1. Introduction

Local Flexibility Markets (LFMs) are emerging regulatory and market arrangements through which electricity distribution networks obtain flexibility services from distributed energy resources (DERs). These resources may include battery storage, demand response, electric vehicles, rooftop solar, aggregators, industrial loads, and other controllable assets.

Traditionally, a Distribution Network Operator (DNO) operated the distribution network primarily by investing in physical infrastructure—such as substations, transformers and lines—to accommodate changing electricity demand. With increasing distributed generation, electrification, electric vehicles and variable renewable energy, distribution networks can increasingly use flexibility services as an alternative or complement to conventional network reinforcement.

The governance question is therefore:

To what extent should DNOs be permitted to design, procure, operate and settle local flexibility markets, and what legal safeguards should constrain their market power?

Modern regulatory systems increasingly distinguish between the DNO's network-management role and the competitive activities of flexibility providers. In some jurisdictions, the DNO has evolved toward a Distribution System Operator (DSO) function, with greater responsibility for procuring and coordinating flexibility while remaining subject to regulatory oversight.

2. Meaning of Local Flexibility Markets

A local flexibility market allows the distribution network operator to procure changes in electricity consumption or generation in a defined geographical area.

For example, suppose a distribution transformer is expected to become overloaded between 6:00 p.m. and 8:00 p.m. Rather than immediately constructing a larger transformer, the network operator could procure:

• battery discharge;
• reduction in industrial consumption;
• delayed EV charging;
• increased consumption by flexible loads;
• temporary curtailment of distributed generation; or
• coordinated demand response.

The flexibility provider receives compensation for changing its electricity consumption or generation according to the agreed market rules.

A simplified transaction can therefore be represented as:

DNO identifies network constraint → flexibility requirement is published → providers submit bids → bids are selected → flexibility is delivered → performance is measured → provider is paid.

3. Why DNO Governance Is Necessary

DNOs occupy a special legal position because electricity distribution is normally a regulated natural-monopoly activity.

A DNO controls essential infrastructure, including:

• distribution lines;
• substations;
• transformers;
• connection capacity;
• network information;
• congestion information; and
• operational control of the distribution network.

If the same entity designs the local market and participates in the market itself, there is a potential conflict of interest.

For example, a DNO could theoretically design market rules that:

1. favour particular technologies;
2. exclude smaller flexibility providers;
3. impose excessive qualification requirements;
4. favour network reinforcement over flexibility procurement;
5. favour particular aggregators;
6. discriminate between customers; or
7. use commercially sensitive information obtained through its monopoly function.

Consequently, LFM governance requires a balance between operational control and competitive neutrality.

4. Core Functions of DNOs in Local Flexibility Markets

A. Identification of Network Constraints

The DNO first identifies locations where flexibility may have value.

Typical constraints include:

• thermal overload;
• voltage problems;
• reverse power flows;
• transformer capacity limitations;
• congestion caused by EV charging;
• renewable generation constraints; and
• short-term balancing requirements.

The DNO should publish sufficiently transparent information about these requirements so that market participants can understand where flexibility is required.

B. Definition of Flexibility Products

DNOs must define the technical characteristics of the flexibility they require.

Products can differ according to:

• response time;
• duration;
• availability period;
• minimum capacity;
• geographical location;
• frequency of activation;
• reliability;
• baseline methodology; and
• recovery requirements.

For example:

Regulation should prevent product design from becoming an indirect barrier to entry.

5. Procurement Governance

One of the most important responsibilities of a DNO is procurement.

A sound legal framework normally requires:

Transparency

Market opportunities and technical requirements should be publicly available.

Non-discrimination

Comparable flexibility providers should receive comparable treatment.

Technology neutrality

Rules should normally specify the required service rather than unnecessarily prescribing the technology.

Competitive procurement

Where appropriate, flexibility should be obtained through competitive tendering or market mechanisms.

Proportional qualification requirements

Small batteries, aggregators and demand-response providers should not be excluded by unnecessarily burdensome requirements.

6. DNOs as Market Facilitators Rather Than Market Competitors

A central governance principle is that the DNO should generally act as a neutral procurer and system operator, rather than as a commercial competitor against the flexibility providers whose services it procures.

This produces an important institutional distinction:

DNO function:

determine network need → procure flexibility → activate flexibility → verify delivery.

Market participant function:

own/operate DER → submit bid → provide flexibility → receive payment.

Where a DNO has commercial interests in flexibility assets, stronger structural or functional separation may be necessary.

7. Relationship Between DNOs and DSOs

The transition from DNO to DSO is important.

A conventional DNO mainly manages physical distribution infrastructure.

A DSO may additionally:

• procure flexibility;
• coordinate DER;
• facilitate local markets;
• manage distribution congestion;
• coordinate with transmission system operators;
• integrate storage;
• support active consumers; and
• coordinate aggregators.

The transformation therefore changes the legal character of the distribution network operator from a relatively passive infrastructure manager toward an active system coordinator.

This raises questions concerning:

• licensing;
• regulatory accountability;
• data governance;
• market neutrality;
• procurement;
• consumer protection;
• cybersecurity; and
• coordination with transmission operators.

8. Regulatory Oversight

Because DNOs have monopoly characteristics, the regulator should establish rules governing:

1. procurement procedures;
2. market access;
3. pricing;
4. data disclosure;
5. conflicts of interest;
6. performance measurement;
7. settlement;
8. dispute resolution;
9. consumer protection; and
10. reporting obligations.

The regulator can also require DNOs to publish periodic reports concerning:

• flexibility requirements;
• procurement volumes;
• successful providers;
• prices;
• activation frequency;
• avoided network reinforcement;
• rejected bids; and
• market participation.

9. Pricing and Market Power

Pricing presents a particularly important governance issue.

A flexibility market may use:

Pay-as-bid

Each successful provider receives the price it bid.

Marginal pricing

Accepted providers receive a market-clearing price.

Regulated procurement

The regulator establishes specific procurement principles or price boundaries.

Bilateral contracting

The DNO negotiates contracts with flexibility providers under regulated conditions.

Each model creates different incentives and risks.

The regulatory framework should prevent the DNO's purchasing power from being used to impose unfair contractual conditions.

10. Baseline and Measurement Problems

Demand response creates a difficult legal and technical issue: How can the regulator determine what electricity consumption would have occurred without flexibility activation?

Suppose a factory normally consumes 10 MW but reduces consumption to 7 MW during a flexibility event.

The market needs to determine whether:

3 MW of flexibility was actually delivered.

This requires a baseline methodology.

Poor baseline rules can produce:

• overpayment;
• underpayment;
• gaming;
• disputes;
• inaccurate market results.

Therefore, baseline methodologies should be transparent, auditable and subject to regulatory review.

11. Aggregators and DNO Governance

An aggregator combines multiple small resources and offers them collectively to the flexibility market.

For example:

• 500 household batteries;
• 200 EV chargers;
• 50 commercial buildings;

could collectively provide several megawatts of flexibility.

This creates an important governance question:

Should a DNO be allowed to impose direct contractual or technical requirements on individual DER customers when those customers participate through an aggregator?

Regulation should avoid unnecessarily restricting aggregation while ensuring that the DNO can maintain network reliability.

12. Data Governance

Local flexibility markets depend heavily on data.

Relevant data can include:

• electricity consumption;
• generation;
• network capacity;
• voltage;
• congestion;
• availability;
• bidding information;
• activation information; and
• customer information.

Governance therefore requires rules concerning:

• access;
• privacy;
• confidentiality;
• cybersecurity;
• interoperability;
• data ownership; and
• publication.

Network data should be sufficiently transparent to facilitate competition while commercially sensitive and personal information should receive appropriate protection.

13. European Union Legal Framework

European energy law provides an important legal foundation for active distribution-system management.

The EU Clean Energy for All Europeans package strengthened the role of active consumers, aggregators, distributed resources and flexibility.

The EU electricity-market framework also places greater emphasis on:

• consumer participation;
• demand response;
• aggregation;
• storage;
• distribution-system operation; and
• non-discriminatory market participation.

The resulting legal architecture moves away from a purely vertically organised electricity system toward a more decentralised and participatory model.

14. United Kingdom Approach

The UK provides one of the most important practical examples of flexibility procurement by distribution network operators.

Distribution network companies have increasingly procured flexibility to manage constraints and defer conventional network reinforcement.

The UK's regulatory framework has involved Ofgem, network companies and industry arrangements aimed at facilitating flexibility markets.

The shift toward Distribution System Operation has also increased the importance of:

• market facilitation;
• transparency;
• flexibility procurement;
• coordination with the transmission system;
• whole-system planning; and
• consumer participation.

The legal principle is that flexibility procurement should serve the regulated network function rather than allow the network monopoly to create an unfair competitive advantage.

15. Important Case Law

Because local flexibility markets are relatively new, there are comparatively few reported judgments dealing directly with a DNO-operated flexibility market. However, several electricity-regulation cases establish legal principles that are highly relevant.

15.1 Michigan Public Service Commission v. Michigan Bell Telephone Co. — regulatory principles

The broader regulatory jurisprudence concerning regulated utilities establishes that monopoly infrastructure providers may legitimately be subject to regulatory controls designed to prevent discriminatory or unreasonable treatment.

The principle is relevant to flexibility markets because DNOs control essential infrastructure and therefore cannot necessarily be treated like ordinary competitive businesses.

15.2 California Independent System Operator Corp. v. FERC, 372 F.3d 395 (D.C. Cir. 2004)

This case concerned electricity-market regulation and the relationship between market mechanisms and federal regulatory authority in the United States.

Its broader significance is that electricity markets cannot be separated from the regulatory architecture governing system reliability and transmission/distribution functions.

For local flexibility markets, this supports the proposition that market design must remain consistent with the statutory responsibilities of electricity regulators and system operators.

15.3 Hughes v. Talen Energy Marketing, LLC, 578 U.S. 150 (2016)

The U.S. Supreme Court considered the relationship between state electricity policy and federally regulated wholesale electricity markets.

The Court held that a state program was pre-empted because it interfered with the federally regulated wholesale market.

Relevance

The case demonstrates an important governance principle:

Different levels of electricity-market regulation must respect their respective statutory jurisdictions.

A local flexibility market therefore cannot be designed in isolation where its operation affects higher-level electricity markets.

16. EU Electricity-Market Jurisprudence

European case law concerning energy regulation provides additional principles.

16.1 Federutility v Autorità per l'energia elettrica e il gas

Case C-265/08, Federutility and Others v Autorità per l'energia elettrica e il gas, EU:C:2010:205

The Court of Justice considered the legality of state intervention in energy pricing.

The Court recognised that public intervention in energy markets can be justified in certain circumstances but must satisfy requirements relating to legitimate objectives and proportionality.

Relevance to local flexibility markets

This principle is relevant where regulators establish:

• flexibility-price controls;
• procurement requirements;
• consumer-protection measures; or
• regulated access arrangements.

Regulation should be connected to a legitimate public objective and should not unnecessarily restrict competition.

17. Commission v Germany and Energy Regulation

EU electricity jurisprudence has repeatedly addressed the relationship between national energy regulation, market liberalisation and regulatory independence.

These decisions reinforce a broader principle:

Energy-market regulation must operate within the legal framework established by EU energy legislation and cannot arbitrarily distort competitive market structures.

This is particularly important for DNOs because they occupy a monopoly position while interacting with competitive flexibility providers.

18. Indian Legal Context

India does not yet have a mature nationwide local flexibility-market structure comparable to the most developed European experiments. Nevertheless, the Electricity Act, 2003 provides an important legal foundation.

Relevant institutions include:

• Central Electricity Regulatory Commission (CERC);
• State Electricity Regulatory Commissions (SERCs);
• distribution licensees;
• system operators;
• consumers;
• renewable-energy generators; and
• emerging storage and demand-response participants.

The Electricity Act's broader objectives include promoting competition, protecting consumer interests and ensuring efficient electricity supply.

Local flexibility markets could potentially develop through regulatory mechanisms involving:

• demand response;
• battery storage;
• distributed renewable generation;
• EV charging;
• smart meters; and
• distribution-system planning.

19. Indian Case Law

19.1 Energy Watchdog v CERC

Energy Watchdog v Central Electricity Regulatory Commission, (2017) 14 SCC 80

The Supreme Court of India examined contractual and regulatory issues in the electricity sector and emphasised the statutory framework governing electricity regulation.

Relevance

For future Indian flexibility markets, the case illustrates the importance of:

• statutory authority;
• regulatory jurisdiction;
• contractual certainty; and
• consistency with electricity-sector legislation.

19.2 PTC India Ltd. v Central Electricity Regulatory Commission

PTC India Ltd. v CERC, (2010) 4 SCC 603

This is one of India's leading electricity-regulation cases.

The Supreme Court examined the regulatory powers of CERC and the relationship between regulations and subordinate legislation.

Importance for local flexibility markets

The case is particularly relevant because a flexibility market would require detailed regulatory rules concerning:

• participation;
• bidding;
• settlement;
• network access;
• technical standards;
• market conduct; and
• dispute resolution.

Such rules must derive their authority from the governing statutory framework.

20. Legal Principles Emerging from the Case Law

The combined jurisprudence suggests several principles for DNO-governed flexibility markets.

1. Statutory authority

A DNO cannot exercise market-design powers simply because it operates the network. Its authority must arise from its licence, legislation and regulatory framework.

2. Non-discrimination

Market participants should receive fair and non-discriminatory access.

3. Proportionality

Regulatory restrictions should correspond to legitimate network and public-interest objectives.

4. Regulatory independence

Market rules should be subject to independent regulatory oversight.

5. Jurisdictional coordination

Local markets must be coordinated with regional, national and wholesale electricity markets.

6. Transparency

DNO decisions affecting market access and procurement should be explainable and reviewable.

21. Conflict of Interest

One of the most significant issues is the potential conflict between:

DNO as monopoly network operator

and

DNO as flexibility-market administrator.

For example, the DNO decides that flexibility is required in a particular area. It then establishes qualification criteria, evaluates bids and determines whether the flexibility was successfully delivered.

This concentration of functions creates a potential governance risk.

Possible safeguards include:

• independent procurement oversight;
• standardized market rules;
• regulator-approved procurement methodologies;
• independent auditing;
• separation of commercial and regulated functions;
• transparent tender procedures; and
• publication of procurement results.

22. Flexibility Versus Network Reinforcement

A major regulatory question is whether DNOs should use flexibility instead of traditional infrastructure investment.

Suppose a substation will become overloaded.

The DNO has two options:

Option A: construct a new transformer.

Option B: procure flexibility from batteries, EVs and demand-response providers.

The regulator must determine whether flexibility is:

• technically feasible;
• cheaper;
• sufficiently reliable;
• available for the required period;
• capable of meeting long-term requirements; and
• compatible with consumer interests.

Flexibility should therefore be considered as a network-planning resource, but not automatically treated as a replacement for physical infrastructure.

23. Consumer Protection

Residential consumers may participate indirectly through:

• smart thermostats;
• EV chargers;
• home batteries;
• rooftop solar;
• demand-response programmes.

Governance must therefore address:

• informed consent;
• transparent contracts;
• payment;
• data privacy;
• automatic control;
• opt-out rights;
• service reliability; and
• protection of vulnerable consumers.

A flexibility programme should not cause unacceptable reductions in essential electricity services.

24. Environmental Dimension

Local flexibility markets can facilitate renewable integration.

For example, excess solar generation during the afternoon can be absorbed by:

• batteries;
• EV charging;
• flexible industrial demand; or
• other controllable loads.

The result can be reduced renewable curtailment and more efficient use of existing network capacity.

However, flexibility procurement should be assessed using transparent environmental and system-cost criteria rather than assuming that every flexibility resource is automatically environmentally beneficial.

25. Cybersecurity and Operational Risk

Digitised flexibility markets create new cybersecurity risks.

A coordinated cyberattack against thousands of smart devices could simultaneously:

• disconnect generation;
• activate batteries;
• increase demand;
• reduce demand; or
• destabilize local networks.

Therefore, DNO governance should include:

• cybersecurity standards;
• authentication;
• access controls;
• incident reporting;
• system redundancy;
• device certification; and
• emergency override procedures.

26. Recommended Governance Architecture

A robust LFM governance framework can be represented as:

Energy legislation
↓
Independent energy regulator
↓
DNO/DSO licence and market rules
↓
Local flexibility procurement platform
↓
Aggregators / batteries / EVs / consumers / generators
↓
Activation and settlement
↓
Regulatory monitoring and audit

This architecture separates rule-making from the DNO's day-to-day operational role.

27. Key Legal Challenges

The major legal challenges include:

1. defining the legal status of flexibility;
2. determining DNO procurement powers;
3. preventing discrimination;
4. managing conflicts of interest;
5. protecting consumer data;
6. establishing baseline methodologies;
7. coordinating local and wholesale markets;
8. regulating aggregators;
9. determining liability for failed flexibility;
10. ensuring cybersecurity;
11. determining appropriate remuneration; and
12. establishing effective dispute-resolution mechanisms.

28. Conclusion

Local flexibility market governance by DNOs represents a fundamental shift in electricity regulation. The DNO is no longer merely a passive operator of wires; it increasingly becomes a coordinator of distributed resources and a purchaser of flexibility.

However, the DNO's monopoly position creates a legal necessity for strong governance. The central regulatory objective should be to permit DNOs to obtain flexibility efficiently while ensuring neutrality, transparency, non-discrimination, proportionality, consumer protection and independent regulatory oversight.

The emerging legal model can therefore be summarized as:

DNO operational authority + competitive flexibility procurement + independent regulatory supervision + transparent market rules.

The case law—from PTC India Ltd. v CERC and Energy Watchdog in India to Federutility, Hughes v Talen Energy, and electricity-market jurisprudence in other jurisdictions—supports broader principles of statutory authority, regulatory competence, proportionality, market coordination and protection against arbitrary intervention. Direct judicial precedent specifically addressing DNO-operated local flexibility markets remains limited because these markets are comparatively new; consequently, much of the legal framework currently develops through legislation, licences, regulatory codes and administrative decisions rather than reported court judgments.