Saturday, 14 December 2013

Are we there yet?

It feels this week as if NZ's monopoly regulation regime might finally be "in place", 14 years after we started down this road. Whether we have indeed now reached the exhalted nirvana of "certainty" will be decided by regulated firms who still have an option to appeal the High Court's 657 page decision (pdf) on their appeals, released on Wednesday.

Here is a brutally brief backgrounder.

In the 1990s we didn't really care what natural monopolies did provided they disclosed a set of information. We called it "light-handed regulation" and kidded ourselves that NZ was world-leading (no-one followed). Firms had a lot of discretion over how to "disclose" and what they defined as "information", so it was hella tough for outsiders to figure out what was going on. Insiders knew though: the revaluation racket involved ratcheting up asset values, and then increasing prices to "compensate" for the revaluations. About $300m of such ill-gotten gains were booked each year for a decade in the electricity lines sector.

The 1999-02 government started to stop this, but regulation was still a dirty word in Wellington, so something fairly tame and non-intrusive was required, ruling out regulatory regimes used elsewhere. The answer was called a "thresholds" regime for electricity lines companies (n=40ish). These firms were clustered into a few groups and each group got a "threshold" which was the annual rate of price change that the Commerce Commission would be comfortable with. Pains were taken to signal that breaching a threshold could lead to actual detailed regulation, but it might not because there could be a good excuse.

This didn't work at all well. Firms breached and the Commission didn't lower the boom but threatened to. End result = UNCERTAINTY! Complaints, tension and lobbying ensued. By now the labour government was in its 3rd term and in need of answers. MED convened a small group of externals (including yours truly) and cooked up the Input Methodologies (IM) plan, the main purpose of which was certainty. We agreed on the basic idea that more pre-commitment would be useful and that an IM-like process would be useful. The end results were baked into Part 4 of the Commerce Act in 2008.

<BTW>  Two basic tensions are relevant to this backstory
1. Firms quite rationally hate being constrained, it takes time for them to adjust to new regimes, and they have strong incentives to haggle vigorously over the rules.

2. Regulation wouldn't be needed if we could specify everything in legislation. Flexibility is useful but we don't want these regulators running amok, do we? So there is a trade-off between the 'certainty' of laws and the discretion delegated to specialist regulators. The Australians addressed this by dividing regulatory roles between different entities for rule-making and rule-enforcing. We did it by requiring a single entity (the Commerce Commission) to first make the rules (IMs), then subject them to merits review in the courts (hence the appeals that have just been decided), then enforce the results. </BTW>

What are IMs and where have we got to?
The IMs required the ComCom to decide in advance how to regulate. It had to determine "input methodologies" that explain in detail how the discretionary bits of the regulatory model would be assessed. That would give CERTAINTY, because firms would fully understand how the regime would work. But the ComCom might stuff up the IMs, so we required it to consult with regulated firms, and gave firms a one-time appeal right to the High Court. But that might become bogged down, so we limited the appeal to material that was already on the record, and required firms to show that some other decision was "materially better" than what the ComCom had determined. The sectors affected were electricity lines, gas pipelines and AKL, WLG and CHC airports.

So the ComCom embarked on this massive pre-commitment project to design the IMs in consultation with the regulated firms, with everyone knowing at the outset that the whole process would end up in the High Court (because of the $@risk) before it was actually a commitment, ie before CERTAINTY.

The first discussion paper was issued in December 2008 and was followed by issues papers, draft views, and conferences that stretched on for another 2 years, until the IMs were finally determined in December 2010. I assisted the ComCom, participating in conferences, reviewing ComCom reports, and writing a paper on asset valuation with three British economists. It was a fascinating experience, not least because lawyers for the regulated firms were constantly trying to trap the ComCom experts into saying silly things that would enter the record and be available for submitting to the High Court.

Sure enough, 58 appeals were filed. The High Court delegated the job of hearing them all jointly to Justice Denis Clifford, who I have never met, but who surely deserves a badge of honour for ploughing through literally thousands of pages of detailed record and emerging still sane. He was assisted by two Australians, recruited as lay members of the High Court especially for this task. Their decision dismisses all but two appeals. Dismissals of appeals on the big ticket items of the cost of capital and the initial valuation for the asset base are particularly important.

So now the big question is whether we are certain enough yet.

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