In response to Ofwat’s proposed a methodology for estimating the risk-free rate (RFR) for PR24, this report presents an alternative methodology that is rigorous and aligned with previous decisions made by the Competition and Markets Authority (CMA) in its redetermination for the PR19 price control.
The report first reviews the methodology proposed by Ofwat for PR24. For the RFR estimate, the regulator is proposing to draw on gilt yields as its primary source of evidence and to place no weight on AAA-rated bonds. Ofwat is considering employing long-term SONIA swap rates and nominal gilt yields as potentially useful cross-checks. It does not consider the inclusion of an uplift to the gilt yields to account for the presence of a convenience premium.
The report then presents a case for an alternative approach to that proposed by Ofwat, examining which proxies should be used to estimate the relevant RFR. The report proposes an approach which is in line with what the CMA proposed in its redetermination for PR19: ‘zero-beta’ assets represent valid proxies for the RFR.