Chapter 10: Possible Packages of "How to Regulate"
182. This Chapter brings together the issues discussed in Chapters 7, 8 and 9 on whether light-handed regulation should be included in the Commerce Act; whether key input decisions should be made up-front; the role of firms in proposing control terms; and options for regulating a sector. For the purposes of illustration, the Chapter sets out two "packages" of proposals for conducting inquiries on whether to regulate and related downstream processes. The options are presented in the form of flow diagrams called "Option One" and "Option Two".
183. The main difference between the "packages" is that Option One (which involves less change from the status quo) retains Part 4A but makes it generic to allow for sectors to be placed under the regime, while Option Two repeals Part 4A but allows sectors to be controlled using comparative benchmarking. Option Two also provides a time-bound opportunity for firms to propose customised control terms to the Commission, and requires the Commission to accept those proposals that meet "reasonableness" criteria pre-set by the Commission.
184. The Chapter then considers the pros and cons and implications of the options.
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]
10.1 Should Part 4A be repealed or retained?
185. Thresholds were intended as a diagnostic tool to identify prima facie evidence of any firm abusing its market power by earning excessive profits, or of any firm operating in a highly inefficient manner. But thresholds, which are backed by the threat of further scrutiny and potentially regulatory control, inevitably create strong incentives for the firms they apply to. It is therefore important to ensure that these incentives reinforce the purpose of the regulatory regime.
186. In concept, thresholds could be a low-cost diagnostic tool to detect the abuse of market power (e.g. excessive profits), and, ideally, they would have good targeting power. That is, firms that least warrant further scrutiny should be least likely to breach, and firms most warranting further scrutiny should be most likely to breach. Thresholds can also have a strong incentive effect, particularly if firms perceive that the regulatory response may carry a punitive element.
187. As noted in Chapter 3, doubts have been raised as to whether the thresholds regime is meeting its original design expectations. To date thresholds have been based on generally backward-looking information and do not take into account the forward-looking circumstances of individual firms (such as the need for major new investments). As a result, some firms may avoid making expenditures that would be efficient, in order to avoid breaches of their threshold. This is because it may be invidious to breach, i.e. the public and media may see a breach as evidence of overcharging even if the breach was justified in order to make a necessary investment. Furthermore, firms may avoid breaching because the consequences of a breach are unknown at the time of the breach (the Commission may decide to take no action, require the firm to come back into compliance with the thresholds, or may declare control). Thus, the regime appears to promote adversarial processes, which may impact negatively on business confidence and certainty for investors.
188. Nonetheless, the thresholds regime does have some desirable aspects. In particular, it allows the regulator to set thresholds using "comparative benchmarking". That is, the Commission can set sector-wide prices and associated quality standards based on industry averages. The main benefit is that it is relatively non-intrusive into business activities and less resource intensive for the regulator.
189. One view then is that the thresholds regime has significant drawbacks (in particular the lack of any mechanism for ex ante approvals of significant (step-change) capital expenditure or other factors which may otherwise lead to a breach) and that these problems are not easily rectified without the regime becoming largely indistinguishable from conventional control.
190. Another view is that the issues associated with the thresholds regime are reducing as the Commission and industry alike gain experience under the regime. For example, the consequences of a breach of thresholds are becoming easier to predict. In addition, the Commission is strengthening the current information disclosure regime with a key focus being the disclosure of asset management plans. Asset management planning involves forecasting the likely capital and maintenance expenditure needs over the medium to long term. Good quality information on such plans should enable more forward looking approaches in setting performance thresholds over time.
191. Accordingly the options identified in this Chapter provide two distinct options with respect to whether or not the Act should provide for a thresholds regime:
- Option One: retain Part 4A and make it generic so that other sectors (e.g. gas pipeline services) can be placed under a thresholds regime if appropriate.17
- Option Two: repeal Part 4A and replace it with the ability to put sectors under regulatory control using comparative benchmarking but provide for a "propose/respond" regime to provide an upfront time-bound opportunity for firms to seek customised terms. The regime would require the Commission to accept "reasonable" proposals that meet pre-set criteria set by the Commission. The design of such a regime, including the type of criteria which might be considered "reasonable" is covered in Chapter 9.
192. On the basis of the earlier discussions in this document, including this Chapter, a summary comparison of the two main options is provided in the table below.18
| Retain Part 4A |
Replace Part 4A |
|
No provision for ex-ante approvals for a revised price path for significant (step-change) capital expenditure (firms forced to breach if want to make significant capital expenditure)
- but likely to be less of an issue in future thresholds incorporate forward-looking information based on asset management plans.
|
Provides up-front opportunity (e.g. within 90 days of the Commission setting initial control terms) for a firm to seek approval for revised price path if it needs to undertake significant capital expenditure. |
|
Uncertain consequences if a firm breaches a threshold. Penalties or consequences are unknown and may be disproportionate to breaches, which may be minor or technical and historic
- but consequences becoming clearer through experience with administrative settlements by the Commission.
|
Penalties are conventional and in proportion to breaches. |
|
On-going open-ended processes throughout threshold periods (i.e. breaches and therefore inquiries and penalties or consequences can occur at any time). Potential for uncertainty. |
Time-bound up-front processes for setting price/revenue paths: settled for five-year period. (Allows incentives for firms to improve efficiency under CPI-X schemes to work properly).
[Where there is uncertainty as to whether a major (step-change) capital expenditure project will go ahead during the five year period (or its specifications are subject to change), either contingent price paths will need to be set or provision made to re-open the price path.] |
|
Commission's work-load is manageable and spread over the five-year threshold period: only needs to address breaches (undertake inquiries and settlements) as they arise
- but there may be an increasing risk that firms will be incentivised to breach (at any time during the 5 year period) and seek a settlement, knowing that at worst any settlement may only return them to the original threshold.
|
Risk that Commission will be overwhelmed by applications for customised price paths during the up-front period. However, this should be minimised by
- ability of CC to set specific "reasonableness" criteria (including not re-opening input methodologies)
- risk for firm that if its proposals are not reasonable, Commission may set revised terms (potentially tougher than initial control terms).
|
|
Thresholds regime gives Commission more flexibility: but this comes at cost of less certainty for firms. |
Commission has less flexibility: but this should increase certainty for firms. |
10.2 Implications for electricity lines businesses if Part 4A repealed
193. If Option Two is adopted, we propose that electricity lines businesses be placed under the new sector control regime.
194. On the one hand this may be seen as disadvantaging electricity lines businesses compared to the current regime since they would be put under direct control. However, the control provisions proposed in this paper are designed to build on experience with comparative benchmarking, while providing a one-off, upfront opportunity for firms to make the case that their circumstances merit a customised price/revenue path and quality provisions.
195. The regime is intended to improve the certainty, transparency and quality of regulatory decisions on control. It also seeks to avoid the implication that control is seen as "punishment" for breaches of thresholds and must be draconian. Rather the objective of control is to impose a limit on the extent of any monopoly rent available to firms with market power.
10.3 What about sectors comprising small businesses and/or community trust owned businesses?
196. It is sometimes argued that small firms are disproportionably affected by the costs of complying with a regulatory regime. As part of this Review, the Ministry is interested to hear from electricity lines businesses regarding the incremental costs they face in complying with the Part 4A regulatory regime and the costs they estimate they would face complying with the alternative regime under Option Two. Costs should be incremental, that is, over and above costs that a well-run business would incur in the absence of regulation. For example, arguably the incremental cost of preparing an asset management plan for regulatory purposes should not be significant given that such a plan should be developed in any event by prudently-managed businesses for their own purposes. Similarly, a significant component of the information required for a control regime should be prepared for management information in any event.
197. Some also argue that there is less need to regulate community trust owned firms since they may already face strong incentives to act in the best interests of their consumers. For example, where consumers of the goods and services in question are also the voters that appoint trustees, the trust may have adequate incentives to ensure prices are minimised and consumers' quality requirements are satisfied. While this argument has some merit, several issues arise:
- Community trusts, while they are likely to support the interests of those consumers living (and voting) inside their boundaries, may do so at the expense of other consumers who are not beneficiaries of the trust;
- Similarly there may be a risk that community trusts seek to favour residential consumers over business customers (which may have low voting power);
- There are tensions between the objectives of trusts and the directors of the company, with the latter obliged to act in the interests of the company, not the owners of the trust; and
- Some electricity lines businesses are owned by a mix of private and community trust entities (which may change over time), making it administratively difficult to draw a line between what does and does not constitute a community trust owned company.
198. Submissions are invited on the issue of whether smaller community-owned trusts should be subject to a lighter-handed regime, such as information disclosure, which takes into account their special circumstances.
Questions for submitters: Chapter 10
Q1. With regard to the Part 4A thresholds regime do you favour:
- retaining the threshold regime and making it more generic (that is, applicable to sectors other than electricity lines businesses), or
- repealing Part 4A and amending Part 5 to allow the Commerce Commission to use comparative benchmarking to set terms and conditions for control while allowing firms to seek customised control terms.
Q2. In your opinion, are there other options for addressing the issues with the Part 4A thresholds regime?
Q3. Are small businesses within a sector likely to be disproportionately affected by the requirements of the regulatory regimes proposed in this document? What are the likely incremental costs of complying with the current Part 4A and proposed alternative regimes? How could these costs be minimised?
Q4. Should local community owned trusts be subject to a different regulatory regime than larger non-trust electricity lines businesses?
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