Explaining Regulatory Capital Value
Regulatory Capital Value (RCV) has been developed by Ofwat for regulatory purposes and is primarily used in setting price limits. Part of Ofwat’s responsibility under the Water Industry Act 1991 is to make sure that water companies like us can properly finance our regulatory requirements.
The RCV is remunerated through price limits using a cost of capital (on a real basis) set by Ofwat at each price review. The impact of inflation on the value of the RCV to investors and lenders is recognised by adjusting the value each year by inflation as measured by CPIH (Consumer Prices Index including owner occupiers' housing costs).
To calculate the RCV we take the opening RCV from the start of the financial year (1 April), add inflation and investment, then subtract depreciation and capital grants. This gives the RCV at the end of the financial year. This is summarised in the diagram below.
Ofwat introduced the concept of RCV in the early 1990s and it is now widely used by the investment community as a proxy for the market value of regulated businesses. The RCV was originally set as the market value of each water and sewerage company for the first 200 days for which the shares were listed, plus the total value of debt at privatisation.
Since then, the RCV has been increased by inflation and investment and reduced by RCV run off (similar to depreciation) and any capital grants or contributions towards the cost of the new assets. The RCV is also used by Ofgem for energy network companies, although it is called the regulatory asset value (RAV) in energy.