New Zealand Legislation: Bills
Bills are proposed Acts
This Bill amends Parts 4, 4A, 5, and 6 of the Commerce Act 1986 (the Act) and makes other consequential amendments. The primary focus of the Bill is to fundamentally reform the regulatory control provisions in the Act. Other amendments include imposing enhanced information disclosure regulation on certain services supplied by 3 international airport companies and providing for the enforcement and variation of undertakings given under section 69A of the Act in relation to clearance or authorisation of mergers.
Part 4 of the Act has generic provisions enabling price and quality control to be imposed where competition is limited and control would be in the interests of acquirers. The gas pipelines of Powerco and the Auckland pipelines of Vector are currently under control.
Part 4A empowers the Commerce Commission (the Commission) to impose control on electricity lines businesses where they breach thresholds set by the Commission. The Commission has entered into or is negotiating “administrative settlements”
with several electricity lines businesses following breaches of thresholds.
Sections 70–74 of Part 5 provide for the Commission to determine requirements for the supply of controlled goods or services.
The Government undertook a review of Parts 4 and 4A between May 2006 and December 2007 in close consultation with interested parties. There was general agreement that the existing legislation needs amendment. As part of the review, the Government also considered the effectiveness of existing regulation of aeronautical-related services supplied by 3 international airport companies.
Section 69A of Part 5 provides for merger parties to give an undertaking to divest assets or shares which, if accepted by the Commission, is deemed to form part of a clearance or authorisation granted by the Commission for the merger. Section 69A undertakings cannot be varied or enforced separately under the Act. Section 62 of Part 5 sets prescriptive time frames for the Commission to hold a conference when consulting on a draft determination for a restrictive trade practice authorisation.
The Government is currently carrying out a review of the clearance and authorisation provisions in the Act. The issues related to enforcing and varying section 69A undertakings and conference time frames have been identified in that review for early consideration and addressing in this Bill.
The key reason for providing for price and quality control, or “economic regulation”
, is to counter the ability of firms that are not faced with competition or the threat of competition to charge excessive prices and/or reduce quality. Such firms may also have weak incentives to improve efficiency and to make investments in a timely manner.
In practice, there are relatively few sectors that are not faced with competition or the threat of competition. These sectors tend to be those supplying core infrastructure such as electricity lines, gas pipelines, and airports. All OECD countries regulate such sectors, particularly where they are privately owned.
The reviews found general (though not unanimous) agreement that the main problems with the existing legislation are as follows:
absence of a specific purpose statement for Part 4. This has led to dispute and uncertainty, since the general purpose statement of the Commerce Act (section 1A), which seeks to “promote competition”
, does not work for sectors where competition is not possible:
there is no specific requirement for any regulation to incentivise investment and innovation:
separate inquiries are required on “whether to regulate”
and “how to regulate”
:
there is uncertainty about the rules governing regulatory decisions (such as the cost of capital):
there are no powers to implement alternative forms of regulation (such as information disclosure) other than price control:
the Part 4A thresholds regime is generally regarded as creating too much uncertainty for businesses and does not provide adequate incentives for investment in infrastructure:
the accountability regime for the Commission is limited (primarily judicial review):
the lack of a credible information disclosure regime to constrain the exercise of market power by 3 international airport companies in the supply of aeronautical-related services:
an inability to enforce and vary section 69A undertakings could result in inefficient outcomes.
The objectives of the Bill are to address these issues, and in particular to—
provide an efficient and credible regime to address the potential to exercise market power in markets where competition is not possible:
improve clarity, certainty, timeliness, and predictability for businesses:
tailor the regime to New Zealand's small size (with small firms and limited resources):
provide specifically for incentives to invest in infrastructure. Certainty is considered a pre-requisite for this.
The proposed purpose statement is to promote the long-term interests of consumers (in markets where there is little or no competition and no likelihood of a substantial increase in competition) by promoting outcomes consistent with competition. The purpose statement spells out that this requires suppliers to—
have incentives to invest and innovate:
have incentives to improve efficiency and provide services at a quality required by consumers:
share the benefits of efficiency gains with consumers:
limit excessive profits.
The Bill provides a new and clearer test for when regulation may be imposed, namely,—
there is little or no competition and no likelihood of a substantial increase in competition and there is substantial scope for the exercise of market power, taking into account the effectiveness of existing regulation or arrangements (including ownership arrangements):
the benefits of regulation (in meeting the objectives of the purpose statement) clearly exceed the costs of regulation.
The Bill retains current provisions for the Commission to undertake inquiries on whether regulation should be imposed on its own volition or on request from the Minister. However, it specifies that any inquiry recommending regulation should comprise a qualitative analysis of all material long-term efficiency and distributional considerations. As part of this analysis, the Commission should, as far as possible and practicable, undertake quantitative analysis of material effects on market efficiency, distributional and welfare consequences, and the costs and risks of regulation.
Decisions on whether to recommend the introduction of regulation (by Order in Council) rest with the Minister, as at present, who must consult with any sector Minister. However, unlike the current legislation, the Minister may not decide to recommend regulation unless the Commission has first undertaken an inquiry and made recommendations.
Any Commission recommendation to regulate must include the detailed regulatory provisions which would apply. Following any Order in Council imposing regulation, the Commission must make determinations setting out the details applying to individual suppliers. These provisions may not materially differ from the Commission's recommendations to the Minister.
The term input methodologies refers to the rules, processes, and requirements relating to regulation, such as how to calculate the cost of capital, value assets, allocate common costs, comply with regulatory specifications and so forth.
The Bill requires the Commission to set input methodologies by 30 June 2010. The purpose of setting input methodologies is to give greater certainty, transparency, and predictability to businesses (including businesses not subject to regulation) and their customers. This certainty is expected to help improve the climate for investment in infrastructure.
The Bill provides for lighter-handed forms of regulation as well as for conventional price control. This is designed to allow “fit for purpose”
regulation to meet the circumstances of specific suppliers and sectors.
The forms of regulation provided for in the Bill are as follows.
Information disclosure is a relatively light-handed form of regulation, although it can be quite powerful in setting standards on what is acceptable and for early identification of trends that may raise concerns.
The powers in the Bill include the ability to require forward-looking information (such as asset management plans, investment intentions, prices, and quality standards) and that the Commission be empowered to monitor compliance and outcomes.
This form of regulation requires the parties (suppliers and their customers) to negotiate a settlement on matters such as investments, quality of service, and prices. If they fail to agree within a specified time frame, they may agree on an arbitrator, or the Commission may appoint an arbitrator.
The Commission would have powers to set processes and time frames for negotiation and any arbitration and the input methodologies to be used. Any enforcement of settlements would be by the parties.
This form of regulation has encouraged parties to reach negotiated settlements in some overseas jurisdictions. It is most likely to be considered for sectors where there are a relatively limited number of customers.
This form of regulation builds on (and replaces) the Part 4A thresholds regime. The main features of the regime are:
the Commission must set default price-quality paths for suppliers based on readily available information such as historic productivity rates or information disclosed under information disclosure regulation:
a supplier, if it is unable to operate within the default path (for example, because it needs to make a step-change investment) may make a proposal to the Commission for a customised path. The Commission sets the requirements for qualifying proposals, the supplier may not relitigate input methodologies, and the Commission must make a determination on the proposal within 12 months. In making a determination, the Commission may set a path tougher than the default.
The advantages of this regime over the current Part 4A regime are that firms will have greater certainty as to their obligations (including the consequences of breaches) and they have an up-front, time-bound opportunity to seek a customised path if the generic default path is unsuitable for them.
The Bill places electricity lines businesses (except for consumer-owned businesses) and gas pipelines on to this regime.
This is a conventional price control regime for individual businesses.
Because of the importance of input methodologies, the Bill makes provision for merits review of input methodology determinations by the Commission. This is in the form of an appeal to a High Court judge assisted by 2 expert lay members (in most circumstances). The appeal provides accountability for the Commission, helps ensure that input methodologies deliver on the purpose statement, and promotes business confidence.
Submitters and the Select Committee are invited in particular to consider whether there should be specific criteria for such appeals. The Bill as drafted provides for a right of general appeal by way of rehearing. This is in line with other parts of the Act and would allow the High Court to apply well-established principles when considering and deciding such appeals. It can be argued, however, that specific and narrower criteria may be appropriate to help reduce gaming risks and to help ensure that only Commission decisions that are unreasonable (rather than unsatisfactory in the view of the Court) are overturned.
The Government gave careful consideration to whether merits review should also be available on final decisions of the Commission applying to individual firms. The pros and cons of merits review are set out in the Regulatory Impact Statement attached to this Bill. On balance, after taking into account costs and gaming risks, and the availability of merits review on input methodologies (which are the detailed decision-rules), the Government decided to limit appeals to points of law. Firms will also have judicial review available to them.
The Bill makes provisions for regulation to apply to the following specific sectors.
Electricity lines businesses (ELBs), which are currently subject to Part 4A, are to be subject to the following arrangements from 1 April 2009:
100% consumer-owned ELBs will be subject only to information disclosure and to monitoring by the Commission. The reason for this relatively light-handed regime is because consumers, as owners, are able to ensure that the business acts in their interests. However, provision is also made for consumers of individual ELBs to petition the Commission to recommend to the Minister that the ELB be subject to the same regime as other non-consumer-owned ELBs:
other ELBs will be subject to the default/customised price-quality regime (as well as information disclosure). The initial default path will be the current thresholds under Part 4A rolled over for 12 months until 31 March 2010. ELBs will be able to apply for customised paths following the setting of input methodologies in mid 2010.
Administrative settlements entered into by the Commission and ELBs by 1 April 2010 for breaches of Part 4A prior to 1 April 2008 will be preserved for their term. Should a business be placed under control it will be as if it were subject to a customised path.
There are special provisions applying to Transpower to recognise its unique position among ELBs.
Existing provisions in the legislation to enable transfer of jurisdiction for administering provisions relating to ELBs from the Commerce Commission to the Electricity Commission are retained.
The Bill imposes information disclosure and, from 1 July 2010, the default/customised price-quality regime on gas pipelines. The pipelines of Powerco and the Auckland pipelines of Vector, which are under Parts 4 and 5 control, will transition to the default/customised price-quality regime at the expiry of the Order in Council imposing control (2016) or any earlier date agreed with the Commission.
The Bill imposes information disclosure on the Auckland, Wellington, and Christchurch International Airports from 1 July 2010. These airports, which have strong natural monopoly characteristics, are currently subject to information disclosure under the Airport Authorities Act 1966, but the Commerce Act regime is expected to be more demanding including specifying input methodologies. The Bill also requires the Commission to report to the Minister as soon as possible after the start of the next pricing period in 2012 on the effectiveness of the information disclosure regime and whether an inquiry is needed.
The Bill provides that merger parties may apply to the Commission for variations to section 69A undertakings after the Commission has given clearance or authorisation to the merger. The Commission may accept the varied undertakings if the variation is not material to its clearance or authorisation decisions. A new prohibition, distinct from the main prohibition against anticompetitive mergers, is established to enable the Commission to separately enforce the undertakings.
The Bill provides for a range of pecuniary penalties and offences for breaches of information disclosure requirements and price-quality paths. It also provides for orders for compensation for breaches of price-quality paths and for injunctions. These provisions replace current powers for the Commission to impose penalties and remedies without reference to the courts, and the ability of the Commission to impose price control on ELBs that breach thresholds under Part 4A.
As noted, enforcement of settlements under the negotiate/arbitrate regime rests with the parties.
The Bill seeks to put in place a modern, flexible, and forward-looking regulatory regime in line with the OECD mainstream to allow for regulation of suppliers of core infrastructural services, which are not subject to competition. In doing so it seeks to preserve incentives for suppliers to invest while at the same time protecting consumers, where required, from excessive prices and poor quality service.
Clause 1 is the Title clause.
Clause 2 relates to commencement. Most of the Bill comes into force on the day after Royal assent is given to it. The exception is that the existing Part 4A relating to electricity lines business price control is repealed on 1 April 2009, and the new provisions in the new Part 4 apply to electricity lines services on and after that date.
Clause 3 says that Part 1 amends the Commerce Act 1986.
Clause 4 repeals and substitutes Part 4. Subparts 1 to 7 of new Part 4 contain the generic provisions for the new regulatory regime. They are described in the general policy statement, and can be read in the Bill. Subpart 8 contains generic miscellaneous provisions (on levies and information gathering), which are the same as the existing provisions. Subparts 9 to 11 contain the transitional provisions for electricity lines, gas pipelines, and the 3 airport companies that are becoming subject to information disclosure regulation.
Clause 5 repeals Part 4A, which relates to electricity lines businesses. The effective date is 1 April 2009.
Clause 6 amends section 62, which relates to the Commerce Commission preparing draft determinations in relation to restrictive trade practices. The amendment removes the 20-working-day restriction for the holding of conferences under that section.
Clause 7 inserts new sections 69AB and 69AC.
New section 69AB provides that if a person contravenes an undertaking accepted under section 69A, the clearance given or the authorisation granted in relation to the acquisition to which the undertaking relates is void and of no effect from the date it was given or granted. This means that the protection created by the authorisation or clearance will be removed.
New section 69AC authorises the Commerce Commission to accept variations of undertakings accepted under section 69A.
Clause 8 repeals sections 70 to 74, which relate to the powers of the Commerce Commission to make authorisations, and to accept undertakings, in respect of prices, revenues, and quality standards of regulated suppliers.
Clauses 9 to 19 amend Part 6, which is about enforcement, remedies, and appeals.
Clause 9 amends section 75(1) to set out the Court's jurisdiction with respect to civil proceedings under new Part 4. The clause also extends the Court's jurisdiction to cover applications for orders under new section 85A or 85B (see clause 14).
Clause 10 consequentially amends section 76, which is about the jurisdiction of the District Court in criminal cases under the Act.
Clause 11 amends section 79, which is about evidence admissible in court. It replaces a reference to the 2 specific sections that currently provide for proceedings for pecuniary penalties with a general reference to proceedings for pecuniary penalties. This means that the new pecuniary penalty provisions proposed by this Bill will automatically be included in the reference.
Clause 12 inserts a new cross-heading and section 79A. The new section sets out 2 standard provisions relating to pecuniary penalties. They relate to the standard of proof applying in pecuniary penalty proceedings, and discovery and the administration of interrogatories.
It consequentially amends 3 sections that currently each contain the same provisions.
Clause 13 amends section 84 (which relates to injunctions) to authorise the Court to grant injunctions in respect of contraventions of undertakings accepted under section 69A.
Clause 14 inserts new sections 85A to 85C.
New section 85A authorises the Court to order a person to pay a pecuniary penalty to the Crown if it is satisfied that the person has contravened an undertaking accepted under section 69A. The Court may also order a person to pay a pecuniary penalty if the person has attempted to contravene such an undertaking or has been a party to a contravention. The pecuniary penalty must not exceed $500,000.
New section 85B authorises the Court to make an order directing the person to dispose of assets or shares in accordance with the undertaking.
New section 85C specifies matters that the Court must not take into account under new sections 85A and 85B.
Clause 15 substitutes new sections 86 to 87C, replacing the enforcement provisions that applied to the former Part 4 with ones relating to the new Part 4. The new provisions provide for the following:
new section 86: pecuniary penalties for contravening information disclosure regulation, with a maximum penalty of $500,000 for individuals and $5,000,000 for bodies corporate:
new section 86A: orders requiring a person to comply with particular information disclosure requirements:
new section 86B: offences for intentionally contravening any information disclosure requirement, or for failing to comply with an order under new section 86A, with a maximum fine of $1,000,000:
new section 86C: orders requiring parties to negotiation or arbitration to comply with a new section 52O determination, and orders requiring one party to pay another party an amount to compensate the other party for loss or damage suffered as a result of inadequately co-operating in a negotiation or arbitration:
new section 87: pecuniary penalties for contravening price-quality requirements, with a maximum penalty of $500,000 for individuals and $5,000,000 for bodies corporate:
new section 87A: orders compensating any person who has suffered, or is likely to suffer, loss or damage as a result of a contravention of price-quality requirements. An order under this section can only be made following an order to pay a pecuniary penalty:
new section 87B: offence for intentionally contravening a price-quality requirement or breaching an order under new section 87C, with a maximum fine of $1,000,000:
new section 87C: injunction restraining a supplier from supplying in contravention of price-quality requirements, and orders requiring a supplier to supply in accordance with price-quality requirements.
Clause 16 amends section 89, which is about other orders the Court may make in response to various contraventions of the Act. The amendment provides that a reference to a contravention of the Act extends to include a reference to contravening the requirements of any form of regulation under new Part 4.
Clause 17 recasts section 91(1), which provides for appeals to the High Court from determinations by the Commission. At present, section 91(1) provides a general right of appeal in respect of all determinations other than—
determinations under section 57F (that goods or services supplied by large electricity lines businesses are controlled); and
determinations under sections 70 and 71 (in respect of authorisations in respect of prices, revenues, and quality standards).
Sections 57F, 70, and 71 are proposed to be repealed by this Bill as they are being replaced by new Part 4. New section 91(1) now provides that, as before, there is a general right of appeal against determinations by the Commission, but not against—
section 52O determinations; and
input methodology determinations (for which a separate right of appeal is provided in new section 52Y).
Section 91(1)(b) presently provides that there is a right of appeal, by way of case stated for the opinion of the Court on a question of law only, against authorisations given under section 70 or 71. New section 91(1A) replaces this with a general right of appeal to the High Court on a point of law against any determination of the Commission. An effect of new section 91(1) and (1A) is that the only form of appeal against a section 52O determination is an appeal on a point of law.
Clause 18 amends section 92 to provide that any supplier or consumer may bring an appeal against a section 52O determination.
Clause 19 consequentially amends the opening words of section 93 of the Act, which is about what the High Court may do following an appeal.
Clauses 20 to 25 amend Part 7, which contains miscellaneous provisions.
Clause 20 amends section 98A, which gives a power to search for the purpose of determining whether there has been a contravention of the Act. The amendment provides that a reference to a contravention of the Act is extended to include a reference to contravening the requirements of any form of regulation under new Part 4.
Clause 21 consequentially amends section 103, which creates offences relating to the Commission's enforcement powers, by inserting references to failing to comply with notices given under any of new sections 53D, 53N, and 53ZC.
Clause 22 consequentially amends section 105 by omitting references to sections 70 to 74.
Clause 23 makes 3 types of amendment to section 106, which sets out various privileges. The first type replaces the references in subsection (5) to proceedings under sections 80 and 83 (which provide for pecuniary penalties) with a general reference to proceedings for pecuniary penalties. The second type omits references to spouses from subsections (4) and (5). This is for consistency with the Evidence Act 2006, which does not extend privileges against self-incrimination to spouses or others in close relationship. The third type is an amendment to subsection (6)(b) that changes a reference to section 103(1)(b) into a reference to section 103. The effect is that the protection against using certain statements in criminal proceedings will not apply to any criminal proceedings under section 103. At present, the protection does not apply only in respect of proceedings under section 103(1)(b).
Clause 24 replaces a regulation-making power that relates to the Commission's power to refund fees when accepting undertakings. At present, the power relates only to undertakings in respect of controlled goods or services. Under the new Part 4 regime, there will be no such undertakings, but the power is retained and now relates to any undertakings under the Act.
Clause 25 repeals sections 116 to 118, which are spent.
Clause 26 adds 2 new Schedules. New Schedule 5 relates to the ability of the Commerce Commission to incorporate other documents by reference in certain determinations. The Commission currently has this power when setting thresholds under Part 4A. New Schedule 6 lists the gas pipelines that are exempt from regulation under subpart 10 of Part 4.
Clause 27 amends the Electricity Act 1992, mainly to replace redundant references to the Corporation.
Clause 28 amends the Electricity Industry Reform Act 1998 to remove an obsolete reference to Part 4A of the Commerce Act 1986.
Clause 29 amends the Gas Act 1992 to replace redundant references to the Corporation.
Clause 30 amends the Airport Authorities Act 1966, mainly so that regulation of Auckland, Wellington, and Christchurch airports under the Commerce Act 1986 is recognised in that Act.
The discussion document released in April 2007 and subsequent submissions have identified a number of problems with the current legislation, including, unclear policy objectives, inefficient decision making processes, regulatory uncertainty, constraints on regulatory approaches, lack of certainty for efficient and timely investment for electricity lines businesses under Part 4A, and a relatively weak accountability regime for the Commerce Commission as regulator.
To address these problems the following key amendments are proposed:
specifying a specific purpose statement for Part 4:
a more conventional, qualitative test for when regulation may be imposed:
broadening the range of forms of regulation available under the Act to include information disclosure, a negotiate/arbitrate regime, and a default/customised price-quality path regime to replace Part 4A:
a requirement that input methodologies (how to determine the weighted average cost of capital, value assets, allocate common costs, etc) should be set as soon as possible by the Commission with the aim of improving certainty and predictability for businesses:
providing for merits review of Commission decisions on input methodologies.
It is also proposed that 100% trust-owned electricity lines businesses be subject to information disclosure only, while the default/customised price-quality path regime would apply to non-trust electricity lines businesses, and to gas pipeline businesses.
The Regulatory Impact Analysis Unit has reviewed the RIS and considers the RIS is adequate according to the adequacy criteria.
The objectives are to provide for a regulatory regime for businesses not subject to competition that—
is credible and coherent, provides sufficient disciplines on firms in markets with natural monopoly characteristics, and provides for incentives to invest in infrastructure:
provides clarity, certainty, transparency, timeliness, and predictability for businesses, and appropriate accountability mechanisms:
is appropriate for New Zealand’s small size (with small firms and limited resources).
Electricity lines businesses (ELBs) have argued that the Part 4A regime has increased uncertainty in the sector. This uncertainty can affect their cost of capital, thereby deterring investment. While industry complaint is not by itself proof of a problem, analysis of the current regulatory mechanisms indicates that the current regulatory model in Parts 4 and 4A has not kept pace with changes in the regulatory environment and international best practice. For instance, Part 4A devolves a significant amount of discretion and flexibility to the regulator, but that has come at the cost of increased uncertainty for business.
The purpose of the review was to identify whether the regulatory control provisions within the Act were achieving the intended regulatory objectives. The following issues were identified as part of the Review.
Currently there is no specific purpose statement for the generic regulatory control provisions in Part 4 of the Act, while the overall Commerce Act purpose statement is to promote competition (which is not feasible in natural monopoly markets). Submissions on the Commission’s 2 draft price control inquiry reports to date indicate that the purpose of the regulatory provisions may be unclear. In particular, there has been debate around whether Part 4 requires consideration of economic efficiency only, or whether consumer protection/distributional considerations should also be taken into account in the context of regulating firms and, if so, what the relative weighting between these objectives should be. There is also debate about whether the current purpose statement for Part 4A of the Act is appropriate given that there is no explicit reference to a key regulatory objective of providing for incentives to invest. Such debate and uncertainty does not fit well with the key regulatory objectives of clarity, certainty, transparency, and predictability.
The review identified weakness with the current tests for whether or not to impose regulation. The existing competition test is relatively low and it is likely that it applies to many markets in New Zealand including where control is clearly undesirable, and thereby fails to provide business certainty for when regulation is likely to be imposed.
The current acquirers benefit test (whether there are net benefits to acquirers from control) may not be appropriately targeted as it does not require explicit consideration of efficiency effects.
Currently the Act requires separate processes for decisions on whether and how control should be imposed. This means that a Minister's decision taken on whether to regulate will be based on incomplete information with regards to how control would be applied. If a Minister decides to regulate, the Commission is charged with doing the analysis again in order to identify how to regulate. This largely duplicative process can be costly and time consuming.
The Act currently does not require that the key technical decisions (input methodologies) relating to how regulation will be imposed be set in advance of control inquiries and the imposition of control. This has resulted in uncertainty and dispute throughout the regulatory process (such as the airports and gas inquiries).
The Commission’s regulatory decisions are subject to judicial review only. There is a general perception that the accountability regime for the Commission is weak, as judicial review applies to questions of law and process only and not the substance of a decision. Thus the regime is less capable of correcting regulatory error or improving the regulator’s decision making over time. This can impact on business/investor confidence in the regime.
The Act only allows a choice between no control or conventional price control. Broadening the choice of regulatory options provides a wider range of regulatory tools to ensure that the most “fit for purpose”
form of regulation is implemented in a given circumstance.
Part 4A is generally regarded by electricity lines businesses as unsatisfactory. The key weaknesses include as follows:
(a) uncertainty for firms over what happens in the event of a breach and the process, time frames, and criteria for assessing administrative settlement processes:
(b) absence of a mechanism for ex ante approval for major capital expenditure:
(c) lack of timeliness in decision making. There is no set time frame for when the Commission can open an inquiry following a breach or for making decisions. Once a firm has breached a threshold they can remain open to Commission action for a number of years:
(d) unusual penalties for a breach. Breaches may be minor, technical, and historic while the consequences can relate to any aspect of a firm’s activities:
(e) administrative settlements do not provide sufficient transparency, consistency, or precedent for the sector going forward.
Investors are less likely to make long-term investments spanning multiple regulatory periods under a regime where the rules are unclear or applied inconsistently.
Various options were considered for addressing the specific problems identified above. Individual proposals could be packaged in several different ways, for example, retaining the Part 4A thresholds while improving regulatory certainty by including the feature of input methodologies set in advance. The different options and the associated costs, risks, benefits, and opportunities are discussed below.
The status quo was considered for each of the proposed changes outlined below. In each case the failure of the current arrangements to meet the quality of regulation objectives listed above has counted against retaining the status quo. It is considered that the short-term regulatory uncertainty resulting from change is mitigated by the long-term benefits of a well-functioning regulatory environment.
The preferred option contains the following features:
(a) a regulation specific purpose statement for Part 4:
(b) a more conventional qualitative test for when regulation may be imposed:
(c) provision for additional forms of regulation, including a default/customised price-quality path regime for sectors to replace Part 4A:
(d) a requirement that input methodologies should be set ahead of any major decision making, as a stand-alone process:
(e) provision for merits review of Commission decisions on input methodologies.
The following options were considered:
(a) no purpose statement for Part 4 (status quo):
(b) a purpose statement that focuses only on improving efficiency upfront, with the implicit expectation that over time all consumers will benefit:
(c) a purpose statement that explicitly states that the objective of regulation is to improve efficiency and to protect consumers from excessive prices, similar to the Part 4A purpose statement (preferred approach).
It is considered unsatisfactory for there to be insufficient clarity about the objectives of economic regulation so option (a) was discarded.
Option (b), on balance, is problematic in the context of natural monopoly sectors. A key objective of economic regulation in New Zealand is the protection of consumers from excessive prices over the long term. This is achieved by explicitly providing for this objective in regulation. Thus, variants of the purpose statement developed in the context of option (b) were not considered appropriate and were discarded.
Option (c) includes both efficiency and distributional objectives, to provide for an appropriate balance between the protection of consumers and that of producers and investors. The proposed purpose statement is similar to the Part 4A purpose statement. Building on the Part 4A purpose statement will mitigate the risk of losing case law.
Several options were considered—
(a) for the test when regulation may be imposed: status quo, competition/market power only, or both market power and distributional considerations and net benefits (preferred option); and
(b) for the form of analysis: status quo, quantitative cost benefit analysis, qualitative assessment only, or qualitative with quantitative analysis where possible and practical (preferred option); and
(c) on the number of inquiries: A separate inquiry for whether to control/regulate and a separate inquiry for how control will be imposed (status quo), or 1 inquiry only (preferred option).
The benefit of the preferred options for the test for when control may be imposed is that they improve clarity and certainty for business. They also move away from the more controversial net acquirers benefit test which requires a trade-off between 2 things (ie, net economic cost against benefits to consumers) that cannot be compared in a meaningful way.
Providing guidance to the Commission provides comfort that qualitative analysis (with quantification wherever possible) is appropriate and will allow for timely and transparent analysis.
The main argument against a single process for the decision on whether and how to regulate is that it risks predetermining the processes and outcomes relating to control before a decision has been made to regulate. It could also result in the initial inquiry being more intrusive than if the 2 processes are considered separately. This risk is considered relatively low and is outweighed by the benefits of having more complete information for the decision on whether to control and the avoidance of costly and largely duplicative processes, ie, essentially 2 separate inquiries into the activities of firms.
It is proposed that a range of regulatory tools be provided for under the Act.
The availability of different regulatory options will enable the Commission to ensure that the most cost effective, “fit for purpose”
form of regulation is recommended in a given circumstance.
A number of submitters were concerned that providing specifically for less costly, lighter-handed forms of regulation may lower the threshold for intervention, noting that even lighter-handed forms also impose additional costs on business. This risk is mitigated by the legislative test for whether to impose regulation. The test will require the Commission to conduct an analysis to ensure that the benefits of regulation exceed the costs, taking into account the purpose statement.
The exact cost of enhanced information disclosure and negotiate/arbitrate options will depend on the final design detail. While there is general agreement regarding the benefits of information disclosure as a low cost tool to constrain the abuse of market power, the case for negotiate/arbitrate is more contentious. The costs and benefits for negotiate/arbitrate are outlined in the table below.
| Arguments in favour | Arguments against |
|---|---|
| Provides incentive for parties to negotiate a settlement | Parties look to the end-game (ie, arbitration/regulation) and position themselves to get the best outcome from arbitration/regulation |
| Less costly for regulator | Some submitters argue it could stall and frustrate investment |
| Parties able to customise settlement to meet own circumstances | Arbitration can be complicated where there are multiple services and parties |
| May improve relationships between suppliers and customers (some evidence from overseas) | Very difficult to get agreement of all parties, so arbitration is inevitable |
| Arbitrator/regulator only involved if parties fail to agree | May be less efficient than price control |
| Over time, parties get better at predicting arbitrated outcomes, speeding up settlement processes |
It is accepted that the negotiate/arbitrate model will not suit all circumstances. But as there may be cases where the benefits outweigh the risks (eg, where there are a few large parties) it is considered that the regime would be strengthened by providing specifically for this form of regulation.
A key feature of the new regime is the replacement of Part 4A with a default/customised price quality path regime (within Part 4). It is proposed that ELBs (except for 100% consumer-trust-owned businesses) and all gas lines business, except Nova Gas and the Taranaki pipelines, will transfer to this regime. The gas pipelines of Powerco and Vector (Auckland pipelines) that are currently controlled under the Commerce (Control of Natural Gas Services) Order 2005 will only be transferred to the new regime following the expiry of the order on 1 September 2016 or on such earlier date as may be agreed in the terms of any undertaking.
The 2 options considered were to—
(a) retain the Part 4A threshold regime with a few changes such as requiring the Commission to set input methodologies in advance of the reset of price-quality paths; or
(b) replace the Part 4A threshold regime with a default/customised price-quality path regime (within Part 4). This would provide for the Commission to set a default price-quality path for a sector (similar to the setting of sector-wide thresholds under Part 4A), and in addition would provide an ex ante, time-bound opportunity for an individual firm to seek a customised path. Under this regime, any breach of a firm’s customised price-quality path (or the default price-quality path if a firm remains on it) would be subject to conventional penalties and remedies that are proportionate to the breach (preferred option).
The arguments that have been made in favour of retaining the status quo and for option (a) above are broadly the same. These are that—
(a) much of the current uncertainty for businesses with the Part 4A regime is due to the current regulatory regime still bedding in (the current regime was introduced in 2001 and has only been through 1 five-year regulatory period). It has been argued that certainty will evolve over time as precedent is set, for example, as the Commission makes more decisions on administrative settlements; and
(b) as the Commission develops the regime further, future threshold resets under Part 4A could take into account future investment requirements to address the need for firms to have certainty around making substantial capital investment.
The main disadvantages with the retention of Part 4A are outlined in the problem definition above. Most submitters thought that these flaws were inherent features of the regime rather than issues that could be resolved over time. For these reasons option (a) was discarded.
There will be little additional cost to those firms that decide to remain on the default path as the default price-quality path will be set in a similar way to the current thresholds. For customised proposals the firm may choose whether or not to put forward a proposal. Firms that choose to put forward a proposal will face costs in the form of management/staff time and external expertise. Many of these costs are evident in the status quo, for instance, the cost incurred as part of an administrative settlement process. To minimise costs and potential for delay the proposal includes strict time frames, input methodologies set upfront, preset criteria for proposals, and statutory timeframes.
There is a risk that the Commission may be overwhelmed by proposals. To address this risk the Commission will only be obliged to make determinations on 4 proposals a year, and prioritise its work. Other proposals would be deferred to the following year, with the affected firms having to comply with the default price path in the meantime.
This creates a risk that some firms might make losses whilst their proposal is being considered because the default price path will apply. This risk has been addressed through allowing the Commission to provide for revenue recovery by the firm where the Commission subsequently sets a higher price path.
There will be additional costs to the regulator of administering the new regime, relating to—
(a) the preparation of input methodologies. However, the Commission already does much of this work anyway:
(b) administering a default/customised price-quality path regime for gas pipelines. In this area, the Commission should also be able to use the extensive information gathered during the inquiry:
(c) processing proposals for customised price-quality paths for electricity lines businesses. The additional costs from this compared to the current regime will be offset by Part 4A no longer applying to 17 trust-owned electricity lines businesses, and the Commission and firms no longer needing to negotiate administrative settlements:
(d) defending merits review on input methodologies. The additional costs from this should also be partially offset by fewer judicial reviews.
The benefit of option (b) is that it builds on the strengths of the Part 4A regime (namely, setting sector-wide price paths based on available information) while addressing its main weaknesses through providing an opportunity for firms to seek Commission approval of a customised path. The proposal will provide an effective regime that over time provides more timeliness, certainty, and incentives for investment. Almost all submitters supported some sort of replacement for the Part 4A regime. On balance, these benefits are considered to outweigh the incremental regulatory and business costs and short-term costs of uncertainty for regulated firms arising from changes to the status quo.
It is proposed that input methodologies be set up front in a stand-alone process at the start of an inquiry and any reset of price quality paths. The purpose is to provide greater certainty, transparency, and predictability to business.
A statutory provision that would require input methodologies to be set up front as a stand-alone process is consistent with approaches adopted in other jurisdictions such as Australia. There was support from almost all submitters for this proposal.
Setting input methods in advance will reduce the flexibility that is inherent in the current regime. It is considered that this risk is outweighed by the significant increase in business certainty. The replicability of the input methodologies will also benefit those in non-regulated sectors. For instance, it will ensure that those negotiating with monopolies can point to a standard model. It will also reduce the number of disputes and areas of contention when considering the appropriate control terms.
There is a risk that having to set input methods in advance will delay the decision-making process. Consequently, it is proposed to specify a statutory time frame for the Commission to complete input methods for the 3 sectors that are to be subject to regulation under the Bill. The Commission will be required to complete these input methods by 1 July 2010, but this deadline may be extended by the Minister for a further 6 months on written request by the Commission. In addition, any delay in setting input methodologies will likely be offset by the reduction of delays and disputes later on in the process of setting control terms.
Two main options have been considered for who should prepare the input methodologies, as follows:
(a) prepared and set by the Commission:
(b) prepared by an independent expert panel, and set as regulations/rules.
There are specific benefits and risks associated with each of the options relating to who prepares the inputs methodologies. The performance against key criteria is outlined in the table below.
| Criteria | The Commission (Option (a)) | Independent Panel (Option (b)) |
|---|---|---|
| Availability of expertise | Uses the Commission’s expertise and integrates well with the Commission’s current work streams. | It will be necessary to recruit the appropriate expertise to sit on the panel. |
| Quality of outcomes | The Commission is experienced at developing input methodologies and has extensive knowledge of the electricity sector. However, the Commission is likely to have a more conservative approach to developing input methodologies than an independent panel. | Would enable a fresh look to be taken at input methods and this approach is more likely to pick up suitable overseas examples. There is a trade-off between striving for “best practice”and certainty and timeliness, and this option improves the chances of striking a good balance. |
| The availability of merits review of input methodologies provides a check of the quality of the proposed methodologies. | It provides for separation of rule making from rule implementation, thereby limiting conflicts of interest. | |
| Political independence | No Ministerial/political involvement. | The Minister would be involved in appointing the panel and accepting or rejecting the recommendation of the Panel. |
| Cost | The Commission has estimated that the cost of developing the input methodologies will be $4 million over 3 years, depending on whether a form of merits review is available and the level of specificity required. | It is estimated that the work would cost $3 million (over 2 years). |
| Timeliness | The Commission estimates a time frame of over 3 years to develop methodologies and frameworks. Appeals to the High Court would involve additional time delays and costs to the Commission. | It is expected a Panel could make a recommendation by the end of 2009. |
An independent panel has the advantage of separating rule making from rule implementation, thereby reducing the likelihood of regulatory bias. However, a robust accountability arrangement (merits review) for the Commission is proposed. There is also a reduced risk of undue political involvement under option (a). It would be more difficult to ensure the neutrality and quality of decisions issued by an independent panel.
On balance, the advantages of the Commission’s sector-specific knowledge, expertise in developing input methodologies, political independence, and proposed accountability arrangements outweigh the advantages of option (b).
The cost of the developing input methodologies could either be government funded (ie, tax) or levy funded. As consumers will be the direct beneficiary of the proposed changes the use of levy powers is the most appropriate option.
In addition to the status quo the review considered whether to make available limited merits review by way of appeal to the High Court for a rehearing. Consideration was given to whether to provide merits review for decisions on input methodologies and control terms or for decisions on input methodologies only (preferred option).
Businesses submitters generally supported the introduction of merits review of the Commission’s decisions, noting the importance and far-reaching effects of regulatory decisions. The main arguments for and against merits review can be summarised as follows:
| For | Against |
|---|---|
| Improves accountability for the regulator | Gaming risk. Though can be mitigated by providing for full implementation of decisions pending conclusion of appeals |
| Likely better quality decisions over time | Cost (most likely recovered by way of a levy on regulated parties) |
| Allows for correction of errors of fact or judgement | Ties the Commission up (time, resource, and management focus) in the courts |
| Improves business confidence in the regulatory regime | Courts lack the specialist expertise of the regulator (notwithstanding lay members) and decisions may be different as opposed to better |
| Consistency with the rest of the Commerce Act | Results in delays and uncertainty |
| Merits review is available on clearances and authorisations | Likely pressure to extend to other sectors, such as telecommunications and electricity |
| Judicial review provides an effective discipline on Commission processes and ensures that decisions are not unreasonable. |
For accountability and transparency purposes some jurisdictions separate the rule maker from the rule enforcer, for example, in Australia, where the rule maker for the energy market is the Australian Energy Market Commission while the rule enforcer is the Australian Energy Regulator (AER). Decisions on the rules are not merits reviewable, though Australia is in the process of introducing limited merits review on AER decisions. In other jurisdictions merits review is often available on regulatory decisions at the end. For example, in the United Kingdom they do not separate the rule maker from the rule enforcer, but have merits review by the Competition Commission on regulatory decisions.
The associated risks of delay and gaming can be mitigated though careful design, for instance, by allowing the Commission’s decision to stand while the courts are considering the case. The overall improvements to the decision-making process outlined above may have the effect that relatively few decisions would go to appeal, thereby limiting the costs of making merits review available. Taking into account the ability to mitigate the risks of merits review and the high cost associated with regulatory error, there is a strong case for providing for merits review of Commission decisions relating to specific matters.
The proposals being recommended as part of this review, ie, clearer regulatory objectives, the ability for firms to propose control terms, and the provision of merits review of input methodologies, will strengthen the regulatory process and will limit the scope for error and dispute. The resulting stronger regulatory process weakens the case for merits review.
The case for having merits review of input methodologies, before a decision on whether and how to regulate is made, is stronger than for review at the end for decisions on the control terms. Decisions on input methodologies are considered integral to the regulatory process as a whole as they have a significant impact on the final outcome and apply to all regulated (and potentially regulated) businesses.
Different options for who should review input methodologies were considered. The 2 main options considered were—
(a) an independent expert panel appointed by the Minister chaired by a person with significant legal experience; and
(b) appeal to the High Court (with specialist lay members) (preferred option).
The pros and cons of each option are outlined below.
| High Court | Independent Panel |
|---|---|
| Pros | Pros |
| Established processes and procedures | Faster decisions than High Court |
| Low risk of further appeals (process or proper interpretation of law) | May allow for more tailored expertise |
| No suggestion of political involvement | Costs met by affected parties (levy) |
| Cons | Cons |
| Timeliness issues (may take up to 2 years) | Higher risk of further appeals |
| Courts may prefer to deal with case-specific applications rather than methodologies in the abstract | Perception of political involvement |
| May be difficult to assign judge with specialist expertise | More difficult to manage conflict of interest issues |
| Need to develop rules for processes and procedures | |
| Levy design may be difficult (fairness issues) | |
| Costs of members may be high |
There is a risk that any review of decisions about input methodologies is not suited for judicial decision making since they relate to fact, rather than interpretation and application of the law. There may also be difficulties in assigning Judges with specialist knowledge in this area. While many Judges have particular areas of interest and particular specialist knowledge, their role is to interpret and apply the law to a particular factual situation, rather than be a principal decision maker in matters which require highly specialised knowledge about input methodologies.
It can be argued that an independent body made up of specialists would have access to a greater level of expertise in this field as an independent panel will enable the appointment of people with the appropriate technical knowledge and skills. To mitigate this risk the proposal allows for the High Court to appoint lay members with specialist knowledge.
An appeal to the High Court is likely to take more time than an independent panel which could dedicate resource to such reviews. This could impact on the timeliness of inquiries under the Commerce Act as well as implementing regulation. However, establishing a panel is also likely to be a costly and time-intensive process, with the increased risk of subsequent appeal, when compared to the High Court option.
On balance, the consideration of appeals by the High Court is a more conventional approach, minimises the risk of further appeals and reviews (because processes are likely to be better), and minimises the difficulties of managing conflict of interest problems. There is also a reduced risk of undue political involvement.
It is difficult to estimate the likely costs which will be demand-driven. However, it is likely that there will be appeals for the first set of input methodologies with the number and extent of appeals reducing over time.
The following options were considered for regulating 100% consumer-trust-owned ELBs:
(a) 100% consumer-trust-owned business subjected to the same form of regulation as other ELBs; and
(b) 100% consumer trust owned business subjected to lighter handed regulation (such as information disclosure) (preferred option).
With respect to option (a), in principle the case for economic regulation is relatively weak where the customers are the owners of the firm. This is because the incentives of trusts to charge excessive prices are relatively low because excess profits are returned to the customer. Their relatively small size means that the cost of heavier handed regulation may outweigh the benefits.
A number of risks were identified for option (b) including the following:
(a) the risk of cross subsidies where voters may vote for trustees favouring lower prices for residential consumers subsidised by business; and
(b) voters/consumers may favour lower price at the expense of long-term security of supply; and
(c) increased cross subsidy to other activities or investments; and
(d) discouraging efficiency-improving amalgamations (though there is little incentive to do so under option (a) or the status quo).
The availability of information disclosure under option (b) will provide pressure on prices and efficiency. The Commission will be able to make a recommendation to the Minister that the default/customised price quality path regime be imposed on a trust firm under certain conditions, for instance, where it no longer qualifies for the lighter regime or where a substantial proportion of its customers have petitioned the Commission and the Commission concludes that a change in the form of regulation would better meet the purpose statement.
The ability for consumers to respond to increased prices or quality concerns by replacing trustees also mitigates the above risks.
Implementation of the proposals above requires amendment to the Commerce Act 1986. It is proposed that the Commerce Act Amendment Bill will be passed by mid 2008.
There will be a transition period for electricity lines businesses. The following transitional arrangement is proposed:
(a) eligible consumer-owned trusts will be subject to information disclosure regulation only from 1 April 2009:
(b) for remaining electricity lines businesses, the existing thresholds set under Part 4A of the Commerce Act will be rolled over from 1 April 2009 to become the new default paths under the default-customised price-quality regulation regime:
(c) the new thresholds will apply until 31 March 2010, whereupon the Commission will be required to reset the default price-quality paths under the new provisions:
(d) the Commission will set input methodologies by 1 July 2010 and electricity lines businesses will be able to submit customised proposals for consideration from that date:
(e) breaches of old Part 4A thresholds up to 31 March 2008 will expire unless the Commission has issued a notice of intention to declare control by 1 October 2008. If the Commission has made such a notice, the Commission has until 1 April 2009 to complete an investigation and determine whether to impose control under the old Part 5 of the Act or enter into an administrative settlement:
(f) breaches of thresholds after 1 April 2008 will be subject to the pecuniary penalty prohibitions in the bill:
(g) any administrative settlements or old Part 5 authorisations or undertakings in place as at 1 April 2010 would continue for their term.
The Commerce Commission will be responsible for implementing and giving force to the proposed regime. Officials from the Energy and Communications Branch will monitor the implementation and outcomes from the new regime as part of regular monitoring of the effectiveness of policy outcomes.
Ministry officials undertook extensive consultation with industry and consumer representatives. This included running an expert advisory group process to identify the key issues that should be addressed in the discussion document. A discussion paper was released in April 2007 with a 3 month consultation period. Submissions were received from 45 submitters. Opportunity was provided for those submitters who wanted to convey their key messages verbally to meet with Ministry of Economic Development (MED) officials. The key messages relating to each of the proposals is discussed in the main body of the RIS. Detailed consultations on design issues have been held with the Treasury, the Ministry of Justice, the Ministry of Transport, and the Commerce Commission.
In the light of the complexity of some of the design issues, a brief and informal period of consultation on design detail was carried out in concert with the legislative drafting process. Eighteen submissions were received and officials submitted advice to Ministers delegated by POL committee to make decisions consistent with the Cabinet decisions. The Ministers of Commerce and Energy, in consultation with the Ministers of Finance and Transport, agreed to further amendments including new transitional arrangements for electricity lines businesses and the adoption of a statutory time frame for the Commission to complete input methods.
Many airports have strong natural monopoly characteristics. A sound regulatory regime should enable the regulator to identify the extent of monopoly pricing which should encourage airports to price their services in a manner consistent with the outcomes of a workably competitive market. The current regulatory regime for airports fails to do this.
In the context of the review of the regulatory control provisions in the Commerce Act, some members of the aviation sector made a number of submissions on the regulatory regime for airports. MED received 8 submissions. The key problem identified with the current regulatory regime for airports is the lack of a credible information disclosure regime to constrain the exercise of substantial market power by major airports in setting airport charges. This problem has been exacerbated by the lack of guidelines on both the desired outcomes from the regulatory regime, and on appropriate input methodologies (how to value assets, calculate the cost of capital, etc) to provide guidance on desired regulatory outcomes.
To address the inadequacies of the current regime a strengthened information disclosure and price monitoring regime under the Commerce Act is proposed for the Auckland, Wellington, and Christchurch airports.
The Regulatory Impact Analysis Unit has reviewed the RIS and considers the RIS is adequate according to the adequacy criteria.
The over arching objectives of economic regulation of airports are to—
(a) provide a credible regulatory regime to address markets where competition is not possible:
(b) constrain the scope for exercise of substantial market power by airports:
(c) protect consumers from prices that would not be consistent with those in a workably competitive market:
(d) improve certainty, timeliness, and predictability for businesses; and
(e) provide for appropriate incentives for efficient investment in infrastructure, taking into account the benefits to end-users.
The intention behind the 1997 introduction of the disclosure regulations for airports under the Airports Authorities Act 1966 was to explicitly help guard against the possibility of monopoly pricing, and to help to better inform the statutory consultation process (refer to the second reading speech by Hon Jenny Shipley, Minister of Transport for the Airport Authorities Amendment Bill 6 March 1997, NZPD 729). The current information disclosure regulations are ineffective in this regard.
Many airports, particularly larger airports, have strong natural monopoly characteristics. This enables them to set prices above those that would prevail in a workably competitive market. Whilst other smaller airport companies are, strictly speaking, natural monopolies, few if any have market power, and most only have 1 airline customer, Air New Zealand, which has substantial countervailing negotiating power. Also, the recent review of the Commerce Act did not receive any comment relating to smaller airports. Consequently we have limited information on the nature of and extent of the problem and possible solutions for the regulation of smaller airports.
The 2002 Commerce Commission inquiry undertook extensive analysis and found that Auckland Airport was earning excessive rents and if the regulatory regime remained unchanged this would continue. The Commission also stated that the criteria for recommending control would also be met for Wellington Airport if prices were subsequently raised significantly. The Commission estimated that forecast excess returns for Auckland Airport would be $27 million over the 6 years from 2002. These forecasts did not include any potential revaluation gains that may have occurred in relation to land. To the extent that there would have been revaluations, these excess returns are likely to have been understated.
The Commission also stated that while any countervailing power by airlines might constrain airport behaviour at the margin, it was unlikely to be sufficient by itself to prevent the exercise or even abuses of market power. The Minister of Commerce in making her decision not to impose control, at the time, based her decision on analysis that overall efficiency costs were negative and consumer benefits were relatively low. Notably, in assessing the costs of regulation the assumption was that the form of regulation was price cap regulation which is a high-cost form of regulation, and the only form of regulation then available under the Commerce Act.
Since 2002, the regulatory regime for airports has not changed, and it is likely that the substantive analysis of market power undertaken in this inquiry is no less relevant.
The current regime lacks the requisite guidance around what information is required to facilitate effective negotiations between airports and users on the level of charges. This is likely to be a significant contributing factor (along with the lack of guidance) to the contentious and litigious features of the current regime. For example, in 1997 and again in 2002, following the setting of airport charges by Wellington International Airport Limited (WIAL), Air New Zealand and WIAL respectively took proceedings against each other. In 1997 Air New Zealand objected to WIAL’s investment programme, and in 2002 Air New Zealand refused to pay the charges set by WIAL based on its revaluation of its assets. Again, following the latest round of pricing announcements earlier this year, Air New Zealand has sought judicial review of the process undertaken by both AIAL and WIAL and BARNZ has been active in calling for a Commerce Commission inquiry (under Part 4 of the Commerce Act) into WIAL’s pricing.
The information provided is also generally insufficient to help the regulator or officials to determine whether excessive prices are being charged. For example, a 2001 review by Arthur Andersen Consulting for the Ministry of Transport found that the lack of clarity and specificity in the disclosure regulations meant that none of the disclosures would allow an interested party to understand the price-setting process to such an extent as to make a meaningful assessment for example, of the appropriateness of cost allocations.
The current disclosure regime does not specify a sufficient level of detail to determine whether airports are over-recovering or not. Some of the crucial components in assessing whether airport user charges are excessive or not are the input methodologies relating to how the value of the asset base is calculated (including how asset revaluations gains are treated) and how common costs are allocated. The disclosure regulations do not specify any clear requirement in respect of the appropriate methodologies that should be used by airports. The lack of specificity also contributes to contention, for example, about which assets should be included in the asset base for aeronautical pricing purposes.
The statutory requirement for airports under the Airport Authorities Act 1966 is to consult, not to negotiate. Because airports have the right to make investment decisions and set charges unilaterally (after consultations) it is inevitable, absent an independent dispute resolution mechanism, or credible and timely threat of heavier-handed regulation, that airports will tend to make decisions in their own interests. Again the lack of pricing principles and binding input methodologies mean that these are a major source of contention between larger airports and airlines, along with the outcomes of consultation.
Furthermore, the current disclosed information is not monitored or reported on at the departmental or regulator level. Thus, whether or not an airport is over-recovering based on the information disclosed is not compiled and presented by an independent body.
The option of taking no further action specifically on airport regulation, but to let the proposals relating to the regulatory control provisions of the Commerce Act take effect, was considered.
This option does not resolve the problems discussed above associated with inadequate information. Also, when compared to the preferred option, it does not provide additional checks on the misuse of market power and will not help facilitate effective negotiation between airports and airport users.
The threat of further regulatory action under the Commerce Act is likely to be a weak vehicle for constraining airports’ market power without an effective means of measuring and monitoring the information disclosed by the airport. Instead a costly inquiry would be needed to determine whether there are grounds for economic regulation.
In addition to the status quo there were 4 options considered for the regulation of airports as follows:
(a) do further work through an independent consultancy study or a Commerce Commission inquiry to identify whether there is a problem, and if so make recommendation on the best solution; and
(b) make a decision now to impose an improved information disclosure regime and a negotiate/arbitrate regime (for international airports) under the revised Commerce Act; and
(c) make a decision to impose price control under the current Commerce Act on major international airports; and
(d) make a decision now to improve the information disclosure regime and undertake price monitoring (preferred option).
The benefits of this option are that it provides for a full review process to consider the nature of the problem to be addressed, the magnitude of this, and the options available to address this. It would also be fully consistent with Government statements on quality regulation being based on evidence and rigorous analysis.
Commissioning an independent review by a consultancy firm or the Commission on whether airports are overpricing and whether there would be net benefits in introducing further regulation, and on the best type of regulation, would cost up to $500,000 and take around 6 months. A full inquiry under Part 4 of the Commerce Act by the Commission could take about 18 months to 2 years and cost around $2 million.
While there are advantages in taking additional time to identify more evidence and undertake further analysis, this will not necessarily lead to a different or better outcome. There is sufficient information from previous reviews, as well as in submissions made on the review of the Commerce Act, regarding the inadequacy of the current information disclosure regime and thus it is unlikely that a full review undertaken in the near future will reveal any significantly or materially different issues that have not been raised previously. Thus, it may just lengthen the process for making a decision for little further benefit. Therefore, this option was discarded.
The benefits of the improved information disclosure regime under this option would be the same as set out below in the preferred option (option (d)), although it can be argued that this would better facilitate effective negotiation.
A negotiate/arbitrate regime should provide incentives for parties to negotiate a settlement, and parties would be able to customise settlements to meet their own circumstances. As a result, it could improve relationships between suppliers and customers. The arbitrator is only involved if parties fail to agree—this reduces costs compared to an option such as price control. Also, over time, parties should get better at predicting arbitrated outcomes, which will again speed up settlement processes.
The risks of such a regime are that parties look to the end game (ie, arbitration) and position themselves to get the best outcome from the arbitration. This may not be conducive to constructive commercial negotiations. The design issues such as the process for invoking arbitration would be important in limiting vexatious and/or trivial requests for arbitration. Should arbitration be too easily invoked, it could become the default form of regulation, rather than a form of regulation only resorted to after constructive commercial engagement.
Some airports also expressed concern that a negotiate/arbitrate regime would stall and frustrate investment, and pointed out that arbitration can be complicated where there are multiple services and parties. As a result, it could be difficult to get the agreement of all parties, which would mean that arbitration is inevitable.
To mitigate the risk of incumbent airlines refusing to pay for capital investment that would encourage or facilitate increased competition by new entrant airlines, it would be proposed that arbitration be required to consider the benefits to end-consumers of investment in facilities reasonably required to improve competition among airlines. Arbitration under the Commerce Act would also be subject to guidance from a proposed regulatory specific purpose statement that explicitly refers to incentives to invest.
Additional costs of arbitration are difficult to estimate as it will depend on the scope of any arbitration. A rough estimate would be an average of $300,000 per arbitration. This allows for 40 days (an indicative time frame for the purposes of cost calculations only) for an arbitrator at $3000/day, plus $100,000 for specialist assistance, plus $80,000 for travel, accommodation, administration, and sundries.
On balance, given the potential risks and costs associated with the negotiate/arbitrate model, it is considered that further work on whether an alternative regulatory regime to the proposed information disclosure regime is necessary.
It is considered that price control should not be considered without a full inquiry. It is a relatively high-cost option when compared to the status quo and preferred option (option (d)).
This option would involve moving the regulation of Auckland, Wellington, and Christchurch airports into the enhanced information disclosure regime provided for under the amended Commerce Act. Under this provision, the Commission would develop input methodologies that the airports would be required to use in preparing information for disclosure. The Commission would also develop additional input methodologies on pricing principles and cost of capital that the Commission would use for monitoring and reporting on the information disclosed by airports.
This regime would be along similar lines to the Australian regime for larger airports which provides pricing principles, information disclosure, and price monitoring and reporting by the ACCC. In most other OECD countries, larger privatised international airports are subject to some form of price cap regulation.
The advantage of this option is that it significantly improves the value and relevance of the information disclosed. Providing for specification of input methodologies provides better information to guide consultations between airlines and airports and pricing decisions. The proposed regulatory specific statement under the Commerce Act would also provide guidance on desired regulatory outcomes. This, together with providing an explicit role of monitoring and reporting by the Commission, should also create a more credible threat of further regulation if prices are shown to be excessive. Improved information disclosure will also allow the regulator to identify whether regulation should be removed.
Specification of binding input methodologies would also remove much of the contention under the current regime. This reduces the scope for dispute, which could mean settlements are reached quicker, and at less cost, and that there are greater incentives to improve commercial relationships.
The input methodologies required for robust information disclosure (such as asset valuations, revaluations, and allocation of common costs) would be binding, while methodologies such as pricing principles and how to calculate the cost of capital (which are required for monitoring and analysis) would be in the form of guidelines against which the disclosed information would be assessed. This would allow airports and airlines and other customers to reach commercial agreements taking into account efficiency, productivity, investment, and other issues while providing clear guidance to assist commercial negotiations.
The application of this regime can occur under either the Airports Authorities Act or the Commerce Act. On balance, the preferred option is to move the regulatory regime for the setting of airport charges by Auckland, Wellington, and Christchurch airports into the Commerce Act. The regulatory provisions of the Commerce Act are specifically designed to address monopoly pricing issues and the proposed regulatory specific purpose statement will guide decisions about appropriate/desired regulatory outcomes. The Commerce Act will also provide for cross-sectoral consistency and has processes and tests/criteria for further inquiries on whether more (or less) regulation is warranted.
The Commission estimates that the main one-off costs for it to prepare input methodologies for information disclosure are estimated at $1.4 million with ongoing costs for administering the information disclosure regime of $400,000 per annum. These costs would be able to be recovered by levy on the 3 relevant airports. Airports and airlines would continue to incur the costs of consultation and litigation. Costs for airports and airlines are likely to be lower than currently as a result of fewer disputes about methodologies.
Implementation of the proposals in this paper requires amendment to the Commerce Act 1986. It is proposed that a Commerce Act Amendment Bill will be passed by mid 2008.
The following transitional arrangement is proposed:
(a) the Commission to develop and prepare generic input methodologies (including pricing principles) for airports to be ready by July 2010; and
(b) the Commission to specify the information disclosure requirements by July 2010 and for the information disclosure requirements to take effect from then; and
(c) disclosure for the regulated airports would be 3 months after the end of a financial year; and
(d) until the input methodologies and information disclosure requirements are finalised, the current information disclosure regulations under the Airport Authorities Act will apply.
Major airports and the airline sector were active in making submissions on the review of the regulatory control provisions in the Commerce Act, and specifically highlighted issues with the regulatory regime for airports. Submissions were received from Air New Zealand, Auckland International Airports Limited (AIAL), the Board of Airline Representatives in New Zealand (BARNZ), Christchurch International Airport Limited (CIAL), the International Air Transport Association (IATA), Peet Aviation, Virgin Blue, and Wellington International Airport Limited (WIAL).
After meetings during consultation with AIAL, WIAL, BARNZ, and Air New Zealand, these parties further submitted on questions posed, and on possible options for regulatory change.
Major airports (AIAL, WIAL, and CIAL) maintain that the current regulatory regime is largely satisfactory. They say that consultation requirements are taken seriously with airports making adjustments to their proposals (in terms of input methodologies, proposed capital expenditure, and charges) as part of this. Judicial review also provides a check on consultation processes. They also state that they take the threat of price control under the Commerce Act very seriously, and that their prices are not excessive and that their charges are generally mid-range compared to international airports overseas.
Airports also claim that some airlines, and in particular Air New Zealand, oppose investments in new facilities required to attract new entry by competing airlines and that this is to the detriment of the travelling public. Airports have also expressed the view that the ability to set charges as they see fit provide a “circuit breaker”
when it does not prove possible to reach agreement. This enables the airports to get on and make investments.
The airlines (BARNZ, Air Zealand, Virgin Blue) and IATA, on the other hand, argue that New Zealand’s regulatory regime lacks credibility. They argue that the information disclosure regime lacks rigour and value because there are no guidelines or methodology specified and the consultation process is unsatisfactory. The absence of guidelines or binding input methodologies is a major source of dispute and means that consultation processes are time-consuming and costly. The statutory power for airports to set charges as they see fit appears to be unique and, as a result of the regime’s current design, the airports can and do make unilateral decisions on investments and set charges as they see fit.
The objective of the Review of the Authorisation and Clearance Provisions of the Commerce Act 1986 is to improve the effectiveness and efficiency of the authorisation and clearance processes. Three issues have been identified as suitable for inclusion in an amendment Bill. The following amendments are being considered:
providing for the enforcement of undertakings that have been approved as part of a merger clearance or authorisation application; and
allowing the Commerce Commission (the Commission) to approve variations of undertakings; and
removing the 20-day statutory time frame within which the Commission is required to hold a conference.
The Ministry of Economic Development has reviewed the RIS and considers that the RIS is adequate according to the adequacy criteria.
The objective of the review is to test whether some possible changes to Part 5 of the Commerce Act 1986 (the Act) could improve the effectiveness and efficiency of the authorisation and clearance systems. The following issues have been identified.
The inability of the Commission to separately enforce undertakings given under section 69A of the Act is unsatisfactory. Weak enforcement provisions provide an opportunity for parties to game the legal system as they can consummate a merger that was approved based on an undertaking, and later advise the Commission that they tried to dispose of the relevant shares or assets but were unable to find a buyer that was prepared to pay a reasonable price. This means that a merger would have occurred that the Commission may have otherwise declined if it were not for the undertaking. There has only been 1 example in recent years where a divestment deed to undertaking was not given effect to. While the magnitude of the problem is small there is an opportunity to improve the effectiveness of the status quo.
The Commission does not have the ability to amend an undertaking once a merger clearance or authorisation decision has been made. This can mean that the acquirer will lose the protection provided by the approval if it does not implement the merger strictly in accordance with the approved undertaking. Thus, immunity from legal challenge by a third party would be lost even if a variation involved only minor changes that had no bearing on competition.
Section 62 of the Act provides time limits within which the Commission would be required to hold a conference following the release of its draft determination for restrictive trade practice authorisation proceedings. The process is inconsistent with the timing for merger authorisations. This lack of consistency between the 2 processes can be problematic when an application has both merger and trade practice implications, as it can be difficult to operate the procedures in parallel.
The objective of the review is to provide for a regulatory regime that provides clarity, certainty, and transparency of decision making, encourages participation of interested parties and timeliness of decisions, and reduces business and administrative costs.
The retention of the status quo in each case is unlikely to result in significant harm and were considered as viable options. However, on balance, the preferred options present an opportunity to improve the efficiency and effectiveness of the authorisation and clearance processes and are unlikely to result in additional costs to government, businesses, and society.
The following options were identified to address the problems outlined above.
It is proposed to allow for the Commission to apply to the High Court to enforce undertakings given under section 69A of the Act to divest assets or shares if the Commission can show that the parties failed to comply with the undertaking. The objective of the proposal is to provide a strong incentive to comply with undertakings and reduce the administrative burden of enforcement.
The proposed option strengthens the current incentives for firms to comply with an undertaking and will reduce the risk of potential gaming. It will also reduce the costs and improve the timeliness of enforcing undertakings and will enable the Commission to have greater confidence in accepting undertakings offered. This amendment is also consistent with other jurisdictions, such as Australia, that provide for the separate enforcement of undertakings.1
As a general rule, law that includes provisions that cannot be easily enforced is unsatisfactory and ineffective. A requirement on the Commission to demonstrate to the High Court that 1 or more orders should be made is also sound from a transparency and accountability perspective.
Under this option, the affected parties would not be able to put forward the defence that the merger did not breach section 47 of the Act, because the question for the High Court will be whether the parties complied with the agreed undertaking only. One submission identified the risk that the Commission may apply to the High Court to enforce an undertaking in cases where non-compliance has not led to an adverse effect on competition.
The risk outlined above is small. The Commission is unlikely to make an order to the High Court to enforce an undertaking for an activity that clearly does not raise competition concerns. The proposal (outlined below) to provide for the Commission to accept minor variations to an undertaking will also alleviate this risk.
It is proposed to amend the Act to allow the original applicant to seek a variation to an approved undertaking to divest shares or assets as part of a merger clearance or authorisation application. The Commission would be able to approve the variation if it were considered that the variation was minor, or would not otherwise defeat the original decision or the competition or public benefit objectives of the Act.
Presently, an applicant who decides that compliance with an approved undertaking may be unnecessary or counterproductive has 3 choices. It could comply with the undertaking in full, although this may result in assets being divested unnecessarily. It could carry out a variation to the undertaking with the knowledge that the protection of the Commission’s approval will not apply. This option does not rate well from a business or legal certainty standpoint. Lastly, the applicant could reapply to the Commission for a clearance or an authorisation with the proposed revised terms. This option rates poorly in terms of timeliness and cost effectiveness for a firm, and poorly in terms of the efficient use of the Commission’s limited resources. Greater flexibility would provide the opportunity for minor variations to be made without losing the original protection.
The ability to vary undertakings after the event may encourage parties to make spurious applications in the hope that it will be impractical to sell the assets by the time the Commission has made a decision. This risk is considered to be minimal as long as the undertakings could be enforceable through correction, punitive, and compensatory orders.
It is proposed to remove the 20-day time limit within which the Commission would be required to hold a conference following a request for a conference to be held.
The current time frames are arbitrary, unnecessary, and do not serve any purpose. There is a lack of consistency between the time frames for the merger authorisation process (there are no interim time frames within the merger authorisation process) and this can be problematic when both processes must be considered as part of 1 application.
These amendments will require changes to the Commerce Act 1986. The Ministry of Economic Development is responsible for reviewing the effectiveness of the Commerce Act 1986.
A discussion document on the authorisation and clearance provisions within the Commerce Act 1986 was published and 33 submissions on the issues raised within this document were received. Officials have also consulted with the Treasury, the Commerce Commission, and the Ministry of Justice regarding the administrative and low-level policy issues within the Part 5 review that are proposed to be progressed. The majority of the submissions supported the proposals.
1 Note that the Australian Trade Practices Act 1974 provides for the enforcement of a wider-range undertaking than is being proposed here.
