Independence of German National Regulatory Authority (NRA) called into Question - Case Comment C-718/18 Commission v Germany

The Court of Justice of the European Union found on 2 September 2021 in case C-718/18 that Germany failed to properly transpose various provisions of the main EU Energy Directives of the Third Energy Package, namely 2009/72 (electricity) and 2009/73 (gas). Especially the allocation of responsibilities in German energy law (Energiewirtschaftsgesetz EnWG) is not in line with the envisaged responsibilities reserved exclusively for national regulatory authorities. In other words: the court found that there is too much possibility for political influence on decisions on network-bound energy in Germany. But what does this mean in detail? Will German Energy Law now have to undergo fundamental revision?

It is a case about an energy issue that can also be found in other jurisdictions, as the underlying issue is one of state control over network bound energy. How much are governments allowed to interfere with energy regulation? What can Transmission System Operators that remain part of Vertically Integrated Undertakings (VIUs) do and what is not allowed in the light of the goal of `effective unbundling`? Germany, being a Member State with a long tradition of reluctancy towards energy market liberalization, now received a spectacular beating by the Court of Justice for the way in which its energy regulation is currently organized. But what exactly happened and how is this decision to be understood?

1) German Energy Regulation

From a legal point of view the key legislative instrument for the regulation of network-bound energy in Germany is the Energiewirtschaftsgesetz. While it is in many ways a quite modern act, it has a rather problematic feature. Many of the key decisions concerning the details of energy regulation in Germany are not described in the Energy Act, but by several ordinances (GasNZV, GasNEV, StromNEV, StromNZV, ARegV). These ordinances clarify how certain aspects of the Act, certain terms, thresholds, etc. need to be interpreted. Crucially, these ordinances are issued by the government and impose certain criteria for tariff regulation and network access with which the National Regulatory Authority (NRA), the Bundesnetzagentur, needs to comply.

 But would independence of a National Regulatory Authority (NRA) not also mean that this authority should be in charge of all these aspects and be completely independent from the government? And can the German Vertically Integrated Undertakings (VIU), in light of the fact that certain standards are set by the government and not by an independent regulator, actually comply with the requirement of `effective unbundling` of Transmission System Operators from other business activities of the VIU?

2) The Four Complaints of Case C-718/18

These questions took centre-stage in case C-718/18. The government ordinances specify, for instance, the exact data and periods of time that the regulator has to look into when assessing complicated issues of the German energy market, like asset valuation or tariff methodology. The Commission’s action against Germany in this case is based on four complaints, all of which concern the incorrect transposition by the Federal Republic of Germany of Directives 2009/72 and 2009/73 in the EnWG.

a)  The definition of `Vertically Integrated Undertaking´ has allegedly been transposed incorrectly into German law, namely paragraph 3(38) of the EnWG, which encompasses only undertakings that operate in the European Union. The Commission argued that the restriction of territorial scope was not in line with the definitions of the EU Directives. The court found (para. 37) that it cannot be ruled out that there may be conflicts of interest between a transmission system operator located in the European Union and electricity or natural gas producers or suppliers carrying on activities in those fields outside the European Union. In a situation where natural gas or electricity produced outside the European Union by an undertaking is transported within the European Union through a transmission system that is owned by the same undertaking, there is an obvious risk of discriminatory conduct in the operation of that network, capable of affecting the transportation of the energy products of competitors.

The court rebuked counter-arguments and assessed that (para. 40/41): contrary to the arguments put forward by the Federal Republic of Germany, that finding does not imply an extension of the European Union’s regulatory power beyond the internal market that would be contrary to the obligation to interpret secondary legislation in accordance with primary law, in this case Article 53(2) and Articles 62 and 114 TFEU, and international law.

It should be noted, in that regard, that Article 2(21) of Directive 2009/72 and Article 2(20) of Directive 2009/73 do not regulate a market outside the European Union, but merely set out a definition of the concept of a VIU, which ensures the effective application of those directives by preventing the circumvention of certain requirements which are necessary to ensure effective unbundling and, therefore, to improve the conditions for the functioning of the internal markets for electricity and natural gas.

This argument, however, is based on an, somewhat artificial, split between the definition of `Vertically Integrated Undertaking`and the effect that this definition might have on the operation of markets. Companies effectively operating outside of Europe for the vast majority of their business activities would need to comply with this definition or not do business with Europe. This seems somewhat presumptuous. Ultimately, the entire discussion about Nord Stream 2, which had different factual and legal circumstances but was also concerned with the question of applicability of EU law to big energy companies, as well as the infamous `Gazprom clause` (article 11 (3) Gas Directive 2009/73/EC), might have played into this appraisal by the court.

b) The second complaint concerns an alleged failure of Germany to transpose correctly the rules on transitional periods contained in Article 19(3) and (8) of Directives 2009/72 and 2009/73. More precisely, the question was whether the `cooling off` period of three years in which staff, previously involved in an activity of the VIU in the electricity or gas sector,  might participate in transmission operation activities, has been correctly transposed into German law or not. Germany law allows a shortening of these three years for personnel that has not been involved in energy-related activites of the VIU.

The bigger point behind this, rather technical, discussion about transition periods is the mode in which Germany decided to unbundle its VIUs. According to the rules of the Directives there are three modes of unbundling that are acceptable to the Commission Full Ownership Unbundling (OU), Independent Transmission Operator (ITO), Independent System Operator (ISO). German Transmission System Operators (TSOs) opted for the Independent Transmission Operator (ITO) - model, the lowest threshold for unbundling. It allows TSOs to stay part of the Vertically Integrated Undertaking, but requires the company to comply with a number of rules aimed at ensuring the independence of its supply and generation activities.

For those parts of the VIU that do not operate directly in the energy sector, an exclusion from the scope of the rules on transitional periods exists in Germany. The question was whether or not this is legitimate as it might in some cases be contrary to the objectives of the rules on effective unbundling, as these rules could be circumvented, according to the Commission. The parts of the VIU which are not active in the energy sector could also be affected by the interests of the VIU in the production and supply of electricity and natural gas (para. 48). According to the Commission it is precisely in order to avoid that risk and to ensure that transport and distribution are independent from the interests of generation and supply in the field of energy that the EU legislature decided to include the VIU as a whole – including the parts whose operations are outside the energy sector – within the scope of Article 19(3) and (8) of Directives 2009/72 and 2009/73, and not to limit the scope of those provisions to only the parts of the VIU carrying on those activities.

 While the court agreed with Germany`s argumentation that the Directives only name ‘electricity undertakings’ and ‘natural gas undertakings’ as previous activities where such a three year period would be required, an argument has been made by the Advocate General (which has been followed by the court) that nonetheless the wording has to be interpreted more extensively, as `those definitions do not support the conclusion that the concept of a ‘VIU’ should exclude the component parts thereof that do not operate in those sectors (...) A restrictive interpretation of that sort would not only call into question the objective of ensuring effective unbundling, but would also give rise to an artificial compartmentalisation of the undertaking that does not accord with economic reality.`(para. 58).

Facts are, however, that the Directives allow for the ITO-model in the first place. It is somewhat peculiar if the law explicitly allows exemptions from the strict model of Ownership Unbundling (OU), as demonstrated by the fact that two other modes of unbundling were allowed (ITO & ISO), and these exemptions are then interpreted so narrowly by the court that they have little meaning left. The court is trying to indirectly restrict the legislatory decision here by taking the route of a rather technical compartmentalized argumentation about a particular detail. In a way the court is trying to almost interpret the fundamental legislatory decisions away that have been made in 2009. This is certainly not new, but it causes question about the seperation of powers, as legislative decisions need to be respected by the judiciary branch of power. The court counters such a train of thoughts by arguing that those rules do not go beyond what is necessary to attain the objective pursued (effective unbundling), which is viewed as superseeding all other goals (para. 64 & 66).

c) The third complaint is equally of detailed nature. The Commission`s complaint relates to the obligation to dispose of any shares held in the capital of the VIU that were acquired up to 3 March 2012 (article 19(5) of Directives 2009/72 and 2009/73). It argues that paragraph 10c(4) of the EnWG, applies only to shares held by the management of the independent transmission system operator and not those held by its employees. According to the Commission, even though the employees of a transmission system operator may not be able to take managerial decisions, they are still in a position to influence the activities of their employer, justifying the requirement to dispose of any shares held in the capital of the VIU up to 3 March 2012 (para. 69). 

The court found that in the present case, although the German legislation at issue requires the disposal of holdings in the capital of the VIU acquired up to 3 March 2012, it restricts that obligation solely to the management of the independent transmission system operator (para. 78). The Federal Republic of Germany claims that that limitation ensures protection of the employees’ right to property as regards their shareholding in the VIU under the German constitution. The right to property, according to the court) is not absolute and its exercise may be subject to limitations justified by objectives of general interest pursued by the European Union, provided that those restrictions genuinely meet objectives of general interest (para. 79). And (probably you guessed already by now) effective unbundling constitutes such an objective in the general interest (para. 80). 

d) The fourth and final complaint concerns an infringement of the exclusive powers of the national regulatory authority, in so far as the first sentence of Paragraph 24 of the EnWG confers on the Federal Government powers to fix transmission and distribution tariffs, and to determine the conditions for balancing services, even though, according to those provisions of the directives, such powers lie exclusively with national regulatory authorities (‘NRAs’). 

The argument here is that the first sentence of paragraph 24 of the EnWG constitute detailed sets of instructions addressed to the NRA on the exercise of its regulatory powers. Those regulations establish the procedure and methods for determining network tariffs, setting out details such as the method of amortisation and indexation, and contain detailed rules on the conditions for network access. This would prevent the NRA from exercising its own discretion. The Commission complains that the German legislature has provided that the conditions under which the NRA can perform those tasks are determined by government regulations, instead of recognising the NRA’s exclusive powers to carry out the tasks (para. 86-88).

Germany made a rather weak point here by claiming that such interferences were requires in view, especially, of [the German government`s] objective to phase out the production of nuclear energy by 2022. The Federal Republic of Germany would need ‘substantially to extend’ electricity and natural gas transmission network and therefore political influence was required (para. 91). In essence the complaint four comes down to a question about the principle of the procedural autonomy of the Member States, under which they have the discretion to transpose provisions of Directives 2009/72 and 2009/73 on the powers of NRAs, Germany argued (para. 94).

The court stated that Article 35(4)(a) and (5)(a) of Directive 2009/72 and Article 39(4)(a) and (5)(a) of Directive 2009/73 specify that NRAs shall exercise their powers independently of any public entity or political body. The strict separation of NRAs from political power enables them to coordinate their actions on a long-term basis, which is necessary to meet the objectives of Directives 2009/72 and 2009/73. It follows that an interpretation of Article 37(1)(a) and (6)(a) and (b) of Directive 2009/72 and of Article 41(1)(a) and (6)(a) and (b) of Directive 2009/73 as meaning that it is possible for a national government to fix or approve the methodologies for calculating rates for access to the network and the balancing services to be used by NRAs would counteract the objectives pursued by those directives (para. 112/113).

Germany made a further argument about the issue of democratic control over a completely independent NRA, but the court rebuked that as well (convincingly). It ruled that the Court has already held that the principle of democracy does not preclude the existence of public authorities outside the classic hierarchical administration and more or less independent of the government, which often exercise regulatory functions or carry out tasks which must be free from political influence, whilst still being required to comply with the law subject to the review of the competent courts. Conferring on NRAs a status independent of the general administration does not in itself deprive those authorities of their democratic legitimacy, in so far as they are not shielded from all parliamentary influence (see, to that effect, judgment of 9 March 2010, Commission v Germany, C‑518/07, EU:C:2010:125, paragraphs 42, 43 and 46) (para. 126).

3) Outlook: Court of Justice & Commission Cracking Down on (Insufficient) Independence of NRAs

The ruling does not come entirely unexpected, as the Court of Justice has previously taken a strict line on the independence of NRAs in a case involving Belgium in December 2020 (C‑767/19 Commission v Belgium). That case was concerned with cross-border exchanges, but the question about influencewas also at its core. This is part of a bigger effort by the European Commission to ensure independence of NRAs throughout Europe. Three years ago a study has been commissioned on that issue and currently there is another request for services by the European Commission on `Assessing the Independence and Effectiveness of NAtional Regulatory Authorities (NRAs) in the field of Energy - Support for a Commission Report on Member States`Compliance with the Principle of Independence`. That assessment shall commence in November 2021 and take 9 months to be completed. Thus, the Commission is determined to tackle the issue of Independence of National Regulatory Authorities with renewed vigor.


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