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130. There are a number of key technical-type parameters that need to be determined as part of any inquiry on economic regulation (particularly whether control should be imposed) and as part of decisions on how any regulation will be imposed or operate.

131. For example, in order to calculate the costs and benefits of control, and to actually impose control, decisions need to be made on:

• the form of control (e.g. price/revenue cap or rate of return regulation);
• how the weighted average cost of capital (WACC) will be calculated;
• how assets will be valued (e.g. historical cost-based or replacement cost-based);
• how common costs will be allocated (e.g. avoidable cost allocation or fully distributed costing);
• the treatment of tax;
• which costs may be "passed through";
• the appropriate reset period and
• circumstances for when the control terms may be re-opened during a regulatory control period.

132. These methodologies, while highly technical in nature, play a key role in the design of the regime, and affect both when and how regulation will be imposed.

133. Some methodologies may be generic, and could be applied across different industries. For example, the methods for calculating WACC may not vary between sectors. Other input methodologies may be more industry-specific. This may be the case with, for example, asset valuation, where industry specific characteristics will dictate whether a historical or replacement cost-based formula is likely to be most effective/efficient.

134. There are options regarding the process for setting input methodologies. For example, such methodologies could be set in advance of undertaking analysis and making recommendations on whether to regulate, or decided upon during the analysis process. There are also options around who should set input methodologies (for example, the Minister or the Commerce Commission), and what status they should have (for example, rules or guidelines).

8.1 Should input methodologies be set in advance of application?

135. Input methodologies could be:

1. set in advance of the decision to regulate, either:
   • once an inquiry has been initiated (i.e. methodologies would be set specifically for the sector or firm into which an inquiry has been initiated); or
   • irrespective of whether an inquiry has been initiated (i.e. methodologies would be set generically, and would then apply to any firm or sector under inquiry subject to any customisation required);
2. decided upon by the regulator at the time that regulation is imposed on a given firm or sector.

136. Setting methodologies prior to any decisions on how to impose control, on a given firm/industry is likely to have the following benefits:

• certainty and predictability would be improved for businesses, the Commission and Government as to how economic regulation, if imposed, would be implemented, and as to the likelihood of regulatory action;
• the decision on whether to impose control on a given firm or sector could be streamlined by having input methodologies set in advance of implementation and on a generic basis, where possible¹¹; and
• transparency of decision-making processes would be improved through the separation of regulatory design and implementation.

137. However, some costs are also likely to be incurred:

• there would be less flexibility to account for firm/industry-specific circumstances, as any change to input methodologies would have to be considered as part of a separate, stand-alone exercise; and
• there may be increased costs and delays in undertaking the required decision-making process.

138. On balance, the Ministry considers it is likely that certainty, transparency, predictability and quality of regulatory outcomes will improve if input methodologies are set in advance of the inquiry and following a transparent consultation process.

139. As a result of the two control inquires to date and the operation of the thresholds regime the Commerce Commission has already gained significant experience with setting input methodologies, and codifying those is unlikely to be costly. However, in circumstances where sector-specific modifications of generic input methodologies are required, setting of methodologies ahead of an inquiry may result in some extra cost and may be more time consuming due to process requirements.

8.2 Who should set input methodologies?

140. There are options around who should set input methodologies and what status they should have. Input methodologies could be set:

1. by the Minister through regulations or rules:¹²
   • on his or her own volition;
   • after receiving recommendations from the Commerce Commission;
   • after receiving recommendations from another body
2. by a separate independent body (independent of Government and the Commission) through rules or mandatory guidelines; or
3. by the Commerce Commission through mandatory guidelines:¹³
   • with no additional check; or
   • with the guidelines subject to merits review.

141. With respect to the decision on who should set (or amend) input methodologies, the options and their pros and cons are as follows:

• Minister - while input methodologies have a crucial impact on the decision on whether and how regulation should be imposed, assessment/analysis of methodologies requires highly technical expertise possessed by an expert body, such as the Commerce Commission. Any Ministerial involvement may be perceived as simply lengthening the process, reducing the Commission's levels of independence, and increasing the scope for politicising the process. These risks could be mitigated by limiting Ministerial powers to either accepting, rejecting, or referring the methodologies back to the Commission (i.e. the Minister may not set or amend methodologies of his/her own volition).
• Commerce Commission - an expert body, such as the Commission, has the appropriate technical expertise to make judgements on appropriate methodological issues. However, this option lacks the extra check and balance potentially provided by Ministerial involvement. This could be rectified by providing for merits review of the Commission's decisions on input methodologies. However, as discussed in Chapter 12, merits review of input methodologies may be costly and time consuming (potentially much more so than having a Minister involved), especially given the incentives it creates for businesses to "game" the process in order to delay a decision on whether regulation should be imposed.
• Independent body - there may be improved transparency and quality of decision-making if methodological decisions are made by an entity separate to that responsible for applying/administering the regime and independent of Ministers. However, there would likely be significant costs and issues around expert capacity associated with creating an independent expert body (in addition to the Commerce Commission), given New Zealand's size and resources.

142. Providing for some "checks and balances" on the Commission's decisions with respect to input methodologies may improve certainty and confidence. It is likely that such "checks and balances" can be provided at relatively low risk if the Ministers' powers are limited to accepting, rejecting or referring back recommendation from the Commission.

143. Possible legislative forms include: regulations, rules or mandatory guidelines:

• Regulations are more appropriate for issues affecting the rights of individuals (and firms), including penalties, whereas rules are more appropriate for highly technical matters (especially when they are recommended by expert bodies).
• Guidelines would be an appropriate vehicle for setting input methodologies if they were to be set by an entity other than government.

144. The Ministry proposes that, if methodologies are to be set by the Minister, then they should be set as rules given their technical nature. If methodologies are to be set by the Commerce Commission, then they would be set as mandatory guidelines.