Executive Summary
Introduction
1. Experience with two regulatory control inquiries (into airports and gas pipelines services) and the application of the Part 4A electricity lines thresholds regime has highlighted a number of issues with the current regulatory control provisions of the Commerce Act. For example, there is some uncertainty around the policy intent of regulatory control, some inefficiency of regulatory processes, potentially insufficient accountability for regulatory decisions, and some concerns as to whether the Part 4A thresholds regime is meeting its design objectives.
2. The primary objective of reviewing the regulatory control provisions of the Act is to ensure that economic regulation in New Zealand is consistent with providing for the long-term benefit of consumers within New Zealand. Economic regulation involves setting or influencing the prices that a firm charges and the quality of goods and services it supplies. Consistent with the broad objective, the Review will consider whether any amendments to the Act are desirable to reinforce the Government's policy objectives on investment in infrastructure.
Purpose of economic regulation
3. Most of the Commerce Act is designed to maintain and promote competition by prohibiting or restricting anti-competitive conduct (Part 2) and restraining business acquisitions which substantially lessen competition unless there are net public benefits (Part 3). However, there are some markets where there is little or no scope for competition, such as natural monopolies. This enables suppliers to charge excessive prices and/or cut back on quality of supply. This is potentially inefficient and raises distributional or consumer protection issues, especially where monopoly provision occurs in the supply of essential services, like electricity. Parts 4, 4A, and 5 of the Commerce Act therefore provide for the economic regulation of such markets.1
4. The discussion paper canvases whether the purpose of economic regulation should be solely or primarily to improve economic efficiency (net public benefits) or to protect consumers (net acquirers' benefits). As part of that discussion it notes that the Commerce Commission considers that analysis focused solely on economic efficiency will virtually always show net costs. On balance, the document concludes that both efficiency and consumer protection objectives are relevant considerations.
5. At present the criteria for when economic regulation may or should be imposed are subject to debate. The document therefore suggests that a regulatory-specific purpose statement and amended criteria for when regulation may be imposed are desirable.
6. The proposed purpose statement is as follows:
The purpose of this Part is, in markets where there is little or no competition or prospect of competition, to provide for economic regulation for the long term benefit of consumers of New Zealand. Any regulation under this Part should seek to ensure that suppliers:
(a) are limited in their ability to earn excessive profits;
(b) have incentives to improve efficiency and provide services at a quality that reflects consumer demands;
(c) share the benefits of efficiency gains with consumers, including through lower prices; and
(d) have incentives to innovate and to invest including in replacement, upgraded and new assets and in related businesses.
7. The current criteria for when regulation may be imposed are that competition is limited or likely to be lessened and that regulation is necessary or desirable in the interests of acquirers or suppliers. The paper proposes options for a more rigorous test for a market without workable competition. It also proposes a test for when regulation may be imposed with a clearer focus on efficiency issues as well as consumer protection, as follows:
"Goods or services may be regulated if economic regulation is necessary or desirable to:
(a) provide efficiencies in a market; or
(b) provide long term benefits to persons acquiring the goods or services that [substantially] [clearly] exceed the direct and indirect costs of regulation."
8. In terms of process, the document proposes that decisions on whether, and (if so) how, to control be undertaken simultaneously rather than sequentially as at present. It is important that the decision on whether to regulate a firm or sector is based on as complete an information set as possible, given that the costs and benefits of regulation depend, to a large extent, on the terms of control.
How to regulate
9. There are several types of economic regulation. The most common ones are: regulatory control (e.g. price/revenue caps and quality requirements); information disclosure/price monitoring; thresholds; and commercial negotiation with mandatory dispute resolution. Different forms of regulation, while aiming to achieve similar policy objectives, are likely to have different implications for the economy, regulated businesses and the regulator.
10. With the exception of the electricity lines businesses threshold regime (which was specifically legislated for), the only regulatory instrument available under the Commerce Act is regulatory control. This document recommends expanding the scope of the regulatory provisions to provide for information disclosure/price monitoring and negotiation/arbitration, in addition to regulatory control. The document also considers whether less rigorous tests would be appropriate for allowing the introduction of these more "light-handed" types of regulation.
11. In the case of regulatory control, the document considers whether firms should have a role in proposing their own regulatory control terms. This may be desirable as firms are likely to be best placed to provide firm-specific information and make firm-specific trade-offs. This is often referred to as a "propose/respond" model. A variant is to require the Commission to accept a proposal that meets criteria for reasonableness that have been pre-set by the Commission. Reasonableness criteria could include matters such as acceptable consultation and agreement with customers and independent verification that the firm is efficient.
12. In respect of the Part 4A threshold regime for electricity lines, there is some concern as to whether the regime is meeting its design objectives, particularly given: the absence of a mechanism for firms to seek ex ante approvals of significant, step-change, capital expenditure; uncertainty as to the consequences of threshold breaches; and the apparent tendency to adversarial processes. An alternative view is that the regime is still settling in, and that any issues associated with the regime are reducing as the Commission and industry alike gain experience. Consistent with these two views, this document presents two options regarding the Part 4A thresholds regime:
(1) Part 4A is retained and made generic so that other sectors (e.g. gas pipeline services) can be placed under a thresholds regime if appropriate; or
(2) Part 4A is repealed and replaced with the ability to put sectors under an amended Part 5 control regime that allows the Commerce Commission to set control terms using comparative benchmarking. This option includes allowing firms to propose customised control terms where they can demonstrate that the sector-wide terms are not appropriate in their case. Electricity lines businesses would be subject to such a regime, if introduced.
Input methodologies
13. There are a number of key parameters of a technical nature that need to be determined as part of any regulatory inquiry. For example, decisions need to be made on the form of control (e.g. price/revenue cap or rate of return regulation) and how the weighted average cost of capital will be calculated, and so forth. At present, these input methodologies are determined by the Commerce Commission as it goes. The document suggests that transparency, predictability and quality of regulatory outcomes may be improved if input methodologies are consulted on and set as a stand-alone process and in advance of any inquiry into whether and how to impose regulation.
14. There is also a secondary question of whether the methodologies should be in the form of guidelines and set by the Commission, or in the form of Rules and set by the Minister on the recommendation of the Commission. While limited Ministerial involvement may improve confidence in the decision-making process by adding additional checks and balances, it may be perceived as reducing the Commission's level of independence and increasing the scope for lobbying.
Accountability mechanisms
15. Regulatory decisions are complex and often require difficult judgements. Thus, some mistakes may be made. At present, no appeal rights on the merits of the Commerce Commission's regulatory decisions are available. It is reasonable to assume that the quality of, and confidence in, regulatory decision-making will improve if some merits review is provided for. However, there are significant costs associated with merits review. This document outlines the potential costs and benefits, and considers whether some form of merits review is desirable.
16. It may be possible to minimise the potential costs of merits review, and hence this document considers how a merits review regime, if introduced, should be designed. The document suggests that only some regulatory decisions should be subject to merits review, the scope of merits review should be limited to appeal by way of rehearing (whereby new evidence can only be presented if it is fresh and material and could not have been presented at the stage of the original decision-making), and that the grounds for merits review should be limited to material issues of contention.
Options for change
17. The above summary includes various proposals for change. Many of the proposed amendments have the potential to work in the absence of other amendments. That is, the proposals can be packaged in various different ways (e.g. retaining the status quo for some components, but amending other components) and it is not "all or nothing".
18. For the purposes of illustration, this document presents two possible packages, namely "Option One" and "Option Two". The main difference between the options is that Option One (which involves less change from the status quo) allows for sectors to be placed under a thresholds regime, while Option Two removes the thresholds regime but allows sectors to be controlled using comparative benchmarking. Option Two also allows firms to propose control terms to the Commission for its consideration, and requires the Commission to accept the proposal, if it is reasonable according to criteria pre-set by the Commission.
19. The following flow diagrams summarise the two options. The advantages and disadvantages of the options are discussed in Chapter 10.
20. Submissions are invited on the issues and proposals canvassed in this paper. A consolidated set of questions is provided in Chapter 13.
Option One (Part 4A made generic; more options for economic regulation)
→ Larger version of "Option One" [22 kB PDF]
Option Two (Part 4A replaced; more options for economic regulation; ability for ex-ante engagement)
→ Larger version of "Option Two" [24 kB PDF]
Back to Top