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There are two broad policy dimensions in relation to institutional design which, together, reflect the various possible policy options. The first dimension relates to the extent of prescriptiveness of the enabling legislation or 'principles'. The second dimension relates to the nature of the decision-making 'regulatory institution'.

We consider four possible 'regulatory institutions': the courts, arbitrators, a specialist regulatory body and the Government (acting under statutory powers).

A specific compulsory arbitration regime is described in Appendix A. Two key features of the proposed arbitration regime are that (i) the proposed regime would be timebound and (ii) the arbitrator would have wide powers to require the disclosure of necessary information.

One of the main drawbacks to conventional arbitration that has been noted[138] is the so-called 'chilling effect'. The chilling effect arises from the observation that, under conventional arbitration, the arbitrator has a tendency to simply 'split the difference' between the parties' final offers. Anticipating this, the parties' incentives to make concessions during pre-arbitration negotiations are diminished.[139] The reason is that, unlike ordinary negotiations, a concession does not increase the likelihood of agreement (as the arbitrator will impose an agreement in any case) and merely shifts the resulting agreement in the favour of the other party.

To a certain extent, this problem can be overcome by limiting the discretion of the arbitrator to 'split the difference'. It is common, for example, for the arbitrator to be constrained to choose, as the outcome of the arbitration, one of the final offers of the parties. This is known as 'Final Offer Arbitration' or 'FOA'.

FOA reduces the chilling effect because, although making concessions in negotiations does not increase the likelihood of agreement, it may increase the likelihood that the arbitrator will choose the offer of the party making the concession. For example, if the arbitrator follows a policy of choosing whichever of the offers is closest to some 'ideal' outcome, and if that 'ideal' is known to both the parties then, under final offer arbitration, the parties have strong incentives to make offers very close or equal to that 'ideal'.

As this example makes clear, under FOA the views of the arbitrator are of prime importance. The parties are likely to make final offers close to the arbitrator's 'ideal' even if that is significantly different from the outcome that the parties would have chosen in the absence of arbitration. If the arbitrator's 'ideal' outcome is not economically efficient, the outcome of the arbitration is unlikely to be efficient.[140]

Comparison of Regulatory Institutions

Across a number of different criteria, the four regulatory institutions mentioned above vary in similar ways. This is illustrated in table 2.

The table indicates that compared to courts[141], institutions such as regulators and ministerial initiatives generally have greater scope for independent action and a greater possible range of actions that can be initiated. However, this extra discretion and capability comes at the price of increased susceptibility to lobbying or influence activities.

This document identifies three possibilities for the 'principles' corresponding to differing degrees of prescriptiveness:

1. No principles other than the Commerce Act;
2. Broad principles;
3. Detailed industry-specific principles.

As a general rule, the more prescriptive the principles, the more likely it is that they will need to modified as time passes. Therefore, while legislation is appropriate for broad, general principles, statutory regulations or some other mechanism is more appropriate for detailed principles.

One such mechanism is described in the body of the text. The regulatory institution could be required to have regard to statements communicated to the institution in a manner along the lines of s.26 (suitably modified) of the Commerce Act. Such statements would also have the advantage that they provide a limited degree of discretion to the institution to disregard the principles in situations where their application will lead to a perverse outcome.

Table 2: Comparison of Regulatory Institutions

On the other hand, s.26-type statements can be vulnerable to lobbying and influence activities in order to influence the outcome of particular decisions. However, to the extent that any s.26-type statement described policies that were inconsistent with the broad legislative principles, the decision-maker would have to apply the broad principles.

The various policy options can be identified by combining the legislation and institution dimensions. These options are illustrated in Tables 3 and 4. Table 3 relates to the appropriate regulatory institution for implementing and enforcing the access pricing regime once it has been decided that such a regime should be in place. Table 4 relates to the appropriate regulatory institution for deciding when such a regime should be put in place (i.e., the 'gatekeeping' role).

The Options For Implementing the Access Pricing Mechanism

Table 3 presents the main options that we will consider for the implementation and enforcement of the access pricing regime. These are discussed further here:

Table 3: Access Pricing Regulatory Institution Options Grid

Option (a): No principles with resolution / enforcement by the courts

This option is the status quo. Reliance is placed upon the generic anticompetitive prohibitions of the Commerce Act together with the courts. The courts establish how the Commerce Act applies to specific problems, resolves disputes and enforces its own decisions.

Use of the legal system for establishing legal rules and applying them is relatively slow and costly. The New Zealand experience has shown that deciding a single (although admittedly difficult) issue - the question of the legality of one interconnection pricing rule - can take several years. At this rate it may take many years before a sufficient body of precedents is established to provide enough transparency about the lawful range of pricing and other behaviour to satisfy a potential entrant. The costs of establishing this body of precedents is borne disproportionately by the present industry participants. Therefore, the body of precedent is likely to develop at a slower rate than is desirable.

Furthermore, the rules and traditions of the court limit both the nature of the disputes that the court will hear and the types of solutions that the court will impose. S.89 of the Commerce Act provides for a wider variety of remedies. However, the courts have shown themselves to be reluctant to use non-traditional remedies. In addition, it is unlikely that the courts will have specific expertise in the relevant industry or of regulatory issues, although the presence of lay members on the bench is of benefit.

On the other hand, the legal system has extensive safeguards against lobbying and other influence activities on the part of the litigants. In addition, decisions of higher courts are binding upon lower courts. Furthermore, since legal decisions are published they are subject to extensive scrutiny and comment by legal colleagues and peers.

Minor changes to the legal system may be possible, such as: (a) reducing the number of levels of appeal; or (b) increasing the magnitude of the penalties imposed for violations of the Commerce Act (such as treble damages). However, these changes would not deal with the fundamental point made by the High Court and the Privy Council that (unlike the American courts in relation to the breakup of AT&T) the courts in the New Zealand judicial system are not prepared to deal with detailed regulatory issues that may require ongoing regulatory oversight.

Option (b): No principles with a new Mandatory Arbitration regime

Some of the problems identified in relation to option (a) can be addressed by increasing the speed and reducing the cost of obtaining clarification of the parties' rights. This might be achieved by granting the competitor the option of resolving the dispute via mandatory arbitration. Although, in the absence of rules to the contrary, each decision made under mandatory arbitration may take just as long as a similar decision in the courts, arbitration can be expected to be faster because:

1. it will result in binding access agreements (c.f., with court decisions under the Commerce Act which merely identify whether particular conduct is lawful);
2. it permits bypass of the queue for court time;
3. the opportunities for appeal are likely to be limited; and
4. it can be made subject to explicit time constraints (as identified as an option in Appendix A).

Mandatory arbitration is less constrained than the courts in terms of the range of remedies that can be imposed. However, in the absence of the procedural and institutional rules (such as life-time appointment of judges) mandatory arbitration may be a little more subject to influence activities and rent-seeking. In addition, the decisions of arbitrators are not binding on subsequent arbitrators or courts, although if the decisions are published they are likely to carry some weight.

Importantly, under the arbitration regime outlined in Appendix A, the arbitrator would have wide powers to require the disclosure of relevant information.

This option has the drawback that, in the absence of legislative principles, heavy reliance will be placed on the arbitrators. Even though arbitration is faster than the court process, each arbitration may still take several months. If there are a large number of disputes it may still take several years before the access pricing regime is sufficiently defined for competitors to enter. The total expected cost and delay may still act as a barrier to competition in some industries.

Option (c) Broad principles with the courts

The problems identified in option (a) might also be addressed by enhancing the specificity of the principles specified in advance. To the extent that the principles clarify for the parties what their access rights will be, this will limit the reliance upon the courts and so reduce the time required to define the access pricing regime.

However, it may not be possible to specify principles which provide sufficient detail to yield meaningful clarification of the parties' rights and, at the same time, apply across a range of industries.

Option (d): Broad principles with Mandatory arbitration

One of the drawbacks of option (b) was the expected heavy reliance upon the arbitrator. Option (c) considerably reduces the reliance upon the arbitrator by legislating principle to guide the expectations of the parties.

Option (e): Broad principles with a Statutory Regulator

Although arbitrators are less restricted than the courts they are still restricted in the types of remedies they can impose. In particular, arbitrators are unlikely to impose a remedy that requires continual regulatory oversight or the taking of a range of ancillary decisions. In addition, the arbitrator may lack industry expertise and the opportunity to build up detailed knowledge. If the optimal regulatory mechanism is sophisticated and requires continual oversight or detailed industry expertise it might be preferable to establish a specialist regulator.

However, the drawbacks of regulatory institutions have been well documented. These include 'regulatory creep' (the tendency of the regulator to increase its powers and jurisdiction), 'goal displacement' (the tendency of the regulator to find new objectives for continuing regulation when the original reasons cease to carry force) and 'regulatory capture' (the tendency for regulatory bodies to shift the emphasis of their regulation away from the public interest to the interest of the regulated industry). These drawbacks arise from the large amount of discretion regulators must, of necessity, have; the limited political understanding and interest of the public; and, therefore, the limited political oversight.

Option (f): Detailed industry-specific principles with the courts

Option (c) can be further enhanced by increasing the specificity of the principles, perhaps by a s.26-type statement directed to the courts. If the access pricing regime could be sufficiently defined, the remaining opportunities for dispute may be limited. In this context the benefits of the courts (increased procedural safeguards, increased precedent value) may outweigh the additional costs and delay over mandatory arbitration.

Option (g): Detailed industry-specific principles with mandatory arbitration

Compared to option (f), in certain circumstances (such as in industries with rapid technological change) the increased cost and delay of the courts may outweigh the benefits from increased procedural safeguards and increased precedent value.

Conclusion

The design of the best regulatory institution will depend upon a variety of factors including:

1. the complexity of the rules that the regulatory institution must implement;
2. the amount of discretion which must be delegated to the regulatory institution;
3. the information available to the regulatory institution;
4. the willingness of the legal system to impose appropriate remedies; and
5. the value of precedents.

The Options For Deciding When An Access Pricing Regime Applies

Table 4 below identifies and discusses the main options for deciding when an access pricing regime should apply.

Option (a): Courts and the Commerce Act

The decision as to what constitutes a natural monopoly facility for the purposes of applying an access pricing regime is difficult and may require specialist expertise. Such expertise may be lacking in the courts (although in Commerce Act cases, at first instance, expert lay members may sit on the bench). In addition, in the absence of legislative principles it may take some time (at a significant cost) for the courts to develop a body of precedents that satisfactorily delineate what may be expected to be defined as an controlled access facility.

Option (b): A specialist regulator subject to broad principles

A specialist regulator may have better access to in-house expertise and may be able to make decisions in a timely fashion. However, it may be much more subject to influence activities. To an extent the undesirable effects of influence can be offset by limiting the discretion of the agency by specifying in legislation the broad principles upon which declarations of controlled access facilities can be made.

Option (c): Government acting under statutory powers and subject to broad principles

Regulatory bodies tend to be less subject to public oversight than Ministerial action. Given the importance of the decision, it may be more appropriate to subject the decision to wide public scrutiny. As with a regulatory body, the undesirable effects of influence can be offset by specifying in legislation the broad principles upon which declarations of controlled access facilities can be made. However, governments can also be vulnerable to influence and lobbying activities.

Table 4: The Regulatory Institution For Invoking Access Pricing