3. The Current Competitive Bidding Rule and Other Rules and Orders Applicable to Financing Applications

3.1. The Competitive Bidding Rule and Exemptions

The purpose of the CBR is to ensure that utilities incur the lowest financing cost available, which is then passed on to ratepayers. The current CBR is mandatory for all domestic debt issues of debentures and first mortgage bonds of $200 million or less, and sets forth specific criteria that need to be satisfied in order to obtain an exemption from the CBR. The Commission determines whether a requested exemption is authorized on a case-by-case basis. Current CBR authorized exemptions include: 1) Requests for exemption from the rule will only be entertained for debt issues in excess of $200 million, and will only be granted upon a compelling showing by a utility that because of the size of the issues an exemption is warranted; 2) Debt issues for which competitive bidding is not viable or available are exempt; 3) The notification requirement to solicit bids is shortened to one day; 4) Telephonic competitive bidding is allowable; 5) The rule is only applicable to utilities with bond ratings of "A" or higher; and 6) Bond issues of $20 million or less are exempt. We note that the California Consumer Price Index (CPI) increased approximately 107% from 1986 through 2011, which would equate to an increase in the exemption of approximately $42 million dollars.⁶

In recent years, modifications requested and received by individual utilities have included, but have not been limited to, authority to: 1) issue debt securities in excess of $200 million via a means other than competitive bid, because the size or type of issuance does not lend itself to competitive bidding; 2) issue debt securities such as tax-exempt financing, foreign debt, government debt, privately placed debt, or debt issued through an affiliate, via means other than competitive bid; 3) be exempt from the CBR if the utility is a multi-state utility whose California operating revenue is 5% or less than the entire utility's total operating revenue; 4) permit competitive bidding via electrical means, such as e-mail, in lieu of telephonic bidding; and 5) waive one-day notification requirement of a competitively bid offer.

3.2. Women, Minority, and Disabled Veterans Business Enterprises

GO 156, which was originally adopted in 1988,⁷ governs the development, implementation, and reporting of programs to encourage, recruit, and increase the participation of Women, Minority, Disabled Veteran Owned Business Enterprises (WMDVBE) in procurement of contracts from electric, gas, telephone, and water utilities with gross annual revenues exceeding $25 million and their Commission-regulated subsidiaries. The Commission's September 2010 Report to the Legislature on Diverse Business Enterprise (DBE) procurement for the year 2009 showed that, although utility procurement of financial services from WMDVBEs shows steady and continuing improvements, the percentage of total procurement directed to diverse financial service firms lags behind traditional procurement areas.⁸ Neither the CBR nor GO 156 addresses the use of WMDVBE firms as underwriters or co-managers in the issuance of debt.

3.3. Debt Enhancement Features Regularly Requested by Applicants

The utilities' use of discretionary debt enhancement has substantially increased since 1986, and has also increased their use of swap and hedging transactions to manage their interest rate risk. Debt enhancements are used by the utilities to improve the terms and conditions of their long-term debt securities and to lower the overall cost of money which, in turn, benefits the ratepayers.

Some of the more recent types of approved debt enhancements included put options, call options, sinking funds, swaptions, caps, collars, currency swaps, credit enhancements, capital replacement, letters of credit, standby bond purchase agreements, surety bonds and insurance policies; delayed drawdown; redemption provisions; tax exemption, warrants; encumbrance of accounts receivables interest deferral, special-purpose entity transactions, hedging strategies, treasury lock, various types of treasury options, various types of interest rate swaps, and long hedges.⁹

However, it is not clear that all of the enhancements being requested by the utilities and being approved actually are being used by the utilities, or whether the enhancements being used result in added risks to ratepayers that should be mitigated.

Even though swaps and hedges are meant to reduce exposure of the issuer to interest rate risk, such features carry their own risks, for example, counterparty risk.¹⁰ Over the past dozen years or so, we have authorized restrictions on the use of swaps and hedges in an effort to reduce the risks these features could carry with them.¹¹ These restrictions require that:

a. A utility must separately report all interest income and expense arising from all swaps and hedging transactions in its regular annual report to the Commission;

b. Swap and hedging transactions will not exceed 20% at any time, of a utility's total long-term debt outstanding;

c. All costs associated with hedging transactions are subject to review in a utility's next cost of capital proceeding;

d. Hedging transactions carrying potential counterparty risk must have counterparties with investment grade credit ratings;

e. If a utility elects to terminate a swap or hedging transaction before the original maturity or the swap or hedging partner terminates the agreement, all costs associated with the termination are subject to review in a utility's next cost of capital proceeding; and

f. The utility will provide the following to Commission staff within 30 days of a request:

i. all terms, conditions, and other details of swap and hedge transactions;

ii. rationale for the swap and hedge transactions;

iii. estimated costs for the "alternative" or un-hedged transactions; and

iv. copy of the swap and hedge agreements and associated documentation.

3.4. General Order 24-B

GO 24-B, requires utilities to submit a monthly report to the Commission that contains, among other things:

a. the amount of debt and stock issued by the utility during the previous month;

b. the total amount of debt and stock outstanding at the end of the prior month;

c. the purpose for which the utility expended the proceeds realized from the issuance of debt and stock during the prior month; and

d. a monthly statement of the separate bank account that the utility is required to maintain for all receipts and disbursements of money obtained from the issuance of debt and stock.

In order to reduce the utilities' administrative cost of complying with the GO and to conform to past practice, the Commission has routinely modified the monthly reporting requirement to quarterly, which has been considered adequate to receive timely information.¹² However, the utilities are required to report this information on a monthly basis if directed to do so by the Commission staff.

⁶ See California Department of Financing website at http://www.dof.ca.gov/HTML/FS_DATE/LatestEconData/FIS_Price.htm.

⁷ See D.88-04-057. See also Pub. Util. Code § 8281, which is one of the code sections on which GO 156 is based. § 8281, in part states, that it is the policy of the state to "to aid the interests of women, minority, and disabled veteran business enterprises in order to preserve reasonable and just prices and a free competitive enterprise, to ensure that a fair proportion of the total purchases and contracts or subcontracts for commodities, supplies, technology, property, and services for regulated public utilities...are awarded to women, minority, and disable veteran business enterprises. ..."

⁸ California Public Utilities Commission 2009 Report to the Legislature on Utility Procurement of Goods, Services and Fuel from Women-, Minority-, and Disabled Veteran-Owned Business Enterprises, dated September 2010.

⁹ Swaps and hedges authorized by this Commission are normally excluded from consideration as separate debt for purposes of calculating a utility's financing authorization. For example, in D.08-10-013 the Commission stated that swaps or hedges will not count against a utility's authorized debt to the extent the swaps and hedges both are recorded as a liability in accordance with generally accepted accounting principles (GAAP), and deemed effective under GAAP in offsetting changes to the fair value or cash flows of the risks being swapped or hedged. On the other hand, swaps and hedges will be counted against a utility's authorized debt to the extent they are recorded as a liability in accordance with GAAP, but are not deemed effective under GAAP in offsetting changes to the fair value or cash flows associated with the risks being swapped or hedged.

¹⁰ Counterparty Risk is defined as the risk that the other party to an agreement will not perform or will default on their part of the agreement.

¹¹ See D.10-08-002, Ordering Paragraph 13. See also D.07-08-012 at 7; D.05-08-008 at 15-18; D.00-10-063 at 6-7; and D.98-02-104 at 8-12.

¹² See, for example: D.10-08-002 (2010) mimeo. at 20; D.09-09-046 (2009) mimeo. at 12; D.08-10-015 (2008) mimeo. at 7; D.07-08-012 (2007) mimeo. at 12; D.06-05-015 (2006) mimeo. at 22; D.05-08-008 (2005) mimeo. at 36; D.04-10-037 (2004) mimeo. at 51; and D.03-12-052 (2003) mimeo. at 11-12.