Changes to the financial parameters of the cap and floor regime for window 3 electricity interconnectors - decision

What this is about

Ofgem has issued a decision on the financial parameters that will govern the cap-and-floor regime for Window 3 electricity interconnectors, and likely subsequent windows. The cap-and-floor mechanism is the standard route by which GB-European interconnector projects receive 25 years of regulated revenue protection funded ultimately by transmission consumers: developers keep merchant revenues between a floor (debt service is protected) and a cap (windfalls are clawed back), with consumers topping up below the floor and receiving rebates above the cap. The financial parameters, particularly the cost of capital allowances embedded in the cap and floor levels, determine how much developers earn, which projects get built, and how much GB consumers pay.

This decision closes out two earlier consultations. The September 2023 First Consultation proposed a package of design parameter changes for Window 3. The July 2024 Second Consultation revisited the cap rate specifically after stakeholder pushback. Today's decision addresses Section 1 of the First Consultation (the design parameter changes) and the entirety of the Second Consultation. Window 3 is the next tranche of cap-and-floor approvals; the projects that pass the Initial Project Assessment are now in the financial design phase, and these parameters are what they will be regulated under. The substance of the decision is in the 550KB PDF rather than the web page, which is essentially a wrapper.

What the decision actually does

The web page is a landing page; the substantive financial parameters, including the chosen cap rate, the floor rate, the indexation approach, and any changes to the depreciation profile or the revenue collection mechanism, sit inside the linked PDF. Without the PDF text in front of me I cannot tell you the specific numbers Ofgem has landed on. What is clear from the structure of the decision is the shape of what has been decided:

- A cap rate (the upper allowed return) applicable to Window 3 and indicatively to later windows. - A floor rate (the downside protection level) and the parameters that drive it, including assumed gearing and cost of debt. - Design parameter changes from the First Consultation: these typically cover the assessment period over which revenues are measured against cap and floor, the treatment of availability incentives, and the indexation of cap and floor levels. - Likely an updated stance on how the regime treats offshore hybrid assets, though the decision text notes that the OHA risk considerations from the First Consultation are being addressed separately, not in this decision.

The fact that Ofgem ran a second consultation focused solely on the cap rate is the tell. The original cap rate proposal in September 2023 attracted enough resistance, almost certainly from developers arguing it was too low to support new interconnector financing in a higher-rate environment, that Ofgem went back out for a fresh round before deciding. The July 2024 reconsultation came after gilt yields had moved materially from where they sat when the September 2023 numbers were calibrated. The decision now lands the final cap rate against that backdrop.

Why the cap rate matters more than the rest

In a cap-and-floor regime, the floor is the financing backstop and the cap is the consumer protection. The floor exists to make the projects bankable: debt providers will lend on the basis that revenues cannot fall below a level that services debt. The cap exists to stop developers earning excessive returns when interconnector spreads are wide, which they have been since 2021. Set the cap too low and developers lose the upside that compensates them for taking construction and merchant exposure between cap and floor; set it too high and consumers fund returns that exceed what the risk warrants.

The cap rate is therefore the parameter that determines the expected return on equity for an interconnector under the regime, given the floor is set to be debt-protective rather than equity-rewarding. Move the cap up by 50 basis points and you have materially changed the project economics for Window 3 entrants. Move it down by 50 basis points and projects that were marginal at Initial Project Assessment may not reach Final Investment Decision.

This is where consumer cost lives. The cap-and-floor regime is not free money for developers; it is a transfer of merchant risk to consumers in exchange for capacity that, in principle, lowers wholesale prices through arbitrage. Whether the trade is worth it depends on whether the cap is set at a level that reflects the actual risk being borne, or whether it bakes in a premium that consumers fund without commensurate benefit.

Where this fits in the wider interconnector picture

Window 3 is the third tranche of cap-and-floor projects. Window 1 delivered the existing fleet (NEMO, ElecLink, IFA2, North Sea Link, Viking). Window 2 brought through projects that are now in construction or commissioning. Window 3 is the next wave, with projects to Denmark, the Netherlands, Germany, and elsewhere having passed Initial Project Assessment. The financial parameters in this decision will govern those projects.

The wider question, which this decision does not address directly but sits underneath it, is whether the cap-and-floor regime is the right instrument at all when GB is moving toward zonal pricing, when constraint costs are rising, and when the European market design is itself in flux. Interconnectors built under cap-and-floor are essentially private monopoly transmission assets whose revenue is socialised through TNUoS and the BSUoS-adjacent mechanisms; they sit outside the wholesale market discipline that, in principle, should price scarce cross-border capacity. The financial parameters decision treats this architecture as given and tunes the dials within it.

Who pays

Consumers, via the transmission charging route. When interconnector revenues fall below the floor, the gap is funded from a charge that flows through to GB transmission users; when revenues exceed the cap, the surplus flows back. Historically the regime has been net positive for consumers in periods of high cross-border spreads (post-2021) and net negative in periods of compressed spreads. The cap and floor parameters determine the long-run expected transfer; with a 25-year regulated life, decisions made now lock in cost flows into the 2050s.

How to respond

This is a decision, not a consultation. There is no response window. Ofgem has closed out Section 1 of the September 2023 First Consultation and the entirety of the July 2024 Second Consultation. The remaining open items from the First Consultation, specifically the offshore hybrid asset risk considerations, are being addressed separately and may be the subject of a later decision or consultation.

If you are a Window 3 developer, the operational next step is reading the 550KB PDF for the precise cap rate, floor rate, indexation methodology, and any transition arrangements, then running these parameters through your project financial model to confirm bankability. If you are a consumer-side stakeholder, the question is whether the cap rate Ofgem has landed on is calibrated against current capital market conditions or against a forward view that may not materialise, and whether the 25-year lock-in is justified given the speed of market design change around it.

The substantive document is linked on the page: *Decision on changes to the financial parameters of the cap and floor regime for Window 3 electricity interconnectors.pdf*. The related Initial Project Assessment decision for Window 3, the Interconnector Policy Review decision, and the First Consultation are all linked from the same page and provide the policy context.