1 Incorporation of the Toronto Hydro Corporation

2 Resources for Access and Equity Functions and Final Recommendations of the Task Force on Community Access and Equity

3 Smog Prevention and Reduction: Status Report and Work Plan

4 Review and Harmonization of Environmentally Responsible Procurement

5 Summary of the City of Toronto's Response to the Mayor's Homelessness Action Task Force and Implementation Plan

6 Community Based Affordable Housing Demonstration Project 647-657 Lawrence Avenue West at Allen Road (Ward 8 - North York Spadina)

7 Housing First Policy for Surplus City-owned Property

8 1998 Adjustments within Consolidated Grants

9 Minor Recreation Grants - Eligibility Assessment of New Applicants

10 Toronto Heritage Fund Grants Program

11 Graffiti Transformation Program - 1999 Recommended Allocations

12 Community Services Grants Program - Eligibility Assessment of New Applicants

13 1999 Recommended Grants Contingency Budget

14 Distribution of the Reallocated Grants Funding

15 Allocation Criteria for a Food Related Capital Grants Program

16 Prepayment Interest and Discount on Advance Payment of Realty Taxes

17 Street Tree Planting Application - Toronto Atmospheric Fund Ward 10 (North York Centre) and Ward 12 (North York Seneca Heights)

18 Transmittal of Evaluation of the Leaside Neighbourhood Branch Library - Capital Budget Project

19 Toronto Youth Job Corps and Youth Outreach Toronto

20 Homes for the Aged - 1999 Operating Budget

21 Use of Sponsorship Revenues from Molson's Sponsorship Agreement for the Construction of Water Park Facilities (Wards 19 and 25 - High Park and Don River)

22 1999 Operating Budget - Follow Up Items

23 Big City Mayors Caucus of the FCM - April 29, 1999 Saskatoon Meeting Report

24 Greater Toronto Services Board 1999 Budget and Business Plan

25 Year 2000 Priority One Business Functions Status Report May 1999

(City Council on June 9, 10 and 11, 1999, amended this Clause by:

(a) deleting Recommendation No. (1)(i) of the Strategic Policies and Priorities Committee embodied in the confidential communication dated June 1, 1999, from the City Clerk, viz.:

"(i) amending Section (2.2) (b) to read as follows:

'(2.2)(b) the Shareholder's income stream from Toronto Hydro be comparable to the Shareholder's estimated financial value as determined by an independent financial evaluation from time-to-time.' ";

so that the recommendations of the Strategic Policies and Priorities Committee shall now read as follows:

"The Strategic Policies and Priorities Committee recommends:

(1) the adoption of the confidential report (May 20, 1999) from the Chief Administrative Officer, subject to the following amendments to Appendix 1, entitled 'City of Toronto, Shareholder Direction Relating to Toronto Hydro Corporation', embodied in the aforementioned confidential report:

(ii) amending Section 2.3 by adding thereto the following additional principle:

'2.3 (i) that Toronto Hydro will operate in a manner which will protect and enhance the City's urban forest.'; and

(iii) amending Section 7.1 to read as follows:

'7.1 The Board will use its best efforts to ensure that Toronto Hydro meets the financial performance standards set out in this Article 7.'; and

(2) that the Business Plan for Toronto Hydro Services address:

(i) the level of risk of this venture;

(ii) the expected subsidies from Toronto Hydro to Toronto Hydro Services for start up costs; and

(iii) the point in time when the one-third dividend from Toronto Hydro will cease."; and

(b) adding thereto the following:

"It is further recommended that:

(1) the Board of Directors of Toronto Hydro be requested to submit a report to Council, through the Policy and Finance Committee, by September 1999, on:

(i) how it is addressing the need, not only in an 'ice storm' eventuality, but also on the general need, for underground wiring in older parts of the City; and

(ii) the capital requirements and projected allocations for such purpose;

(2) the Board of Directors of the Toronto Hydro Corporation be directed to:

(i) examine the issue of harmonization of rates across the new City, specifically as it relates to whether any changes to the harmonization policy adopted by the former Hydro Corporation should be made, with a view to phasing in that harmonization over a time frame similar to that adopted by the new City with respect to water rates, user fees and snow removal services; and

(ii) report thereon to the Policy and Finance Committee by September 1999;

(3) any hydro programs with respect to telecommunications and telecommunications access agreements be co-ordinated with the Chief Administrative Officer, through the Telecommunications Steering Committee;

(4) the Chief Administrative Officer be requested to submit a report to the Policy and Finance Committee on the potential avenues, such as conditions on licences issued by the Ontario Energy Board, that could be undertaken by the City to accomplish the City's environmental goals with the other electricity providers;

(5) the Chief Administrative Officer and the Board of Directors of the Toronto Hydro Corporation be requested to submit a joint report to the Works Committee on Toronto Hydro's planned approach to achieve deep lake water cooling and an integrated district cooling system for Toronto;

(6) Council express its appreciation to the staff of the Chief Administrator's Office and other Departmental staff involved with this matter for their exemplary work in this regard; and

(7) the following motion be referred to the Chief Administrative Officer for report thereon to the Policy and Finance Committee by September 1999:

Moved by Councillor Adams:

'That the Clause be amended by adding thereto the following:

"It is further recommended that City Council provide the following additional directions to the Board of Directors of the Toronto Hydro Corporation:

That:

(1) Toronto Hydro's retail company offer a variety of energy purchase programs which provide opportunities for consumers to purchase clean or green electricity and energy efficiency services;

(2) the retail company's marketing strategy encourage the use of clean or green energy;

(3) the business plan of Toronto Hydro include a strategy to reduce the company's reliance on energy generation which emits CO², SO² and NO^x;

(4) Ontario Power Generation, the current primary supplier of electricity for Toronto Hydro, be encouraged to make available a choice of electricity sources which are clean or green, so that Toronto Hydro can buy clean power, especially on smog days; and

(5) Toronto Hydro purchase clean power on smog days, regardless of price, up to a maximum premium of 50 percent above market rates, when this choice is available to meet its default supply demand on smog days." ' ")

The Strategic Policies and Priorities Committee recommends the adoption of the Recommendations of the Strategic Policies and Priorities Committee embodied in the confidential communication (June 1, 1999) from the City Clerk which was forwarded to Members of Council under confidential cover.

The Chief Administrative Officer and Mr. David McFadden, Legal Advisor, Smith Lyons, Barristers and Solicitors, gave an overhead presentation to the Strategic Policies and Priorities Committee in connection with the foregoing matter.

The following Members of Council appeared before the Strategic Policies and Priorities Committee in connection with the foregoing matter:

- Councillor Mario Silva, Trinity Niagara; and

- Councillor Jack Layton, Don River.

(City Council on June 9, 10 and 11, 1999, had before it, during consideration of the foregoing Clause, the following confidential communication (June 1, 1999) from the City Clerk:

Recommendations:

The Strategic Policies and Priorities Committee recommends:

(1) the adoption of the confidential report (May 20, 1999) from the Chief Administrative Officer subject to the following amendments to Appendix 1, entitled "City of Toronto, Shareholder Direction Relating to Toronto Hydro Corporation", embodied in the aforementioned confidential report:

(i) amending Section 2.2 (b) to read as follows:

"(2.2) (b) the Shareholder's income stream from Toronto Hydro be comparable to the Shareholder's estimated financial value as determined by an independent financial evaluation from time-to-time.";

(ii) amending Section 2.3 by adding thereto the following additional principle:

"2.3 (i) that Toronto Hydro will operate in a manner which will protect and enhance the City's urban forest.";

(iii) amending Section 7.1 to read as follows:

"7.1 The Board will use its best efforts to ensure that Toronto Hydro meets the financial performance standards set out in this Article 7."; and

(2) that the Business Plan for Toronto Hydro Services addresses:

(i) the level of risk of this venture;

(ii) the expected subsidies from Toronto Hydro to Toronto Hydro Services for start up costs; and

(iii) the point in time when the one-third dividend from Toronto Hydro will cease.

Background:

The Strategic Policies and Priorities Committee on June 1, 1999, at its in-camera meeting, had before it a confidential report (May 20, 1999) from the Chief Administrative Officer recommending that:

(1) the City retain ownership of Toronto Hydro for the foreseeable future and that the City's ownership be re-evaluated if the financial return is not sustained at a level comparable to the City's cost of new debt issuance;

(2) Council leave open the option for Toronto Hydro to develop and invest in the non-regulated, competitive businesses permitted by legislation wherever there is a good business case, risks are reasonable, and returns are satisfactory;

(3) the Board of Directors of Toronto Hydro Corporation provide for Council's information an overall business strategy indicating the businesses it intends to develop, the forecasted investment required, and the financial and environmental benefits to Toronto Hydro, the City and consumers and the Board of Directors be authorized to assess individual initiatives and commit resources in accordance with the strategy;

(4) Council endorse the following as the City's objectives in structuring its relationship with Toronto Hydro:

(a) the value of the corporation be maintained or increased;

(b) the City's income stream from Toronto Hydro be comparable to the City's estimated financial benefit if the asset had been sold;

(c) consumers not be unduly impacted by the change in structure; and

(d) environmental impacts be improved;

(5) Council authorize the incorporation of Toronto Hydro-Electric System Limited as the distribution company, Toronto Hydro Energy Services Inc. as the competitive company, and Toronto Hydro Corporation as the holding company, wholly owned by the City of Toronto, which owns the shares of the aforementioned two corporations and authorize the City Solicitor to file the Articles of Incorporation;

(6) the Board of Directors of the Toronto Hydro Corporation, who were appointed by Council, in turn appoint the members to the boards of directors of the two subsidiaries from among its own members and in accordance with Provincial regulations;

(7) in addition to the following approvals required by the shareholder under the Ontario Business Corporation's Act:

(a) amendments to the articles of incorporation or by-laws of the corporation;

(b) plans to amalgamate or incorporate under other jurisdictions;

(c) plans to dissolve the company;

(d) changes to the share structure;

(e) sale of substantially all of the corporation's assets;

(f) appointment of the auditor; and

(g) changes to the structure and membership of the Board of Directors;

the following additional matters be approved by City Council as shareholder:

(h) any recommended financial assistance to directors or officers of the corporation or subsidiaries;

(i) capital investments in the distribution company significantly above those anticipated in the initial business plan;

(j) expansion of the area of service of the distribution system beyond the City of Toronto; and

(k) investment in other than approved classes of securities and debt instruments;

(8) Council appoint Ernst & Young, Chartered Accountants as the first auditor of the Toronto Hydro Corporation and its subsidiaries;

(9) the City Clerk be named the voting proxy for the City as shareholder to convey to the Board of Directors any decisions made by Council respecting the Toronto Hydro Corporation;

(10) the Board of Directors develop corporate by-laws for approval by Council and include specifically a policy requiring submission of receipts for reimbursement of out-of-pocket expenses for board members;

(11) the following control mechanisms be implemented in addition to any regulatory requirements of the Ontario Energy Board and the right of Council to replace any or all members of the Board of Directors at any time:

(a) an annual business plan be reviewed by the City Chief Financial Officer to ensure consistency with the City's overall financial and strategic expectations as outlined in the Shareholder's Direction from time to time and the Chief Financial Officer report any irregularities to Council recommending appropriate action;

(b) quarterly reports be submitted to the City Chief Financial Officer and annual consolidated financial statements be submitted by the Board of Directors to Council; and

(c) the City Chief Financial Officer and City Auditor or their designates be granted unrestricted access to the books and records of the corporation and subsidiaries during normal business hours;

(12) the City's consideration upon transfer of the assets to Toronto Hydro consist of 40 percent equity and 60 percent debt to the City;

(13) upon transfer of the assets to the new Toronto Hydro Corporation, the City retain cash deemed as surplus to the immediate needs of Toronto Hydro and any surplus properties which may be useful or sellable by the City as listed in Schedule E of the attached Transfer By-Law;

(14) initially, the financial expectations for Toronto Hydro be stated as follows:

(a) the distribution company maintain a financial structure and risk profile that will achieve a credit rating of A (low) or higher;

(b) annual capital expenditures in excess of the normal maintenance requirements be approved by Council;

(c) the distribution company be authorized to set distribution rates in accordance with the regulations forthcoming from the OEB; and

(d) the quarterly dividend paid to the City be equal to 2/3 of the increase in cash of the distribution company after allowances have been made for operating and capital needs, the balance being retained by Toronto Hydro for investment in its competitive business;

(15) all proceeds of the debt and dividends from Toronto Hydro be used toward the existing City capital obligations and not be used to increase City operating expenses;

(16) the Strategic Policies and Priorities Committee endorse in principle the terms of the Shareholder Direction and the Transfer By-Law as attached in Appendices 1 and 2 of this report and that, if necessary, the City Solicitor finalize the form of these documents for approval by Council; and

(17) the appropriate City Officials be authorized and directed to take the necessary action to give effect thereto.

The Chief Administrative Officer and Mr. David McFadden, Q.C., Legal Adviser, Smith Lyons, Barristers and Solicitors, gave an overhead presentation to the Strategic Policies and Priorities Committee in connection with the foregoing matter.

The following Members of Council appeared before the Strategic Policies and Priorities Committee in connection with the foregoing matter:

- Councillor Mario Silva, Trinity Niagara; and

- Councillor Jack Layton, Don River.

Purpose:

This report provides an overview of the options available to the City in responding to the Electricity Competition Act (Bill 35), recommends a course of action for the City, and proposes terms of the documents required to implement those actions.

Financial Implications and Impact Statement:

Incorporation of the Toronto Hydro Corporation as a share capital corporation under the Ontario Business Corporations Act with the City as the sole shareholder presents the opportunity for the City to realize significant new revenues from surplus funds and future profits of Toronto Hydro.

Recommendations:

It is recommended that:

(1) the City retain ownership of Toronto Hydro for the foreseeable future and that the City's ownership be re-evaluated if the financial return is not sustained at a level comparable to the City's cost of new debt issuance;

(2) Council leave open the option for Toronto Hydro to develop and invest in the non-regulated, competitive businesses permitted by legislation wherever there is a good business case, risks are reasonable, and returns are satisfactory;

(3) the Board of Directors of Toronto Hydro Corporation provide for Council's information an overall business strategy indicating the businesses it intends to develop, the forecasted investment required, and the financial and environmental benefits to Toronto Hydro, the City and consumers and the Board of Directors be authorized to assess individual initiatives and commit resources in accordance with the strategy;

(4) Council endorse the following as the City's objectives in structuring its relationship with Toronto Hydro:

(a) the value of the corporation be maintained or increased;

(b) the City's income stream from Toronto Hydro be comparable to the City's estimated financial benefit if the asset had been sold;

(c) consumers not be unduly impacted by the change in structure; and

(d) environmental impacts be improved;

(5) Council authorize the incorporation of Toronto Hydro-Electric System Limited as the distribution company, Toronto Hydro Energy Services Inc. as the competitive company, and Toronto Hydro Corporation as the holding company, wholly owned by the City of Toronto, which owns the shares of the aforementioned two corporations and authorize the City Solicitor to file the Articles of Incorporation;

(6) the Board of Directors of the Toronto Hydro Corporation, who were appointed by Council, in turn appoint the members to the boards of directors of the two subsidiaries from among its own members and in accordance with Provincial regulations;

(7) in addition to the following approvals required by the shareholder under the Ontario Business Corporation's Act:

(a) amendments to the articles of incorporation or by-laws of the corporation;

(b) plans to amalgamate or incorporate under other jurisdictions;

(c) plans to dissolve the company;

(d) changes to the share structure;

(e) sale of substantially all of the corporation's assets;

(f) appointment of the auditor; and

(g) changes to the structure and membership of the Board of Directors;

the following additional matters be approved by City Council as shareholder:

(h) any recommended financial assistance to directors or officers of the corporation or subsidiaries;

(i) capital investments in the distribution company significantly above those anticipated in the initial business plan;

(j) expansion of the area of service of the distribution system beyond the City of Toronto; and

(k) investment in other than approved classes of securities and debt instruments;

(8) Council appoint Ernst & Young, Chartered Accountants as the first auditor of the Toronto Hydro Corporation and its subsidiaries;

(9) the City Clerk be named the voting proxy for the City as shareholder to convey to the Board of Directors any decisions made by Council respecting the Toronto Hydro Corporation;

(10) the Board of Directors develop corporate by-laws for approval by Council and include specifically a policy requiring submission of receipts for reimbursement of out-of-pocket expenses for board members;

(11) the following control mechanisms be implemented in addition to any regulatory requirements of the Ontario Energy Board and the right of Council to replace any or all members of the Board of Directors at any time:

(a) an annual business plan be reviewed by the City Chief Financial Officer to ensure consistency with the City's overall financial and strategic expectations as outlined in the Shareholder's Direction from time to time and the Chief Financial Officer report any irregularities to Council recommending appropriate action;

(b) quarterly reports be submitted to the City Chief Financial Officer and annual consolidated financial statements be submitted by the Board of Directors to Council; and

(c) the City Chief Financial Officer and City Auditor or their designates be granted unrestricted access to the books and records of the corporation and subsidiaries during normal business hours;

(12) the City's consideration upon transfer of the assets to Toronto Hydro consist of 40% equity and 60% debt to the City;

(13) upon transfer of the assets to the new Toronto Hydro Corporation, the City retain cash deemed as surplus to the immediate needs of Toronto Hydro and any surplus properties which may be useful or sellable by the City as listed in Schedule E of the attached Transfer By-Law;

(14) initially, the financial expectations for Toronto Hydro be stated as follows:

(a) the distribution company maintain a financial structure and risk profile that will achieve a credit rating of A (low) or higher;

(b) annual capital expenditures in excess of the normal maintenance requirements be approved by Council;

(c) the distribution company be authorized to set distribution rates in accordance with the regulations forthcoming from the OEB; and

(d) the quarterly dividend paid to the City be equal to 2/3 of the increase in cash of the distribution company after allowances have been made for operating and capital needs, the balance being retained by Toronto Hydro for investment in its competitive business;

(15) all proceeds of the debt and dividends from Toronto Hydro be used toward the existing City capital obligations and not be used to increase City operating expenses;

(16) the Strategic Policies and Priorities Committee endorse in principle the terms of the Shareholder Direction and the Transfer By-Law as attached in Appendices 1 and 2 of this report and that, if necessary, the City Solicitor finalize the form of these documents for approval by Council; and

(17) the appropriate City Officials be authorized and directed to take the necessary action to give effect thereto.

Background:

The City of Toronto Act 1997 amalgamated the 6 former Hydro-Electric Commissions into one and designated the new City of Toronto as the owner of the combined assets, under the management and control of the new Toronto Hydro-Electric Commission. The Commission is not an agency of the City and does not rely on the property tax base for funding. All expenses are covered through consumer electricity rates. The City currently has the right to appoint the Commission, but has no right to give direction to the Hydro Commission, approve its budget, or receive funding from company surpluses. The Commission is governed by the Public Utilities Act.

The Energy Competition Act (Bill 35) was introduced by the Provincial Government in June 1998, was passed by the Ontario Legislature and given Royal Assent on October 30, 1998. The Act requires that the City incorporate Toronto Hydro under the Ontario Business Corporations Act (OBCA) within 2 years, ending November 7, 2000. This new entity will be required to pay to the Province an amount equivalent to corporate income tax.

The legislation also stipulates that the City will be the sole shareholder of the new corporation. Bill 35 requires that the electricity distribution system be separated from other activities of municipal electric utilities, such as power generation, electricity retailing, and the rental or sale of water heaters. The electricity distribution system (wires) will continue to operate as a monopoly regulated by the Ontario Energy Board (OEB), but the generation and retailing of electricity will be open to the competitive market. To avoid cross-subsidization of the competitive businesses by the distribution business, the legislation requires that the municipal utilities establish separate corporations to manage the regulated and non-regulated businesses.

Council Reference/History:

Over the last year, Toronto Hydro has been preparing for the changes introduced by Bill 35. The Mayor requested that the City Chief Administrative Officer co-ordinate the efforts of the City and Toronto Hydro in defining the relationship between the City and Toronto Hydro. A CAO report dated September 23, 1998, outlined the steps necessary to address this issue.

As a first step, the CAO organized a series of briefings for Councillors to become familiar with the legislation and the decisions which Council would have to make respecting incorporation of both Toronto Hydro and TDHC. The material from these briefings was distributed to all Members of Council.

The CAO also reported on the selection process and the qualifications of the Board for the new Toronto Hydro Corporation. The issue was referred to the Mayor who recommended that a Steering Committee be authorized by Council to nominate the new Board of Directors. The CAO engaged Caldwell Partners to assist the Steering Committee and a new Board of Directors took office on April 19,1999.

The City CAO organized a joint staff working group comprised of both City and Toronto Hydro staff to develop the terms of the new relationship between the City and the new Toronto Hydro Corporation. Financial and legal advisors to both the City and Toronto Hydro were also participants in this working group. This report is the product of the working group activities and recommends the structure of the new corporation, the principles recommended to guide in developing the financial relationship, and the terms of the Shareholder's Direction and the Transfer By-law required to establish the new corporation and give direction to the new Board.

Related to this issue, but quite separate, are a number of directives regarding the Toronto District Heating Corporation (TDHC) and its new initiative in district cooling. Bill 35 also permits TDHC to incorporate as a share capital corporation under the OBCA. TDHC is a partnership among the City of Toronto, the Province of Ontario, the University of Toronto, and the group of downtown hospitals. Although traditionally TDHC's business has centred around generation and supply of district steam heating systems, TDHC has developed a plan to provide district cooling systems as well through Deep Lake Water Cooling (DLWC). At the same time, Toronto Hydro, in co-operation with other partners, has been developing plans for a new cooling system using ice plants. Several Council directives have indicated a need to ensure that these two initiatives, both having a City interest, are complementary to one another rather than in competition. Before TDHC can be incorporated, it will be necessary to determine the relative value of shares of the partners and develop a shareholders' agreement which will govern how the shareholders will conduct business. The incorporation of TDHC and its relationship with Toronto Hydro will be the subject of a separate report to be brought forward to Council by the CAO in the near future.

Discussion:

This report provides an overview of the options available to the City in responding to Bill 35, recommends a course of action for the City, and outlines the terms of the documents required to implement those actions.

There are a number of decisions which the City has to make in response to Bill 35 and in establishing the corporate structures as required by the legislation. These include:

(1) Should the City keep the company or sell it - wholly or in part?

(2) Should the City continue to own the monopoly distribution component only or enter into the competitive market of generation, retailing, and related businesses?

(3) What City objectives will guide the Board of Directors in making business decisions?

(4) What is the corporate structure of the new company and what processes are necessary for the City to carry out its duties as a shareholder?

(5) What degree of latitude in making business decisions will be afforded the Board and what controls are required?

(6) What assets are required to establish the new corporation and what financial structure is necessary to enable it to grow while providing a return to the City?

(7) What financial return does the City expect from this investment?

(8) How should the City apply income from this investment?

This report discusses each of these questions and recommends a course of action.

(1) Sell or Keep:

There are a number of issues in considering whether the City should retain sole ownership of its electric company or sell all or part of it to another investor.

First, is there a willing buyer? Early on there was considerable interest in the market in investing in or outright purchasing of electric companies, possibly at prices considerably above book value. However, interest in selling has been tempered by the introduction of a Provincial transfer tax of 33% of gross assets. The transfer tax will be used to pay down the stranded debt, the residual remaining from the Ontario Hydro debt that was not transferred to the new Provincial corporations. The transfer tax is to be applied to the sale of any interest in a municipal electric utility, or of any property that was used in connection with its business, upon the sale to any party other than another municipal electricity utility or other public sector entities. By November 7, 2000, these non-taxable entities will also be subject to this transfer tax. This limits the interest in selling to the private sector as it adversely impacts the proceeds which the City would realize from such a sale compared to the future benefits of retaining ownership.

There are still many willing investors who would like to invest in any electric utility, particularly in Toronto Hydro with its high-density market, because of the stability of the regulated portion of the business. Revenues are predictable for the monopoly and the customer base is relatively static. Given that the rates for the distribution business will be regulated by the Ontario Energy Board, the distribution rates will be less influenced by economic cycles than for other corporate entities.

A partial sale could bring significant new private sector money into the City, but such investments usually come with some strings attached. Large investors would be entitled to a share of the profits of the company and would likely demand membership on the Board and possibly other influences. The implications of partnering with additional shareholders would likely differ depending on the individual proposed partners and would need to be thoroughly assessed through a formal offering process before proceeding.

In assessing the sell/keep option, the City must also determine whether it has an on-going interest in the business beyond financial considerations. The distribution business forms an integral part of the infrastructure of the City and the City may want to have an influence on the maintenance and operation of that infrastructure. The City also has an interest in ensuring that the company remains stable and viable in order to guarantee the reliability of a service which is essential to business and residents of the City as well as the City's own services.

Finally, the City must consider whether keeping the distribution company is in the financial best interests of the City. The current book value of Toronto Hydro is $1.7 billion. Toronto Dominion Securities (TDSI) was engaged by Toronto Hydro to provide an assessment of the current value of Toronto Hydro. The assessment was also reviewed by the City's financial advisor in this matter, RBC Dominion Securities (RBCDS), who concurred with the findings. TDSI's findings indicated that the indicative value range of Toronto Hydro was:

With Gradual Recapitalization $1.4 billion to $2.4 billion

With Immediate Recapitalization $1.6 billion to $2.8 billion

The value on sale of the company depends on the degree and speed with which the corporation moves to a commercial debt/equity ratio and moves toward a commercial rate of return. The corporation is worth more the faster it moves to a higher debt level and commercial rate of return.

If the City keeps its investment in Toronto Hydro, it should look for an income stream which matches the interest which could be earned or avoided through sale of the company in order to justify retention of the company on purely financial terms.

It is recommended that the City retain ownership of Toronto Hydro for the foreseeable future and that the City's ownership be reviewed if the financial return is not sustained at a level comparable to the City's cost of new debt issuance.

(2) Investment in Competitive, Non-regulated Business

Most of the current activities of Toronto Hydro consists of the distribution of electricity and will be, therefore, a regulated, monopoly business in the restructured electricity market. All other current or future business activities associated with the electricity business carried on by Toronto Hydro will fall in the competitive, non-regulated sector. Bill 35 establishes those competitive activities in which municipal electric utilities may become involved. These activities are:

(i) power generation;

(ii) retailing electricity;

(iii) distributing or retailing gas or other energy products;

(iv) providing meter installation and reading services and billing services;

(v) managing or operating water and sewage services;

(vi) renting or selling hot water heaters; and

(vii) providing services to improve energy efficiency.

In the new competitive electricity market, Toronto consumers will continue to be supplied their electricity through the wires of the distribution company, but will have a choice as to the party from whom they will purchase this power.

Consumers may choose to buy power from a retailer who will typically guarantee a price level to its customers and buy direct from generators in volumes based on their customer demands. This business can be risky compared to the distribution business since the retailer must match generators' prices to pricing offered to consumers in what can be a volatile market. The retail business will also likely be highly competitive. Toronto Hydro's competitive affiliate could be involved in this kind of activity.

Those customers who choose not to buy from a retailer would be deemed to be "default supply" customers. These customers would be provided their power through the distribution company or through its competitive affiliate at the spot price for power in the Province. Default supply customers would see their prices rise and fall from time to time to reflect movements in the spot price. They would not receive their power at a guaranteed price level, like customers buying from a retailer, since no one would be assuming the price risk for them nor would they expect to be paying any form of premium to avoid price fluctuations.

A key question is whether the City wants to invest in or continue to hold ownership of those portions of the electricity business that will now compete with the private sector. The considerations include capital investment required, expected return, level of risk, diversity of the portfolio, responsiveness to market forces, ability to maintain a business agenda, and competency.

Competitive pricing is generally driven by market forces rather than being based on the cost of the product, as is the case for the distribution company and most public sector pricing. This in itself has inherent risks if costs cannot be held in check and reduced when market prices are forced down by competition. At this point, it is unknown how many companies and which companies will be players in the electricity market. Observations of other deregulated utility industries would predict that a flood of new and existing companies will enter the market as early as permitted and aggressive marketing and pricing strategies will initially create a highly competitive market in retailing electricity.

However, Toronto Hydro has the advantage of already supplying all of its current 650,000 customers in Toronto. Even so, aggressive marketing and pricing will still be required to retain this customer base in the new market and it is unlikely that all customers will be retained. It will be difficult for the corporation to change its mind-set from that of a monopoly, but Toronto Hydro has already recruited specialist staff in preparation for these changes. In addition, Toronto Hydro could consider engaging a partner with experience and a similar client base to develop the retail business.

Of all electric utilities in Ontario, Toronto Hydro has the size, resources, customer base, and credibility to be successful in this new market which is no longer limited to the Toronto area. There may be synergies between the new initiatives and the distribution company which may give Toronto Hydro a competitive advantage in providing consumers with a wide range of services.

As a major player in the competitive industry, Toronto Hydro could be influential in ensuring that energy conservation and environmental responsibility are retained as important issues for consumers. Council has indicated its strong support for action on environmental issues, particularly those related to air quality and global climate change. Toronto Hydro is well situated to develop co-generated electricity with natural gas technologies that emit far fewer pollutants than either coal-fired or nuclear generating stations, and renewable energies such as wind and solar energy, which emit no air pollutants. With a planned business approach, Toronto Hydro could become an environmental leader in this field while remaining a viable business enterprise.

The new Board of Directors selected by Council at its meeting of April 13, 1999, brings the business perspective necessary to lead the company into the competitive businesses. However, care must be taken by Council to permit the new Board to operate on a commercially prudent basis if it is to enter the competitive market. The pursuit of a non-profit agenda could result in a non-viable business.

It is recommended that Council leave open the option for Toronto Hydro to develop and invest in the non-regulated, competitive businesses permitted by legislation wherever there is a good business case, risks are reasonable, and returns are satisfactory.

At its meeting of April 13, 14 and 15, 1999, Council requested that the new Board of Directors submit a strategic business plan to Council in September. The Board of Directors will be expected to assess the business risks, determine the investment required, forecast the financial returns, and assess the benefits of investing in the non-regulated businesses. The Board should also articulate its environmental strategy including its commitment to renewable energy. These are important strategic investments which may involve risk as yet unknown and may impact the City's ultimate return on investment. Council should be apprised of the strategy. In future years, the Board of Directors will be expected to assess project business plans and authorize investments within their mandate and which the Board deems appropriate to support the high level strategy.

It is recommended that the Board of Directors of Toronto Hydro provide for Council's information an overall business strategy indicating the businesses it intends to develop, the forecasted investment required, and the financial and environmental benefits to Toronto Hydro, the City and consumers and the Board of Directors be authorized to assess individual initiatives and commit resources in accordance with the strategy.

(3) City Objectives

In order to ensure that Toronto Hydro is managed in accordance with the City's objectives, it is necessary for the City to outline some specific objectives and guiding principles. The following City objectives were developed in co-operation with the staff working group:

(a) The value of the corporation is maintained or increased;

(b) The City's income stream from Toronto Hydro be comparable to the City's estimated

financial benefit if the asset had been sold;

(c) Consumers are not unduly impacted by the change in structure; and

(d) Environmental impacts be improved.

The strategies outlined in this report and the Shareholder Direction and Transfer By-Law attached to this report were developed in accordance with these objectives. It is recommended that these objectives be endorsed by City Council.

(4) Corporate Structure and Duties of Shareholder

Toronto Hydro Corporate Structure

In the past, Toronto Hydro purchased power from Ontario Hydro (the generator) and sold and delivered this power to the consumer. Under the new legislation, distribution will continue to be a monopoly business regulated by the OEB, but both generation and retailing will be non-regulated and competitive. The legislation requires that the regulated business be kept structurally separate from the non-regulated businesses. This means that the corporate structure must establish different companies for these components.

A number of structural options are possible:

(a) Separate corporations each owned individually by the City. This is the model that the Provincial government has implemented.

(b) The regulated business owns each of the non-regulated corporations.

(c) A "holding company" owns and manages the various corporations which deliver regulated and non-regulated services.

The joint working group determined that option (c) was the most appropriate for Toronto Hydro. It has the following advantages:

(a) one overall board can manage the transition from the current structure to the required structure;

(b) the City deals with one entity and establishes overall objectives for the entire portfolio;

(c) one overarching structure can develop centralized services for various companies to keep overhead and administrative costs down; and

(d) one board can co-ordinate activities which are complementary to maximize returns and manage strategic investments.

Under this scenario, the Board of Directors which has been selected by Council will become the holding company board of directors. The Toronto Hydro Corporation (the holding company) will be wholly owned by the City as the sole shareholder. In turn, the Toronto Hydro Corporation will own all of the shares of its two subsidiaries. The Toronto Hydro-Electric System Limited will be the subsidiary distribution company which is a monopoly and regulated by the Ontario Energy Board. The Toronto Hydro Energy Services Inc. will be the non-regulated subsidiary operating businesses in the competitive market.

Provincial regulations requires that 1/3 of the members of the board of directors of the distribution company be independent from directors of competitive subsidiaries. The boards of the subsidiaries need not be large and could be comprised of at least 3 members of the holding company board. These members could be selected by the holding company board from among its own members. This assures Council that the members appointed by Council are indeed managing the business directly.

It should be noted, however, that some strategic investments will require partnerships with other public and private sector concerns. At present, Toronto Hydro is already in partnership with Ontario Power Generation Inc. (OPGI), Mississauga Hydro and Canadian Utilities in OPGI's Lakeview generation project and intends to develop other projects in partnership with both OPGI and the private sector. These individual projects and businesses may require their own boards comprised of members from all partners. However, Toronto Hydro's share in these joint ventures would be managed by the board of the competitive subsidiary, Toronto Hydro Energy Services Inc.

With time, it is conceivable that several individual corporations will be required to develop distinct projects or specific services to niche markets. The overall corporate structure could eventually become quite complex. However, under the holding company model, the City's interests will be managed by a single Board of Directors appointed by Council.

It is recommended that Council authorize the incorporation of Toronto Hydro-Electric System Limited as the distribution company, Toronto Hydro Energy Services Inc. as the competitive company, and Toronto Hydro Corporation as the holding company, wholly owned by the City of Toronto, which owns the shares of the aforementioned two corporations and authorize the City Solicitor to file the Articles of Incorporation.

It is also recommended that the Board of Directors of the Toronto Hydro Corporation, who were appointed by Council, in turn appoint the members to the boards of directors of the two subsidiaries from among its own members and in accordance with Provincial regulations.

Shareholder Duties and Processes

The shareholder of any private corporation incorporated under the OBCA has certain rights and obligations as outlined in the attached Shareholder Direction in Section 5.2. The shareholder must approve:

(a) amendments to the articles of incorporation or by-laws of the corporation;

(b) plans to amalgamate or incorporate under other jurisdictions;

(c) plans to dissolve the company;

(d) changes to the share structure;

(e) sale of substantially all of the corporations assets;

(f) appointment of the auditor; and

(g) changes to the structure and membership of the Board of Directors.

The Board of Directors has a fiduciary duty to act in the best interests of the corporation. As such, the Directors are legally accountable for the performance and actions of the corporation. If the shareholder (the City) interferes with the decisions of the Board, the City may assume legal liability for such decisions and cannot hold the Board accountable. Care must be taken to ensure that the Board retains responsibility for the corporation while ensuring that Council protects its investment. In addition to the statutory requirements noted above, it is recommended that the following matters also be approved by City Council as shareholder:

(h) any recommended financial assistance to directors or officers of the corporation or subsidiaries;

(i) capital investments in the distribution company significantly above those anticipated in the initial business plan;

(j) expansion of the area of service of the distribution system beyond the City of Toronto; and

(k) investment in other than approved classes of securities and debt instruments.

These are detailed in section 5.3 of the attached Shareholder Direction.

The shareholder must also approve the by-laws which govern the operation of the corporation and the board of directors. These should be developed in conjunction with the new Board of Directors and submitted to Council for approval at the earliest opportunity. Given the specific concerns expressed in the past regarding expenses of board members, it may be prudent for the City to request that the by-laws include a policy on reimbursement of board members' expenses. It is recommended that the Board of Directors develop corporate by-laws for approval by Council and include specifically a policy requiring submission of receipts for reimbursement of out-of-pocket expenses for board members.

One of the initial duties of the shareholder is to appoint the auditor of the corporation. Ernst & Young are currently the auditors for the Toronto Hydro-Electric Commission and for the City. To maintain continuity for the first year of operation, it is recommended that Council appoint Ernst & Young, Chartered Accountants as the first auditor of the Toronto Hydro Corporation and its subsidiaries.

It is the norm for a corporation to hold an annual shareholders' meeting where required decisions are made and the financial reports are received. City of Toronto Council represents the shareholder, but the shareholder in this case is considered one entity and any votes cast by the shareholder are really one vote. A shareholder meeting can be any meeting of Council. In order for City Council to carry out the shareholder's obligations, the following process is envisioned at this time:

- The Board of Directors puts the questions to the City

- City staff recommend decisions for Council approval

- Council debates the issues and makes a decision

- A City proxy (the City Clerk) conveys the decisions of the shareholder to the Board of Directors

It is recommended that the City Clerk be named the voting proxy for the City as shareholder to convey to the Board of Directors any decisions made by Council respecting the Toronto Hydro Corporation.

(5) Board Latitude and Controls

Beyond the approvals required of the shareholder as stated above, the Board of Directors would be given full authority to make individual business decisions and further develop the corporate structure and financing required to implement its business plans. At all times, the Board will be expected to act in accordance with a Shareholder Direction which will be approved by Council.

However, Council must be assured on an on-going basis that the business is performing according to direction and in the best interests of the City and the corporation's other stakeholders. It is recommended that the following control mechanisms be implemented in addition to any regulatory requirements of the Ontario Energy Board and the right of Council to replace any or all members of the Board of Directors at any time:

(a) an annual business plan be reviewed by the City Chief Financial Officer to ensure consistency with the City's overall financial and strategic expectations as outlined in the Shareholder's Direction from time to time and the CFO report any irregularities to Council with a recommendation for appropriate action;

(b) quarterly reports be submitted to the City CFO and annual consolidated financial statements be submitted by the Board of Directors to Council; and

(c) the City Chief Financial Officer and City Auditor or their designates be granted unrestricted access to the books and records of the corporation and subsidiaries during normal business hours.

(6) Asset Transfer and Financial Structure

The new Toronto Hydro Corporation will be a private corporation owned by the City of Toronto and not an agency of the City. As such, it is a business investment whose shares can be sold or used to earn a profit for the investor. A Transfer By-Law is necessary to transfer the Toronto Hydro assets and liabilities from the City to the new corporation. In exchange for these assets, the City will receive consideration in whatever form it chooses, which may include cash, shares, and debt to the City.

The corporation will be required to pay amounts equivalent to corporate income taxes to the Provincial Government, as does any other private corporation. Although consumer rates and cost of power will be driven by market forces on pricing, the rates applicable to distribution of electricity to all consumers by the monopoly will be subject to regulation by the OEB. Although regulations concerning the distribution rates are not yet available, it is anticipated that the OEB will permit the distribution rates to cover operating costs, interest on a commercial debt/equity ratio, and a commercially acceptable profit margin. The rationale is that even the regulated monopoly is a business enterprise that should operate as a commercial business and remain attractive to commercial investors. Evidence of this direction can be found in the proposed rates for the Province's own distribution company, Ontario Hydro Services Company, which includes an operational 60/40 debt/equity ratio and a return on equity of 9.35%.

The City should expect an income from Toronto Hydro because it is a business investment rather than an agency and:

(i) a reasonable return history will maintain the value of the corporation in case the City wishes to take in future investment partners or sell part or all of its shares at some future point. The corporation must remain an attractive business investment;

(ii) the City could have sold the company and invested the proceeds or reduced its own debt and therefore should not forego returns which would have otherwise been available; and

(iii) the requirement of a return will encourage the corporation to be as efficient as possible to meet the City expectations as well as invest in growing the businesses.

Every taxable corporation strives to minimize its tax liability. Capital cost allowance (depreciation) and debt interest are both deductions from net income for tax purposes. These deductions should be maximized in order to minimize taxes payable. Capital cost allowance is a function of the level of capital assets owned and represents the deemed usage of those assets on an annual basis. It is not actually an outflow of cash. However, the actual capital investments may be an outflow of cash, but are not deductible for tax purposes.

In order to minimize income taxes and maximize return to the City while providing Toronto Hydro sufficient cash to cover capital investments required, it is proposed that the City divide its investment in Toronto Hydro between debt and equity. No actual cash passes between the City and Toronto Hydro regarding the debt; the value of the equity is reduced accordingly.

The following hypothetical example illustrates the benefits of this split between debt and equity in two corporations with precisely the same operations and capital investment:

With Debt to

Without Debt Shareholder

Equity $1,000,000,000 $400,000,000

Debt to Shareholder 600,000,000

Operating Income $130,000,000 $130,000,000

Depreciation (50,000,000) (50,000,000)

Interest Expense (30,000,000)

Net Income Before Tax 80,000,000 50,000,000

Tax at 40% (32,000,000) (20,000,000)

Net Income After Tax 48,000,000 30,000,000

Return on Equity 4.8% 7.5%

Province gets 32,000,000 20,000,000

Shareholder gets (interest + 50% divid.) 24,000,000 45,000,000

Corporation retains:

Contribution to Retained Earnings 24,000,000 15,000,000

Cash from depreciation 50,000,000 50,000,000

The advantages of dividing the investment in Toronto Hydro into debt to the City and equity shares are:

(1) The city is guaranteed an income stream regardless of the performance of the corporation and beyond the discretion of the Board of Directors.

(2) Debt can be sold to the market at any time to realize new money to the City if the need arises without diluting the City's ownership interest in Toronto Hydro.

(3) Debt interest payable to the City reduces the corporate income taxes payable to the Province in favour of before-tax payments to the City. Debt payments to the City, therefore, may be more lucrative to the City than after-tax dividends.

(4) The value of the corporation is improved through a reasonable and commercially acceptable debt/equity ratio because it generates a higher rate of return on equity.

(5) The average cost of capital is lower with debt than without. Without debt, greater revenues would be required to sustain the same level of capital investment.

The financial advisors to the City and Toronto Hydro have indicated that a debt level of 60% of the value of the corporation is reasonable for the type of business and its risk profile and is an acceptable level to maintain a good credit rating. It is recommended that the City's consideration upon transfer of the assets to Toronto Hydro consist of 40% equity and 60% debt to the City.

The City is required to transfer to Toronto Hydro all of the assets used in the generation, distribution, or sale of electricity, including peripheral services. At present, Toronto Hydro has a cash surplus and surplus properties. Much of this surplus was generated as a result of amalgamating the six former municipal utilities. Surpluses could be retained by the City without impairing the corporation's ability to carry on business. It is recommended that the City retain cash deemed as surplus to the immediate needs of Toronto Hydro and any surplus properties which may be useful or sellable by the City. The list of surplus assets to be retained by the City is included as Schedule E in the attached Transfer By-Law.

Toronto Hydro currently has an outstanding long term debt of approximately $80 million which the City has debentured on behalf of Toronto Hydro. Under the legislation, the City is not permitted to transfer any outstanding City debentures to Toronto Hydro. This debt will be included in the overall new debt as part of the consideration for the transfer of assets. These liabilities are listed in Schedule F in the attached Transfer By-Law.

(7) Financial Expectations

For any investment, the investor desires the maximum return on investment. It is generally held that the level of return is commensurate with the level of risk to be assumed. If higher rates of return are required, some degree of risk is expected. However, the City manages its investments on behalf of the City of Toronto ratepayers and is expected to be conservative in its use of funds and the risks that it assumes.

To control the level of debt and risk in investments, the new Toronto Hydro's distribution company should be expected to maintain a credit rating of A (low) or better. This constraint will ensure the corporation's continued conservatism and low-risk profile.

In addition, the City should encourage Toronto Hydro to continue its capital maintenance program to ensure that the distribution assets maintain their value and ensure the reliability of the distribution service. The corporation should be permitted to invest in these assets without shareholder approval up to a reasonable ceiling.

For the competitive businesses, the Board of Directors will be expected to conduct business according to the strategic business plan. Any significant deviations from the initial plan should be forwarded to Council for information.

Rates

Under the new market design, the consumer rate will be composed of several different charges by several different companies. A redistribution of the charges is expected to occur over the next few years as competitive forces work on the charges by generators and retailers and the distribution companies are recapitalized. The Provincial government is also adding a surcharge direct to consumers to be used to repay the stranded debt. Beginning in 2001, Toronto Hydro will be subject to payments in lieu of corporate income taxes. This added expense will require an upward adjustment to the distribution charge.

The income level of the distribution company is directly related to the distribution rates to be charged. The higher the rate, the higher the income level. However, the distribution rate will be capped by regulation of the OEB. This will protect consumers from unduly rising distribution rates. The distribution rates comprise only about 15% of the total consumer charges. If all other components of the consumer rate remained the same, an increase of 10% in the distribution charge would equate to only 1.5% increase in consumer rates which is less than $1 on an average monthly homeowner bill.

At the same time, the cost of power from the generators, which comprises a much more significant percentage of the consumer rate, is expected to decline for Toronto consumers due to competitive influences. Therefore, any increases in distribution rates are expected to be offset by declines in the cost of power from generators.

Rates for the competitive retail business will be regulated by the market. Free competition usually forces rates down.

It should be noted that all of the above influences will occur in 2001. For 2000, the consumer rate structure will be set as in the past except that the OEB will approve the rate rather than Ontario Hydro.

Dividend Policy

The Board of Directors of any company has the authority to determine the amount of dividends it will pay to its shareholders. The City as sole shareholder, however, can outline its expectations for dividend disbursements.

There are a number of ways in which a dividend policy can be expressed. It is common practice to express a dividend in terms of a percentage of the net income. The percentage may vary depending on the capital needs of the business. For instance, a company requiring substantive cash for capital investment may provide a low dividend payout, whereas a company with lower capital needs may establish a dividend policy using higher percentages. Generally, some of the net income is retained within the company as retained earnings.

Because some items on the income statement are not cash items (depreciation), net income does not represent clearly the cash available or required for working capital. Another approach to defining the dividend policy is to determine annually what cash is available, what is needed for maintenance, working capital and strategic investments, and distribute the balance or a high percentage of the residual cash to the shareholder.

It would also be appropriate to set a separate dividend policy for each of the businesses. However, since the competitive businesses are not currently in operation, investment is required in the early years to develop these businesses. No significant dividend is expected from the competitive businesses in the first few years.

Dividends of the distribution company are payable to its shareholder, the Toronto Hydro Corporation. The Toronto Hydro Corporation will immediately pay 2/3 of this dividend to the City as its shareholder and will retain the balance. This retained portion will initially be used to fund the development of the competitive subsidiary.

It is recommended that initially, the financial expectations be stated as follows:

(a) the distribution company maintain a financial structure and risk profile that will achieve a credit rating of A (low) or higher;

(b) annual capital expenditures for the distribution company which are significantly in excess of the normal maintenance requirements be approved by Council;

(c) the distribution company be authorized to set distribution rates in accordance with the regulations forthcoming from the OEB; and

(d) the quarterly dividend paid to the City be equal to 2/3 of the increase in cash of the distribution company after allowances have been made for operating and capital needs, the balance being retained by Toronto Hydro for investment in its competitive business.

(8) Disposition of City Proceeds from Toronto Hydro

Under the proposed financial arrangement, the City should expect to receive a significant amount of Toronto Hydro's surplus cash in 1999 and interest and dividends in 2000 and later. A planned approach to the disposition of these proceeds needs to be determined.

The Debt Proceeds:

The municipal credit rating agencies are watching carefully how the City makes use of its investment in Toronto Hydro. The City's credit rating has been under pressure, having been recently put on notice of review of its AAA rating by the Canadian Bond Rating Service. A reduction in the credit rating can make it more expensive to issue future debt.

Forecasts of debt and debt service costs indicate a rapid rise over the next ten years unless mitigating actions are identified. By applying the debt proceeds (i.e. interest payments) received from Toronto Hydro against City debt service costs, it helps to ameliorate the situation.

Some aspects of the recapitalization will be dependent on the future actions of the OEB. In addition, the terms of the debt to the City have not yet been determined. The debt could be perpetual debt where the balance remains stable and only interest payments are made. Perpetual debt guarantees a long-term interest payment stream, but does not provide any principal repayment. Alternatively, debt principal could be repaid through a normal amortization of principal. This approach increases the annual obligation of Toronto Hydro to the City, but will end at some point when the debt is repaid.

If debt principal is to be repaid or if the City converts the Toronto Hydro debt to market debt, then principal repayment or proceeds from monetization should be directly applied to City debt. In this way, overall debt on a consolidated basis remains the same. Through responsible application of the proceeds to offset or reduce the City's debt obligations, the credit rating is supported. Proceeds from principal repayment should not be used to finance increased capital expenditures, nor should debt principal repayments be allocated to fund program expenditures in the City's operating budget because the City should not come to rely on a temporary source of funds for these purposes.

The Dividends:

Dividends also form part of the income stream resulting from capital investment. If Toronto Hydro had been sold, the proceeds would likely have gone to repay the City debt or to finance capital. Dividends therefore, should also be applied to reduce the City's capital obligations. Dividends are not guaranteed and tend to fluctuate in amount, depending on the profitability of Toronto Hydro. Until the dividend becomes a predictable source of income, it should also be applied to the City's debt reduction through the capital current contribution vehicle. Once there is a predictable dividend income stream, capital from current increases could be reliably funded, reducing operating budget pressures.

It is recommended that the proceeds of the debt and dividends from Toronto Hydro be used toward the existing City capital obligations and not be used to increase City operating expenses.

(9) Next Steps:

It is proposed that the new companies be incorporated immediately and the transfer of assets take place on July 1, 1999. This will permit the companies sufficient time to organize and prepare their operations for the opening of the competitive market in 2001, In addition, it sets in place the necessary structures which enable the City to begin receiving dividends and interest payments from Toronto Hydro in 2000. For administrative simplicity, however, staff will be transferred as of January 1, 2000.

The attached Transfer By-Law reflects asset values as at December 31, 1998, the date of the most recent audited financial statements. Actual values as of July 1, 1999 will not be known until several weeks after the quarter-ending when all necessary adjustments have been processed. It is proposed and allowed for in the Transfer By-Law that the City CFO in consultation with Toronto Hydro's CFO adjust the values in the schedules attached to the By-law to reflect the values as at July 1, 1999 when the information comes available.

The legislation requires that the value of assets transferred be at fair market value. The determination of fair market value may be impacted by Provincial regulations which are not yet available. For purposes of this transfer, the fair market value has been deemed to be book value. When the regulations come available, a further adjustment may be necessary. The terms of the attached Transfer By-Law authorize the City CFO to make this adjustment.

There is one technical legal issue still being discussed with Provincial officials as at the date of this report. Since the City of Toronto is the first municipality to proceed with the incorporation and transfer of assets, it is not yet clear what sequence of transfers is most acceptable in order to effect the transfer of assets to the subsidiaries through the holding company. This issue will be resolved in time for a technical amendment to the By-Law prior to Council's consideration of this matter.

It is recommended that the Strategic Policies and Priorities Committee endorse in principle the terms of the Shareholder Direction and Transfer By-Law as attached in Appendices 1 and 2 of this report and that, if necessary, the City Solicitor finalize the form of these documents for approval by Council.

Incorporation of Toronto Hydro Corporation - Appendix 1

SHAREHOLDER DIRECTION

RELATING TO

TORONTO HYDRO CORPORATION

July 1, 1999

Prepared by:

Smith Lyons

Suite 5800, Scotia Plaza

40 King Street West

Toronto M5H 3Z7

Page

Article 1 Interpretation

1.1 Definitions

1.2 Calculation of Time

1.3 Regulatory Matters

Article 2 Objectives And Principles

2.1 Purposes

2.2 Shareholder Objectives

2.3 Principles

Article 3 Business Of Toronto Hydro

3.1 Business of Toronto Hydro

3.2 Business of the Distribution Company

Article 4 Operation And Control

4.1 Board of Directors and Responsibilities6

4.2 Board of Directors of Subsidiaries

4.3 Qualifications of Directors

4.4 Vacancies

4.5 Term

4.6 Conflict of Interest Policy

4.7 Confidentiality

4.8 Remuneration

Article 5 Shareholder Matters

5.1 Decisions of the Shareholder

5.2 Matters Requiring Shareholder Approval under the OBCA

5.3 Other Matters Requiring Shareholder Approval

Article 6 Reporting

6.1 Business Plan

6.2 Quarterly Reports

6.3 Access to Records

6.4 Audit

6.5 Accounting

6.6 Annual Financial Statements

Article 7 Financial Performance

7.1 Financial Performance

7.2 Credit Rating

7.3 Debt Financing

7.4 Dividend Policy

7.5 Operation Policy

7.6 Amendments

SHAREHOLDER DIRECTION

WHEREAS Toronto Hydro Corporation (the "Corporation") is a corporation existing under the Business Corporations Act (Ontario);

AND WHEREAS the City of Toronto (the "Shareholder") is the beneficial owner of all of the issued shares of the Corporation;

AND WHEREAS the Corporation and the Subsidiaries (together, "Toronto Hydro") are the successors to the business of Toronto Hydro Electric Commission;

AND WHEREAS Toronto Hydro's business (the "Business") is integral to the well-being and infrastructure of the City of Toronto;

AND WHEREAS the Business is subject to the provisions of the Electricity Act, 1998 and the Ontario Energy Board Act, 1998 being Schedules A and B, respectively, to the Energy Competition Act, 1998, S.O. c.15, as such statutes may be amended or re-enacted from time to time;

AND WHEREAS the Shareholder wishes to establish certain principles of governance relating to Toronto Hydro;

NOW THEREFORE THIS DIRECTION WITNESSES:

ARTICLE 1

INTERPRETATION

1.1 Definitions

In this Direction, in addition to the terms defined in the recitals, the following terms will have the meanings set out below:

"Associate" means a person that is associated with the Corporation or any Subsidiary as such relationship is defined in the OBCA;

"Board" means the board of directors of the Corporation;

"body corporate" means a firm, partnership, unincorporated association, joint venture, body corporate, corporation, bank, trust, pension fund, union, governmental agency, board, tribunal, ministry or commission or other legal entity of any kind whatsoever, but excludes an individual or natural person;

"Business Plan" means a five year business plan and budget for the Corporation and the Subsidiaries prepared and approved in accordance with Section 6.1;

"Chair" means the director of the Corporation appointed as Chair of the Board by the Board upon the nomination by the Shareholder from time to time;

"Distribution Company" means any one or more Subsidiaries that carries on the business described in Section 3.2 and that owns any distribution system, structures, equipment or property used for that purpose;

"Distribution Company Cash Flow" means the increase (decrease) in cash of the Distribution Company, including cash provided by (used in) operating activities, investing activities and financing activities but before deducting the Distribution Company Dividend, as calculated and presented in the Corporation's unconsolidated audited annual Financial Statements;

"Distribution Company Dividend" has the meaning given to it in Section 7.4;

"Financial Statements" means, for any particular period, audited or unaudited (as stipulated in this Direction), consolidated or unconsolidated (as stipulated in this Direction), comparative financial statements of the Corporation consisting of not less than a balance sheet, a statement of income and retained earnings, a statement of changes in financial position, a report or opinion of the Auditor (in the case of audited Financial Statements) and such other statements, reports, notes and information prepared in accordance with generally accepted accounting principles (consistently applied) and as are required in accordance with any applicable law;

"Lien" means any mortgage, hypothec, assignment, encumbrance, lien or security interest, regardless of form, that secures the payment of any indebtedness or liability or the observance or performance of any obligation;

"OBCA" means the Business Corporations Act (Ontario), as such statute may be amended or re-enacted from time to time;

"person" means an individual, a natural person or a body corporate;

"Regulator" means the Ontario Energy Board, the Independent Electricity Market Operator and each other governmental or regulatory authority having jurisdiction over Toronto Hydro;

"Subsidiary" means, with respect to the Corporation, any body corporate of which more than 50% of the outstanding securities of any class carrying exercisable voting rights are beneficially owned, directly or indirectly, by the Corporation, and includes any body corporate in like relation to a Subsidiary;

"third party" means a person who deals at arm's length (as interpreted by subsection 251(1) of the Income Tax Act (Canada)) with the Corporation or the Subsidiaries.

1.2 Calculation of Time

In this Direction, a period of days will be deemed to begin on the first day after the event which began the period and to end at 5:00 p.m. (Toronto time) on the last day of the period. If, however, the last day of the period does not fall on a business day, the period will terminate at 5:00 p.m. (Toronto time) on the next business day.

1.3 Regulatory Matters

In the event of any conflict between any approval or direction or other requirement of the Shareholder under this Direction and any decision, order or policy of any Regulator, the decision, order or policy of the Regulator shall govern and Toronto Hydro will at all times comply with any decision, order or policy of the Regulator whether or not an approval or direction has first been given in respect thereof by the Shareholder under this Direction. For greater certainty, Toronto Hydro will not seek any order from any Regulator for any matter that would require the approval of the Shareholder under this Direction without first giving notice of its intention to seek such an order to the Shareholder.

ARTICLE 2

OBJECTIVES AND PRINCIPLES

2.1 Purposes

The purposes of this Direction are as follows:

(a) subject to the Board's authority to manage or supervise the management of the business and affairs of the Corporation, to provide the Board with the Shareholder's fundamental principles regarding the Business;

(b) to inform the residents of the City of Toronto of the Shareholder's fundamental principles regarding the Business; and

(c) to set out the accountability, responsibility and relationship between the Board and the Shareholder.

2.2 Shareholder Objectives

The Shareholder's objectives in connection with its relationship with Toronto Hydro are as follows:

(a) the value of Toronto Hydro be maintained or increased;

(b) the Shareholder's income stream from Toronto Hydro be comparable to the Shareholder's estimated financial benefit if Toronto Hydro had been sold as a going concern;

(c) Toronto Hydro's consumers not be unduly impacted by the succession by Toronto Hydro of Toronto Hydro Electric Commission; and

(d) environmental impacts related to Toronto Hydro be improved.

2.3 Principles

The following principles will govern the operations of Toronto Hydro:

(a) The Business is integral to the well-being and the infrastructure of the City of Toronto. The Corporation recognizes that it is in the best interests of Toronto Hydro and the community of stakeholders whom the Business affects that Toronto Hydro conduct its affairs:

(i) on a commercially prudent basis;

(ii) in a manner consistent with the energy policies established by the Shareholder from time to time;

(iii) in accordance with the financial performance objectives of the Shareholder as set out herein.

(b) Toronto Hydro will provide, through the Distribution Company, a reliable, effective and efficient electricity distribution system.

(c) Distribution rates applicable to customers of the Distribution Company will be set by the Board in accordance with the rates fixed by the Ontario Energy Board from time to time.

(d) The Business is at all times subject to such licences, codes, policies, rules, orders, interim orders, approvals, consents and other actions of any Regulator.

(e) Toronto Hydro will provide its services with an emphasis on customer orientation and satisfaction.

(f) Toronto Hydro will operate in a safe and environmentally-responsible manner.

(g) Toronto Hydro will promote energy conservation and environmental responsibility.

(h) The Board is responsible for determining and implementing the appropriate balance among the foregoing principles and for causing Toronto Hydro to conduct its affairs in accordance with the same.

ARTICLE 3

BUSINESS OF TORONTO HYDRO

3.1 Business of Toronto Hydro

Subject to the ongoing ability of Toronto Hydro to meet the financial objectives of the Shareholder set out in this Direction and the ability of the Board to demonstrate the same, Toronto Hydro, except for the Distribution Company, may engage in any of the following business activities permitted by the Ontario Energy Board Act, 1998:

(a) selling (i) through the Corporation, (ii) through a third party, (iii) through a Subsidiary, or (iv) through a combination of the foregoing, electricity to every person connected to the distribution system of the Distribution Company;

(b) owning, operating or having an ownership interest in an electricity generation facility;

(c) retailing electricity;

(d) distributing or retailing gas or any other energy product which is carried through pipes or wires to the user;

(e) business activities that develop or enhance the ability of Toronto Hydro to carry on any of the activities contemplated by subsections 3.1 (c) or (d) or subsection 3.2 (b);

(f) business activities, the principal purpose of which is to use more effectively the assets of the distribution system of the Distribution Company, including, without limiting the generality of the foregoing, meter installation and reading services, and billing services;

(g) managing or operating a public utility or sewage services;

(h) renting or selling hot water heaters;

(i) providing services relating to improving energy efficiency; and

(j) using the real property that Toronto Hydro has the right to use for the purpose of providing telecommunications services, or entering into agreements with any third party, including Subsidiaries, authorizing such third party or Subsidiaries to use such real property for the purpose of providing telecommunications services.

3.2 Business of the Distribution Company

The Distribution Company may engage only in the following business activities:

(a) selling (i) directly, (ii) through a third party, (iii) through a Subsidiary, or (iv) through a combination of the foregoing, electricity to every person connected to the distribution system of the Distribution Company;

(b) transmitting or distributing electricity;

(c) business activities, the principal purpose of which is to use more effectively the assets of the distribution system of the Distribution Company, including, without limiting the generality of the foregoing, meter installation and reading services, and billing services;

(d) using the real property that the Distribution Company has the right to use for the purpose of providing telecommunications services, or entering into agreements with any third party, including Subsidiaries, authorizing such third party or Subsidiaries to use such real property for the purpose of providing telecommunications services.

ARTICLE 4

OPERATION AND CONTROL

4.1 Board of Directors and Responsibilities

Subject to any matters requiring approval of the Shareholder pursuant to this Direction, the Board will supervise the management of the business and affairs of the Corporation, including the following specific matters:

(a) establishing appropriate reserves consistent with sound financial principles and the financial performance objectives set out herein;

(b) approving any dividend payment or distribution of capital in excess of the payments provided for in Section 7.4;

(c) selecting bankers and other financial institutions and establishing all banking authorities; and

(d) appointing the officers of the Corporation and nominating the individuals to be appointed senior officers of the Subsidiaries.

4.2 Board of Directors of Subsidiaries

Subject to any matters requiring approval of the Shareholder pursuant to this Direction, the business and affairs of the Subsidiaries will be managed or supervised by their respective boards of directors. The Corporation will elect the directors of the Subsidiaries from among the directors of the Corporation.

4.3 Qualifications of Directors

A majority of the Board and the board of directors of each Subsidiary will be residents of Canada. In electing directors to the Board the Shareholder will give due regard to the qualifications of candidates, including:

(a) experience or knowledge with respect to:

(i) public utility commissions or boards of major corporations or other commercial enterprises;

(ii) corporate finance;

(iii) corporate governance;

(iv) market development;

(v) large system operation and management;

(vi) urban energy industries;

(vii) public policy issues and laws relating to Toronto Hydro and the electricity industry; and

(viii) environmental matters, labour relations and occupational health and safety issues;

(b) commercial sensitivity and acumen,

(c) independence of judgment, and

(d) personal integrity.

4.4 Vacancies

If a member of the Board ceases to be a director for any reason, the Shareholder will fill the vacancy created thereby as soon as reasonably possible. If a member of the board of directors of any Subsidiary ceases to be a director for any reason, the Corporation will cause the vacancy to be filled by another director of the Corporation as soon as reasonably possible.

4.5 Term

The term of office for a director who is not a member of the City of Toronto Council will be three years or until his or her successor is elected. The term of office for a director who is a member of the City of Toronto Council will be eighteen months or until his or her successor is elected. The term of the first directors of the Corporation who are members of the City of Toronto Council will be deemed to begin on the later of (i) June 14, 1999 and (ii) the date of incorporation of the Corporation, and to end on November 30, 2000. For greater certainty, any director may stand for re-election to the Board at the expiry of his or her term.

4.6 Conflict of Interest Policy

The directors and officers of the Corporation and the Subsidiaries will strictly abide by the requirements of the OBCA and the Corporation in respect of conflicts of interest, including any requirements in respect of disclosure and abstention from voting.

4.7 Confidentiality

The Shareholder and the directors and officers of the Corporation and the Subsidiaries (each a "Receiving Party") will ensure that no confidential information of the Shareholder or Toronto Hydro is disclosed or otherwise made available to any person, except to the extent that:

(a) disclosure to a Receiving Party's employees or agents is necessary for the performance of any Receiving Party's duties and obligations under this Direction;

(b) disclosure is required in the course of judicial proceedings or pursuant to law; or

(c) the confidential information becomes part of the public domain (other than through unauthorized disclosure by the Receiving Party).

4.8 Remuneration

The remuneration of the members of the Board for their respective services as directors will be as determined by the Shareholder from time to time. Initially, each director of the Corporation will be paid $12,500 per annum for his or her services, plus $1,000 for each meeting of the Board attended. Notwithstanding the foregoing:

(a) directors of the Corporation who are members of the City of Toronto Council will receive no remuneration; and

(b) the Chair will be paid a total of $75,000 per annum.

ARTICLE 5

SHAREHOLDER MATTERS

5.1 Decisions of the Shareholder

The following will apply to any approvals or decisions that the Shareholder must provide:

(a) all approvals and decisions will be made in writing signed by the authorized signatory of the Shareholder; and

(b) no approval will be given unless the Corporation has given reasonable advance notice in writing of the need for approval and has provided such information as is reasonably necessary for the Shareholder to make an informed decision regarding the subject matter requiring approval.

5.2 Matters Requiring Shareholder Approval under the OBCA

In accordance with the provisions of the OBCA, neither the Corporation nor any Subsidiary will, without the approval of the Shareholder:

(a) amend its articles or make, amend or repeal any by-law;

(b) amalgamate (except for an amalgamation with one or more Subsidiaries), apply to continue as a body corporate under the laws of another jurisdiction, merge, consolidate or reorganize, or approve or effect any plan of arrangement, in each case whether statutory or otherwise;

(c) take or institute proceedings for any winding up, arrangement, reorganization or dissolution;

(d) create new classes of shares or reorganize, consolidate, subdivide or otherwise change its outstanding securities;

(e) sell or otherwise dispose of, by conveyance, transfer, lease, sale and leaseback, or other transaction, all or substantially all of its assets or undertaking;

(f) change the Auditor;

(g) make any change to the number of directors comprising the Board;

(h) enter into any transaction or take any action that requires shareholder approval pursuant to the OBCA.

5.3 Other Matters Requiring Shareholder Approval

Without the approval of the Shareholder the Distribution Company will not:

(a) provide any financial assistance, whether by loan, guarantee or otherwise, to any person;

(b) create, incur or assume any unsecured indebtedness that, by its terms or by any other agreement, ranks higher than any indebtedness of the Distribution Company held by the Shareholder while the promissory note of the Corporation or the Distribution Company issued pursuant to clause 4-1(B)(b)(ii) of By-law No. [x-1999] (the "Promissory Note") is held by the Shareholder;

(c) create any Lien on its assets while the Promissory Note is held by the Shareholder, other than:

(i) any Lien in favour of the Shareholder;

(ii) Liens securing purchase money obligations, trade debts or other liabilities incurred in the ordinary course of business (other than in relation to the borrowing of money) if the aggregate principal amount of such obligations does not exceed $10,000,000 at any time;

(iii) Liens securing credit facilities created or incurred for the purpose of providing operating financing for day-to-day working capital requirements of the Distribution Company if the aggregate principal amount of such credit facilities does not exceed $100,000,000 at any time;

(iv) Liens held by any governmental authority that have not at the time been filed or registered against the title to the Distribution Company's assets or served upon the Distribution Company pursuant to law or that relate to obligations of the Distribution Company that are not due or delinquent;

and without the approval of the Shareholder, neither the Corporation nor any Subsidiary will:

(d) provide any financial assistance, whether by loan, guarantee or otherwise, to any director or officer of the Corporation or of any Subsidiary or Associate;

(e) make any capital expenditures in an amount exceeding in aggregate $170,000,000 in any fiscal year in connection with the distribution system of the Distribution Company or any person;

(f) acquire any interest in the distribution system, undertaking or securities of a distributor (as defined in the Electricity Act, 1998) operating outside of the municipal boundaries of the City of Toronto;

(g) invest funds in publicly-traded securities other than government debt, Canadian chartered bank or Canadian corporate securities rated less than A/R-1 (low) (or its equivalent) by CBRS Inc. or Dominion Bond Rating Service Limited;

(h) enter into any agreement, commitment or investment that provides recourse to the assets of the Corporation or the Distribution Company or creates any encumbrance, lien, security interest or recourse in favour of any third party in such assets.

For greater certainty, in this Section 5.3, the term "financial assistance" does not include remuneration paid in the normal course of business to directors, officers or employees, including honoraria, wages, salaries or bonuses, or any reimbursement for expenses arising from such persons' duties.

ARTICLE 6

REPORTING

6.1 Business Plan

Not later than 60 days prior to the end of each fiscal year, the Board will approve and submit to the Finance Department of the Shareholder (the "Finance Department") a business plan for the next five fiscal years (the "Business Plan"). The Business Plan will be prepared on a consistent basis with the Business Plan then in effect. The Corporation will carry on its business and operations in accordance with the Business Plan which will include, in respect of the period covered by such plan:

(a) the strategic direction and any new business initiatives which Toronto Hydro will undertake;

(b) an operating and capital expenditure budget for the next fiscal year and an operating and capital expenditure projection for each fiscal year thereafter, including the resources necessary to implement the draft business plan;

(c) the projected annual revenues and profits for each fiscal year for the Corporation and each of the Subsidiaries;

(d) pro forma consolidated and unconsolidated financial statements, including projected dividend payments to the Shareholder;

(e) an acquisition budget setting forth the nature and type of capital expenditures proposed to be made in the following fiscal year, supported by explanations, notes and information upon which the budget was based;

(f) energy conservation programmes and environmental plans, including the level of commitment to renewable energy and co-generation;

(g) any material variances in the projected ability of any business activity to meet or continue to meet the financial objectives of the Shareholder; and

(h) any material variances from the Business Plan then in effect.

6.2 Quarterly Reports

Within 45 days after the end of each fiscal quarter, the Board will prepare (on a consistent basis with the previous fiscal quarter) and submit to the Finance Department a quarterly report. The quarterly report will include, in respect of the immediately preceding fiscal quarter:

(a) quarterly unaudited consolidated and unconsolidated Financial Statements;

(b) such explanations, notes and information as is required to explain and account for any variances between the actual results from operations and the budgeted amounts set forth in the current Business Plan, including any material variances in the projected ability of any business activity to meet or continue to meet the financial objectives of the Shareholder;

(c) information that is likely to materially affect the Shareholder's financial objectives or energy policies;

(d) information that is likely to materially affect customers' perceptions or opinions regarding Toronto Hydro;

(e) information regarding any matter, occurrence or other event which is a material breach or violation of any law; and

(f) any such additional information as the Shareholder may specify from time to time.

6.3 Access to Records

The duly appointed representatives of the Shareholder (as approved by report to the Council of the City of Toronto from time to time) shall have unrestricted access to the books and records of the Corporation and the Subsidiaries during normal business hours. Such representatives shall treat all information of Toronto Hydro with the same level of care and confidentiality as any confidential information of the Shareholder.

6.4 Audit

The Corporation's consolidated and unconsolidated Financial Statements will be audited annually. The first auditor of the Corporation is Ernst & Young, Chartered Accountants, (the "Auditor").

6.5 Accounting

The Corporation will, in consultation with the Auditor, adopt and use the accounting policies and procedures which may be approved by the Board from time to time and all such policies and procedures will be in accordance with generally accepted accounting principles and applicable regulatory requirements.

6.6 Annual Financial Statements

The Board will cause the Auditor to deliver, as soon as practicable and in any event within 90 days after the end of each fiscal year, the audited consolidated Financial Statements of the Corporation for consideration by the Shareholder.

ARTICLE 7

FINANCIAL PERFORMANCE

7.1 Financial Performance

The Board will be responsible for ensuring that Toronto Hydro meets the financial performance standards set out in this Article 7.

7.2 Credit Rating

The Distribution Company shall maintain a financial structure that will achieve a rating of A (low) (as defined by CBRS Inc.) or higher on senior debt securities on or before December 31, 2001.

7.3 Debt Financing

The Distribution Company will optimize its debt financing in accordance with the provisions of this Direction, in particular, subsection 2.3(a), Section 7.2 and subsection 7.5(c).

7.4 Dividend Policy

Subject to any law, the Distribution Company will pay to the Corporation a quarterly cash dividend (the "Distribution Company Dividend") as follows:

(a) The Distribution Company Dividend will be the greater of $0 and the Distribution Company Cash Flow adjusted for changes in cash balance to meet the Distribution Company's ongoing operational requirements.

(b) Subject to subsections 7.4(d) and (e), the Distribution Company will pay the Distribution Company Dividend on the last day of each of the Distribution Company's fiscal quarters based upon the Distribution Company Cash Flow stated in the operating and expenditure budget in the Business Plan then in effect (the "Projected Distribution Company Cash Flow").

(c) Upon receipt, the Corporation will immediately pay two-thirds of the Distribution Company Dividend to the Shareholder as a cash dividend.

(d) After the last quarterly payment of the Distribution Company Dividend for any fiscal year, if the audited annual Financial Statements for such past fiscal year reveal that the actual Distribution Company Cash Flow was different than the Projected Distribution Company Cash Flow, the first quarterly payment for the immediately following fiscal year shall be adjusted to reflect such actual Distribution Company Cash Flow.

(e) Notwithstanding the foregoing, the obligation to pay the Distribution Company Dividend will begin on January 1, 2000 and the first payment thereof will be made on March 31, 2000.

The amount of the cash dividend paid by the Corporation to the Shareholder may be subject to adjustment by the Shareholder from time to time based on the financial requirements of the Shareholder or the Corporation.

7.5 Operation Policy

Toronto Hydro will:

(a) employ the most efficient cost structure available for like businesses;

(b) mandate the creation and implementation of cost reduction programs to ensure that distribution costs are minimized; and

(c) maximize return on the Shareholder's equity.

7.6 Amendments

This Direction may be amended solely at the discretion of the Shareholder. The Shareholder will provide prior written notice to the Board of any proposed amendments to this Direction.

DATED at Toronto this ______ day of _______________, 1999.