Review of Regulatory Control Provisions under the Commerce ... · 649602 Review of Regulatory Control Provisions under the Commerce Act 1986 Discussion Document Prepared by the Ministry

649602

Review of Regulatory Control Provisions under the Commerce

Act 1986

Discussion Document

Prepared by the Ministry of Economic Development,

Wellington, New Zealand

April 2007

Review of Regulatory Control Provisions under the Commerce Act 1986: Discussion Document

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ISBN 978-0-478-30484-8 (PDF) ISBN 978-0-478-30484-1 (HTML) © Crown copyright First published in April 2007 by the Ministry of Economic Development PO Box 1473, Wellington New Zealand http://www.med.govt.nz

Permission to reproduce: The copyright owner authorises reproduction of this work, in whole or in part, so long as no charge is made for the supply of copies, and the integrity and attribution of the work as a publication of the Ministry of Economic Development are not interfered with in any way.


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Disclaimer The opinions and proposals contained in this document are those of the Ministry of Economic Development and do not reflect government policy.

Readers are advised to seek specific legal advice from a qualified professional person before undertaking any action in reliance on the contents of this publication. The contents of this discussion paper must not be construed as legal advice. The Ministry does not accept any responsibility or liability whatsoever whether in contract, tort (including negligence), equity or otherwise for any action taken as a result of reading, or reliance placed on the Ministry because of having read, any part, or all, of the information in this discussion paper or for any error, inadequacy, deficiency, flaw in or omission from the discussion paper.


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Contents Disclaimer .............................................................................................................3 Contents................................................................................................................4 Information for persons making submissions ........................................................5 Executive summary...............................................................................................6

PART I: INTRODUCTION, CURRENT PROVISIONS AND POTENTIAL ISSUES....12 Chapter 1: Introduction........................................................................................13 Chapter 2: Current regulatory control provisions under the Commerce Act ........15 Chapter 3: Potential issues with the current regime ............................................17

PART II: OBJECTIVES OF REGULATION ..............................................................20 Chapter 4: Objectives of economic regulation.....................................................21 Chapter 5: Purpose statement ............................................................................27 Chapter 6: The decision on whether to impose regulation ..................................30

PART III: HOW TO REGULATE ...............................................................................37 Chapter 7: Types of economic regulation............................................................39 Chapter 8: Key input decisions............................................................................43 Chapter 9: Regulatory control design issues.......................................................48 Chapter 10: Possible packages of ‘how to regulate’............................................56 Chapter 11: Processes for amending and enforcing control terms......................64

PART IV: ACCOUNTABILITY ..................................................................................68 Chapter 12: Accountability mechanisms .............................................................69

PART V: SUMMARY .................................................................................................77 Chapter 13: Next steps........................................................................................78 Chapter 14: Summary of options.........................................................................82

APPENDIX 1: GLOSSARY OF TERMS....................................................................87


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Information for persons making submissions Written submissions on the issues raised by the discussion paper are invited from all interested parties. The closing date for submissions is Friday 6 July 2007 at 5pm.

Submissions should be directed to:

Commerce Act Review Ministry of Economic Development PO Box 1473 Wellington Delivery address; Level 8, 33 Bowen Street, WELLINGTON Email: [email protected]

Submissions will be considered by officials in the preparation of advice to Ministers concerning the regulatory provisions in the Commerce Act.

Specific questions have been posed to submitters in boxes at the end of most of the Chapters. Comment on the potential costs and benefits of proposals is also sought.

Official Information Act and Privacy Act requirements Posting and Release of Submissions

The Ministry may post all or parts of any written submission on its website at www.med.govt.nz. The Ministry will consider you to have consented to posting by making a submission, unless you clearly specify otherwise in your submission.

In any case, content of submissions provided to the Ministry are likely to be subject to public release under the Official Information Act 1982 following requests to the Ministry (including via e-mail). Please advise if you have any objection to the release of any information contained in a submission, and in particular, which part(s) you consider should be withheld, together with the reason(s) for withholding the information. The Ministry will take into account all such objections when responding to requests for copies and information on submissions to this document under the Official Information Act 1982.

Privacy

The Privacy Act 1993 establishes certain principles with respect to the collection, use, and disclosure of information about individuals by various agencies including the Ministry. It governs access by individuals to information about themselves held by agencies. Any personal information you supply to the Ministry in the course of making a submission will be used by the Ministry only in conjunction with the matters covered by this document. Please clearly indicate in your submission if you do not wish your name to be included in any summary of submissions that the Ministry may publish.


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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

1 Part 4 of the Commerce Act allows for goods or services to be placed under price, revenue, or quality control (regulatory control) by the Minister of Commerce, or, in the case of energy, the Minister of Energy. Part 4A provides specifically for electricity lines businesses to be placed under regulatory control by the Commerce Commission if they breach thresholds set by the Commission. Once a decision to impose control has been made under Part 4 or Part 4A, the controlled goods or service may not be supplied unless an authorisation to supply has been made by the Commerce Commission under sections 70-74 of Part 5.


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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


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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


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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.


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Option One (Part 4A made generic; more options for economic regulation)

Input methodologies recommended by Commission; set by Minister as Rules (where not already set). Minister may only accept/reject or refer back the recommendation.

Commission determines whether criteria are met1

Minister decides whether or not to accept Commission’s recommendation or make a different decision.

1 Commission may recommend economic regulation where competition test and efficiency/net acquirers benefit tests are passed (see Chapter 6). See also option to apply less stringent test for lighter-handed forms of regulation (see section 7.2). 2 Commission may recommend a sector be subject to economic regulation where, in addition to the competition and efficiency/net acquirers benefit tests (see Chapter 6) being met for the sector as a whole (see section 9.2), comparative benchmarking is feasible.

If firm(s) inquiry If sector inquiry

Commission determines whether sector criteria2 passed

Commission recommends whether the sector be subject to: • no action, • information disclosure, • negotiate/arbitrate regime, or • Part 4A thresholds regime.

Commission recommends whether the firm(s) be subject to: • no action, • information disclosure, • negotiate/arbitrate regime, or • regulatory control (recommendation

must include control terms).

No: regulation may not be imposed yes no yes

Commission implements the decision • Powers to implement the options (e.g. information

disclosure, negotiate/arbitrate) are provided for in the Act

• The decision-making processes and criteria under Part 4A thresholds regime remain as present, but with explicit provisions for administrative settlements.

Inquiry initiated into a sector or firm(s) at Minister’s request or Commission’s initiative.


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Option Two (Part 4A replaced; more options for economic regulation; ability for ex-ante engagement)

Inquiry initiated into a sector or firm(s) at Minister’s request or Commission’s initiative


Commission recommends3 [final] that the sector be subject to: • no action, • information disclosure, • negotiate/arbitrate regime, • regulatory control of sector (recommendation

must include proposed control terms).

Commission prepares draft recommending that the firm(s) be subject to: • no action, • information disclosure, • negotiate/arbitrate regime, • regulatory control of firm (recommendation


If regulatory control proposed^: a) Firm(s) may propose alternative control

terms within 90 days; b) Commission must accept if ‘reasonable’

(criteria pre-set in the ‘input methodologies’);

c) If criteria for ‘reasonable’ are not met, Commission may propose different control terms.

Based on above, Commission makes final recommendation.






If sector control imposed^: a) Firm(s) may propose customised

control terms within 90 days; b) Commission must accept if ‘reasonable’


c) If criteria for ‘reasonable’ are not met Commission determines control terms.

If regulatory control imposed, merits review of final control terms (not of Minister’s decision to control; but Minister may reconsider if reviewed terms are materially different)

Applies to Electricity Lines Businesses

1 Commission may recommend economic regulation where competition test and efficiency/net acquirers benefit tests are passed (see Chapter 6). See also option to apply less stringent test for lighter-handed forms of regulation (see section 7.2). 2 Commission may recommend a sector be subject to economic regulation where, in addition to the competition and efficiency/net acquirers benefit tests (see Chapter 6) being met for the sector as a whole (see section 9.2), comparative benchmarking is feasible. 3 For the avoidance of doubt, usual consultation processes apply, including consultation on a draft report. ^ Same process steps apply to any re-set of control terms.



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PART I: INTRODUCTION, CURRENT PROVISIONS AND POTENTIAL ISSUES This Part provides an overview of the current regulatory provisions under the Commerce Act and outlines potential issues with the current provisions.

Chapter 1 Introduction

1.1 Objectives of the review

Questions for submitters

Chapter 2 Current regulatory control provisions under the Commerce Act

2.1: Part 4 of the Commerce Act

2.2: Part 4A of the Commerce Act

2.3: Part 5 of the Commerce Act

Chapter 3 Potential issues with the current regime



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Chapter 1: Introduction 21. On 13 September 2006 the Ministers of Commerce and Energy announced a review of the regulatory provisions under the Commerce Act 1986 to be undertaken by the Ministry of Economic Development.

1.1 Objectives of the review 22. Experience with two regulatory control inquiries and the electricity lines thresholds regime have highlighted a number of potential issues with the regulatory control provisions of the Commerce Act (Parts 4, 4A, and Sections 70-74 of Part 5). It is therefore desirable to review the regulatory control provisions in the Commerce Act to ensure that regulatory control is consistent with providing for the long-term benefit of consumers within New Zealand. Economic regulation involves setting or influencing the prices that firms charge and the quality of goods and services they supply. Consistent with the broad objective, the Review will consider whether any amendments to the Act are desirable to reinforce the Government’s objectives concerning infrastructure investment.2

23. The Ministry considers that the desirable characteristics of a regulatory regime include:

• regulatory uncertainty is minimised and stability and predictability of regulatory outcomes are improved over time;

• regulatory approaches are consistent and coherent across different firms/industries and over time;

• regulatory processes are transparent, cost-effective and timely, and also tailored to New Zealand’s small scale in terms of resources and business size;

• the regulatory regime is sufficiently flexible to account for firm/industry specific circumstances, changing market conditions, innovation and experience; and

• there are appropriate levels of regulatory accountability and independence.

24. Note that there is tension between some of the characteristics, for example between flexibility and predictability. Note also that the process of review and subsequent change, in itself, generates a degree of uncertainty and instability as it takes time for legislative changes to be made and implemented and for case law to develop. In the interest of regulatory certainty, legislative change should only occur in circumstances when it is likely to result in clear benefits, such as greater certainty over time.

25. Throughout this document, the Ministry has attempted to assess proposed amendments to the regulatory provisions against the above characteristics. In

2 On 7 August 2006 the Minister of Commerce issued a s26 statement of the Government’s economic policies concerning the incentives of regulated businesses to invest in infrastructure. The statement is available on http://www.med.govt.nz/templates/MultipageDocumentTOC____21483.aspx


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addition, an economic cost benefit analysis may be undertaken after submissions have been accounted for and prior to making final policy proposals.

26. The Ministry promotes improvements in the quality of regulations that shape the business environment, to minimise the compliance burden and provide as much certainty and flexibility as possible. This Review is separate to the current Quality Regulation Review, which will work with businesses to identify aspects of regulatory frameworks that are constraining economic growth and implement practical solutions to address these problems. However, the principles and objectives of the two reviews are consistent.

Questions for submitters: Chapter 1

1. Do you have any comments on the desirable characteristics of a regulatory regime as outlined in this Chapter?


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Chapter 2: Current regulatory control provisions under the Commerce Act

2.1 Part 4 of the Commerce Act 27. Part 4 of the Commerce Act allows for goods or services to be placed under price/revenue and/or quality control (regulatory control) subject to specific tests being met.

28. In particular, section 52 allows goods or services to be controlled if competition in the relevant market is limited or likely to be lessened and there are positive net benefits of control to the persons acquiring or supplying the goods or services.

29. The final decision on whether or not to impose control is taken by the Minister of Commerce or, in the case of energy matters, by the Minister of Energy. The Minister may (but is not obliged to) request that the Commerce Commission undertake an inquiry and make recommendations on whether control may and should be imposed. The Commerce Commission may also undertake an inquiry and make a recommendation on its own volition.

30. Since 2001 (when the Commerce Act was substantially amended) there have been Part 4 inquiries into whether regulatory control should be declared in respect of airport activities and gas pipeline services. In 2003, the Minister of Commerce decided not to impose control over airport activities. In 2005 regulatory control was declared over some gas pipeline services.

2.2 Part 4A of the Commerce Act 31. In addition to the generic control provisions in Part 4 and sections 70-74 of Part 5, Part 4A of the Commerce Act allows for individual electricity lines businesses to be placed under regulatory control by the Commerce Commission if they breach price or quality thresholds set by the Commission. This regime was introduced in August 2001 and covers all ‘large’ electricity lines businesses (currently 29 in total), including Transpower.

32. Thus, control is targeted, in the sense that lines businesses are not controlled by default. A business may only be controlled by the Commission if it has crossed some ‘threshold’ of performance. Businesses that do not breach the thresholds are not subject to regulatory constraints beyond a requirement to file an annual thresholds compliance statement and comply with the electricity lines information disclosure requirements. Where an electricity lines business breaches a threshold, sanctions are not immediately imposed. The Commission might investigate further through a post-breach inquiry. During the post-breach inquiry, the Commission may decide to take no further action against the business, it may resolve the matter through an administrative settlement, or it may determine to declare control. The latter decision requires the Commission to publish its intention to declare control and undertake further analysis and consultation. Control, if imposed, would be under Part 5 of the Commerce Act.


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33. While legislation provides high level objectives for the targeted control regime, the Commerce Commission is responsible for the design and implementation of the regime. The Commission has used ‘benchmarking’ to set the thresholds.

2.3 Part 5 of the Commerce Act 34. Once a decision to impose control has been made (under either Part 4 or Part 4A), the controlled good or service may not be supplied unless an authorisation to supply has been made by the Commerce Commission under sections 70-74 of Part 5.

35. Under section 70 of the Act, the Commission may make an authorisation in respect of all or any component of the prices, revenues, or quality standards that apply in respect of the supply of controlled goods or services, using whatever approach it considers appropriate.


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Chapter 3: Potential issues with the current regime 36. Experience with two regulatory control inquiries (into airports and gas pipelines services) and the evolution of the Part 4A electricity lines thresholds regime have highlighted a number of potential issues with the current regulatory control provisions. The issues with the Part 4A thresholds regime are discussed further in Chapter 10, where the question of whether or not the thresholds regime should be retained is considered in greater detail.

Are policy objectives sufficiently clear?

37. The generic regulatory control provisions (those in Parts 4 and 5) do not have a specific purpose statement. In addition, while the Act is relatively clear on the test for when control may be imposed3, it is silent on criteria for when control should be imposed, leaving this decision for judgement by the Minister.

38. The absence of a specific purpose statement gives rise to debate around the objectives of the regulatory control provisions. The regulatory provisions do not fit easily with the overall purpose of the Commerce Act (“to promote competition in markets for the long-term benefit of consumers within New Zealand”) because Parts 4 and 4A of the Act relate to markets where it would not be economic to promote and/or achieve effective competition.

39. Furthermore, the two regulatory control inquiries to date have highlighted uncertainty about the policy intent of the regulatory provisions. In particular, there has been debate around whether the Act requires consideration of economic efficiency only, or whether distributional considerations (e.g. the incidence of costs and benefits between consumers and producers) should also be taken into account, and if so the relative weighting between consumer protection and economic efficiency objectives. The overall purpose statement of the Act has been interpreted by the courts in decisions relating to other parts of the Act to be an efficiency test, and, in the absence of a specific purpose statement for the regulatory control provisions, it has been argued that a similar approach should apply to interpreting the purpose of the regulatory control provisions.

40. Overall, there appears to be inadequate clarity and certainty concerning the legislative tests for economic regulation.

41. Part 4A does have a specific purpose statement (s 57E of the Act). However, some commentators argue that the purpose statement is unclear and/or may not be appropriate. In particular, s 57E does not refer to incentives to invest.

3 Under Part 4, s 52 of the Act sets out the criteria for when regulatory control may be imposed. Under Part 4A, ‘thresholds’ are set by the Commerce Commission and are the test for when control may be imposed on electricity lines businesses.


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Are decision-making processes efficient?

42. The current Act requires separate processes and decisions on whether and how control should be imposed. This means that the decision on whether to control will be based on incomplete information regarding how control would be applied. Furthermore, the separation is arguably time-consuming and costly as it requires two, largely duplicative, processes. As such the regulatory processes may be more cost-effective and timely if the decisions on whether and how to impose regulation are considered concurrently.

Is there regulatory uncertainty? 43. The Commerce Act currently does not require that key technical decisions relating to how regulation will be imposed (e.g. type of control, how to determine rates of return and asset valuation), be set in advance of control inquiries and the imposition of control. Furthermore, the Act does not require that specific processes, such as consultation requirements, be followed in setting and amending such methodologies. This may create uncertainty for businesses (because it is difficult to predict regulatory outcomes) and lead to concerns that the Commerce Commission has the ability to settle on and change methodologies ‘as it goes’.

Are there constraints on regulatory approaches?

44. Arguably, the existence of the thresholds regime in Part 4A, and the Commerce Commission’s use of a certain methodology to set thresholds, has the effect of constraining the methodologies that the Commission may use to set control terms under Part 5. This is notwithstanding that Part 5 (s70) allows the Commission to use “whatever approach it considers appropriate”.

45. Thus, arguably, the Commission does not have a full ‘toolbox’ of regulatory approaches available to it under Part 5 because the approach needs to be different from those used under Part 4A. In particular, because control under Part 5 may be perceived to be a ‘penalty’ for breaches of the Part 4A thresholds, control under Part 5 is seen as needing to be relatively ‘heavy handed’.

Are there sufficient regulatory accountability mechanisms?

46. The Commerce Commission’s decisions to recommend and impose regulatory control are generally subject to judicial review only, although there is a right to appeal on a question of law against the Commission’s authorisation or provisional authorisation. There may therefore be insufficient regulatory accountability.

47. Regulatory decisions are complex and often require difficult judgements. A key design parameter of an effective regulatory regime is therefore to ensure that accountability mechanisms provide strong incentives for high-quality decision making by the regulator, error correction, and guidance to the regulator and stakeholders (so that the quality of decisions improves over time, and the regime is more predictable for those affected by it).

48. While judicial review provides an important check on the regulator’s decision and process, it can be argued to be insufficient because it does not provide for a check of the substance and reasoning of the decision itself.


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Is the Part 4A thresholds regime meeting its design objectives?

49. The evolution of the thresholds regime has highlighted several potential issues, including:

• uncertainty resulting from breaching a price or quality threshold (a breach of a threshold, including technical and/or historical, may lead to an inquiry into whether or not control under Part 5 of Act should be imposed);

• the inability for firms to seek ex ante approvals for major capital expenditure (the methodology to set price and quality thresholds used by the Commission is based on sector averages and has to date been largely backward-looking4); and

• potentially wrong targeting (firms with a too-easy threshold are able to price up to that level while firms subject to a threshold that is too tough for their individual circumstances are most likely to breach, resulting in subsequent regulator focus potentially being on the wrong firms).

50. These issues may be inherent features of a thresholds regime, since the more that thresholds applying to individual firms are customised for particular circumstances the more this form of regulation becomes the same as conventional firm-specific price control.

51. The question of whether the Part 4A regime should be retained is considered in detail in Chapter 10.


1. Does the above list capture the main issues with the current regulatory regime?

2. Are these issues adequately identified and described?

3. Are there are any other issues with the current regime that are not listed above and should be considered as part of this review?

4 The legislation is silent on the methodology the Commission should use to set thresholds, and does not preclude taking into account the forward-looking circumstances of firms. The Commission’s ability to take account of forward-looking circumstances may be improving over time through improved information disclosure requirements relating to asset management plans.


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PART II: OBJECTIVES OF REGULATION This Part discusses the objectives of economic regulation and then considers whether a regulatory-specific purpose statement is desirable. The Part then considers when regulation should be imposed and whether further guidance (in addition to a purpose statement) is desirable.

Chapter 4: Objectives of economic regulation

4.1 Background

4.2 Possible efficiency and distributional outcomes

4.3 Alternative objectives for economic regulation


Chapter 5: Purpose statement

5.1 Is a regulatory-specific purpose statement desirable?

5.2 What would a regulatory-specific purpose statement say?


Chapter 6: The decision on whether to impose regulation

6.1 When regulation may be imposed

6.2 When regulation should be imposed

6.3 Who should decide whether or not to impose regulation?

6.4 Sequence of decisions on whether and how to regulate



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4.1 Background 52. The Government’s primary objective, in reviewing the regulatory provisions of the Commerce Act, is to ensure that economic regulation in New Zealand provides for the long-term benefit of consumers within New Zealand.

53. The presumption of the Commerce Act is that competition is the most effective means to achieve long-term consumer welfare in most cases.5 It is generally agreed that competitive markets deliver benefits to consumers over time by incentivising firms to deliver the goods and services consumers want and to improve prices and quality. In order to make profits in a competitive market, firms must invest and innovate, lower their costs and prices and/or improve quality.

54. Thus 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).

55. However, there are some markets where there is little or no scope for competition. This occurs particularly in markets with natural monopoly characteristics; that is, where there are economies of scale, sunk costs and barriers to entry such that it is only economic for one firm to supply the market. Such markets typically occur for basic infrastructural or utility services where substitutes are not readily available.

56. In these markets the basic dynamic of competition, or the threat of competition, is absent. The effect of this is that a natural monopolist will have the incentive and scope to raise price and restrict the quantity and/or quality of the good or service offered. In other words, an unregulated natural monopoly could earn very substantial profits, or ‘monopoly rents’, since consumers will be willing to pay prices well above cost as there is no alternative supply. This is especially true in the case of ‘essential services’ such as electricity, where electricity lines businesses have strong natural monopoly characteristics. These ‘monopoly rents’ are considered by many to be unfair and potentially inefficient, especially when they occur in the supply of essential services.

57. As such, economic regulation seeks to mimic, in a market with little or no competition, the outcomes that would occur in a market with workable competition. That is, both the pro-competitive provisions in Parts 2 and 3, and the regulatory provisions in Parts 4, 4A and 5 strive to achieve the same outcomes. The difference lies in the instruments used to realise that goal.

5 This presumption is conveyed in the purpose statement of the Commerce Act, which states that: “the purpose of this Act is to promote competition in markets for the long-term benefit of consumers within New Zealand” [emphasis added].


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4.2 Possible efficiency and distributional outcomes 58. There are a number of outcomes that may result from economic regulation. These are grouped below in terms of efficiency outcomes and distributional outcomes. Efficiency effects relate to how efficiently the economy uses its limited resources and incentivises investment and innovation. Distributional effects relate to the share of benefits to consumers and producers arising from regulation.

Efficiency outcomes 59. With lower prices, output in the regulated market will expand, improving the efficiency of resource use in the economy (allocative efficiency). The size of this effect will depend on how price-responsive demand for the product is. In markets for essential services such as electricity, demand is not very responsive to price and so the allocative efficiency gain is likely to be small.

60. The monopolist might produce more or less efficiently than it did prior to regulation (productive efficiency) — this will depend in part on the level of efficiency the monopolist was producing at prior to regulation and the share of any efficiency gains regulation allows the monopolist to keep as increased profit. Note that in a competitive market, a firm that fails to minimise costs will be unable to compete. A well-designed regulatory regime seeks to replicate this outcome.

61. The monopolist may face stronger or weaker incentives under regulation for investing in new assets, maintaining existing assets, and/or innovating (dynamic efficiency). Dynamic efficiency means ensuring that there is an appropriate level of investment and innovation to meet future consumer demand.6 Dynamic efficiency may improve if regulation is designed in such a way that it encourages the regulated firm to invest. On the other hand there may be diminished incentives for investment and innovation because of a lower rate of return for the monopoly on such investment. A competitive market provides strong incentives to invest and innovate efficiently, since innovation provides an opportunity to command a premium over competitors, at least for a period of time. A well-designed regulatory regime seeks to replicate this outcome, and in particular to avoid disincentivising investment.

62. There will be costs incurred by the regulator (in administering the regime) and the regulated business (in complying with the regime).

Distributional outcomes 63. As a consequence of economic regulation, consumers (both households and downstream businesses) should face lower prices and/or improved quality (i.e. increasing consumer surplus) while the monopolist receives less for the regulated

6 The goal of improving incentives to invest was reinforced by the Government in August 2006, through a statement to the Commerce Commission outlining economic policy on infrastructure investment in the context of businesses that are regulated under the Commerce Act. The statement emphasises the long term risks of underinvestment and the need for a stable and certain regulatory environment to facilitate investment in regulated and unregulated infrastructure businesses. It is available at http://www.med.govt.nz/templates/ContentTopicSummary____21482.aspx.


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product (i.e. reducing producer surplus). That is, producers will be prevented from appropriating or keeping monopoly rents, resulting in a redistribution of economic rent from producers to consumers.

Graphical representation of monopoly impacts The following simplified diagram illustrates the problem of monopoly. In the absence of competition, the monopolist raises prices above costs and restricts output. Consumers are worse off as a result of the higher price (the loss measured by the two shaded areas). The higher price benefits the monopolist, who sells less but receives more per unit (the darker shaded rectangle). There is an allocative efficiency loss (deadweight loss) equivalent to the lighter shaded triangle (this simple representation does not capture productive or dynamic efficiency effects). Note also that the more inelastic (steeper) the demand curve (which is characteristic of demand for basic infrastructure services) the smaller the allocative inefficiency from monopoly pricing, and, hence, the smaller the allocative efficiency gains from regulation.

Weighing up efficiency and distributional effects

64. There are clear economic benefits and costs arising from regulation. The economy potentially benefits from improvements in the allocation of resources, any lowering of production costs and improvements in the incentives for appropriate investment. On the other hand, there are direct costs to the economy from devoting resources to administering and complying with regulation, and potential indirect costs such as weakened incentives for investment and innovation.

Competitive market quantity

Price

Quantity

Marginal Cost

Demand

Competitive market price = Marginal cost

Monopoly Price

Monopoly quantity

Allocative inefficiency or deadweight loss from monopoly

Transfer of surplus from consumer to producer


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65. In practice, measuring these economic effects can be difficult. The Commerce Commission has done this as part of its inquiries into whether sectors should be regulated (i.e. gas pipelines and airports inquiries). In recent evidence in relation to the decision on gas pipelines, the Commission has indicated that its methodology is likely to show that there will be net economic costs from regulating in virtually all cases.

66. Whether the redistribution of wealth from producers to consumers should be regarded as a benefit of regulation is more contentious. One argument is that since these wealth effects are a redistribution or transfer from one group (producers) to another (consumers), the respective gains and losses offset each other with no net gain to the economy and so should not influence the decision to regulate.

67. Another argument is that the redistribution matters for economic performance. The presence of monopoly profits could encourage wasteful ‘rent-seeking’ behaviour as the monopoly seeks to protect or capture these rents, or it could mean reduced incentives for investment and innovation in businesses downstream of the monopoly. It could also be argued that distribution matters for social cohesion reasons and for the sustainability of economic growth (although this argument would need to be judged in the context of wider Government policies affecting income distribution and social protection).

68. It could also be the case that distributional outcomes matter simply because society considers that the outcomes from leaving a monopoly unregulated are unfair. This is a value judgement that Ministers are best placed to make a final decision on — taking account of factors such as the nature of the consumers and producers in the market, the materiality of impacts on consumers (e.g. share of total household budget) and the impact of other current or potential government policies to mitigate impacts on consumers.

4.3 Alternative objectives for economic regulation 69. The potential benefits and costs arising from regulatory intervention will depend on the specific circumstances of the sector in question. This means it is not possible to make an a priori judgement that regulation will lead to better outcomes for New Zealand compared to the outcomes from leaving the sector unregulated. The key question is how should the Act guide Ministers and the Commission in terms of how they should weigh up the various factors?

70. Four broad alternatives are:

• Economic efficiency or total surplus standard;

• Framing the test so that improving economic efficiency is the primary purpose of regulation but that distributional outcomes also matter;

• Framing the test so that improving consumer welfare is the primary purpose of regulating but recognising that impacts on economic efficiency also matter; or

• Consumer surplus standard.

71. The table below compares these alternatives.


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Test Impacts on economic efficiency considered?

Distributional outcomes considered?

Comment

Economic efficiency standard

Yes No Counts only net efficiency gains — assumes transfers from producers to consumers offset each other in terms of overall community welfare.

Economic efficiency primary objective

Yes Yes Assumes that generating efficient market outcomes is the primary objective for regulating.

Test asks whether there is a net efficiency gain, if not, it requires a judgement on whether distributional outcomes are substantial enough to justify incurring net efficiency costs.

Requires consideration of the value of distributional outcomes.

Consumer welfare primary objective

Yes Yes Assumes that generating consumer welfare improvements is the primary objective for regulating.

Counts consumer gains as a benefit and requires a judgement on whether any efficiency costs necessary to bring about this gain are acceptable.

Assumes distribution outcomes are a benefit.

Consumer surplus standard

No Yes Counts only the benefits that consumers receive from lower regulated prices.

72. If net economic efficiency is found to be increased by regulation, a judgement would not generally be needed to balance off efficiency and distributional objectives, as the middle two tests would be effectively equivalent.

73. In the situation where economic efficiency is found to be reduced (which has been argued by the Commission, and others, is likely in most cases):

• a test with consumer outcomes as the primary objective, will lean toward regulating unless the efficiency costs are considered ‘too high’;

• a test with economic efficiency as the primary objective, will lean toward not regulating unless the distributional outcomes are considered of sufficient value to justify regulating.

74. In the Ministry’s view, both economic efficiency and distributional objectives are important and should be considered in the judgement on whether or not to regulate in any particular circumstances.


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75. Note that there is a question of whether regulatory provisions should be designed to limit/minimise or eliminate/prohibit monopoly rents. However, because the costs of regulatory error tend to be asymmetric (i.e. the cost of errors leading to too-tough control terms and potential under-investment are likely to outweigh the costs of errors allowing higher than normal rates of return) the rest of this document focuses on the objective of limiting, rather than eliminating, monopoly rents.

Current position

76. The current framework under Part 4 lacks a clear purpose statement and there is some dispute over the test that should be applied. In practice, the Commission uses a ‘Net Acquirers’ Benefit test. This test, which is based on the wording of s 52 of the Act, focuses on benefits to acquirers of the good or service to calculate benefits to acquirers after netting off estimated efficiency costs. The resulting estimate of Net Acquirers’ Benefit is then compared with estimated efficiency costs through an estimated transfer-cost ratio. This test has a consumer benefits/wealth transfer flavour.

77. There have been ‘control inquiries’ into whether regulatory control should be declared in respect of airport activities and gas pipeline services.

78. In both instances, there were negative net public benefits of control (i.e. negative efficiency effects) but positive benefits to acquirers of the services (i.e. positive welfare effects).

79. In the Airports Inquiry the Commerce Commission recommended control of Auckland International Airport but the Minister decided that control was not desirable because the benefit to acquirers was relatively small, especially relative to the efficiency costs of control.

80. In the Gas Pipelines Inquiry, the Minister agreed with the Commerce Commission’s recommendation and decided that some gas pipeline services should be controlled because the gains of control to consumers were sufficiently large to outweigh the loss in overall economic efficiency resulting from control.

81. Thus, Government policy to date has been to treat consumer welfare effects as a benefit (i.e. to regulate for distributional reasons), as long as the effect on overall economic efficiency is acceptable relative to the gains to consumers.


1. Do you agree that a regulatory regime needs to be available to address issues in markets with monopoly characteristics?

2. Do you consider that the sole or primary objective of a regulatory regime should be economic efficiency or consumer protection (distribution), or do you consider that both should be taken into account?


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Chapter 5: Purpose statement 82. A purpose statement sets out the purpose and intent of the Part in broad terms and, in doing so, provides guidance on the interpretation and application of the provisions within that Part.

Current provisions

Part 4 (unlike Part 4A) does not have a separate purpose statement from the overall purpose statement of the Commerce Act (‘to promote competition in markets for the long term benefit of consumers within New Zealand’).

The absence of a specific purpose statement has led to uncertainty, and hence debate, regarding the intent of the provisions. In particular, there is debate around the extent to which and how s1A (the overall purpose statement of the Commerce Act) and s3A (which requires the Commission to have regard to efficiency) apply to the regulatory control provisions.

Under Part 4A, the Commerce Commission is guided by a separate purpose statement, which states that: “The purpose of this subpart is to promote the efficient operation of markets directly related to electricity distribution and transmission services through targeted control for the long-term benefit of consumers by ensuring that suppliers:

(a) are limited in their ability to extract excessive profits; and

(b) face strong incentives to improve efficiency and provide services at a quality that reflects consumer demands; and

(c) share the benefits of efficiency gains with consumers, including through lower prices.”

The presence of a purpose statement has meant that there has been less debate about the intent of Part 4A relative to Part 4. Nonetheless, some concerns/issues have been raised about the Part 4A statement. For example, some argue that the purpose statement is unclear and that it does not give sufficient weighting to the objective of maintaining incentives to invest.

5.1 Is a regulatory-specific purpose statement desirable? 83. Irrespective of the policy intent of economic regulation, it is unsatisfactory and inefficient for all parties for there to be uncertainty and ambiguity about that policy intent. The purpose of regulation, as conveyed in legislation, will affect both when and how regulation is imposed and must be unambiguous.

84. The regulatory provisions of the Commerce Act do not fit easily with the overall purpose of the Commerce Act (to promote competition in markets for the long-term benefit of consumers). The regulatory provisions exist because there are markets where effective competition is not possible and therefore ‘promoting competition’ will not benefit the economy and/or consumers.


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85. Having said that, the regulatory provisions do sit well with the outcomes of a competitive market, since competitive markets maximise both efficiency and consumer welfare (by limiting monopoly rents).

86. In the interests of clarity and certainty, the Ministry considers that there should be a separate purpose statement that applies to the regulatory provisions of the Act, and that the statement should be the same for Part 4, 4A, and the relevant sections of Part 5.

5.2 What would a regulatory-specific purpose statement say? 87. On the basis of the discussions in Chapter 4, the Ministry proposes the purpose statement noted below. It is based on the overall purpose statement of the Act plus s57E of Part 4A, and picks up the government’s recent s26 Statement of Economic Policy on the importance of investment and innovation for regulated businesses. To the extent possible, it is desirable to use terminology already in the Act, as it allows industry, Government, and the Commission to rely on the jurisprudence that has emerged on the current Act.

Proposed purpose statement

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.

Subparts (a) and (c) seeks to limit monopoly rents and to ensure that consumers face prices closer to costs.

Subpart (b) conveys that an objective is to ensure incentives for suppliers to improve productive efficiency.

Subpart (d) incorporates the Government’s policy in relation to infrastructure investment set out in the government’s recent s26 Statement of Economic Policy.


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1. In your opinion, is a regulatory-specific purpose statement desirable?

2. If so, do you agree with the proposed regulatory-specific purpose statement, or do you prefer an alternative formulation? If so, please suggest specific wording.


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Chapter 6: The decision on whether to impose regulation 88. In addition to a regulatory-specific purpose statement, further guidance is likely to be desirable on when regulation should (and/or should not) be imposed on a firm or sector. Such guidance would improve certainty for decision-makers and businesses with respect to when regulation may (and may not) be imposed.

89. Note that in most jurisdictions overseas the decision on whether a firm or sector should be subject to economic regulation has already been determined and is set in legislation. Detailed cost-benefit analysis is not normally undertaken on whether control should be imposed. As far as the Ministry is aware, prices for basic infrastructural services with monopoly characteristics are controlled in some way in all other OECD countries.

90. While it appears that New Zealand is unusual in providing for a decision-making process, and in particular detailed cost-benefit analysis, on whether economic regulation should be imposed, the Ministry proposes that this should continue to be the case. Regulation incurs costs and may result in a net cost to the economy, and accordingly should be a last resort measure.

Current provisions

Under Part 4, the Minister of Commerce (or Energy in the case of energy matters) may make a recommendation to the Governor-General that control be imposed (by Order in Council) on a given good or service if two specific thresholds are met (s52). Specifically, s52 states that:

“Goods or services may be controlled if:

• the goods or services are, or will be, supplied or acquired in a market in which competition is limited or is likely to be lessened; and

• it is necessary or desirable for those goods or services to be controlled either:

- in the interests of persons acquiring the goods or services (whether directly or indirectly), if the goods or services are acquired from a person who faces limited or lessened competition for the supply of those goods or services; or

- in the interests of suppliers, if the goods or services are supplied to a person who faces limited or lessened competition for acquisition of those goods or services.”

The competition test (whether competition is limited or likely to be lessened) is relatively low. It likely applies to many markets in New Zealand, including many where control is clearly undesirable, and thereby fails to provide certainty for businesses as to when regulation will likely be imposed.

The acquirers’ benefit test (whether there are net benefits to acquirers from control) may not be appropriately targeted as it does not require explicit or separate consideration of efficiency effects. The role of economic efficiency was illustrated in the Airports inquiry, where Minister decided that control of Auckland International


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Airport was not desirable because, despite positive net benefits to acquirers from control, there was a relatively large net efficiency loss and the benefits to acquirers were not large enough to justify such a loss.

The Act also currently provides no specific guidance for when control should be imposed. This has resulted in debate regarding the legislative intent of:

- whether the tests for when control should be recommended are different from the tests in s52;

- the applicability of the overall purpose statement of the Act (and what that purpose statement means in the context of markets which are not subject to competition); and

- the applicability of s3A of the Act, which requires the Commission, when considering whether or not conduct will result in a benefit to the public, to have regard to any efficiencies that will likely result from that conduct.

The Act also requires separate decisions on whether and how control should be imposed. This means that decisions on whether to control will be based on incomplete information. Furthermore, the separation is arguably time-consuming and costly as it requires two, largely duplicate, processes. As such the regulatory processes may not be cost-effective and timely.

Part 4A

Under Part 4A of the Act (the electricity lines threshold regime) a breach of a threshold triggers the Commerce Commission’s consideration of whether control should be imposed.

6.1 When regulation may be imposed 91. This section considers the criteria to guide decision-makers on when a firm (in a firm-specific inquiry) or sector (in the case of a sector-wide inquiry) may be regulated.

Competition test or criterion

92. A competition criterion, covering the extent of, and scope for, competition, provides some guidance to business, the Commission and the courts as to one of the minimum necessary conditions for regulation. It is generally agreed that regulation should only be considered where market power is significant and sustained and cannot be more effectively addressed by other means.

93. One option is to test, as a prerequisite for regulation, whether the relevant goods or services are supplied by a natural monopoly. A natural monopoly is where the goods or services are most efficiently supplied by one supplier. However, the economic proof of the existence of a natural monopolist is highly complex and requires that there be subadditivity7 of costs across the relevant output range. A

7 Subadditivity is a mathematical concept which, in this context, means that output is produced at least cost by one firm.


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major disadvantage of this option is that it is not easily understood and, by virtue of being cost-based, would not have the predictability value of other competition tests.

94. Accordingly, it may be appropriate for the standard to be somewhere between the range of a ‘substantial degree of market power’ to ‘natural monopoly’. The term ‘substantial degree of power in a market’ is used elsewhere in the Act (such as s36) so it has an established meaning.

95. Note that the proposed purpose statement (see Chapter 5) also includes reference to markets with little or no competition or prospect of competition. The wording in any competition criterion and in the purpose statement would need to be brought into alignment during the legislative drafting process.

96. Possible options include:

Competition criterion

[Goods or services may be regulated if:]

Option A

There is little or no competition or prospect of competition in the relevant market

Option B

The goods or services are supplied by a person or persons with a substantial degree of market power.

97. While the above options are ‘tougher’ tests than the current test for when control may be imposed (‘competition is limited or likely to be lessened’), it is expected that the decisions would not necessarily differ from those that have been made to date on whether control should be imposed. To date, control has only been imposed in markets with natural monopoly characteristics and it is likely that the tests proposed above would have been passed for those markets.

Efficiency and distributional (consumer welfare/protection) criteria

98. Following from the discussion in Chapter 4 on the policy objectives of economic regulation, the Ministry proposes both an efficiency and a consumer welfare/protection or distributional test for when control may be introduced. The first test is economic efficiency; while the second test (assuming that economic efficiency test is negative) is similar to the net acquirers’ benefit test in the current legislation.

Efficiency and distributional tests or criteria

Goods or services may be regulated if economic regulation is necessary or desirable to:

(a) promote 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.


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99. The second limb of the test (net acquirers’ benefit test) offers two alternatives in square brackets as to the extent that long term benefits to acquirers exceed the direct and indirect costs of regulation, namely “substantially exceed” or “clearly exceed”. The views of submitters are sought on the preferred weighting of consumers’ or acquirers’ benefits to any costs.

100. Potentially, further, more explicit guidance could be provided to assist the decision-maker in the weighing up of any direct and indirect costs against the consumer welfare benefits of limiting monopoly rents. If such guidance is provided, it may result in greater regulatory certainty for decision-makers and businesses as it would indicate an explicit minimum standard that must be passed for regulation to be imposed. However, such an explicit standard (e.g. a specific figure for how much economic efficiency loss is acceptable to transfer $1 from producers to consumers8) is likely to lack flexibility to account for policy objectives of different governments and for industry/firm specific circumstances. It might also be impractical, as it would require an unattainable degree of precision around the appropriate weight. The Ministry therefore considers that such explicit trade-offs should not be set in legislation.

Other issues

101. The current legislation allows control to be introduced where it is necessary or desirable to benefit both acquirers and suppliers of goods and services. The latter applies to markets with monopsony characteristics, i.e. where there is only one buyer of goods and services. Such markets are relatively rare, and it is questionable whether the power to regulate is needed to address this situation. Submissions are sought on this point.

102. The ‘net acquirers’ benefit’ test in the current legislation also refers to persons acquiring goods or services (whether ‘directly or indirectly’). Again, submissions are invited on whether the ‘directly or indirectly’ provision should remain. The effect of the provision is likely to be that the Commerce Commission does not need to establish (as part of its cost-benefit analysis on whether the tests for when control may be imposed have been met) whether the benefits of any reductions in monopoly rent in an upstream market will be passed through to end-users. The assumption behind this provision is that competition in downstream markets will ensure that benefits flow to end-users, or alternatively that if there are enduring factors that preclude such pass-through (such as lack of competition due to inappropriate barriers to entry), that these matters should be addressed as a separate issue.

8 For each gas pipeline company the Commerce Commission calculated the efficiency costs of transferring $1 of excess returns from suppliers to acquirers. The results were as follows: NGCT cost of $0.30 to transfer $1 to acquirers; NGCD $0.37 to transfer $1 to acquirers; Powerco cost of $0.17 to transfer $1 to acquirers; Vector cost of $0.09 to transfer $1 to acquirers; and WGL $0.71 to transfer $1 to acquirers. On the basis of these calculations the Commission recommended that control should be declared on Powerco and Vector, but not on the other firms. The Minister agreed with the Commission’s recommendation. This implies that an efficiency loss of somewhere between $0.17 and $0.30 was considered acceptable in this instance.


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103. Submissions are sought on whether the Commission should be required to establish that any benefits from control will be passed on to end-users in New Zealand as a necessary pre-condition for control, or whether the present provisions should remain.

6.2 When regulation should be imposed 104. While the Ministry considers it is clearly desirable to state the purpose of regulation and when regulation may and may not be imposed, the Ministry does not propose that there be a legislative test or criterion that states when regulation should be imposed. That is, the Ministry proposes that the only test in the legislation for imposing regulation (in addition to having a regulatory-specific purpose statement) should remain a ‘may’ test.9 The reasons for this is to retain flexibility for the Minister to take into account wider policy matters and to retain the presumption that regulation is a last resort.

6.3 Who should decide whether to impose regulation? 105. There are several options as to who should make the decision on whether or not to impose regulation on a given firm/industry:

a. The Minister (by way of a recommendation to the Governor-General for an Order in Council) following a recommendation from the Commerce Commission or on his/her own volition;

b. The Minister (as above) but only after receiving a recommendation from the Commerce Commission; or

c. The Commerce Commission could have the power to declare that a given firm/industry will be regulated.

106. The main argument for having the decision made by the Minister is that the decision on whether or not to regulate, while being based on technical analysis, often comes down to a ‘policy-type’ judgement. In particular, it often requires judgements on how to make trade-offs between conflicting policy objectives. For example, regulation may be expected to limit monopoly rents and hence improve or maintain consumer welfare, but may come at a net cost to the economy.

107. Furthermore, there may also be wider factors that need to be considered, such as effects on business confidence, effects on overseas investors, credibility of the overall regulatory regime and so forth.

9 For the avoidance of doubt, it may be desirable to make it explicit in the legislation that there is no separate or specific test for when control should be imposed. The issue of the nature of any “should” test (separate from or additional to the “may” test) has arisen in litigation on control decisions in the context of s56 (“the Commission may report to the Minister on whether or not an Order in Council under s53 should be made, amended or revoked”).


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108. Policy decisions of this nature are usually considered to be the prerogative of government where political accountability mechanisms are designed to ensure a robust decision-making process.

109. On the other hand, the decision does require extensive informational and technical input, such as calculation of the costs and benefits of regulation versus no regulation. Such expertise usually resides with a specialist regulator, such as the Commerce Commission. The Ministry proposes that the Minister should make the decision on whether or not regulation should be imposed on a particular firm/sector. However, the Minister should be required to seek the advice of the Commerce Commission. For example, the Commerce Commission would be required to advise on whether or not the purpose of the regulatory provisions and the tests or criteria for when regulation may and/or may not be imposed, as set out in the Act, have been met.

110. In other words, the current decision-making powers should be retained, except that the Minister’s discretion to recommend regulation (to the Governor General) without seeking a recommendation from the Commerce Commission would be removed.

111. For the avoidance of doubt, if the Part 4A regime is retained, it is proposed that the Commerce Commission retain its current powers to decide on whether to control a firm in the event of a threshold breach.

6.4 Sequence of decisions on whether and how to regulate 112. As noted earlier, the Act currently requires decisions on whether and how to impose regulation to be made sequentially. The alternative would be to require that the decisions be undertaken at the same time. That is, the Commerce Commission, in estimating the costs and benefits of regulation versus no regulation, would be required to recommend how regulation would be imposed (if the Minister were to decide that it should be imposed).

113. The main implication of the Commission’s inability to consider how regulation will be imposed when undertaking the ‘whether to regulate’ analysis, is that the Minister must rely on incomplete information in deciding whether or not to impose regulation. Furthermore, in the event that the Minister recommends that regulation be declared, a second inquiry is necessary to determine the terms of control. This inquiry is potentially just as significant in complexity and length as the first one.

114. A possible disadvantage of compressing the current two-step process into one stage is that the decision on whether to impose regulation may take longer. This may increase uncertainty for companies as to whether they will be subject to regulation while the decision is being made. The main gain from concurrent decisions, however, is a better informed, and potentially timelier decision-making process (by avoiding two separate inquiries) with a saving in resources and greater certainty for interested parties. Note however, that a further proposal in this document related to setting input methodologies (outlined in Chapter 8) may extend the overall timeframes somewhat.


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115. The Ministry proposes that, on balance, it is desirable that the decisions on whether and how to regulate be undertaken simultaneously to the extent possible.10 The Ministry considers it is important that the decision on whether to regulate a given firm or sector is based on as complete an information set as possible, given the significant implications of a decision to regulate.


1. Do you agree with the proposed criteria for deciding on whether regulation may be imposed?

2. If you agree that one of the tests for whether control may be imposed should be where the long term benefits to acquirers exceed direct and indirect costs, do you consider that such benefits should (a) ‘substantially’ or (b) ‘clearly’ exceed costs, or should there be some other guidance on weighting?

3. If you agree that one of the tests for whether control may be imposed should be where the long term benefits to acquirers exceed direct and indirect costs, should those benefits be considered regardless of whether acquirers acquire the goods and services directly or indirectly, or should it be necessary to establish that benefits will be passed on to end users (or consumers or end-acquirers)?

4. Should the current provisions in the Act allowing control to be imposed in the interests of suppliers (to a monopsonist) be retained?

5. Do you agree that there should not be a legislative test for when regulation should be imposed?

6. Do you agree that the Minister should remain the decision-maker on whether control should be imposed under Part 4, but that that the Minister must receive a report and recommendation from the Commerce Commission before making a decision?

7. Do you agree that the decisions on whether and, if so, how to regulate should be undertaken simultaneously rather than sequentially?

10 Note that Chapter 9 considers whether a controlled firm should have a role in proposing its own regulatory control terms. If this approach is adopted, there may be merit in providing for the proposal of the firm to be considered after the declaration of control. Refer to section 9.2 for further discussion.


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PART III: HOW TO REGULATE There are several types of economic regulation. This Part considers which types should be provided for under the Commerce Act, and then how each type should be implemented.

Chapter 7: Types of economic regulation

7.1 Should ‘lighter-handed’ regulatory options be included in the Commerce Act?

7.2 Criteria for imposing more light-handed regulation


Chapter 8: Key input decisions

8.1 Should input methodologies be set in advance of application?

8.2 Who should set input methodologies?


Chapter 9: Regulatory control design issues

9.1 Methodology for setting control terms

9.2 Sector regulation

9.3 Role of firm in proposing regulatory control terms


Chapter 10: Possible packages of ‘how to regulate’

10.1 Should Part 4A be repealed or retained?

10.2 Implications for electricity lines businesses if Part 4A repealed

10.3 What about sectors comprising small businesses and/or community trust owned businesses?



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Chapter 11: Process for amending and enforcing control terms

11.1 Process for ‘re-opening’ control terms within a regulatory period

11.2 Enforcement of penalty/remedy regime



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Chapter 7: Types of economic regulation 116. As discussed in Chapter 4, markets where there is little or no competition or prospect of competition (or where a firm or firms have significant market power) may need to be subject to some form of economic regulation in order to provide for the long term benefit of consumers. There are several types of economic regulation. The most common are:

• Regulatory control (e.g. price/revenue caps and quality requirements) – the regulator sets prices and related terms and conditions, including quality standards.

• Thresholds – the regulator sets thresholds, which if breached, could lead to an inquiry into whether a firm should be put under a regulatory control regime. Electricity lines businesses are currently subject to such a regime under Part 4A of the Commerce Act. New Zealand appears to be unique in providing for such a regime.

• Commercial negotiation with mandatory dispute resolution – the supplier and its customers are encouraged to negotiate a commercial outcome, with the facility for the regulator or an arbitrator to make binding decisions on supply terms and conditions if the parties fail to reach a commercial agreement.

• Information disclosure/price monitoring – the regulator requires regulated firms to disclose extensive information to facilitate price monitoring, with an implicit threat of more direct intervention if firms’ behaviour becomes unacceptable.

117. Recognising that regulation is far from costless, it is desirable to ensure that the most cost-effective type of regulation is implemented in a given circumstance. Note that this does not necessarily imply that the least intrusive type of regulation should be introduced first. Moreover, it is necessary to ensure that the process for considering and assessing different types of regulatory intervention is cost-effective and efficient.

Current Provisions

The Commerce Act provides for regulatory control under Part 4 and a thresholds regime for electricity lines businesses under Part 4A. Implementation powers for control are provided under Part 5.

It is not clear whether the Act allows the Commerce Commission to make recommendations on alternative forms of regulation. The absence of a clear mandate is inefficient, since the Commission is likely to have the expertise and knowledge to make informed recommendations on whether an alternative form of regulation has the potential to offer a more favourable trade-off between costs and benefits than control under Part 5.

It is clear however, that there are no powers in the Act to implement other lighter-handed forms of regulation. Thus, if an alternative regulation was found to offer net benefits compared to control (or no regulation), implementation powers would need to be provided for through legislative amendment.


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7.1 Should ‘lighter-handed’ regulatory options be included in the Commerce Act? 118. 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. That is, they differ in their ability to constrain market power, degree of regulatory intrusiveness (and therefore business compliance costs), ability to offer predictability and certainty, and regulatory costs. The Commerce Act currently provides for regulatory control under Part 4 and a thresholds regime for electricity lines businesses under Part 4A. This section considers whether ‘lighter-handed’ types of regulation should also be provided for in the Commerce Act.

Negotiation/arbitration

119. As noted, negotiation/arbitration involves encouraging the supplier and its customers to negotiate a commercial outcome, with a backstop power for the regulator or an arbitrator to make binding decisions if the parties fail to reach a commercial agreement.

120. Relative to control, negotiation/arbitration is likely to be less intrusive for businesses and less costly to the regulator (as it is only used if commercial negotiations fail). However, negotiation/arbitration will likely only be suitable where an entity with market power is dealing with a small number of relatively large customers (such as retailers and major users). In such a situation, customers may have sufficient bargaining power to negotiate their own terms with the supplier, and transaction costs and information asymmetry are likely to be less of an issue. The prospects for success are likely to be enhanced if information disclosure is also available.

121. The backstop powers under this option would provide for the regulator to undertake, or require, binding arbitration if the parties are unable to agree. Careful design of this provision would be needed. (The Telecommunications Act uses a negotiate/arbitrate/determination regime, and considerable experience in design of such regimes is now available). It is important to allow sufficient time for parties to reach commercial agreement, while discouraging gaming behaviour and incentivising the parties to reach agreement. Arbitration also needs to be expert, cost-effective and timely. Powers for the regulator to set pricing principles may also be helpful.

122. The Ministry proposes that the scope of the economic regulation provisions be expanded to allow for a negotiation/arbitration regime. Regulation or rule making powers would need to be provided in the Act to empower the Commerce Commission to develop, consult on and recommend to the Minister the process and relevant principles (including pricing principles and input methodologies) for implementing a negotiate/arbitrate regime. The Minister would have an ability to accept/reject or refer back such a recommendation.

Information disclosure/price monitoring

123. An information disclosure regime is generally less intrusive for regulated businesses and incurs less administrative expense than, for example, direct price/revenue control. However, given that information disclosure on its own has no direct consequence and is subject to considerable time lags, it may not be very


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effective at constraining any significant abuses of market power. Furthermore, this approach may lead to regulatory uncertainty for regulated business and their investors, as disclosure by itself may be seen as a temporary arrangement, with the possibility of much tougher regulation being introduced at any given time.

124. Information disclosure also involves cost (although less than other forms of economic regulation) and detailed rules need to be put in place and enforced to ensure that the disclosed information is informative, robust and comparable over time and between firms.

125. The Ministry proposes that powers to put in place an information disclosure/price monitoring regime be provided under the Commerce Act. Information disclosure has the potential to be suitable in situations where direct intervention is not justified, but some form of regulation and watching brief is required to temper the potential abuse of market power and to provide information on when more direct intervention may be required.

7.2 Criteria for imposing more light-handed regulation 126. Chapter 6 discusses the criteria that need to be satisfied prior to regulation being imposed. There is, however, a question of whether the same criteria are appropriate for more ‘light-handed’ types of regulation. For example, there is a question of whether both the competition and efficiency/net acquirers’ benefit criteria should need to be passed to impose information disclosure. And, if so, should the same rigour be applied to calculations in determining whether the criteria are passed?

127. Chapter 6 proposes to make the ‘competition test’ tougher than the current test. One view is that satisfying only the (tougher) competition criterion should be sufficient to allow the introduction of light-handed regulation, such as information disclosure. According to this view, sectors where there is on-going market power should be subject to light-handed regulation to allow monitoring of prices and performance and provide consumers with on-going assurance that advantage is not being taken of that market power.

128. An alternative view is that the efficiency/net acquirers’ benefit test is central to the question of whether or not any type of regulation should be considered.

129. However, one potential problem with requiring consideration of the efficiency/net acquirers’ benefit test, is that it has come to be taken as requiring comprehensive quantitative cost-benefit analysis. As noted earlier, New Zealand appears to be unique in applying such analysis to the question of whether to regulate sectors with natural monopoly characteristics. While the Ministry does not propose any change to this requirement when considering whether control may be introduced, there is a question as to the practicality and value of requiring comprehensive quantitative cost-benefit analysis with respect to light-handed regulation, such as information disclosure. Such analysis can be very resource-intensive and time-consuming. An option therefore would be to require only qualitative assessments of costs and benefits to determine whether information disclosure (and potentially negotiation/arbitration) should be imposed. Submissions are sought on this point.


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1. Do you agree that it is desirable to widen the scope of the Commerce Act by providing for regulatory options other than control, specifically:

• negotiation/arbitration; and

• price monitoring/information disclosure?

2. Do you consider that specific, easier tests should be provided to determine whether lighter-handed types of regulation, such as information disclosure, may be imposed, such as:

• meeting the competition criteria only; or

• requiring qualitative (rather than quantitative) cost-benefit analysis?


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Chapter 8: Key input decisions 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).

Current provisions

At present, input methodologies are set by the Commerce Commission. There are no statutory requirements regarding timing and processes for setting input methodologies, although the Commission’s processes are subject to judicial review.

One view is that the Commission’s ability to make methodological decisions ‘as it goes’ causes uncertainty regarding control, and hence adversely impacts on investment incentives.


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An alternative view is that the Commission needs time and flexibility to learn with experience, and that certainty will improve over time as industry and the Commission alike gain experience under the regime.

8.1 Should input methodologies be set in advance of application? 135. Input methodologies could be:

a. set in advance of the decision to regulate, either:

o 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

o 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);

b. 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.

11 Recall that in Chapter 6 the Ministry proposes that the decision on whether and how to regulate should be undertaken simultaneously.


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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:

a. by the Minister through regulations or rules12:

o on his or her own volition;

o after receiving recommendations from the Commerce Commission; or

o after receiving recommendations from another body

b. by a separate independent body (independent of Government and the Commission) through rules or mandatory guidelines; or

c. by the Commerce Commission through mandatory guidelines13:

o with no additional check; or

o 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).

12 A further alternative would be to set the methodologies in legislation, but the technical nature of the issues makes this inappropriate. Regulations are made by the Governor-General by Order in Council on the recommendation of the Minister. Rules are made by the Minister by publication in The Gazette. A key process difference between regulations and rules is that regulations are approved by Cabinet and reviewed by a Parliamentary Committee, whereas rules are not submitted to Cabinet.

13 Guidelines would be mandatory in the sense that they would be binding on the Commission, and if the Commission wished to change the guidelines it would need to repeat the specified consultation processes.


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• 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.


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1. Do you see value in having key input decisions set as a stand-alone process in advance of an inquiry and recommendation to regulate? If so, should they be set for a specific sector once an inquiry has been initiated, or set generically irrespective of whether or not an inquiry has been initiated?

2. Is it practical, or possible, to set generic methodologies that could apply to all potentially regulated sectors?

3. Do you consider that input methodologies should be set:

• as guidelines by the Commerce Commission;

• as Rules by the Minister following a recommendation from the Commission; or

• another option (please specify)?


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Chapter 9: Regulatory control design issues 145. This section considers issues relating to the design of a regulatory control regime including processes for setting control terms (i.e. price/revenue paths and quality requirements). In particular it considers:

a. The merits of using comparative benchmarking versus customised ‘building blocks’ analysis to set thresholds and control terms

b. Whether provision should be made to regulate sectors as well as individual firms, and if so, what criteria or test should apply

c. The role of firms in the process of setting control terms, and in particular, whether a ‘propose/respond’ model should be provided for.

9.1 Methodology for setting control terms 146. In setting regulatory control terms (i.e. price/revenue path and quality requirements), the regulator may employ comparative benchmarking and/or firm-specific analysis.

147. Comparative benchmarking uses a high degree of assumption, approximation and statistical averaging. The main benefit is that it is relatively non-intrusive into business activities and less resource intensive for the regulator. However, for this approach to be cost-effective there may need to be several firms in a controlled industry (e.g. >5).

148. Applying comparative benchmarking may, however, be problematic as companies are often very different from each other and their capital expenditure profiles differ too. For example, in a sector characterised by very lumpy investment, if one company is just starting a major capital investment cycle, its prices may need to rise so that it can earn a return on the new investment. Applying sector-wide regulatory parameters to this company could discourage it from carrying out essential capital expenditure and/or put it at risk of making non-commercial returns. If another company in the sector has no requirement for significant capital expenditure, its prices may be able to fall. Applying industry parameters to this company may result in it earning a substantial margin above its costs of capital.

149. A customised approach avoids the problems with comparative analysis by taking into account firm-specific investment plans, cost structures, demand growth, and so forth. The main disadvantage of this approach is that it is likely to be more intrusive for businesses and very resource intensive for the regulator, especially if applied to a sector comprising a large number of firms.

150. Note that these methodologies are not mutually exclusive and it may be possible to use them in combination with each other.

Current provisions

Section 70 of the Commerce Act allows the Commission to use “whatever approach it considers appropriate” for making authorisations.


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However, the existence of the thresholds regime in Part 4A (and the use of benchmarking to set thresholds) may have the effect of constraining the type of approaches to control that the Commission considers it may use under Part 5. That is, because Part 4A uses thresholds (and because the Commission uses benchmarking to set thresholds) it is possible that these approaches are precluded from use under Part 5.

Thus, arguably, the Commission does not have a full ‘toolbox’ of approaches available to it under Part 5 because the approaches it takes are regarded as needing to be different from those used under Part 4A. Similarly, control under Part 5 is seen as necessarily intrusive and ‘heavy-handed’ because it is regarded as a ‘penalty’ for breaches of Part 4A thresholds, and because it needs to be seen as different to Part 4A.

151. As outlined above, there are pros and cons of either using comparative benchmarking or setting customised control terms. It is likely that, for a given firm or sector at a given time, one methodology will be more cost-effective and appropriate relative to the others.

152. For example, comparative benchmarking is likely to be a more cost-effective methodology to set control terms for a sector comprising many firms, relative to setting customised control terms for every firm in that sector. Note that employing comparative benchmarking may mean foregoing some level of allocative efficiency that might otherwise be achievable if the Commission was to undertake detailed firm-specific analysis. However, this allocative inefficiency may be acceptable given the reduced costs of setting control terms and given that the most significant abuses of market power would be constrained.

153. It is worth noting here that benchmarking does allow for pressure to be put on a sector to improve its average efficiency over time. This is illustrated in the figure below:

154. The Ministry therefore considers that the Commerce Commission should have the ability to either use comparative benchmarking or a customised approach, depending on which option provides the most cost-effective and efficient outcomes.

Firms Firms

1 2 3 4 5 6 7 8 9… 1 2 3 4 5 6 7 8 9…

First control period Re-set period

New average

average

Relative efficiency of firms

Best

Worst

These firms required to achieve average efficiency over time


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The Ministry proposes that the legislation is clarified so that either approach, or a combination of the approaches, can be availed.

9.2 Sector regulation 155. The Act is currently unclear as to whether the Commission may recommend that a sector (with natural monopoly characteristics) be placed under economic regulation without needing to establish that regulation is justified for each and every firm individually in the sector.

156. Several considerations are relevant:

• As noted earlier, the convention has developed in New Zealand that comprehensive, quantitative cost-benefit analysis should be undertaken for each inquiry on whether control may and should be introduced, and that analysis is undertaken in detail for each firm in the sector. This is time-consuming14 and resource-intensive and appears to be unique to New Zealand.

• As noted in the previous section, there are some cost-effectiveness advantages in using comparative benchmarking. However, the detailed firm-by-firm cost-benefit analysis currently undertaken effectively loses these advantages since the analysis is of similar scope to customised building-blocks analysis.

• Again related to the advantages of comparative benchmarking, benchmarking requires all firms in a sector (above a de minimus size) to be included in the regime, since, by definition, it is based on comparing the performance of firms in a sector in order to put pressure on less efficient firms to become as efficient as industry norms. This process becomes less effective if a number of key firms are excluded from the regime.

157. The issue arises therefore as to whether provision should be made in the legislation to allow for a sector to be placed under some form of economic control involving a benchmarking process. This could take the form of providing for:

• The costs and benefits of regulating to be considered for a sector as a whole (rather than each individual firm within the sector, with the implication that the tests must be fully met for each firm), and, possibly

• The costs and benefits to be determined in qualitative terms rather than quantitative terms. (Quantitative analysis is likely to require detailed assessment on a firm-by-firm basis).

158. Submissions are sought on the above issues and options. In the meantime, options identified later in this document assume that it is possible to regulate a sector and not just individual firms within a sector.

14 The recent inquiry and decision-making concerning gas pipeline services took over two years to complete. The determination and application of final control terms may take an additional two years.


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9.3 Role of firm in proposing regulatory control terms 159. Irrespective of whether control terms are set on a customised basis or largely using comparative benchmarking, there are options around whether the controlled firm has a role in proposing its own regulatory control terms. That is, the control terms may:

a. be set by the Commerce Commission, with no ability for firms to propose alternative terms; or

b. be proposed by a firm to the Commerce Commission, which would then have some degree of discretion in accepting/rejecting the proposal (see following section).

Current provisions

The Commerce Commission has full discretion on setting the terms and conditions of control. The Commission is required to consult with the firm and other interested parties on proposed terms and conditions, but has full discretion on setting final terms and conditions.

160. There is significant information asymmetry between a firm and a regulator. Firms are likely to be best placed to provide firm-specific information, make firm-specific trade-offs, and understand their customers’ needs. A more efficient outcome may therefore be achieved if the firm is initially able to propose its own control terms. For example, one option is for a controlled firm to be given the opportunity to propose control terms and submit them to the Commission for its consideration.

161. The information asymmetry argument only applies when control terms are set using firm-specific information. In cases where control terms are to apply to a number of firms in a sector, it is likely to be more appropriate (and cost-effective) for the Commission initially to propose the control terms. For example, the Commission could propose sector-wide price-caps and associated quality standards based on industry averages.

162. However, benchmarking has the potential disadvantage of being too tough for some firms, and therefore may discourage such firms from carrying out essential capital expenditure. Therefore, if the Commission proposes sector-wide control terms that would disincentivise investment in particular instances, it may be desirable to allow that company to seek customised control terms if it can demonstrate that the benchmark is not suitable in its case.

163. In allowing such companies to propose alternative terms, there is a potential risk that a large proportion of firms within the controlled sector would propose customised terms, thereby undoing the cost-effectiveness benefits of employing benchmarking. It would be important, therefore, to ensure that firms were disincentivised from applying for customised control terms unless they had a strong case for such terms (discussed further below).

164. Therefore, when imposing control on a sector using benchmarking, it may be desirable for the Commerce Commission to be required to set initial control terms with an ability for firms to propose customised control terms within a statutory


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timeframe (e.g. 90 days). If the firm decided not to propose customised terms, the initial control terms would become binding.

165. A time limit of 90 days to apply for customised control terms may seem too demanding. However, firms would have had lengthy advance notice of pending decisions on initial control terms so could start their preparation early. Moreover, firms should know their business sufficiently well to mount a case in a timely manner.

Discretion of the Commerce Commission in accepting or rejecting firms’ proposals

166. If firms have the ability to propose control terms as discussed above, then there is a question of how much discretion the Commission should have in accepting/rejecting proposals. That is:

a. the Commission could be required to accept proposals that meet specified criteria; or

b. the Commission could be able to exercise more discretion in deciding whether or not to accept proposals.

167. There are pros and cons associated with each option. If the Commission is required to accept proposals that meet specified criteria, then there is a likelihood that the resulting control terms will be ‘looser’ than would be the case if control terms were determined by the Commerce Commission. That is, there may be an upward bias in price paths.

168. However, this upward bias needs to be weighed against several risks associated with increasing the Commission’s discretion in deciding whether or not to accept proposals. In particular, the costs of regulatory error tend to be asymmetric: errors leading to too-tough control terms and resulting in under-investment are likely to outweigh the costs of errors of higher than normal rates of return being allowed. Also, firms are in the best position to make firm-specific trade-offs and to make investment decisions. It may also be more cost-effective for the Commission to assess proposals against broad criteria.

169. On balance, under this option we propose that the Commission should be required to accept proposals that meet specified criteria for a ‘reasonable’ proposal. These criteria should be set by the Commission as one of the key input methodologies. When the criteria are not met the Commission should be able to determine the appropriate control terms.

What might ‘reasonable’ criteria look like?

170. Setting the criteria for what constitutes a reasonable proposal would require the Commission to consider (and consult on) what type of information and evidence, and to what standard, the firm needs to provide in order to persuade the Commission that its proposal is reasonable (and meets the requirements of the Act).

171. Such criteria might include matters such as the following:

• Compliance with the input methodologies (that is, an application would not be an opportunity to re-open issues relating to input methodologies, such as how to calculate WACC);


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• Evidence that significant capital expenditure (that is, of a different level and character than in the recent, say 10 years, past) is required in order to meet customers’ quality expectations and requirements;

• Evidence that full and proper consultation with customers on the requirements for the significant capital expenditure has been undertaken and that customers (or a reasonable proportion of consulted customers) agree with the company’s proposals and price/quality trade-offs15;

• Evidence that the necessary capital expenditure cannot be financed within the proposed price/revenue path even with reasonable levels of efficiency gains;

• Evidence that the firm is efficient and that the scope for significant efficiency gains is limited;

• Evidence that the proposed quality terms are too stringent;

• A requirement for evidence to be certified by independent experts approved by the Commission (prior to the 90 day timeframe commencing); and

• Evidence of materiality.

172. Several additional provisions are suggested to remove or mitigate any incentives for firms to seek customised control terms for gaming reasons (e.g. to delay control decisions or overload the Commission). It is important that firms are only motivated to submit proposals if they clearly meet ‘reasonableness’ criteria. Proposed additional provisions include:

• A requirement that the firm fund the Commission’s reasonable costs in considering the firm’s proposal;

• Power for the Commission to set control terms at an appropriate level different from (and if appropriate more stringent than) the initial benchmark control terms where the firm’s proposals do not meet the Commission’s pre-set criteria for a reasonable proposal; and

• That the Commission’s initial proposed (benchmarked) control terms would apply from the time of a control decision, and pending the outcome of any application for customised terms.

173. Firms may be concerned about the level of discretion the Commission may have in assessing the firm’s application against the ‘reasonableness’ criteria. This paper proposes that this risk may be mitigated by the ability to take merits review of the Commission’s decisions on final control terms (refer Chapter 12).

15 Consultation with customers is easier said than done, and is time-consuming. Clearly it would be very difficult if not impossible for it to be undertaken, and conclusions reached, in the suggested timeframe of three months (for firms to submit ‘reasonable’ proposals). However, firms should have on-going processes in place in any event for consulting with their customers relating to major capital expenditures that have pricing implications. Note also that major capital expenditure programmes have long lead times.


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Order of decision-making (if firms have ability to propose control terms)

174. If firms have the ability to propose control terms as discussed above, then there is a question of whether the proposal and consequent consideration by the Commerce Commission should occur before or after the decision to declare control.16 That is, either:

a. Declaration of control first: If a declaration of control is made (based on the Commission’s initial control terms), then firms may propose different control terms. Provisional control terms would apply in the interim;

b. Firm proposal first: If the Commerce Commission issues a draft recommendation to control, then the firm may propose different control terms. Only after the proposal and consideration process has occurred, is control declared and hence control terms imposed.

175. Each option has pros and cons. If control is declared first (and hence control terms apply before the firm has a chance to propose different control terms), then there is a possibility that firms will suffer losses in the interim. For example, this may occur if terms are set for a sector using benchmarking and the price path is too low for a specific firm. Another potential issue with this approach is that the decision to declare control would not be based on complete information. That is, the final control terms may differ from those on which the decision to control was based.

176. However, if control is declared after the proposal and consideration process, a long drawn-out process could occur. If a firm is making excessive profits, it will take longer for its market power to be constrained.

177. It also carries a risk of gaming by firms. In particular, given that control terms would not apply throughout the proposal and evaluation process, firms would have an incentive to overload the Commission with proposals and draw out the process to extend the period of no-control.

16 See Chapter 6 for a discussion on the decision of whether to impose regulation.

Commission issues a draft recommendation to control

Firms may propose different control terms

Minister declares control and hence control terms apply

Commission estimates “initial” control terms

Minister declares control

Provisional control terms apply in interim

Firms may propose different control terms

Commission estimates “initial” control terms and makes recommendation to Minister


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178. In the case of a sector inquiry, we consider that there may be value in providing for the proposal and evaluation process after a declaration of control. This is because the decision to control a sector is based on the characteristics of the sector in aggregate. The final terms for individual firms within the sector are not crucial to the decision to declare control over the sector.

179. Furthermore, we consider that the risk of the initial benchmarked control terms causing financial distress is very low. Benchmarked terms only (normally) set the X in a CPI-X formula and do not make a Po (start price) adjustment. The reason for this is that a Po adjustment requires a full building-blocks analysis. Thus benchmarked prices will only be substantially lower than the most efficient price if major capital expenditure is required. Such expenditure typically has significant lead time, and could be postponed during the proposal and consideration process.

180. The risk of a ‘too tough’ price path could also be mitigated through an ability for a firm to recoup losses if the firm-specific control terms are materially different to those set initially (provided that any recovery is done in such a way as to minimise any price shock). In addition, the Commerce Commission could have the ability to prioritise proposals, and thereby consider as a priority proposals of companies who could show that they would make substantial losses.

181. On balance we propose that for firm-specific inquiries, the proposal and evaluation process should occur before a declaration of control. This is because, unlike a sector inquiry, the final control terms for the firm under investigation are crucial to the decision on whether or not to control that firm. It is unnecessary to wear the risk of the decision to control being based on incomplete information.

Questions for submitters: Chapter 9 1. Should specific provision be made (e.g. in Part 5) to allow the Commerce

Commission to use comparative benchmarking as a methodology for setting control terms?

2. Should specific provision be made to allow the Minister to request the Commission to consider whether economic regulation may be imposed on a sector as a whole (rather than each individual firm within a sector) and if so, should provision be made for cost benefit analysis on this matter to be undertaken in qualitative (rather than quantitative) terms?

3. Is there value in allowing firms to propose their own control terms for the Commission’s consideration (‘propose/respond’ model)?

4. If firms are able to propose their own control terms, should the Commission be required to accept proposals that meet pre-set criteria? Do you have any comment on the proposed ‘reasonableness criteria’?

5. If firms have the ability to propose their own control terms, should this proposal take place before or after declaration of control by the Minister (note that in section 9.3 the paper proposes different sequences for control of individual firms compared to sector control)?


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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.


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Option One (Part 4A made generic; more options for economic regulation)




1 Commission may recommend economic regulation where competition test and efficiency/net acquirers benefit tests are passed (see Chapter 6). See also option to apply less stringent test for lighter-handed forms of regulation (see section 7.2). 2 Commission may recommend a sector be subject to economic regulation where, in addition to the competition and efficiency/net acquirers benefit tests (see Chapter 6) being met for the sector as a whole (see section 9.2), comparative benchmarking is feasible.



Commission recommends whether the sector be subject to: • no action, • information disclosure, • negotiate/arbitrate regime, or • Part 4A thresholds regime.

Commission recommends whether the firm(s) be subject to: • no action, • information disclosure, • negotiate/arbitrate regime, or • regulatory control (recommendation

must include control terms).


Commission implements the decision • Powers to implement the options (e.g. information

disclosure, negotiate/arbitrate) are provided for in the Act

• The decision-making processes and criteria under Part 4A thresholds regime remain as present, but with explicit provisions for administrative settlements.

Inquiry initiated into a sector or firm(s) at Minister’s request or Commission’s initiative.


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Option Two (Part 4A replaced; more options for economic regulation; ability for ex-ante engagement)

Inquiry initiated into a sector or firm(s) at Minister’s request or Commission’s initiative


Commission recommends3 [final] that the sector be subject to: • no action, • information disclosure, • negotiate/arbitrate regime, • regulatory control of sector (recommendation


Commission prepares draft recommending that the firm(s) be subject to: • no action, • information disclosure, • negotiate/arbitrate regime, • regulatory control of firm (recommendation


If regulatory control proposed^: a) Firm(s) may propose alternative control

terms within 90 days; b) Commission must accept if ‘reasonable’


c) If criteria for ‘reasonable’ are not met, Commission may propose different control terms.

Based on above, Commission makes final recommendation.






If sector control imposed^: a) Firm(s) may propose customised

control terms within 90 days; b) Commission must accept if ‘reasonable’


c) If criteria for ‘reasonable’ are not met Commission determines control terms.

If regulatory control imposed, merits review of final control terms (not of Minister’s decision to control; but Minister may reconsider if reviewed terms are materially different)

Applies to Electricity Lines Businesses

1 Commission may recommend economic regulation where competition test and efficiency/net acquirers benefit tests are passed (see Chapter 6). See also option to apply less stringent test for lighter-handed forms of regulation (see section 7.2). 2 Commission may recommend a sector be subject to economic regulation where, in addition to the competition and efficiency/net acquirers benefit tests (see Chapter 6) being met for the sector as a whole (see section 9.2), comparative benchmarking is feasible. 3 For the avoidance of doubt, usual consultation processes apply, including consultation on a draft report. ^ Same process steps apply to any re-set of control terms.



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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.


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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

17 On 27 July 2005, the Minister of Energy announced that a gas threshold regime, akin to the regime for electricity lines businesses, would be introduced for gas pipeline services through legislation. Under this option, gas pipelines would likely be subject to the new generic Part 4A regime (in addition to electricity lines businesses).

18 Two arguments in favour of retaining the Part 4A regime are not included because the Ministry has doubts about their robustness.

The first is that the Part 4A regime is “incentive-based” whereas actual control is “enforcement-based”. It is not clear to the Ministry that there is a substantive difference between the regimes in this regard. In practice, under both regimes firms have incentives to behave in a particular way, namely to avoid the consequences. Under Part 4A, they have an incentive to avoid breaching the price/revenue path and quality requirements in order to avoid the risk of onerous control terms being imposed. (As an aside, this incentive is likely to be increasingly mitigated by the Commission’s known preference for administrative settlements, and indications that the worst outcome from any settlement is a return to the original price path). Under a replacement (control) regime, firms similarly have an incentive to avoid breaching the price/revenue path and quality requirements in order to avoid penalties.

The second argument is that control terms are necessarily tougher and more exact than threshold terms, and that unless they are, consumers will object. It is not clear why this should be the case. Under the thresholds regime firms are immune from any consequences or penalties if they do not breach the price/revenue path and quality requirements. The same applies to control terms. Thus in both cases firms are free to price up to the specified price/revenue path. Accordingly it is not clear why consumers would be comfortable with a firm pricing up to the price path under thresholds but not be comfortable with a firm pricing up to the same price path under control. The outcome (for consumers) is the same in both cases.


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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 if 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.


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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);


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• 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.


1. 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.

2. In your opinion, are there other options for addressing the issues with the Part 4A thresholds regime?

3. 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?

4. Should local community owned trusts be subject to a different regulatory regime than larger non-trust electricity lines businesses?


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Chapter 11: Processes for amending and enforcing control terms 199. The section outlines the processes for amending and enforcing control terms, irrespective of whether control is imposed on a firm or sector.

11.1 Process for ‘re-opening’ control terms within a regulatory period 200. Once control terms are proposed, accepted and set, there is a question of whether there should be an opportunity, under some circumstances, for either the regulated firm or the Commission to re-open the control terms prior to the end of the regulatory period.

201. Relevant considerations include:

• Disallowing the re-opening of the control terms would likely to be timelier, more cost-effective and create incentives for both the regulator and the regulated entity to ‘get it right’ in the first instance;

• Disallowing re-opening also creates stronger incentives for the regulated firm to make efficiency gains (noting that customers benefit when the price/revenue path is re-set); but

• There are risks for the regulated firm that the control terms may prove too tough, which results in a higher cost of capital than otherwise;

• Note that it is proposed that cost increases outside a firms’ control be accounted for under the pass through costs methodology (see Chapter 8).

202. Given the need for timely and cost-effective regulatory processes, and noting that factors that are outside of firms’ control will be accounted for as part of pass through costs methodology, it is proposed that both the regulator and the regulated firms are only provided with an opportunity to re-open the control terms within a regulatory period under very limited circumstances.

203. For example, it may be desirable to allow control terms to be re-opened in exceptional circumstances such as:

• force majeure events (e.g. an extreme storm that caused significant damage to infrastructure); or

• where control terms have been set based on a presumption of a certain level of capital expenditure that, for reasons beyond the firm’s control, will no longer go ahead during the regulatory period.

11.2 Enforcement of the penalty/remedy regime 204. The regulatory control regime needs to provide for the enforcement of penalties that result from a breach. As such, decisions have to be made with respect to the


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appropriate institutional arrangements for investigating breaches and the extent of penalties required to remedy any such breach.

Who should investigate a possible breach and decide on the penalty?

205. There are several bodies that could, if required, undertake the function of investigating a breach and imposing penalties, these include:

a. The Commerce Commission;

b. The Government/Minister;

c. An independent expert panel (e.g. similar to the Rulings Panel provided for by the Electricity Act 1992);19 or

d. The courts.

Current provisions

The Commerce Commission may impose and enforce, as part of a control authorisation, provisions providing for remedies and penalties if control terms are breached. The Act provides that the remedies and penalties may include the payment of refunds, specified amounts, and compensation, or deductions from the prices charged in the future.

There is a requirement in Part 5 (s70C) that the remedies and penalties are ‘reasonable’ taking into account the matters in section 70A namely: the extent to which competition is limited or is likely to be lessened; the necessity or desirability of safeguarding the interests of acquirers; and the promotion of efficiency.

Some commentators argue that it is inappropriate for the same body to be setting the control terms, judging whether the terms have been breached, and determining penalties.

206. In considering these options the following factors should be taken into account:

• Both the government and the courts may lack the appropriate regulatory expertise to easily identify the nature and causes of a breach. With respect to the latter, however, there may be the option of appointing a lay member with the appropriate expertise to the court;

• The courts have experience/expertise in applying and enforcing penalties;

• There would likely be issues around institutional capacity if an independent body (in addition to the Commerce Commission) was to be set up in New Zealand; and

19 The Rulings Panel is appointed by the Electricity Commission, but makes decisions independently of the Commission and is subject to the Electricity Governance Regulations. The Panel determines whether rules have been breached and, if so, what penalties (if any) should be imposed.


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• There may be a perceived lack of checks and balances if the body imposing the penalty is the same as the body imposing control terms, though this could be mitigated through the design of the decision-making process.

207. On balance, the Ministry proposes that the Commerce Commission should continue to have responsibility for identifying breaches and enforcing penalties and/or remedies. The Commission has the requisite regulatory expertise and is well placed to understand the nature and causes of a breach.

208. To minimise the risk of insufficient checks and balances, extra legislative guidance and the requirement for separation between penalty design and enforcement could be provided for.

209. The level of discretion/guidance comes down to a trade-off between certainty and flexibility:

• Less guidance/more discretion implies greater flexibility for the decision-maker to adjust consequences to firm specific circumstances;

• More guidance/less discretion implies greater certainty for firms and the decision-maker as to what will and what should happen in the event of a breach.

210. We propose that the Act should provide extra guidance on the matters that the Commerce Commission should have regard to in undertaking this task. For example, ensuring that the penalty/remedy regime:

• is proportionate to the harm caused by the breach;

• acts as a deterrent to future breaches; and

• ensures firms are held accountable to investments that were provided for as part of the control terms.

211. Requiring the Commission to set the consequences of a breach at the time control terms are set would have the following benefits and costs:

• Certainty and predictability would be improved for businesses, the regulator and Government, as to the consequences of a breach;

• Transparency of decision-making process would be improved through the separation of penalty/remedy design and enforcement; but

• There would be less flexibility to account for changing circumstances.

212. On balance, the Ministry considers that the Act should require the Commission, when imposing control terms, to include detail on the consequences of a breach.

213. Merits review of penalties is also proposed (see Chapter 12).


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1. Do you agree that control terms should not be re-opened within a specified control period, other than under exceptional circumstances? If so, do you agree with the exceptional circumstances suggested in this Chapter?

2. Are the current provisions relating to penalties in the Act for breaches of control terms (s70C) satisfactory or should additional guidance be provided?


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PART IV: ACCOUNTABILITY This Part considers whether the current accountability arrangements are appropriate for regulatory decisions under the Commerce Act.

Chapter 12: Accountability mechanisms

12.1 Background

12.2 Should regulatory decisions be subject to merits review?

12.3 Which regulatory decisions should be open to merits review?

12.4 What form of merits review?

12.5 What grounds for merits review?

12.6 What is the appropriate review body?

12.7 Summary



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12.1 Background 214. Regulatory decisions have wide ranging implications that affect the rights and interests not only of businesses in regulated markets but also those of the wider community.

215. The purpose of regulatory accountability arrangements is therefore to support good quality regulatory outcomes. Because regulatory decisions are complex and often require difficult judgements, some mistakes may be made. A key design parameter of an effective regulatory regime is therefore to ensure that accountability mechanisms provide strong incentives for high quality decision-making by the regulator, error correction (so that any incorrect decisions are likely to be reviewed and re-considered), and guidance for the regulator and stakeholders (so that the quality of decisions improves over time, and the regime is more predictable for those affected by it). If the accountability arrangements are not sufficient, errors are more likely to occur, and uncertainty is likely to be greater.

216. Policy decisions made by politicians are subject to contestable advice from different Government agencies, various forms of Parliamentary scrutiny, judicial review and the overall political accountability of democratic processes. We propose that these mechanisms are sufficient to ensure that regulatory decisions made by Ministers are appropriately scrutinised.

217. We have also proposed to make a clear distinction between making rules and applying them to individual cases, with the aim of ensuring improved transparency of regulatory processes. However, improved transparency does not always provide parties directly affected by a poor-quality decision with a means of redress. This section therefore examines what appeal rights are appropriate for the regulator’s decisions.

218. There are different forms of review and/or appeal mechanisms and each addresses different types of error:

• Judicial review provides a check on the regulator’s decisions and processes. The grounds for review can be broadly characterised as illegality (including acting outside the scope of its powers or making errors or law), unfairness (including breach of natural justice and poor process) and unreasonableness.

• In some contexts, judicial review is supplemented with merits review. Merits review is a review of the substance and reasoning of the decision itself. It requires a person, or a body (other than the primary decision-maker) to reconsider the facts, law, reasoning and other relevant aspects of the original decision, and determine the correct and preferable decision. The process of review may be described as 'stepping into the shoes' of the primary decision-maker. The result of merits review is the confirmation or variation of the original decision, or a requirement that the primary decision-maker reconsider all or part of its decision. As discussed later in this chapter, there are various forms of merits review, ranging from appeals on a question of law only through to a full ‘de novo’ rehearing.


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219. The two options to ensure that regulator’s decisions are subject to sufficient accountability mechanisms, therefore, are:

a. judicial review only; or

b. some form of merits review in addition to judicial review.

Current provisions

At present the Commission’s decisions to recommend and impose regulatory control (and to set thresholds for electricity lines businesses) are subject to judicial review only. Authorisations made under ss 70 and 71 are appealable on matters of law, which also provides a check on the quality of the decision making process. However, no review on merits is provided for by legislation.

Decisions made by the Commerce Commission in relation to clearances and authorisations of mergers and acquisitions, and authorisations of trade practices, are subject to merits review. Appeals are heard by a High Court Judge sitting with a lay member (usually an economist). (There is a further right of appeal to the Court of Appeal, with the leave of the High Court or Court of Appeal. Leave can be sought to appeal from the Court of Appeal to the Supreme Court if the criteria in the Supreme Court Act 2003 are satisfied.) The form of merits review for these decisions is an ‘appeal by way of rehearing’,20 key features of which are:

the onus is on the appellant to show that the decision of the regulator was wrong in some material way;

the Court recognises that the expertise and resources of the Commission equip it, rather than the Court, to be the primary fact-finding and adjudicative body. The Court will give considerable weight to the advantages enjoyed by the Commission, and will show some deference to its conclusions unless persuaded that they are wrong. On the other hand, the Court is not merely a ‘rubber stamp’;21

further evidence can be introduced at the appeal stage only with the leave of the Court. Leave will not be granted unless the evidence is ‘fresh’ (i.e. was not placed before the Commission, and could not reasonably have been placed before the Commission) and material. In practice this means that limited updating evidence about recent developments is often filed, and in a few cases there has also been economic evidence addressing the implications of that updating evidence. The Courts have emphasised the importance of this rule for ensuring that the first hearing is not merely a ‘dummy run’, with the appeal turning into a new trial with large quantities of new material;22

20 Commerce Act s 91, High Court Rules r 718.

21 Air New Zealand v Commerce Commission (No 6) (2004) 11 TCLR 347 paras 9-13.

22 High Court Rules, r 716; Telecom Corp of NZ Ltd v Commerce Commission [1991] 2 NZLR 557 (CA). For examples of evidence being excluded because it is not fresh or is not material, see Air New Zealand v Commerce Commission (No 3) (unreported, High Court, Auckland Registry, CIV2003-404-


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the Court can confirm the Commission’s decision, or send the matter back to the Commission for reconsideration, or modify or reverse the Commission’s decision. 23

Some commentators argue that the safeguard of judicial review is not sufficient, because it does not look into the substance of the regulator’s decision, and that it should be supplemented with merits review of regulatory decisions. They argue that the experience of merits review of Commission decisions relating to mergers and acquisitions and trade practices has been a positive one, and that merits review could provide similar benefits in the regulatory context.

12.2 Should regulatory decisions be subject to merits review? 220. While judicial review addresses issues of natural justice and poor processes, it may be considered insufficient to ensure high quality regulatory outcomes.

221. Availability of merits review, in addition to judicial review, may result in the following benefits:

• strengthening incentives for high quality analysis and decision-making by the regulator;

• correcting poor quality decisions in individual cases;

• providing principles and guidance for future cases; and

• reducing the incentive or need for resort to political processes/lobbying.

222. However, the following issues are likely arise if merits review is provided for regulatory decisions:

• Additional costs, including:

o costs of litigation for both the Commission and businesses;

o extra funding required by the Commission to ensure that they ‘get it absolutely right’ in the first instance. Note that while this may improve the Commission’s chances of having their original decision confirmed by the review body, it will not necessarily reduce the likelihood of firms seeking review of its decision.

• Delays to regulatory processes.

• Potential for simply different (rather than better) outcomes, as different experts may come to different conclusions.

6590, 20 May 2004, R Hansen J) and Air New Zealand v Commerce Commission (No 5) (unreported, High Court, Auckland Registry, CIV2003-404-6590, 23 June 2004, R Hansen J and K Vautier).

23 Commerce Act ss 93-94, High Court Rules r 718A.


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• Incentives for regulated businesses to ‘game’ the system in search of the ultimate decision maker.

223. Thus, while availability of merits review may improve quality of and confidence in the regulatory decision-making, this may come at a substantial cost. Therefore, if merits review is provided for, it will need to be designed in such a way that the impact of cost and delay factors is minimised.

224. The following sections outline possible measures that could be considered in an attempt to limit merits review provisions (if introduced).

12.3 Which regulatory decisions should be open to merits review? 225. If merits review of regulatory decisions is provided for, then decisions would have to be made on what elements of the regulatory regime should be subject to merits review.

226. If the proposals, as outlined in this paper are implemented, the Commerce Commission will have responsibility for making the following decisions:

a. Recommending methodologies for calculating key design parameters of the regime such as WACC, allocation of common costs, pass through costs, etc.

b. Undertaking an inquiry and making recommendations to the Minister on the questions of whether control should be imposed.

c. Setting the control terms for individual firms.

d. Approving or determining the (final) customised control terms (where a proposal is submitted).

e. Imposing penalties for individual breaches.

227. The Australian Administrative Review Council identifies decisions that are unsuitable for merits review.24 These are:

• legislation-like decisions of broad application which, by their nature do not affect the interest of any one person and which are subject to the accountability safeguards that apply to legislative decisions; and

• decisions that automatically follow from a statutory obligation to act in a certain way upon the occurrence of a specified set of circumstances (which leaves no room for merits review to operate).

228. The Council also identifies some additional factors that may justify excluding merits review. Among these are:

24 Commonwealth of Australia, Administrative Review Council, What decisions should be subject to merits review? http://www.ag.gov.au/


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• preliminary or procedural decisions;

• recommendations to ultimate decision-makers;

• decisions of a law enforcement nature; and

• decisions with limited impact.

229. The New Zealand Legislation Advisory Committee has also issued some guidance on when regulatory decisions should be subject to appeal and review rights. The Committee’s Guidelines 13.1.1 states that:

“It is generally desirable for legislation to provide a right of appeal against the decisions of officials, tribunals and other bodies that affect important rights, interests or legitimate expectations of citizens. The reasons for providing an appeal are to correct error and to supervise and improve decision-making. However, the value of having an appeal right must be balanced against the following factors:

o Costs;

o Delay;

o Significance of the subject matter;

o The competence and expertise of the decision-maker at first instances;

o The need for finality.

It will usually be appropriate to respond to concerns about cost and delay by limiting the scope of any right of appeal, rather than denying it altogether.”

230. Input methodologies by and large are not envisaged to be directed towards the circumstances of particular persons/firms, but will apply generally to businesses in a given sector/economy. In addition, if set by the Minister, who is subject to political accountability mechanisms, the decisions on input methodologies may not need to be merits reviewable.25 However, if input methodologies are set by the Commission, without any Ministerial involvement, than merits review on these decisions may be desirable.

231. The Commission’s advice to the Minister on whether or not to impose control on a given firm/industry (i.e. if there is a need to deviate from the default) is also unsuitable for merits review. This is because the ultimate decision-maker need not adopt this recommendation.

232. The Commission’s decisions with respect to setting initial control terms should not also be subject to merits review since it is proposed that firms have an ability to 25 Though note that, as per the section on input methodologies, the Commission will be required to follow transparent processes in recommending the methodologies to the Minister.


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propose customised terms if the initial terms are not appropriate. In addition, merits review of this step would create pressure on the Commission to undertake a very conservative estimate, thereby undoing the cost-effectiveness of the proposed approach.

233. On the other hand, the Commission’s decisions with respect to setting customised firm-specific control terms should be subject to merits review.

234. The Commission’s action in the event of a breach, e.g. the decision that there was a breach and the amount of the penalty imposed, may also be suitable for merits review.

12.4 What form of merits review? 235. Costly delays and tactical use of appeal rights could be minimised by limiting the scope of the right of appeal.

236. The scope of merits review could range from:26

a. pure appeals - no new evidence can be presented, starting from a presumption that the original decision was correct;

b. appeals by way of re-hearing - further evidence can be submitted with the leave of the appeal body if it could not have been presented at the stage of the original decision-making, discretion as to whether the whole or a part of the determination is to be re-heard, starting from a presumption that the original decision was correct;

c. hearings de novo - the case is heard entirely from the beginning, new evidence can be introduced, and there is no presumption that the decision appealed from is correct,

d. appeals by way of case stated - this is not a re-hearing of a dispute, rather a procedure whereby further clarification, usually on the point of law, is sought.

237. The Legislation Advisory Committee Guidelines 13.4.1 recommend that appeals should usually be by way of rehearing, and this is the approach that has been adopted for Commerce Commission decisions on mergers and acquisitions and trade practices, which most commentators consider has worked well to date. This minimises costs compared with appeals de novo, and ensures that firms put all relevant material before the Commission. However it does enable updating material to be placed before the appeal body, which can be important where for example discretion is re-exercised because of an error at first instance. We propose that appeals on regulatory issues should be by way of rehearing.

238. Tactical delays could also be addressed by ensuring that a merits review does not of itself prevent the regulator’s decision coming into effect, i.e. the regulator’s decision would stand unless overturned by the appeal body.

26 LAC Guidelines 13.4.2.


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12.5 What grounds for merits review? 239. In some contexts appeal rights are limited to particular types of error, such as errors of law. But this reduces the scope and benefit of the merits review procedure, and can raise difficult issues about the boundary between questions of law and questions of fact, or discretion. The proposal that appeals be by way of rehearing means that the starting point is a presumption that the decision appealed from is correct, and the onus is on the appellant to show that it is wrong in some material way. We propose that this is a sufficient limit on the grounds for review.

12.6 What is the appropriate review body? 240. Judges in generalist courts may not have the necessary highly technical skills and expertise to review price control determinations (which are complex and based on economic and technical concepts which are subject to considerable debate between experts). While this issue could potentially be resolved/minimised by the ability for the Court to sit with a lay member under s77 of the Act, as in the context of appeals from other Commission decisions, it remains an important consideration.

241. A specialist tribunal may be more appropriate, to ensure that appeals are heard by a small pool of Judges and expert lay members with relevant expertise, who can build up a body of experience in dealing with appeals on these matters over time. An equivalent model is the Australian Competition Tribunal which comprises a pool of judges, economists and business people, with each case being heard by one judge, one economist, and one business person. While the make-up of such a team may appear very similar to the option of appointing a lay member to the Court, there may be greater opportunity to appoint judges with specialist regulatory expertise, and to enable the tribunal members to build up experience in these matters over time. This may be an expensive option, however. In general, there must be compelling reasons for creating specialist tribunals and not referring matters to the courts.

242. With either the option of appointing a lay member to the High Court or setting up a specialist tribunal, issues may arise with getting the necessary skills and independence of the review body given New Zealand’s limited pool of resources.

243. If merits review of regulatory decisions is provided for, then it would be sensible to ensure that the same body also considers/hears the judicial review procedures.


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12.7 Summary 244. The table below summarises the decisions and relevant forms of review (if merits review is provided for):


1. Do you consider that it is desirable to provide for merits review of regulatory decisions or does judicial review provide sufficient constraints on regulatory decisions?

2. Do you agree with the document’s conclusions that, if merits review is provided for, it should only apply to control decisions made by the Commission and be limited to the form of ‘appeals by way of re-hearing’ where new evidence can be introduced only if it is fresh and material and it could not have been submitted at the original decision-making stage?

3. What is your preferred composition of any merits review body, taking into account New Zealand’s small size and limited resources?

Decision Form of review Recommendations on input methodologies

Judicial review only, as this is a recommendation to a different decision-maker (who faces political accountability).

Recommendation to Minister on whether or not to impose control

Judicial review only, as this is a recommendation to a different decision-maker (who faces political accountability).

Setting of initial control terms for a given firm or industry

Judicial review only, as it is proposed that the firm has an opportunity to apply for customised terms

Setting of customised control terms for a given firm

Merits review by way of appeal by rehearing, in addition to judicial review. Regulator’s decision stands in interim.

Action in the event of a breach

Merits review by way of appeal by rehearing, in addition to judicial review. Regulator’s decision stands in interim.

Minister’s decisions on the Commerce Commission’s recommendations

Judicial review only, as Minister is subject to political accountability mechanisms.


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PART V: SUMMARY This Part summarises two possible options for change which are based on the options identified in Chapter 10. However, note that potential amendments 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’.

The main difference between the two options presented here, 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. Option Two also allows firms to propose control terms to the Commission for its consideration.

A summary of these options, and brief consideration of the costs and benefits of these options, are presented in this Part.

A further cost-benefit analysis of options may be undertaken once submissions have been considered. The provision of specific quantified information by submitters on costs and benefits will assist the Ministry in undertaking any quantitative cost-benefit analysis.

Chapter 13: Next steps

Chapter 14: Summary of options


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Chapter 13: Next steps 245. The overall objective of the review of regulatory provisions is to ensure that economic regulation in New Zealand is consistent with providing for the long-term benefit of consumers within New Zealand.

246. This document identifies potential issues with the currently regulatory provisions under the Commerce Act 1986 and outlines potential amendments to these provisions.

247. Your feedback is sought on the material presented throughout the document. Specific questions have been posed at the end of most Chapters and are consolidated below for easy reference.

248. Feedback is also welcomed on any other aspect of the document. Page 5 provides information on how to make a submission.


Chapter 1: Introduction

1. Do you have any comments on the desirable characteristics of a regulatory regime as outlined in this Chapter?

Chapter 3: Potential issues with the current regime

1. Does the above list capture the main issues with the current regulatory regime?

2. Are these issues adequately identified and described?

3. Are there are any other issues with the current regime that are not listed above and should be considered as part of this review?


1. Do you agree that a regulatory regime needs to be available to address issues in markets with monopoly characteristics?

2. Do you consider that the sole or primary objective of a regulatory regime should be economic efficiency or consumer protection (distribution), or do you consider that both should be taken into account?

Chapter 5: Purpose statement

1. In your opinion, is a regulatory-specific purpose statement desirable?

2. If so, do you agree with the proposed regulatory-specific purpose statement, or do you prefer an alternative formulation? If so, please suggest specific wording.


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Chapter 6: The decision on whether to impose regulation

1. Do you agree with the proposed criteria for deciding on whether regulation may be imposed?

2. If you agree that one of the tests for whether control may be imposed should be where the long term benefits to acquirers exceed direct and indirect costs, do you consider that such benefits should (a) ‘substantially’ or (b) ‘clearly’ exceed costs, or should there be some other guidance on weighting?

3. If you agree that one of the tests for whether control may be imposed should be where the long term benefits to acquirers exceed direct and indirect costs, should those benefits be considered regardless of whether acquirers acquire the goods and services directly or indirectly, or should it be necessary to establish that benefits will be passed on to end users (or consumers or end-acquirers)?

4. Should the current provisions in the Act allowing control to be imposed in the interests of suppliers (to a monopsonist) be retained?

5. Do you agree that there should not be a legislative test for when regulation should be imposed?

6. Do you agree that the Minister should remain the decision-maker on whether control should be imposed under Part 4, but that that the Minister must receive a report and recommendation from the Commerce Commission before making a decision?

7. Do you agree that the decisions on whether and, if so, how to regulate should be undertaken simultaneously rather than sequentially?

Chapter 7: Types of economic regulation

1. Do you agree that it is desirable to widen the scope of the Commerce Act by providing for regulatory options other than control, specifically:

• negotiation/arbitration and

• price monitoring/information disclosure?

2. Do you consider that specific, easier tests should be provided to determine whether lighter-handed types of regulation, such as information disclosure, may be imposed, such as:

• meeting the competition criteria only

• requiring qualitative (rather than quantitative) cost-benefit analysis?

Chapter 8: Key input decisions

1. Do you see value in having key input decisions set as a stand-alone process in advance of an inquiry and recommendation to regulate? If so, should they be set


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for a specific sector once an inquiry has been initiated, or set generically irrespective of whether or not an inquiry has been initiated?

2. Is it practical, or possible, to set generic methodologies that could apply to all potentially regulated sectors?

3. Do you consider that input methodologies should be set:

• as guidelines by the Commerce Commission;

• as Rules by the Minister following a recommendation from the Commission; or

• another option (please specify)?

Chapter 9: Regulatory control design issues 1. Should specific provision be made (e.g. in Part 5) to allow the Commerce

Commission to use comparative benchmarking as a methodology for setting control terms?

2. Should specific provision be made to allow the Minister to request at the Commission to consider whether economic regulation may be imposed on a sector as a whole (rather than each individual firm within a sector) and if so, should provision be made for cost benefit analysis on this matter to be undertaken in qualitative (rather than quantitative) terms?

3. Is there value in allowing firms to propose their own control terms for the Commission’s consideration (‘propose/respond’ model)?

4. If firms are able to propose their own control terms, should the Commission be required to accept proposals that meet pre-set criteria? Do you have any comment on the proposed ‘reasonableness criteria’?

5. If firms have the ability to propose their own control terms, should this proposal take place before or after declaration of control by the Minister (note that in section 9.3 the paper proposes different sequences for control of individual firms compared to sector control)?

Chapter 10: Possible packages of ‘how to regulate’

1. 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.

2. In your opinion, are there other options for addressing the issues with the Part 4A thresholds regime?


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3. 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?

4. Should local community owned trusts be subject to a different regulatory regime than larger non-trust electricity lines businesses?

Chapter 11: Processes for amending and enforcing control terms

1. Do you agree that control terms should not be re-opened within a specified control period, other than under exceptional circumstances? If so, do you agree with the exceptional circumstances suggested in this Chapter?

2. Are the current provisions relating to penalties in the Act for breaches of control terms (s70C) satisfactory or should additional guidance be provided?


1. Do you consider that it is desirable to provide for merits review of regulatory decisions or does judicial review provide sufficient constraints on regulatory decisions?

2. Do you agree with the document’s conclusions that, if merits review is provided for, it should only apply to control decisions made by the Commission and be limited to the form of ‘appeals by way of re-hearing’ where new evidence can be introduced only if it is fresh and material and it could not have been submitted at the original decision-making stage?

3. What is your preferred composition of any merits review body, taking into account New Zealand’s small size and limited resources?

Chapter 13: Next steps 1. Submitters are requested to provide specific, quantitative information on costs

and benefits wherever possible to assist the Ministry in undertaking any cost-benefit analysis.


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Chapter 14: Summary of options STATUS QUO OPTION ONE OPTION TWO When to regulate Inquiry into whether to control a firm is guided by: • overall purpose of the Act and s 3A

efficiency consideration, • the ‘may’ test in s 52, stating the competition

(competition is limited or likely to be lessened) and welfare (benefits to acquirers) criteria

• no express legislative test on when control ‘should’ be imposed.

Part 4A provides for a thresholds regime for electricity lines companies, which, if breached, triggers an investigation into whether or not control under Part 5 should be imposed. The thresholds regime is guided by a specific purpose statement in s57E. Act limited to consideration of control versus no control only. Processes for whether and how to control a sector or a firm are undertaken separately.

Inquiry into whether and how to regulate is guided by: • adapted s 57E to apply to generic regulatory

provisions and explicitly provide for incentives to invest, e.g.

“The purpose of this Part is, n 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; and

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.”

• amended s52, e.g. regulation may only be imposed if:

“There is little or no competition or prospect of competition in the relevant market”; OR “The goods and services are supplied by a person or persons with a substantial degree of market power”, and

“Regulation is necessary or desirable to: (a) promote efficiencies in a market; or (b) provide long term benefits to persons acquiring

the goods and services that [substantially] [clearly] exceed the direct and indirect costs of regulation”

Inquiry into whether and how to regulate is guided by: • New regulatory-specific purpose statement,

as per Option One. • amended s52, as per Option One. • further guidance on when regulation may not

be imposed, as per Option One. Act extended to provide for other regulatory options to be considered by the Commission in addition to control, namely: • negotiate/arbitrate model, and • information disclosure. Criteria for imposing control on a sector as per Option One. Processes for whether and how to regulate are considered simultaneously.


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• further guidance on when regulation may not be imposed could also be provided, e.g.:

“Regulation may not be imposed unless any net costs to economy are acceptable relative to the benefits to consumers [persons acquiring the goods or services (whether direct or indirect)] (or suppliers who face little or no competition or prospect of competition for the acquisition of the goods or services) of limiting excessive returns in the opinion of the Minister.” Act extended to provide for other regulatory options to be considered by the Commission in addition to control, namely: • negotiate/arbitrate model, and • information disclosure. Processes for whether and how to regulate a firm are combined but kept separate in a sector inquiry.

Key input decisions Made by the Commerce Commission ‘as it goes'

Input methodologies (e.g. how to calculate WACC, asset valuations, etc) set in advance of use (i.e. when an inquiry is announced, unless already set)

• recommended by the Commission,

• option as to whether these should be approved by the Minister (who may accept or reject or refer back)

As per Option One.


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Regulatory control design issues Under Part 4A, price thresholds are set using comparative benchmarking.

Under Part 5, control terms are based on firm specific information.

Both thresholds and control terms are determined by the Commission.

Part 4A made generic so that other sectors (e.g. gas pipeline services) can be placed under a thresholds regime.

Control terms may be set using comparative benchmarking (likely approach for control of sector) and/or firm-specific information (likely approach for control of firm). Part 4A is replaced with generic sector control provisions under Part 5. Firms have a role in proposing their own regulatory control terms, which the Commerce Commission assesses against pre-set reasonableness criteria.

If breach occurs Breach of an authorisation under Part 5 results in direct sanctions

Breach of Part 4A thresholds results in an investigation by the Commission into whether control under Part 5 is desirable.

As per Status Quo.

Breach of final authorisation (whether based on customised or comparative information) results in direct sanctions.

Appeal rights Judicial review only (no appeal rights on merit).

As per Status Quo. Merits review rights (in addition to judicial

review), on final control terms and action taken in the event of a breach for an individual company (original decision stands in the interim).

Form of merits review limited to ‘appeal by way of rehearing’ (new evidence can not be presented unless it could not have been presented for the original decision-making), and material points of contention.


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Assessment of the options against desirable characteristics of a regulatory regime

OBJECTIVES STATUS QUO OPTION ONE OPTION TWO

Clarity of policy intent, resulting in certainty and predictability of regulatory outcomes

Lack of a regulatory-specific purpose statement (other than in Part 4A which may not be sufficiently clear) and the Commission’s ability to set, and amend, input methodologies ‘as it goes’ result in regulatory uncertainty for businesses.

However, the developing case law may, with time, provide certainty over the legislative intent.

Uncertainty about policy objectives

A clear regulatory-specific purpose statement, amended s 52 criteria, and input methodologies set as a stand alone process ahead of inquiry, would improve clarity and predictability of regulatory objectives. Clarity improved

As per Option One. Clarity improved

Consistent, coherent and transparent application of the regulatory regime across different firms/industries and over time

Commission’s ability to set, and amend, input methodologies ‘as it goes’ may result in inconsistent application of the regulatory regime and lack transparency.

Potentially inconsistent and obscure processes

Input methodologies set as a stand alone process ahead of inquiry, and according to a transparent consultation process, would ensure consistency in the application of the regime.

Consistency and transparency improved

As per Option One.

Consistency and transparency improved

Regulatory processes are cost-effective and timely, and also tailored to New Zealand’s small scale

Separate processes for consideration of whether and how questions could be inefficient, costly and time consuming.

Thresholds under Part 4A may not be low cost.

Providing for a range of regulatory options under the Act and combining consideration of whether and how to control an individual firm is likely to improve cost-effectiveness and timeliness of regulatory decision-making

Retaining Part 4A means that processes and criteria for deciding on whether to put a sector under the thresholds regime have to be separate from processes and criteria for imposing control on a firm that breaches a threshold.

Providing for a range of regulatory options under the Act and combining consideration of whether and how questions, is likely to improve cost-effectiveness and timeliness of the decision-making process.

However, widening the Commission’s mandate to consider a range of regulatory options; requiring the Commission to develop input methodologies for Ministerial consideration, engaging with firms on ex ante basis, and allowing appeal rights on merits - will increase the


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Potentially not cost-effective processes

A post breach inquiry under Part 4A could look at the questions of whether and how to impose control simultaneously. Widening the Commission’s mandate to consider a range of regulatory options and requiring the Commission to develop input methodologies for Ministerial consideration will increase the costs to the Commission. Cost-effectiveness may improve

costs to the Commission. Cost-effectiveness may improve

Regulatory regime is sufficiently flexible to account for firm/industry specific circumstances, changing market conditions, innovation and experience

The Commission’s ability to use “whatever approach it considers appropriate” (as per s70) is constrained by the perceived need to employ different methodologies for setting thresholds (under Part 4A) and control terms (under Part 5). Lack of ex ante approval under Part 4A regime does not allow for firm specific circumstance to be provided for. Flexibility of the regime is limited

Widening the Commission’s mandate to consider a range of regulatory options (rather than just control versus no control) improves flexibility of the regime. However, setting input methodologies as a stand alone process ahead of inquiry reduces the Commission’s flexibility to account for firm specific circumstances promptly. Flexibility may improve

Explicitly provides for ex ante engagement by allowing firms to submit proposed control terms to the Commission for consideration. Widening the Commission’s mandate to consider a range of regulatory options (rather than just control versus no control) improves flexibility of the regime. However, setting input methodologies as a stand alone process ahead of inquiry reduces the Commission’s flexibility to account for firm specific circumstances promptly. Flexibility may improve

There are appropriate levels of regulatory accountability and independence

Inability to appeal on merits results in limited ability to identify and correct errors.

Limited accountability mechanisms

As per Status Quo.

Limited accountability mechanisms

Some ability to appeal on merits would provide additional incentives for high quality analysis, error correction and future guidance.

However, regulatory independence may reduce due to Ministerial involvement in the rule setting process. Stronger accountability mechanisms


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APPENDIX 1: GLOSSARY OF TERMS Airports inquiry – an inquiry into whether airfield activities should be controlled at the three major international airport companies at Auckland, Wellington and Christchurch; undertaken by the Commerce Commission in 2002.

Comparative benchmarking – a methodology for setting control terms based on high degree of assumption, approximation and statistical averaging.

Control period – a period of time over which regulatory control terms apply.

Control terms – terms and conditions for regulatory control as determined by the regulator.

Customised approach – a methodology for setting control terms based on firm specific information.

Desirable characteristics of a regulatory regime:

• Regulatory certainty – refers to a stable regulatory environment, where outcomes are predictable.

• Consistency – refers to an adherence to the same principles, rules and methodologies across sectors, firms and time.

• Transparency – refers to an environment where the rationale for the decisions is provided to the public in a comprehensible, accessible, and timely manner.

• Flexibility – refers to an ability to account for different/changing market circumstances.

• Regulatory accountability – refers to the regulator being held responsible for carrying out its task, and for conforming with legislative requirements.

• Regulatory independence – refers to the regulator being autonomous of firms and government.

Economic regulation – government rules that are intended to influence and/or modify the economic behaviour of firms with respect to both price and quality of supply.

Gas inquiry – an inquiry into whether or not supply of gas pipeline (transmission and distribution) services should be controlled; undertaken by the Commerce Commission in 2004.

Input methodologies – methodologies for how to calculate key parameters of regulatory control.

Judicial review – a review of the regulator’s decisions and processes. The grounds for review can be broadly characterised as illegality (including acting outside the


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scope of its powers or making errors or law), unfairness (including breach of natural justice and poor process) and unreasonableness.

Market power – an ability of a firm (or group of firms) to raise and maintain prices and/or restrict quality/quantity relative to price and quality/quantity than would prevail under competition.

Merits review – a review of the substance and reasoning of the decision itself. It requires a person, or a body (other than the primary decision-maker) to reconsider the facts, law, reasoning and other relevant aspects of the original decision. The process of review may be described as 'stepping into the shoes' of the primary decision-maker. The result of merits review is the affirmation or variation of the original decision.

Monopoly rent – a surplus captured by a monopoly supplier, which can be extracted because consumers place a greater value on a good or a service than the cost of producing it.

Natural monopoly – a situation where there are economies of scale, sunk costs and barriers to entry such that it is only economic for one firm to supply the market.

Regulatory control – a form of economic regulation, whereby the regulator, not the firm, sets the terms and conditions (such as price, quality or quantity) under which a good or a service is to be supplied.

Thresholds regime/thresholds – a regulatory regime, currently applied to electricity lines businesses, under which the Commerce Commission sets certain thresholds which, if breached, can lead to an inquiry into whether regulatory control should be imposed.

Wealth effects – a transfer of wealth from one group to another, with no corresponding increase in total wealth in the economy as a whole.

Workable competition – perfect competition is an economic model that describes a hypothetical market form in which no producer or consumer has the market power to influence prices. Workable competition is an economic model of a market in which competition is less than perfect, but adequate enough to give buyers genuine alternatives.

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Review of Regulatory Control Provisions under the Commerce ... · 649602 Review of Regulatory Control Provisions under the Commerce Act 1986 Discussion Document Prepared by the Ministry