts.