5. New Financing Rule

We adopt the Financing Rule attached to this decision as Attachment A. In replacing the CBR with this Financing Rule, we considered input of the parties, the extended time periods between reviews of the rule, and interests of the ratepayers. The Financing Rule provides utilities with the freedom to choose whether to use competitive or negotiated bidding, while protecting the ratepayers by requiring that the utility's bidding choice results in the lowest cost of debt to the ratepayers.

With the ever-changing means of communication, which have changed from the more time consuming written method when we first adopted a CBR to the now immediate forms of electronic communications, we have eliminated any time requirement for issuance of bids and require only that a utility use the most efficient form of communication.

The Financing Rule we adopt today will also encourage the development of a broader pool of underwriters and investors, which will be reflective of the population served by our regulated utilities as well as the financial market as a whole.

The Financing Rule also provides a more detailed list of exemptions, providing utilities with more guidance and certainty for their financial planning and a detailed list of requirements by which utilities may utilize debt enhancement features.

Finally, the Financing Rule will also lay the foundation for the engagement of WMDVBE firms to maintain access to utility debt and preferred stock financing opportunities. Fortunately, this access is supported by an established record of competitive performance for California's investor-owned utilities. Introducing a broader class of investors, record low coupon and dividend rates, moves utility financing activities towards a more accurate reflection of California's growing diverse ratepayer base.

5.1. Financing Rule

5.1.1. Parties' Positions

Initially, the Joint Energy Utilities, Southwest Gas, and CWA and Class A water, supported the position that no rule regarding the issuance of securities was necessary, given current market conditions.

The Joint Energy Utilities stated that the CBR should not be retained because it is outdated. The Joint Energy Utilities believe that negotiated bidding is now the market standard and the method by which they are able to achieve low cost financing for ratepayers while at the same time increasing their use of WMDVBE firms in financing transactions.14 The Joint Utilities assert that competitive bidding is not the most cost-effective means of issuing debt securities and is even less effective in times of market volatility.

The Joint Energy Utilities also reference a J.P. Morgan study, that nearly all debt issuances are currently accomplished using negotiated bids.15 This study shows that for the period 2008-2010, only five out of 5,663 debt issues (across all industries) in the United States investment grade corporate bond market were competitively bid. None of these competitive bid issues were done by utilities. AT&T, Verizon, and SureWest, as well as CALTEL,16 state that any revisions to the CBR should make clear that the revised rule is subject to statutory exceptions applicable to them. Both suggest language that clarifies the statutory exemption applicable to them, referencing Public Utilities (Pub. Util.) Code §829(b)(1).17

In their Workshop Report, however, the Joint Energy Utilities propose a rule in place of the current CBR that addresses the concerns of utilities and other parties. In particular, the Joint Energy Utilities' proposed rule would: 1) provide utilities with the freedom to choose the method by which it issues debt, while still requiring such issuance to achieve the lowest long-term cost to ratepayers; 2) include reporting of utilities' efforts towards the use of WMDVBE firms; and 3) include what type of information to provide when requesting debt enhancement features and rules governing such features. In their opening comments, the Joint Energy Utilities reiterate support for their proposed new rule, which they believe will enable utilities to access cost effective capital and be in the best interest of the ratepayers.

In support of their proposed revised rule, the Joint Energy Utilities also reference revisions to the rules governing the issuance of long-term debt financing by other regulatory agencies. For example, in 1984, the New York Department of Public Service gave utilities "flexibility in selecting the method of selling the securities,"18 while in 1985, the Interstate Commerce Commission (ICC) repealed its competitive bidding requirement, finding that "the need for our oversight of railroad securities has decreased as a result of changed circumstances and recent Congressional action."19 In 1994, the Securities and Exchange Commission (SEC) rescinded its Rule 50, which required competitive bidding for the issuance of securities by a registered holding company or its subsidiary. Originally, the SEC instituted this rule to prevent abuses in the issue and sale of securities.20 The SEC found that Rule 50 was "no longer necessary in view of the extensive reporting requirements imposed by the Act [Public Utility Holding Act of 1935] and the other federal securities laws."21 By rescinding Rule 50, the SEC gave companies the independence to choose the marketing method with the most advantageous terms. In 1995, the Federal Energy Regulatory Commission amended its policies to permit public utilities to "issue securities by either a competitive bid or negotiated placement."22

5.1.2. Discussion

We recognize the various studies referenced by parties, the revisions by other regulatory agencies, as well as the utilities' use of negotiated bids, private placement, and government loans, but are concerned that given the volatility of the financial markets, financial trends could change at any time. Since we cannot know for sure what the economy and financial market will be like over the next several years, let alone the next decade or more, we must retain some form of a rule that governs the issuance of securities.

We therefore find that allowing utilities to choose between competitive and negotiated bidding with the goal of achieving the lowest long-term cost of capital for ratepayers, as proposed by the Joint Energy Utilities, provides the utilities with the independence to manage how to issue their own debt, while ensuring that ratepayers pay the lowest cost of capital.

We also want to ensure that ratepayers are charged the most cost effective price in the rates they pay. Given the state of the economy, more and more ratepayers are finding it difficult to pay their bills.23 It is therefore essential to require utilities to demonstrate the cost effectiveness of the method they use to issue debt securities.

Since the utilities must still request authority to include their specific costs of debt in rates as part of the cost of capital proceeding, we find that a cost benefit study to determine whether the method of bidding and the use of debt enhancements is cost effective when the utility requests financing authority is not necessary. We find the review performed as part of the utility cost of capital proceedings provides an opportunity for ratepayers and interested parties, to assess the reasonableness of all debt related costs and for the Commission to determine such reasonableness. Performing a cost benefit study as part of a utility's request for financing authority would be duplicative of the review performed in the cost of capital proceedings, in which the reasonableness of each component of the cost of capital, including common equity, preferred equity, and long-term debt is assessed for reasonableness. This duplication of effort would result in more work for the Commission and all parties involved.

We reject AT&T's, Verizon's, and SureWest's suggestions that the new rule only apply to utilities and not their affiliates. On a regular basis, utilities are authorized to issue debt through their regulated affiliates.24 Since the utility and ultimately the ratepayer is responsible for paying for this debt, and the affiliate is acting for the utility, we must ensure that the affiliate performs their duties in the same manner as the utility.

We therefore adopt the following rules:

1. Public utility long-term debt issues shall be conducted in a prudent manner consistent with market standards that encompass competition and transparency, with the goal of achieving the lowest long-term cost of capital for ratepayers; and

2. Public utilities shall determine the financing terms of their debt issues with due regard for their financial condition and requirements, and current and anticipated market conditions.

5.2. Exemptions from the Financing Rule

5.2.1. Parties Positions

In their Workshop Report, the Joint Energy Utilities did not include any exemptions to their proposed version of the Financing Rule. In its Pre-Workshop Statement and opening comments to the Workshop Report, PacifiCorp states that it wants the Commission to retain an existing exemption from the CBR for multi-state utilities with less than 5% California revenues. In its Opening Comments, PacifiCorp reiterates that it has been granted an exemption (see D.88-04-062) from the provisions of the Public Utilities Code relating to stocks and securities transactions and the encumbrance of utility property, and therefore should not be required to provide proof of such exemption when it issues debt.

CWA and Class A water support exemptions for small issues, government debt, and private placement debt. CWA and Class A water originally proposed that the limit for small issues be raised to $200 million from $20 million. In their Opening Comments to the Proposed Decision, CWA and Class A water instead support an increase of this limit for small issues to $42 million, adjusted each year pursuant to the CPI.

The Small LECs support an exemption for small debt issuances, as well as those issuances for which telecommunications utilities are already exempted. In particular, the Small LECs suggest new language that would specifically identify the code section that exempts them from Pub. Util. Code §§ 816-830. In their joint Opening Comments, AT&T and Verizon California Inc. reiterate that, pursuant to Pub. Util. Code § 829(b), certain telecommunications utilities are statutorily exempt from applicable sections of the Public Utilities Code regarding the issuance of debt, and therefore should not be required to prove such exemption from the Financing Rule.

5.2.2. Discussion

Even though the new Financing Rule adopted herein allows a utility to choose the method by which it will issue debt, it includes other requirements regarding WMDVBEs and debt enhancements. Some types of utilities should not be subject to these requirements due to their size or the type of debt they issue, which is consistent with historical exemptions from the CBR. We therefore include the exemptions discussed below.

These exemptions address a number of the concerns raised by the utilities, such as the size of recent debt security issuances, as well as the types of debt securities that do not lend themselves to a specific type of bidding.

We also continue to allow an exemption for smaller issues of debt securities. The current CBR allows exemption for issues of $20 million or less. Given the CPI increase of approximately 107% from 1986 through 2011 (discussed in Section 3.1 above), which would equate to an increase in the exemption of approximately $42 million, and since revisions to the CBR are infrequent, we require that the current exemption baseline of $20 million be increased to $42 million for 2012, and be adjusted each year by the most recent CPI found on the California Department of Finances' website or its successor. Since government loans and tax-exempt debt are governed by their own set of rules and regulations, and may not be bid at all, we should exempt such debt from the Financing Rule adopted herein.

As discussed in Section 4 above, government loans are governed by their own set of rules and regulations, may not be bid at all, either competitively or through a negotiated bid (unless required by the government entity issuing the debt securities). Along these same lines, a tax exempt debt security, which is also normally issued by a government entity, is governed by its own rules and regulations. We also find it reasonable to exempt a utility from the Financing Rule if its California operations account for a small percentage of its total operations. Similarly, we find it reasonable that if an affiliate provides debt issuance services to the utility, and the utility's debt accounts for less than five percent (5%) of the affiliate's annual debt issuances, such issuances are exempt from the Financing Rule.

These exemptions provide more specific guidance to the utilities than is provided in the current CBR. For example, when a utility plans to obtain a government loan, there is no specific exemption in the current CBR that addresses this requested exemption. In the future, a utility will have certainty that if it provides the support for such a requested exemption, such exemption is available.

We therefore adopt the following exemptions, which will only be granted upon a compelling showing by a utility in its financing application, that the terms of such exemption are applicable to the utility, for the proposed debt issuance:

1. Bond issues of $42 million or less, adjusted each year for the CPI found on the California Department of Finance's website or its successor, are exempt from the Financing Rule;

2. Tax exempt or government debt issues are exempt from the Financing Rule;

3. Debt issues, such as the Safe Drinking Water Bond Act loans, Rural Utility Service loans, and pollution control loans, are exempt from the Financing Rule;

4. Debt issues made through an affiliate that provides debt issuance services to all affiliates of the same parent are exempt from the Financing Rule if such debt accounts for less than five percent (5%) of the financing affiliate's annual issuances; and

5. For multi-state utilities operating in California, if the operating revenues from California operations represent less than five percent (5%) of the entire utility's total operating revenues for the most current calendar year, the utility is exempt from the Financing Rule.

In D.88-04-062, we authorized an exemption for PacifiCorp from the provisions of the Public Utilities Code relating to stocks and securities transactions and the encumbrance of utility property. Given this authority, we do not require PacifiCorp to provide proof of the applicability of such exemption from the Financing Rule.

Pursuant to Pub. Util. Code § 829(b), debt issues for telephone utilities whose rates are subject to the Uniform Regulatory Framework (URF),25 and whose rates are therefore not subject to rate of return regulation, are exempt from all other applicable provisions of Pub. Util. Code §§ 816-830. Given that such debt issuances are governed by Public Utilities Code, we do not require the affected telephone utilities to provide proof of the applicability of such exemption from the Financing Rule. However, in accordance with GO 156, these utilities are encouraged to make their best efforts to engage WMDVBE booking firms.

5.3. Women, Minority, and Disabled Veterans Business Enterprises

5.3.1. Parties Positions

Initially, the Joint Energy Utilities did not think any extra GO 156 rules were necessary, since they are already proactively utilizing WMDVBEs in their financing activities and did not see the need for further rules governing such activities. Subsequently, in their Workshop Report, the Joint Energy Utilities propose that utilities with $25 million or more of annual operating revenues from California operations shall use their best efforts to encourage, assist, and recruit WMDVBE for financing issuances and that the utilities report on such activity as part of their GO156 Annual Report. They go on to propose that such actions regarding WMDVBEs be cost effective, and be consistent with Section 6 of GO 156. In their Pre-Workshop Statement, CWA and Class A water stated that any rules regarding GO 156 should be separate from the Financing Rule. In their Pre-Workshop Statement as well as their comments to the Workshop Report, AT&T, Verizon, and SureWest initially stated that GO 156 is sufficient, and there is no reason to add a requirement in a financing related rule.

5.3.2. Discussion

GO 156 sets forth the Commission's policy statement on utility utilization of resources from WMDVBEs. To the extent this decision comports with and compliments GO 156, we encourage utilities to follow those principles in their issuance of long-term debt.

We appreciate the efforts made by Commission regulated utilities to include WMDVBEs as underwriters, leads, and co-managers of debt they have issued in recent years. We find that, in order to officially encourage the use of these firms we must apply the tenets of GO 156 to the issuance of debt. Therefore, we add a section to the Financing Rule which would promote additional opportunities for WMDVBE and emerging firms, to the ultimate benefit of the utilities ratepayers and shareholders. With the inclusion of WMDVBE firms in the available pool of underwriters, we also encourage healthy competition, which should result in lower costs to the ratepayers.

Such a requirement is consistent with promoting the goals of GO 156 and does not conflict with GO 156, which takes precedence over the Financing Rule requirement.

We therefore adopt the following:

3. Utilities with $25 million or more of annual California operating revenues, requesting financing authority, shall use their best efforts to encourage, assist, and recruit Women-, Minority-, and Disabled-Veteran Owned Business Enterprises (WMDVBE)26 in being appointed as lead underwriter, co-manager, or in other roles in the issuance of debt security offerings.

5.4. Debt Enhancement Features

5.4.1. Parties Positions

In their Pre-Workshop Statements, the Joint Energy Utilities and Southwest Gas recommended that no cost benefit study should be required to receive authority for debt enhancement features. In particular, the Joint Energy Utilities stated that: "A cost/benefit study is neither necessary nor feasible, and would lack any meaningful value if required as part of a request for financing authority, because the existing market conditions at the time a financing opportunity is identified cannot be accurately or timely analyzed in advance when a financing application is filed and reviewed by the Commission."27 Southwest Gas suggested as an alternative, that utilities provide a description and rationale for their debt enhancement choices, as well as being subject to a prudency review.

In their Workshop Report, though, the Joint Energy Utilities presented a rule addressing Debt Enhancement Features that removed a cost effectiveness requirement but required utilities to provide a brief description and rationale for their proposed debt enhancements, and included certain restrictions commonly authorized by us with regards to the use of swap and hedging transactions.

5.4.2. Discussion

As discussed earlier, utilities regularly request and receive authority for the inclusion of Debt Enhancement Features in their financing requests, which are supposed to improve the terms and conditions of debt securities and reduce the overall cost of money. Until now, we have never required a showing by the utilities as to whether they have used the authorized features, or whether their use has lowered the cost of debt securities issued.

Since the utilities must still request authority to include their specific costs of debt in rates as part of the cost of capital proceeding, we find that a cost benefit study to determine whether the method of bidding and the use of debt enhancements is cost effective when the utility requests financing authority is not necessary. We find the review performed as part of the utility cost of capital proceeding provides an opportunity for ratepayers and interested parties to determine the reasonableness of all debt related costs. Performing a cost benefit study as part of a utility's request for financing authority would be duplicative of the review performed in the cost of capital proceedings, and would result in more work for the Commission and all parties involved.

Therefore, we include a section in the Financing Rule that addresses requests for debt enhancement features that does not require a cost benefit study, but instead requires a description of and rationale for the potential debt enhancement feature being requested.

We also place the restrictions on the use of swaps and hedges by utilities. We have authorized such restrictions for over a dozen years (see Section 3.3. above), and find them effective in controlling the risk of swap and hedge transactions.

We therefore adopt the following:

6. Debt Enhancement Features shall only be used in connection with debt securities financings, and may include but are not limited to: put options, call options, sinking funds, swaptions, caps, collars, currency swaps, credit enhancements, capital replacement, interest deferral, special-purpose entity transactions, delayed drawdown, treasury lock, treasury options, and interest rate swaps.

d. For each Debt Enhancement Feature requested in a financing application, the utility shall provide a brief description and rationale for the potential use of a debt enhancement or the risk management properties associated with the potential use of a derivative instrument to hedge risk exposures.

e. Debt Enhancement Features are not considered as separate debt for purposes of calculating a financing authorization.

f. Swap and hedging transactions are restricted as follows:

      i. Utilities shall separately report any interest income and expense arising from all swaps and hedging transactions in their annual General Order 24-C reports to the Commission.

      ii. Swap and hedging transactions shall not exceed 20% at any time of a utility's total long-term debt outstanding.

      iii. All costs associated with hedging transactions are subject to review in a utility's next regulatory proceeding addressing its cost of capital.

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

      v. 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 regulatory proceeding addressing its cost of capital.

      vi. Utilities shall provide the following to Commission Staff within 30 days of receiving any written request: (i) all terms, conditions, and other details of swap and hedge transactions; (ii) rationale(s) 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.

14 See May 9, 2011 Joint Response Of Southern California Edison Company (U338E), Pacific Gas and Electric Company (U39M), San Diego Gas & Electric Company (U902M), and Southern California Gas Company (U904G) at 7-8. ("Issuing securities in challenging market conditions requires the ability to have discussions with investors and to pre-market the securities, adjusting the transaction size, structure and other elements, as necessary. Such discussions are not possible in competitive bids; there is no opportunity to test investors' appetite for the securities in advance of the actual offering. In challenging markets, competitive bidders are likely to add an even higher risk premium to yields for the issuer's existing securities (secondary market levels) or other comparable issues than under normal market conditions in order to avoid potential losses. This would increase the cost of financing for the utilities and their ratepayers. It is even possible that investment banks may opt not to bid at all given the uncertainty and risk of mispricing the securities, resulting in a potentially large loss to the bank.")

15 See May 9, 2011 Joint Response of Southern California Edison Company (U338E), Pacific Gas and Electric Company (U39M), San Diego Gas & Electric Company (U902M), and Southern California Gas Company (U904G) at 5, which references the study titled Competitively Bid Transactions 2008-2010, dated April 15, 2011.

16 In its comments to the Workshop Report, CALTEL also requested that revisions be made to the Workshop Report to provide more detail of the comments made by its representative at the workshop. Since CALTEL's comments to the Workshop Report were filed, and are therefore part of the record of this proceeding, we find no need to include this information in the Workshop Report.

17 Pub. Util. Code § 829(b)(1) "Except for Section 828, a telephone corporation that is not regulated under a rate-of-return regulatory structure is exempt from this article. This subdivision does not exempt a telephone corporation that is also an electrical corporation or a gas corporation, unless the commission determines the telephone corporation is exempt pursuant to subdivision (c). As used in this subdivision, a `rate-of-return regulatory structure' means a system under which the rates and charges of the telephone corporation are limited by a maximum permissible price that may be charged for a specific service. Telephone corporations regulated by a framework under which they may exercise pricing flexibility for all or most of the services offered are not regulated under a rate-of-return regulatory structure."

18 1984 N.Y. PUC LEXIS 227 * 8 (May 18, 1984). See also 1985 N.Y. PUC LEXIS 784 * 9 (January 14, 1985) ("Considering Niagara Mohawk's current financial posture, the company should be given flexibility in selecting the method of selling the securities.")

19 Exemption of Railroads from Securities Regulation under 49 U.S.C 11301, 1985 ICC LEXIS 492, at *2 (April 1, 1985). The ICC determined that rescission of the competitive bidding requirement was warranted in order to promote the Congressional policies to increase the attractiveness of investing in railroads, and in light of the fact that many of the government regulations affecting railroads had become unnecessary and inefficient.

20 Pursuant to Public Utility Holding Company Act Rules, File No. S7-35-92, Securities and Exchange Commission, Release No. 35-25668; 17 CFR Parts 250 and 259; RIN: 3235-AF68, 1992 SEC LEXIS 2849, November 4, 1992 "Rule 50, adopted in 1941 under sections 6(b), 7, 12(d) and 20, imposes a general requirement of competitive bidding with respect to the issuance or sale of securities by a registered [*17] holding company or its subsidiary. n31. The rule was intended to ensure the maintenance of competitive conditions, the receipt of adequate consideration, and the reasonableness of fees or commissions to be paid in connection with the issuance or sale of securities by a registered holding company or its subsidiary." And "As we recently noted in another context, companies in a registered holding company system should have the flexibility to access the capital markets by the use of competitive bids, negotiated sales, or private placements." For the information of the reader, subsequent to the SEC's actions, in September of 2005, the Public Utility Holding Act of 1935 was repealed and replaced with the Public Utility Holding Act of 2005.

21 Utility Holding Company Act Rules, File No. S7-35-92, Securities and Exchange Commission, Release No. 35-26031; 17 CFR Parts 250 and 259; RIN 3235-AF68, 1994 SEC LEXIS 1176, April 20, 1994.

22 Code of Federal Regulations Title 18: Conservation of Power and Water Resources; Part 34 - Application for Authorization of the Issuance of Securities or the Assumption of Liabilities; Section 34.2 - Placement of Securities. Pursuant to Federal Energy Regulatory Commission Order 575, 60 FR 4853, January 25, 1995.

23 United States Census Bureau, "Poverty: 2009 and 2010, American Community Survey Briefs." http://www.census.gov/prod/2011pubs/acsbr10-01.pdf. In 2010, 15.8% of California's population was below the poverty level.

24 For example, see D.10-08-002 at Ordering Paragraph 7 (SCE); D.10-10-022 at Ordering Paragraph 4 (Southwest Gas); and D.10-10-023 at Ordering Paragraph 6 (SDG&E).

25 See D.06-08-030.

26 Pursuant to GO 156 and D.11-05-019, definitions of Women, Minority, and Disabled Veterans Owned Business Enterprises are as follows:

1.3.2. "Women-owned business" means (1) a business enterprise (a) that is at least 51% owned by a woman or women or (b) if a publicly owned business, at least 51% of the stock of which is owned by one or more women; and (2) whose management and daily business operations are controlled by one or more of those individuals.

1.3.3. "Minority-owned business" means (1) a business enterprise (a) that is at least 51% owned by a minority individual or group(s) or (b) if a publicly owned business, at least 51 % of the stock of which is owned by one or more minority groups, and (2) whose management and daily business operations are controlled by one or more of those individuals. The contracting utility shall presume that minority includes, but is not limited to, Black Americans, Hispanic Americans, Native Americans, Asian Pacific Americans, and other groups, as defined herein.

1.3.4. "WMDVBE" means Women-, Minority-, Disabled Veteran-Owned Business Enterprises; under these rules, the women and/or minorities owning such an enterprise must be either U.S. citizens or legal aliens with permanent residence status in the United States.

1.3.5. Black Americans - persons having origins in any black racial groups of Africa.

1.3.6. Hispanic Americans - all persons of Mexican, Puerto Rican, Cuban, South or Central American, Caribbean, and other Spanish culture or origin.

1.3.7. Native Americans - persons having origin in any of the original peoples of North America or the Hawaiian Islands, in particular, American Indians, Eskimos, Aleuts, and Native Hawaiians.

1.3.8. Asian Pacific Americans-persons having origins in Asia or the Indian subcontinent, including, but not limited to, persons from Japan, China, the Philippines, Vietnam, Korea, Samoa, Guam, the U.S. Trust Territories of the Pacific, Northern Marianas, Laos, Cambodia, Taiwan, India, Pakistan, and Bangladesh.

1.3.9. Other groups, or individuals, found to be disadvantaged by the Small Business Administration pursuant to Section 8(a) of Small Business Act as amended (15 U.S.C. 637 (a)), or the Secretary of Commerce pursuant to Section 5 of Executive Order 11625.

1.3.10. Disabled Veteran - a veteran of the military, naval or air service of the United States with a service-connected disability who is a resident of the State of California.

27 Pre-Workshop Statement of Joint Energy Utilities at 3.

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