Building trust in regulation: A global study of operator-regulator relationships

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member fi rms of the KPMG network of independent fi rms are affi liated with KPMG International. KPMG International provides no client services. No member fi rm has any authority to obligate or bind KPMG International or any other member fi rm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member fi rm. All rights reserved.

ECONOMICS & REGULATION

Building Trust in Regulation A global study of operator-regulator relationships

ADVISORY

1. Foreword 1

2. About the research 2

3. Executive summary 3

4. Introduction 5

5. The state of relationships 7

6. KPMG Comment: Working more constructively together 11

7. The consequences of mistrust 13

8. KPMG Comment: Emerging issues in emerging markets 20

9. The mechanics of trust 21

10. KPMG Comment: Building firm foundations for the

regulatory process 25

11. KPMG Comment: Tackling uncertainty, safeguarding

investment 27

12. The people factor 29

13. KPMG Comment: Converged data, improved performance 31

14. Conclusion: A positive outlook for trust 33

15. Appendix: Survey demographics 35

5 BUILDING TRUST IN REGULATION

Contents



Foreword

Trust is the glue that holds relationships together but also the lubricant that keeps things moving. This study, from the Economist Intelligence Unit, commissioned by KPMG International examines the current state of trust between regulators and the industries they regulate around the globe.

Many of the findings relate to the need for better communication and ensuring that regulators and operators can establish a common understanding between one another: concerns that KPMG firms care deeply about and work with many clients to address.

While it is encouraging that levels of trust seem to be improving, these relationships can be extremely fragile. Moreover, as global economic uncertainty continues, the potential cost of related regulatory uncertainty is an unnecessary burden at a time when investment and revenues are under threat. Now, more than ever, trust between parties is critically important.

This is not to say that we all ‘hug a regulator’, or that we throw away robust regulatory strategies, or that regulators shouldn’t take decisions that might negatively affect certain stakeholders, but it’s the environment in which you communicate those decisions that is important: one characterized by respect.

We hope that the findings stimulate further thoughts in an area of consistent change and challenge and would be delighted to talk with you about what KPMG firms are doing to help our clients build levels of trust that enable better regulation and benefi ts to the economy.

Finally, I would like to thank the survey’s participants and interviewees for their time.

David Thomas Global Head of Communications Regulation, KPMG


BUILDING TRUST IN REGULATION 2

About the research

KPMG International commissioned the Economist Intelligence Unit to write Building Trust in Regulation. The report is based on the following research activities:

The Economist Intelligence Unit conducted a survey, completed in 2009, of 213 executives who are closely involved with the regulation of current and former utilities. The survey brings together practitioners from both sides of the commercial operator-regulator divide, including 165 respondents from operators and 48 from regulators. All are closely familiar with their organization’s key regulatory relationships, and they hail from fiv e heavily regulated industries – telecommunications, power, water,

transport and post. The survey sample is global, with 36 percent of participants based in Europe, 23 percent in North America and 20 percent in Asia-Pacifi c. A total of 77 respondents – 36 percent of the sample – are based in developing countries.

To supplement the survey, the Economist Intelligence Unit conducted a program of interviews with senior executives of both commercial operators and regulators in the aforementioned industries. We are grateful to the survey participants and interviewees for sharing their valuable time and insights.

The views and opinions expressed herein are those of the Economist Intelligence Unit and do not necessarily refl ect the views and opinions of KPMG International or KPMG member fi rms. The KPMG comment sections were written by professionals from KPMG member fi rms.



Executive summary

Recent revelations of failures in regulatory oversight have helped to put regulation under the microscope.

Effective regulation resulting in effi cient markets, however, is the result not only of the regulator’s performance but also of the quality of interaction between the regulator and the market’s commercial players. In heavily regulated sectors where existing or former public utilities are dominant – telecommunications, power, water, transport and post1 – and where policy reforms over the past two decades have created new regulatory bodies and competitors, relationships between regulator and regulated have frequently been troubled. Trust is the foundation of any good relationship; it has arguably been in shorter supply among market players in these sectors than others, and the lack of it has stifled aspects of market growth even in fast-growing economies.

This study of operator-regulator2 interaction in five heavily regulated sectors reveals, perhaps surprisingly, a large percentage of regulatory relationships in which the parties deem the level of trust to be “high”. However, the research – based on a global survey of 213 operator and regulator executives, as well as a series of one-onone interviews with practitioners – also suggests that relationships in some sectors and parts of the world are weaker

than others. It also makes clear that, even where relationships are good, trust is an extremely fragile commodity which does not take much to undermine. Mistrust often breeds uncertainty, which can have tangible negative consequences for market players.

Following are the main conclusions of the research:

• Operator-regulator relationships are

evolving for the better. This is encouraging in a global context that has seen renewed calls for a more vigorous approach to regulating competitive markets. More executives in our survey characterize the level of trust between operators and regulators in their sector as “high” than those who think the opposite, and more participants believe that operator-regulator relationships are improving than those who see deterioration. Operators are less satisfied than regulators with the levels of mutual trust, and operators in developed economies are not as positive in their assessments as their counterparts in the developing world. But majorities of both operators and regulators in our survey expect improvement in their mutual relationships in the coming years.

• Breakdowns in trust often result from

regulatory uncertainty, which can

negatively impact industry

development. Uncertainty and a resulting loss of trust carry a variety of

1 This study’s coverage of the power sector includes electricity and gas utilities. In the transport sector the research focuses on railways, airports and other ports.

2 The term “operator” is used in this report to refer to commercial service providers in the five sectors covered by our research. Other terms, such as “utility” or “company”, are also commonly used in different parts of the world to describe these entities.



potential consequences for market players, from direct financial losses to an increase in litigation. Operators in the survey cite the most frequent outcomes of regulatory uncertainty to be direct increases in cost, lost revenue, cancelled or postponed investments, business initiatives put on hold or increased litigation. Taken at overall market level, the uncertainty can quickly translate into slower market development and service penetration.

• Achieving genuine trust between

operator and regulator hinges on

the development of a mutual

understanding of each side’s

objectives and constraints. With each party’s perception of the other shaped by its own experience, culture and market interests, the ability to understand the influences and motives driving the other side is a vital factor in building trust. Operators are adamant that regulators must achieve a greater appreciation of business operations and risks. Regulators, for their part, insist that operators gain an improved knowledge of regulatory and policy objectives.

• Transparency of processes and clarity

of the regulatory framework increase

levels of trust. The trust gap widens on issues that are susceptible to political influence and unpredictability, while routine, process-oriented interaction tends to proceed more smoothly for the parties. For example, both operators

and regulators highlight licensing as a largely problem-free area of interaction, with monitoring and compliance, consumer protection, and data transfer also proceeding relatively smoothly.

• Industry consultations, a key tool in

building trust, will widen the trust

gap if they are more form than

substance. While the survey revealed a consensus on the need for consultations on key issues, several operators voice concern with the consultation process itself, complaining that regulators treat consultations as no more than a formality. Generally speaking, operators also tend to value informal consultations over the public variety. By contrast, regulators seem more wary of such informal exchanges, which they see as contradicting the need for transparency.

• Trust suffers without strong

mechanisms to share relevant and

accurate information. The provision of relevant information is another important rung in the trust-building ladder, but information-sharing remains an area of friction between operators and regulators. There is a substantial gap between the regulator’s need of information to fulfill its mission, and operator willingness to share information, owing to concerns around confidentiality and relevance of information. Ultimately, the parties must work together to make the information-sharing process productive.

• Processes and frameworks are

important, but people and personal

relationships are the critical

ingredients in building trust. Asked to identify the most important contributors to an effective operator-regulator relationship, both groups of survey respondents point with equal emphasis to good personal rapport between senior executives from both parties. Strong personal relationships help to smooth potentially antagonistic relationships by offering each side some visibility into the motives and constraints of the other, and they ultimately help build trust among the parties.



Introduction

The role of industry regulation across the world has risen in prominence with an economic crisis brought about – at least in part – by regulation in a number of sectors that appears to have been inadequate to the task.

Even prior to the global downturn, however, the fundamental nature of market regulation was already evolving in a number of industries. Rapid technological change and increased competition broke the traditional, silo-based structure of the telecommunications market, for example. In many countries, increased environmental concerns refocused regulation in the energy and water sectors even as they were being opened to competition. Security considerations led to an expansion, in some parts of the world, of the regulatory purview in the transportation sector.

To societies and governments, the effective regulation of certain industries is a necessity in order to ensure that the latter’s services or products are made available to the population in as affordable, safe and efficient a manner as possible. This is particularly the case when it comes to services provided by existing and former “public utilities”, such as telecoms, water, power, post and transport. The suppliers of these services and products also benefi t from good regulation in many ways, but many of the largest suppliers tend to view regulation less as a virtue than as an unavoidable aspect of doing business.

Over the past two decades, markets for these services have been liberalized to some degree in many parts of the globe, resulting in the emergence of competitors to erstwhile monopoly providers. This has not only made the regulatory agencies’ tasks more complex, but has greatly


“As a consequence of the economic crisis, we are in a fundamentally different place than we were fi ve ye ars ago,” according to Lord Carter, former UK Minister for

Communications, Technology and Broadcasting, speaking of the challenges facing regulators and policymakers in

today’s environment. Rapid response to problems posed by the crisis is imperative, he says, but existing policy

frameworks do not necessarily allow for this.


expanded the scope for potential confl ict between regulators and regulated. In many heavily regulated industries, the numbers of people employed to deal with these issues – both at regulators and commercial providers (here termed “operators” for convenience of use) – have expanded in a like manner.

This expansion reflects a recognition on the part of both regulator and operator that smooth and effective interaction usually benefits both the industry as a whole and most of the players that operate in it. In turn, effective regulation is now widely acknowledged as a core foundation of a sustainable industry growth framework.

Even as regulators become more engaged, however, their effectiveness in increasingly competitive environments has become a function of their ability to act as – and be seen to be – independent arbiters. In this context, trust between regulator and

operator is a crucial requirement of regulatory effectiveness. Operators need to trust the regulator’s ability to maintain distance from both policymakers and other operators, to deliver consistent, timely and transparent decisions, and to have the requisite authority to oversee the sector. Conversely, regulators need to trust operators to abide by established rules and be co-operative. As this study makes plain, the ability to build trust in regulation requires enormous patience and fortitude from regulators and operators alike.



The state of relationships

The level of operator-regulator trust in the fi ve industries researched in this study is surprisingly strong in light of the expanding role of regulation across industries and countries over the past ten years.

More executives in our survey characterize the level of trust – between operators and regulators – in their sector as “high” than those who think the opposite. Similarly, trust-building seems to be moving in the right direction: more participants believe that operator-regulator relationships are improving than those who see deterioration. While by no means glowing assessments of the mutual relationships, these findings are encouraging in a global context that has seen renewed calls for a more vigorous and potentially more intrusive approach to regulating competitive markets.

Lord Carter, for one, is not surprised by the improvement in relationships and the relatively high levels of trust registered in the survey. One reason for this, in his view, is a vast improvement achieved in the quality of regulatory execution in recent decades. “In the UK and elsewhere in Europe, we have seen a ‘professionalization’ of the regulatory discipline in the last 25-30 years.” An increasingly professional and thorough approach on the part of regulators helps also to engender respect – and trust – from operators.

The assessments of trust are not uniformly positive across all groups of executives. Operators, for example, are more guarded than regulators in their appraisal of existing levels of trust. Among operators, views also differ between executives based in developing economies – where 42 percent of operators say relationships are improving – and those in developed economies – where only 23 percent say they are.



How would you characterize the overall level of trust that exists between

operators and regulators?

Very high

High

Neither high nor low

Low

Very low

Don’t know

1%

8%

33%

39%

15%

4%

Operators

8%

61%

21%

10%

Regulators

Source: Economist Intelligence Unit 2009

How, if at all, has your operator–regulator relationship changed in the

past year?

It has improved

It has remained the same

It has deteriorated

Don't know

2%

12%

56%

30%

Operators

10%

48%

42%

Regulators




The varying assessments may be explained by different levels of maturity of the relationships or sector dynamics at a given point in time, among other factors. Operators, moreover, who do not benefi t from all regulatory decisions, may be expected to display a slightly more critical perspective on relationships. Still, the larger point remains that regulator-regulated relationships appear to be evolving for the better.

What’s going right?

Precisely what is working better will also vary in line with individual and institutional experiences, but there are some common threads. The regulatory manager of an Asia-

Pacifi c electricity provider points to the clarity of the regulatory framework in his national market and the clear demarcation that exists between those who make the rules and those who enforce them. While this contrasts with many markets where responsibility for both regulatory rules and their implementation lie with a single body, clarity as to where accountability lies remains key.

More transparency of regulation, at least in some markets, is contributing to better relationships. Patricia De Suzzoni, Director of Markets with France’s energy regulator CRE, believes that regulator efforts to increase the levels of transparency have contributed positively to building trust. This

is particularly the case in areas of operator-regulator interaction that are process-driven and clearly outlined. “The level of trust is higher when an issue is subject to global, objective analysis and scrutiny,” says Sean Williams, Managing Director, Retail Strategy, with BT, the United Kingdom’s largest fixed-line telecoms operator. “Lower levels of trust exist,” he maintains, “concerning issues that are susceptible to political influence and unpredictability.” “Routine functions tend to go smoothly,” agrees Julie Veach, Acting Chief of the Competition Policy Division at the US Federal Communications Commission (FCC), “while larger policy issues bring tougher discussions.”3

In which operational areas does interaction between operator and regulator

work smoothly? (Top responses)

0 10 20 30 40 50 60 70 80

49% Licensing 65%

42% Monitoring and reporting on regulatory compliance 52%

41% Consumer protection issues 44%

37% Transfer of operational data 50%

36% Tariff regulation 42%

35% Quality of service issues 58%

31% Policy consultations 54%

21% Market definition 29%

19% Resolution of disputes with competing operators 38%

6% None 4%

Operators Regulators


3 Julie Veach’s remarks, here and elsewhere, reflect her personal views only and are not necessarily the official position of the FCC


BUILDING TRUST IN REGULATION �0

The survey findings support these views. Both operators and regulators, for example, highlight licensing as one area that has benefited from largely problem-free interaction, with monitoring and compliance, consumer protection issues, and data transfer also cited as areas of relatively smooth interaction.

The impact of market structure on trust

The ability of market participants to develop and maintain a relationship of trust is also a function of the dynamics that shape the overall operating environment. Operators in markets with high competitive intensity, for example, seem to offer a dimmer view of relationships with the regulator.The highly competitive telecoms sector provides an illustration: only 32 percent of operator executives in this sector characterize the level of trust in their market as high, compared with 52 percent of their counterparts in other sectors.

“This is a very difficult environment,” states Karabo Motlana, CEO of South African telecoms regulator ICASA, about his country’s telecoms market. “As the regulator introduces more competition in the sector,” he says, “people tend to be

suspicious of the drivers of and the influences on decision-making.”

Important though they may be, market dynamics are only one part of a complicated equation.Trust is also in the eye of the beholder, with each player’s perception of the other party shaped by its own experience, culture and market interests. “Trust in the regulator is largely an issue of corporate culture,” says Ms De Suzzoni. Some operators may regard regulation more favorably if they are set to benefit from it, while those that stand to see their position negatively impacted by regulatory action may be more guarded towards the regulator.

Regulatory conservatism induced by a sense of self-preservation can develop into a full-blown suspicion of any regulatory action. Steve Smith, Managing Director, Networks at Ofgem, the UK energy regulator, points out that some operators have an inherent conservatism that makes them more guarded about regulatory action. “It’s not that operators don’t trust the regulator”, says Mr Smith. “There is just a risk aversion ingrained in operators that makes them sometimes not give the benefit of the doubt to the regulator.”

A modicum of structural stability is also important in building trust.The tenure of the regulator, a track record of reliability and – as already discussed – transparent processes are critical foundations. Ofgem, for example, has been regulating the British energy sector for the past twenty years, a tenure that has built some goodwill for the regulator.

More broadly, trust in the regulatory process is also often an extension of market participant trust in the political and policy processes. Regulatory bodies are a reflection of the institutional framework within which they evolve, argues Michael Pollitt, Assistant Director of the Electricity Policy Research Group at the University of Cambridge. In turn, the best regulatory agencies – or at least those perceived as such – are typically found in countries that have strong political and competition institutions, notably in western and northern Europe.To illustrate this point, around one-third of the operators in our survey that had noted a deterioration in their relationship with the regulator pointed to political uncertainty at government level as the primary factor, with 36 percent also pointing to excessive government influence.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.


KPMG Comment Working more constructively together

Building trust in the regulatory relationship is about improving the efficiency but not changing the fundamental dynamics of the relationship between a regulator and operator.

Respondents indicated in the survey that a better understanding of business operations and risks on the part of regulators, and a better understanding of policy objectives on the part of industry were the best means of improving the overall levels of trust. The ability for respective stakeholders to put themselves ‘in the shoes’ of others is clearly, therefore, a key competence for all engaged in the regulatory sphere.

It is clear that this means setting the appropriate ‘tone at the top’: the relationships between the regulator and the regulated and the example it sets for the rest of their respective organizations. The survey results suggest that respondents agree, citing good senior level relationships as the key contributor to effective regulator–industry relationships.

In some instances, however, the relationships are fundamentally fractured and more drastic action is required. By the late 1990s, relations between the UK telecommunications incumbent, BT plc, and former regulator, Oftel, were considered poor by many commentators and in the words of former chairman, Sir Christopher Bland, ‘adversarial’4. From its creation in 2003, Ofcom and BT were able to use the different environment and personalities

brought by the change to establish a more trusting and effective relationship, as evidenced by Sean Williams, formerly of Ofcom and now at BT.

It is striking that the UK government has been considering extending Ofcom’s powers to incorporate the responsibilities currently held by PostComm, the postal regulator. In his report on the UK postal system as chairman of the Independent Review of the Postal Services Sector, Richard Hooper writes that he is:

...struck by the depth and range of disagreements between Royal Mail and Postcomm. Even the most basic facts are disputed… The systems and necessary data needed to build a constructive and professional regulatory relationship are not yet in place…

There is a lack of trust on both sides.5

KPMG firms’ regulatory specialists have been employed around the globe to advise on the development of new regulators, working with governments, lawyers and other stakeholders to identify what powers, skills and competencies are required where confidence in regulators has been significantly eroded. In other instances, we have worked closely alongside regulators to help them identify where they could perform more effectively and effi ciently.

Equally, business, both through boards and regulatory functions, can play its part in understanding the policy agenda and communicating its operational agenda.

Moreover, as KPMG’s report Bringing Regulation into the Boardroom (KPMG LLP (UK), 2007) demonstrated, good communication within business, and particularly between the board and regulatory team, is a precondition for a robust but effective regulatory strategy.

As Mr Williams of BT demonstrates, there is some career ‘cross-over’ between regulators and industry, and vice versa. However, if there are concerns about ‘regulatory capture’, the survey does not bear this out. Nor does the practice seem particularly frequent. Rather, this suggests that there are further opportunities to build relationships and understanding between regulators and industry without major risk of regulatory capture, and that there may also be improved mutual understanding through some ‘cross-over’ – both better operational and policy competency.

4 “‘New BT’ told it’s time to deliver - Broadband Britain benefits from lighter regulation”, The Guardian, 25 July 2002

5 “Modernise or Decline: Policies to maintain the universal postal service in the United Kingdom”, Richard Hooper, 2009



Turning the tables

KPMG firms are developing a new

approach, ‘Turning the Tables’, in which

managers and staff at operators and

regulators are taken through scenarios

developed by specialists and asked to take

a role on the “opposing team” and make

decisions that reflect realistic corporate

and regulatory challenges. Approaches

such as this are clearly needed to respond

to some deeply entrenched differences in

perception between parties.



The consequences of mistrust

There is much that can go awry in operator-regulator relationships, but the perception of what doesn’t work may be colored by each party’s own vested interests.

Asked to identify specifically what goes wrong, respondents to our survey point primarily to those areas of regulatory implementation that have a direct, negative impact on their ability to operate or fulfi ll

their mission. Market participants are also likely to assign a negative grade to an area of interaction that has an adverse impact on their primary constituency (whether it’s the government, consumers or shareholders). For example, operators in the survey cite dispute resolution and tariff regulation as the areas that are most problematic in their relationship with regulators. By contrast, regulators see quality of service as the key area of difficulty, although they also acknowledge problems with dispute resolution among competing operators.

In which operational areas does interaction between operator and regulator

work poorly? (Top responses)

0 5 10 15 20 25 30 35

33% Resolution of disputes with competing operators 21%

31% Tariff regulation 15%

22% Market definition 17%

21% Policy consultations 8%

19% Monitoring and reporting on regulatory compliance 17%

19% Quality of service 23%

15% Licensing 8%

14% Transfer of operational information 19%

10% Consumer protection issues 19%





Breakdowns in the operator-regulator relationship often occur when there is a lack of transparency in a decision or with an increase in the degree of subjectivity required by the decision or rule-making process. While most decisions involve some degree of subjectivity, some categories – for example, dispute resolution – are more subject to interpretation than others and are more likely to create an aggrieved party.

The blame game

As a result, determining the source of a breakdown in trust can easily devolve into a blame game. Operators, for example,

are prone to blame a breakdown in trust on the performance of the regulator. Of the respondents that say that their relationship with the regulator had deteriorated, 63 percent blame poor regulator performance, with another 37 percent pointing to unduly close relationships of the regulator with other players in the marketplace.

Most of the operators surveyed give a rating ranging from mixed to poor on regulatory performance on key items such as timeliness, consistency and transparency of decisions. A regulatory manager in one Africa-based operator interviewed for this study complains that

regulator performance has negatively impacted market confi dence: “The regulator does not meet timelines, does not digest all the inputs and does not follow procedures. Over time, you start questioning their abilities.”

On a more positive note, regulators get their best rating on enforcement of regulation, with 46 percent of operators rating them as good or very good in this area.

How would you assess the performance of the regulator on timeliness of

decisions and rulings?

Very good

Good

Mixed

Somewhat poor

Very poor

Don’t know

1%

26%

17%

5%

17%

34%

Operators’ rating of regulators

6%

21%

17%

56%

Regulators’ self-assessment




How would you assess the performance of the regulator on consistency of


8% 3%

26%

33%

28%

2%


29%23%

46%

2%


Very good

Good

Mixed

Somewhat poor

Very poor

Don’t know


How would you assess the performance of the regulator on transparency of


Very good

Good

Mixed

Somewhat poor

Very poor

Don’t know

12%

2%

21%

28%

7%

30%


31%

6%

17%

46%





How would you assess the performance of the regulator on enforcement of


Very good

Good

Mixed

Somewhat poor

Very poor

Don’t know

It is probably not surprising that regulators in the survey have a better opinion of their performance in these areas than operators have. The magnitude of the gap in some areas, however – 77 percent of regulators consider their performance in the area of timeliness of decisions as good or very good compared with only 22 percent of operators who feel the same – is striking. There may be a number of reasons for such a divergence of views. First, regulators are more likely to rate their own performance positively, while operators take a more nuanced view. Further, the two parties often have differences on what

2%

5%

10%

37%

10%

36%



should be the key functions of the regulator, or the focus of its activities at any given point in time. In turn assessment of regulator performance is based on a distinct set of expectations. Whatever its reasons, this gap in the assessment of regulator performance points to often tense relationships and highlights the scale of the effort that must be undertaken to build trust between the two sides.

Regulators are just as likely to ascribe some of the blame for a breakdown in trust to the other side. Regulator respondents, for example, blame regulatory uncertainty

2%

58%

15%

19%

6%


on insufficient resources at their disposal but also point to inaccurate or inadequate information submitted by operators.

Past operator behavior can play a role in deepening the trust gap. Paul Foran, Vice President, Regulatory Programs of American Water, a US water utility, points out that past abuses by some providers often lead regulators to regard an entire sector with suspicion. “Utilities have to do their share to engage in building trust,” he says.



License conversion, litigation and

trust in South Africa

The South African telecoms market offers a good illustration of the challenges of maintaining trust between parties in a context of rapid technology evolution, increased competition and a policy framework looking to keep pace. In 2005, the country’s parliament enacted the Electronic Communications Act (ECA), a new law designed to replace one which was deemed both complex and obsolete. Where the previous law created silos primarily based on the types of services offered (for example, one for voice and one for data), the ECA separated the physical network infrastructure from the communications services running on top of the networks.

The task befell the relatively young regulator, the Independent Communications Authority of South Africa (ICASA), to convert licenses issued under the previous law to the new licensing regime. In effect, ICASA was to set the framework for transforming a market with five major operators and an array of value-added service providers to one having nearly 300 market players with varying degrees of fl exibility to deploy their own network infrastructure.

ICASA’s task required the creation of new processes and regulations across a multitude of issues, from license conversion to frequency licensing, facilities leasing, interconnect, license fees and others, each issue rife with potential for acrimony. “The market is at a critical juncture”, remarks Karabo Motlana, CEO of ICASA, “and there are a lot of fights on ancillary issues”.

The ECA provided a two-year transition period during which ICASA was to complete the license conversion process and replace existing regulations, with a possible six- month extension (to January 2009). After industry consultations, the regulator determined that some smaller players would receive services licenses rather than network infrastructure licenses (which some felt they should receive). As a result, ICASA was taken to court in a bid to force the judicial body to provide an interpretation of established policy that would allow those players who wanted to do so to build their own networks.

Following a court decision siding with the operators, ICASA awarded licenses to the relevant players, but not before levels of trust between parties had effectively sunk to low levels. Nonetheless, the market had taken some important steps towards legal clarity.

Why does trust break down?

These differences in the perception of what goes amiss raise some larger issues. If the sides cannot agree on what is wrong, fixing it becomes all the more diffi cult. A key step in developing some common ground is to devote more effort toward understanding the motives of the other party.

The precise role of regulators, for example, can be a source of friction. Mr Foran notes that there is an increasing trend of market regulation overlapping with consumer advocacy. A number of regulators are perceived to straddle the fine line between protection of the consumer interest and consumer activism; this is particularly the case in developing economies, or in markets with a higher level of public-service influence (water and postal services, for instance). On the fl ip side, many operators see the regulator as a custodian for the sector, one that protects the interest of the market at large, including consumers and service providers.

As a result of these differences, operators are typically accused of focusing excessively on short-term fi nancial results at the expense of the greater good of the overall market. Regulators, on the other hand, are blamed for either not holding real power or, when they do, leveraging their power in an unwieldy manner, acting primarily as consumer advocates.


BUILDINGTRUST IN REGULATION ��

Tangible costs of uncertainty

A breakdown in trust carries a variety of consequences, from direct financial implications to a potential increase in litigation. For an operator, regulator uncertainty can be harmful to the business, either in the form of lost revenue, investments cancelled or diverted elsewhere, or initiatives simply put on hold. If widespread, such uncertainty can quickly translate into slower development and service penetration of the overall market.

A full 41 percent of the operators polled say they have suffered a direct loss of revenue due to instances of regulatory uncertainty, and 44 percent say uncertainty has led directly to increases in operating costs. Of operators who state that regulatory uncertainty has had an impact on planned investments, nearly one-third claim the impact has been damaging to their business in monetary terms.The impact is more frequently damaging for developing-country operators, judging by the survey, as well as for those in the telecoms industry.

For other operators, the consequences of regulatory uncertainty are more indirect, but still perceptible on a day-to-day basis as focus is diverted from running the business to dealing with regulatory matters. “For us, the regulatory function requires too much firefighting.That makes it tough to execute [on strategy]”, says a regulatory manager at one west African telecoms operator interviewed for this study.

Another frequent outcome of uncertainty is litigation, as market players seek some finality to compensate for the lack of regulatory clarity. Regulators that

Percentage of operator respondents stating that regulatory uncertainty has had a “somewhat” or “severely damaging” impact on their investments, revenue or operating costs.�

0 10 20 30 40 50

30%

24%

Postponement or cancellation of planned investment 39%

34%

26%

36% 33%

Direct loss of revenue 40% 44%

26%

37%

30%

Direct increase of operational costs 45% 45%

26%

Total Developed Country Developing country

Telecoms operators Other operators


6 Other responses were “problematic but not severly damaging to the business”, “little or no monetary impact” and “don’t know/not applicable”



acknowledge increased regulatory uncertainty in their markets highlight an increase in litigation as among the leading consequences of such uncertainty.

Litigation is by no means ideal for operators. “As an operator, you only go to court as a last resort – when all else has failed,” says Nkateko Nyoka, Executive Director, Regulatory Affairs with Vodacom, South Africa’s largest mobile telecoms provider. “The inherent problem with litigation is that, while sometimes necessary, it is not the most effi cient and

expeditious method of resolving disputes,” especially in cases where the parties seek immediate remedies and relief.

One positive side effect, however, is that litigation can often bring finality to a lingering issue. In South Africa for example, courts have been very involved – albeit reluctantly – in helping to interpret telecoms policy. “Litigation can be drawn out and tiresome,” observes one regulatory manager working with an African commercial operator, “but it allows for the exposure of policy contradictions.”

It should be noted that not all litigation results from a breakdown in trust. In some cases, an element of litigation management and prevention is built into the regulatory process. In the words of one regulatory manager of an electricity provider interviewed for this report, “the regulatory regime provides for court resolution of those cases where one isn’t happy with a regulatory decision, but it also discourages vexatious appeals.”



KPMG Comment Emerging issues in emerging markets

The cost of regulation would seem to be proportionately greater in small and developing nations and yet they generally have fewer resources in terms of experience, available information and often funding. The range of issues faced by any regulator in a networked industry is likely to be similar in any country: market analysis, dominance, accounting separation, retail and wholesale pricing and merger control, to name but a few, are as likely to apply to small island states as to major global economies.

That is not to say that there are not opportunities for ‘leapfrogging’ – avoiding some costly regulatory remedies as the course of time has provided lower cost or simpler alternatives. Advancing faster up the “ladder of investment” (by avoiding early versions of access such as Carrier Pre-Select and Indirect Access) is but one example from the communications arena. However, these examples are the exceptions not the rule.

Nor is it just the regulators who feel the strain in emerging markets. Companies – whether independent or subsidiaries – face resource constraints managing and

responding to regulatory consultations, data requests and negotiations with regulators. Those resource constraints are rooted in both staffing and information retrieval capacity. It is clear from the survey that levels of trust are lower in emerging markets. Some of this is likely to be through starting from a lower base than their developed counterparts, but may also relate to resource constraints.

A common and practical response on behalf of regulators and governments is to draw upon leading experience elsewhere in the world. KPMG firms are regularly asked to benchmark performance and approaches, and to identify leading practice. As discussed elsewhere in this report, however, there are risks from not sufficiently acknowledging the nuances of local markets, crossing the line between learning the lessons from others and copying them blindly. ‘Cutting and pasting’ legislation and research from other markets may minimize costs in the short term but is likely to incur costs further down the line. There can be no substitute for a combination of local knowledge and international experience.

Another issue is the comparative skills base of regulators in emerging markets – the “chicken and egg” question being how do you get the sufficient skills and competencies required without having the experience? They can also be augmented by secondments to other industry regulators or other markets. “Pairing” regulators from developed countries with those in emerging markets has also been deployed as a tool, but with varying results. Increasingly, however, in countries where similar skill sets are likely to be required across a range of networked industries, multi-sector regulators are being created. This has the benefi t of maximizing economies of scale, providing challenging work for the brightest minds in the jobs market, and providing more effi cient means for managing the inconsistent workflow associated with the regulatory process.



The mechanics of trust

If the market structure and overall institutional framework provide the context for trust-based relationships, the mechanics of regulation – information provision, consultations and other areas of direct interaction – are the pillars upon which trust is built on a day-to-day basis.

As discussed earlier, surveyed operators cite areas of regular interaction with regulators as among the smoother spheres of their relationship. But some operators interviewed for this study also raise concerns about the quality of interaction at the point of relationship. Operators often have to focus efforts on a single point of contact at the regulator, and there are often instances of disconnect between the decision-makers – typically commissioners – and the day-to-day regulator staff that carry out research and render opinions, and who are frequently unavailable for operator contact. “At the best agencies,” notes Cambridge University’s Michael Pollitt, “senior regulator staff will typically be available for discussions with market participants.” This may not always be the case at lower levels, however. “The backroom people do a lot of analysis that impacts on our business, and we never get to see them,” explains Lew Owens, CEO of ETSA Utilities, an electricity distributor in

the state of South Australia. In some cases, however (for example, in North America), regulatory rules often expressly prohibit direct contact with regulators.

Conflicts between form and

substance

Some operators also voice concern with the consultation process, complaining that regulators treat consultations as a formality, rather than as a tool to truly integrate industry input. One regulatory manager interviewed for this study voices the opinion that “the [regulatory] engagement is not sincere. They know what they want to do, they go ahead and they do it.”

Generally speaking, operators tend to value informal consultations over public ones. One regulatory manager of an African operator notes that the public hearings favored by the regulator in his market typically lead to superficial discussions and grandstanding that do not go to the heart of issues. The more valuable exchanges, he says – of views and information – take place on an informal basis. “You need that informal, one-on-one space to share information,” this executive affi rms. By contrast, regulators seem more wary of such informal exchanges, which they see as contradicting the need for transparency.

Notwithstanding the setting, it is critical for the exchanges to remain civil and mature, according to BT’s Sean Williams. “If the relationship is not mature, the parties involved are not predictable and it’s a bit more difficult to have open, informative discussions”, he says.



Are industry consultations always

productive?

Many market participants recognize the

need for frequent consultations as a

foundation of a relationship of trust

between operators and regulators.

But operators do not always view

consultations kindly. In one Asian energy

market, a regulator carried out extensive

consultations prior to releasing an

important new draft decision. Despite

the consultations, the directive turned

out to be a surprise for operators, who

complained that its substance appeared

inconsistent with what the regulators had

suggested during the consultations.

In an African telecommunications market,

the decision-making rules explicitly require

industry consultations, ostensibly in order

to ensure that major regulatory decisions

are only made after widespread

discussion with commercial providers.

The regulatory manager of one provider,

however, deemed that the holding of a

discussion forum open to the public “led

to grandstanding”. As a result, he reports,

limited meaningful information was

exchanged, and the operators withheld

information they did not want made

public. In addition, in a country in which

the success of the telecoms sector has

made it something of a lightning rod for

public opinion, the operators felt picked

on, hampering their enthusiasm to

participate in similar future fora. Where

the regulator saw an optimal process with

wide industry and public consultations,

operators saw a process that was fl awed

and stacked against them.

These cases help to underscore the need

to strike a balance between the

transparency of decision-making (a critical

driver of trust) and information protection,

and also to find the optimal forum for

substantive consultations. Ultimately, it is

critical for regulators to create a

framework in which the objectives of the

consultation are established with clarity,

and the mechanics of such consultation

provide participants with some assurance

that their views will be heard.

Trust in information

The provision of relevant information is another important rung in the trust-building ladder, but information-sharing remains an area of friction between operators and regulators. As they seek to minimize subjectivity in decision-making, regulators increasingly build on past jurisprudence, international benchmarking and objective economic analysis to develop their opinions. In this context, the accuracy, relevance and timeliness of the information become critical. Indeed, regulators in our survey highlight inadequate or inaccurate information as one of the primary causes of regulatory uncertainty (along with their own insuffi cient resources). “Limited

information definitely hampers the ability of the regulator to do its work”, says Patricia De Suzzoni of CRE France.

Many operators, on the other hand, are wary of seeing information they consider sensitive made public. “We provide information informally and make clear it is not for public dissemination,” says one regulatory manager who declined to be identified, “but there is a concern that it will be leaked.” For this and other reasons, operators are reluctant to share information with the regulator. Over 40 percent of operators in the survey (and 49 percent of telecoms operators) consider the information requested by the regulator in their market is sensitive enough to harm

their businesses. Half of operators deem the volumes of data required too large. And 28 percent believe the requested information is not even relevant to the actual situation of the business (a view most in evidence among North American respondents).

Regulators in the survey tend to disagree with their operator counterparts on the above points, and give operators mixed ratings on the relevance and timeliness of data submissions. At the same time, there is overall satisfaction among regulators with the accuracy of information provided, with 73 percent saying it is mostly or very accurate.


�� BUILDING TRUST IN REGULATION

Do you agree or disagree with the following statements about the information that the regulator requires from your organization? (Operator responses)

0 5 10 15 20 25 30 35 40

4%

The required information is not relevant to the actual 24%

28% situation of our business or our market 32%

10% 2%

10% 40%

28% The volume of information required is too large 18%

3% 1%

7%

The frequency with which information 27%

32% needs to be submitted is too high 28%

4% 2%

10% The required information is of a commercially

sensitive nature, the disclosure and use of which could harm our business 7%

23% 24%

32%

4%

Strongly agree Agree Neutral

Disagree Strongly disagree Don’t know


With such a gap between need and willingness to share, the parties should work together to make the information-sharing process productive. Julie Veach of the FCC says the burden of proof is on the regulator to demonstrate that they really need the information for which they are asking. Ofgem’s Steve Smith agrees:

“The challenge for the regulator is to be clear on what they want and what they are going to do with it.” Agencies like the FCC and Ofgem have put in place a rigorous, formalized process of information sharing that is continuously reviewed and has raised the level of operator compliance.



When the needs of transparency

and confi dentiality clash

In a west European energy market where retail tariff changes are subject to regulator approval, an energy utility submitted a request for tariff adjustment. To review the demand, the regulator noted the need to conduct further economic analysis and requested additional information from the utility, including some details on the utility’s cost structure. The company rejected the regulator’s request, on the grounds that the information was of a sensitive nature and considered confi dential. The regulator

subsequently rejected the tariff changes, mainly citing the inability to assess the changes objectively based on hard data. This set the stage for several rounds of recrimination between both parties.

Such cases, the regulator says, are “lose-lose” situations that ultimately hamper trust between the parties and overall market development. While the operator has a right to be concerned at the risk of publication of sensitive information, the ability of a regulator to make critical market rulings hinges on its ability to have access to relevant data and assess it as objectively as possible,

consistent with its overall mission. In the end, to help assuage operator concerns that sensitive commercial information could be divulged, the regulator has developed a stringent set of rules for information collection and circulation.

This highlights the importance of both sides understanding and buying into each other’s objectives. The regulator should create a process that reduces the likelihood of information leakage, and operators must understand that relevant and accurate information is a critical element of operator decision-making.

The adequacy of resources

The quality of the relationship between regulator and regulated also hinges on the resources available to the parties, and on this score there is cause for some optimism, but also considerable room for improvement, particularly when it comes

to regulators. The clear majority of operators in the survey deem the volume and quality of financial and human resources assigned to the regulatory function in their companies as adequate to the task. It is not as clear, however, that regulators are similarly satisfied with the resources available to them. We pointed

out earlier that one-third of regulators in the survey cite insufficient resources available to it as a key factor in instances of regulatory uncertainty.This is not merely a concern about financial resources; it is also a concern about the most important factor of all in operator-regulator interaction – the people managing it.



KPMG Comment Building firm foundations for the regulatory process

It should be of little surprise that information – the gathering, sharing and use of data by regulators and network industries – continues to be an area of debate and concern. For instance, a quarter of business respondents stated that the required information is not relevant to the situation of their business or market. Even some regulators have concerns that the data they are requesting is not entirely relevant with a quarter of North American regulators suggesting this is so.

KPMG views relevant and reliable information to be the one of the fundamental corner-stones of effective regulation. Our member firms work closely with regulators to identify what should be requested from business and how they might interpret it, and with businesses to develop effective means of gathering data and providing the right level of assurance over it – both financial and non-financial data.

This can be a costly process for regulated industries that may historically have had little reason or incentive to establish the systems and processes necessary to produce the information that regulators demand – for example activity based costing – thus requiring new systems, skills and often significant revisions to underlying databases such as asset registers. In emerging markets, the transformation from a paper-based to a computer-based financial and operational record-keeping system presents unique challenges in the face of significant resource costs.Therefore regulators should seek to make a strong case for how the

data requested will benefit competition, and ultimately consumers, if business is to trust that regulators are being fair and proportionate whilst causing network industries to incur significant expenditures for new record-keeping systems.

Many regulators may not have sufficient capabilities and experience in financial accounting and operational finance to be able to best interpret the data for regulatory purposes and understand the context in which it was gathered: financial data can prove dangerous in the wrong hands, particularly in the development of policy based on misunderstandings. In our member firms’ experience, the closer that regulators, businesses and their auditors work together on defining the information requirements, the less likely it is that poor policy-making results.

These discussions should also focus on the degree of assurance needed to be proportionate in the circumstances. These can vary from the business self-reporting to involving external assurance which covers light touch “agreed upon procedures” all the way through to “fairly presents” opinions.

Confidence in a business’ own data can reap significant benefits. KPMG firms have helped companies challenge regulatory decisions by making a case based upon robust evidence from the business’ own systems, saving them millions of dollars. KPMG firms have also advised regulators on the imposition of fair and proportionate reporting frameworks that seek the right balance between robustness and relevance.

Finally, in small markets and developing countries there is an added risk that resource constraints lead regulators to take a ‘cut and paste’ approach to regulation – requesting the same level of data of a small island operator, for example, as a US multinational. A proportionate approach by a regulator tailored to local markets is likely to build trust with business, taking concerns and resource constraints into account and demonstrating fairness.

Widespread trust in the data that forms the basis of regulatory decisions provides the foundation for trust in policy and the broader trust in the process of other stakeholders – without this confidence, other aspects of regulation are likely to suffer.

Relevance versus reliability – a financial reporting conundrum

Many regulators around the world struggle with setting a balance in regular reporting of financial performance by regulated entities. At one end of the spectrum is robust financial reporting that companies already perform for the financial markets and shareholders, under strong national and international sets of accounting principles and rules, by a large body of professionals who know how to do it. Certainly robust, but how relevant to the answering of specfic economic questions? At the other end of the spectrum there are “bottom-up” models of specific products or markets that are forward looking, use engineering and economics and modelling skills and use concepts such as current costs and long run incremental costs. Highly relevant to answering a specific economic question – but how robust and reliable when models differ country by country, on each iteration and depending on whether the operator, the regulator or a third party builds it. KPMG firms work with both regulators and operators in finding a balance between these polar opposites.



KPMG Comment Tackling uncertainty, safeguarding investment

Debates about strong versus weak regulation are generally less useful than consideration about the levels of certainty whole regulatory environments provide. In some emerging markets, certainty has been supplanted by significant levels of uncertainty when economic conditions have triggered changes in regulatory arrangements from those embodied in licenses. It is in the interests of both regulators and businesses to reduce uncertainty to levels that give investors sufficient comfort to invest in licenses, infrastructure and skills. This also provides management teams with the opportunity to deliver performance under a stable reward system.

In some sectors the pace of change is being driven by climate change. In the energy sector for example, the UK government altered the principal objective of Ofgem in 2008 to ensure it addressed the interests of future customers; a further change is proposed in the 2009 White Paper (the low carbon implementation plan) to make clear that this includes reducing carbon emissions. And changes to market design are also heralded, with concerns that the pace of change will test electricity markets during the transition to a low carbon economy. But where change is necessary, development of new regulatory paradigms and market designs are likely to be more attractive to investors than a period of prolonged regulatory uncertainty.

Furthermore, there seems to be an increasing acknowledgment that the focus

on protecting consumer interests must be balanced with investor needs in developing regulation. In its recent Digital Britain report (2009), the UK government stated that it intends to rebalance the primary objectives of the unified communications regulator to ‘amend the Communications Act 2003 to make the promotion of investment in communications infrastructure one of Ofcom’s principal duties alongside the promotion of competition’.

As many governments around the world increasingly look to private regulated industry to meet public objectives such as universal access in communications, improved water quality or lower carbon emissions, it is crucial that investors understand the risks they undertake ahead of acquisitions, mergers, alliances, divestments or major capital expenditure. Significant changes in government and regulator policy can result in stranded assets and significant loss of revenue. If, for instance, a regulator is not confi dent that a monopolistic operator is simply incapable of acting in a profi t-maximising way, its approach may be to attempt to micro-manage the business through regulatory intervention with severe consequences for the level of trust and investor confi dence.

Moreover, the tremors that have shaken the world economy continue to challenge prior assumptions about the cost of capital, the availability of debt and the stability of exchange rates.

Insufficient due diligence on the part of investors or poor preparation and understanding of regulatory impact by regulators raises the prospect of increased likelihood – and costs from – litigation, with an associated reduction in trust between stakeholders.

Equally, the survey’s corporate participants widely acknowledge that insuffi cient trust and a lack of certainty is a cause of postponed investment (over 30 percent), inability to implement major initiatives (46 percent in developing countries, 23 percent in developed countries), direct loss of operator revenue (45 percent developed, 38 per cent undeveloped) and a direct increase in costs (47 percent developed, 42 percent undeveloped). [See graph on page 18]. Global investments and revenues of industries, with economic regulations, amount to hundreds of billions of dollars every year. If even a small proportion of that indicated by respondents is put at risk by regulatory uncertainty, the figures lost will still be in billions of dollars.

In KPMG firms’ experience, being able to combine a global understanding of corporate finance and due diligence, with deep knowledge of the local regulatory environment can offer clients a better picture of the potential impact of the risks they are undertaking.


BUILDING TRUST IN REGULATION ��

Trusting the regulator in times of market uncertainty?

Operators and markets should be able to trust regulators to maintain reasonable certainty by acting consistently with broader economic environment and market expectations.

For example in December 2008, in the midst of the global credit crisis, the Australian Energy Regulator (AER) published for consultation its first periodic review of Weighted Average Cost of Capital parameters for future regulatory determinations of electricity network serviced prices. However the AER’s proposals did not appear to reflect relevant market realities. It assumed such things as:

• investors would continue to contribute capital to Australian regulated energy infrastructure for a significantly lower return;

• the cost of equity risk had fallen compared to that applied by regulators historically; and

• regulated businesses could maintain a higher credit rating with the same level of gearing (and lower revenue) than that applied by regulators historically.

Such assumptions could hardly be further removed from prevailing market conditions.

The publication of the draft determination provoked significant reactions from the financial sector which immediately and explicitly focussed on consistency of the regulator’s signals to the markets. For example among a wide range of similar commentaries by the financial media and advisors, Macquarie Equities stated that:

While the regulator modified some of its controversial draft parameter determinations in its final review, both the process and the substance of the decision making appears to have reduced market trust in the AER’s behavior. It may be reasonably expected that this particular regulatory uncertainty and the risks of future periodic reviews, will be priced by the market into the cost of capital for the long term assets regulated by the AER, for some time to come.

“This is a negative surprise to us and the market and in our view runs inconsistent with recent commentary by the AER

…There is no doubt the market will be disappointed in this decision. At a time when investors are nervous enough about the levels of debt in these businesses, this is the last thing the market needed

The decision to move away from a BBB+ metric in the current debt environment is confusing. We struggle to understand why the AER has chosen to move this parameter in possibly one of the most skittish markets in history.”7

7 “Regulated Utilities – WACCed”, Macquarie Research Equities, 12 December 2008



The people factor

In at least one area, operators and regulators are unanimous.

Asked to identify the most important contributors to an effective operator-regulator relationship, both groups of survey respondents point with equal emphasis to good personal rapport between senior executives from both

parties.This is true across industries, but applies with particular urgency in highly competitive environments. Strong personal relationships help to smooth potentially antagonistic relationships by offering each side some visibility into the motives and constraints of the other, and they ultimately help build trust among the parties.

What do you view as the most important contributors to an effective operator-regulator relationship? Select up to two.

0 10 20 30 40 50

46% Good personal rapport between senior executives at both organizations 46%

38% Good understanding between junior managers responsible for regular interaction between the organizations 25%

High degree of regulator independence from the government 29%

19%

The regulator has the capacity and means 26% to drive regulatory strategy forward 31%

Simplicity/ease of information-transmission 26% procedures between operator and regulator 31%

High business relevance of information 18% required by the regulator 31%

100% or majority commercial (non-state) 2%

ownership of the operator(s) 6%



The quality of such personal interactions varies across markets. As already noted, many operators state that they have good relationships at the highest level, with commissioners or very senior staff. By contrast, the rapport with day-to-day staff does not earn such high assessments. This creates something of a disconnect, as commissioners – who in many cases have varied backgrounds – largely build

their decisions on the ground work carried out by the day-to-day research staff.

“One of the key challenges for operators is to grapple with the differences between the commissioners and the day-to-day staff” says Lew Owens of Australia’s ETSA. Mr Nyoka of Vodacom agrees: “Commissioners (or in the case of South Africa, councillors) make the decisions, but they have a variety of backgrounds


BUILDING TRUST IN REGULATION �0

and come at issues from different vantage points,” he says. Day-to-day-staff and backroom researchers, by contrast, have considerable influence – and yet the interaction between operators and these background actors is not as meaningful as it can be.

Another challenge may be parties that do not appear to speak the same language, not an uncommon occurrence in light of often antithetical objectives. In turn, operators have to continuously adapt their teams to the nature of the regulation. “When a market moves from ministry-based regulation to more independent regulation,” says Michael Pollitt of Cambridge University, “the regulatory teams of the operators have to adapt.”

In the view of Lord Carter, the former UK Minister for Communications,Technology and Broadcasting, the regulatory function and relationships work best when the regulator is staffed by technical experts: “Regulators need to be able to attract first-class people with a thorough knowledge of their field.” In operator-regulator relationships, he says, “mutual respect of each other’s expertise help to build the trust dynamic.”

Staff cross-over: help or hindrance?

One factor that could help smooth personal relationships – or alternatively, complicate them – is the cross-over of staff between regulators and operators. Staff cross-overs have the advantage of mixing people with varied experiences and create an environment in which the parties have a keen understanding of the other side’s drivers and constraints. “Having people with diverse backgrounds raises the quality of the debate,” says Dr Pollitt, “and that helps the overall process.”

Cross-over is not a frequent occurrence; no more than 12 percent of operators in the survey and even fewer regulators say they experience it often. Among those operators where cross-over does occur, half see such staff movement as a positive factor, and over three-quarters of regulators where it occurs say the same.

While there is an unquestionable value to cross-overs, frequent switches can also be unhealthy for a sector. First, they can lead to environments that are closed to original thinking, with the same staff simply recycled from one side to the other. Perhaps more importantly, frequent cross-overs can impact public perception negatively and erode the public trust. This leads Steve Smith of Ofgem to say that while cross-overs can be beneficial, “you should not have too much of it. It is important to avoid the impression in the public’s mind that this is all a cozy club.”

The level at which the cross-over takes place is also important; as one regulator noted, staff cross-over is healthier at a lower, operational level and drives negative public perception if too intense at senior, more exposed levels. Other pitfalls include potential conflicts of interest or worse.

Ultimately, there appears to be general agreement that cross-overs are only healthy in small doses.To manage the practical concerns generated by staff changing sides, a number of governments have adopted a set of stringent cross-over rules, notably for moves from the public sector to the private sector. In some markets, for example, no cross-over within the same industry is allowed within two years of leaving the public sector.

Needed: leadership at the top

The underlying question in building trust is whether the emphasis should be put on people or on overall structural frameworks. Human beings are unquestionably at the core of operator-regulator relationships and as such, are foundational factors in building trust in regulation. Personal competence, character and integrity – or the perception thereof – have a direct impact on regulator performance. “You can’t divorce the character of the people from trust issues” says Sean Williams. “Trustworthy people must be involved in the process”.

Likewise, the role of the leadership – on both sides – is critical. “Building trust largely depends on leadership commitment to do it right,” assert Mr Williams. “You decide you want to engage and you set about doing it from the start – in the type of people you bring in, the processes you establish and so on”. In many markets, the personality of the chief regulator and the identity of the institution itself are often not separable. It is the commitment of the leadership to building trust and honestly engaging the other side that ultimately defines the depth of the relationship and the trust that is derived from it.

Nonetheless, people alone are not enough, warns ICASA’s Mr Motlana. “The smoothness of personal interactions alone doesn’t improve the quality of the argument,” he says. Mr Owens of ETSA agrees, adding that people have to operate within a given structural framework.Trust is ultimately a function of both the people and the structure within which they operate. Weakness in one element can undermine the overall foundation.



KPMG Comment Converged data, improved performance

In our report Finance of the Future: looking forward to 2020 (KPMG International, 2008) we explored the trends and opportunities in finance functions that might emerge in the next decade.Though focused upon the finance function, many had implications across the business, not least regarding regulation.

Particularly during an economic downturn, leading businesses are able to deliver added value through identifying what needs to be measured and managed, whether that is financial or non-financial data, through the CFO, the head of regulation or elsewhere. As Finance of the Future expressed it:

…organizations are beginning to seek benefits from a more rigorous risk control regime. Using technology and culture management, they are incorporating it into “business as usual”. The challenge now is to ensure that controls are efficient and to put policies, procedures and processes in place that allow the organization to continue to grow and evolve while still managing its business-wide risks.

It also identified better data management and increased standardization as having an impact:

Constantly evolving internal and external reporting needs will require businesses to constantly review and update their underpinning data sets and capture processes. If organizations are to efficiently and effectively meet new reporting requirements, such as carbon reporting, they will have to find innovative ways of capturing and processing new business metrics.

The data sets will support the decade old aspiration to have “management dashboards” that provide a real-time and simplified matrix of corporate data. By 2020, if management is to have a real-time grip on the business and a rapid understanding of the impact of its decisions, dashboards need to become reality.

This will include regulatory-reporting. To take the example of communications, before the 1980s and 1990s, many state owned fixed-line operators were run as government departments. Decades on longer-living assets from preprivatization days are not properly accounted for and former state incumbents are finding it necessary to reconcile operational and financial data to face the challenges from regulators and the more commercial new entrants to the market. As companies become increasingly cost conscious in current market conditions, the benefit of product-level data becomes increasingly evident.

Or take the example of smart-metering in energy where in some markets the mandatory introduction of the technology for public policy objectives bring the potential for a much greater range of

products targeting more specific consumers. Data that might enable regulators to make decisions on behalf consumers or ministers the state, might prove significant commercial advantage.

The challenge, therefore, is in defining and accepting standardized data sets which can both deliver policy objectives and commercial demands.The development of effective ‘management dashboards’ will require regulatory functions that can stand shoulder-to-shoulder with their finance colleagues, cogent expressions of corporate strategy and a logical and well communicated means of demonstrating which indicators need to be managed and why.

In a converged world, it will be the shapers and adaptors who are likely to benefit most from change.



Regulatory information – Absence of trust

Over several years the former gas and electricity network regulator in the Australian State of Victoria had expressed mistrust8 of the information submitted to it by utilities in support of their revenue submissions.

On the other hand, in some areas at least, the regulator’s capacity to acquire and understand information did not appear to be either well founded9 or trusted by operators.

However, the regulator sought to make information requirements increasingly “probative”10, which among other things transferred risk of misunderstanding by the regulator to operators and imposed significant compliance risk on operators.

This approach led to:

• an increased focus on the form of information submission including independent information being prepared in anticipation of possible submission as expert witness reports to a subsequent judicial review of the regulator’s decision;

• the admissibility of evidence submitted by operators rather than its substance becoming a matter of focus. This included the regulator’s process seeking to discredit independent experts with opinions that supported operators’ submissions11, without necessarily fully considering their reports12; and

• appeals becoming common. For example in the 2006 Electricity Price Review 4 out of 5 businesses appealed the regulator’s decisions and in the 2008 Gas Access Arrangement Review, all 3 businesses appealed, on multiple grounds.

The consequence was an adversarial and increasingly prescription process of information provision founded on assumptions of absence of trust. It is difficult to see how this could be regarded as a good regulatory outcome for operators, the regulator or energy customers.

8 p17, “Gas Access Arrangement Review 2008-12 Consultation Paper No. 1”, Essential Services Commission, May 2006

9 For example, see “Powercor Australia and CitiPower Response on Guideline No.3 Draft Decision”, Essential Services Commission, November 2006

10 p17-19, “Gas Access Arrangement Review 2008-12 Consultation Paper No. 1”, Essential Services Commission, May 2006

11 p86-88, “Gas Access Arrangement Review 2008-12, Final Decision”, Essential Services Commission, March 2008

12 For example, see para 126 at Essential Services Commission Appeal Panel Ref. E1/2008, November 2008



Conclusion A positive outlook for trust

For all the challenges outlined in Building Trust in Regulation, operator executives and regulators appear generally optimistic that their relationships will continue moving in the right direction.

How do you think the operator-regulator relationship will change in

the future?

0 10 20 30 40 50

18%

It will improve in the short to medium term 27%

33% It will improve in the long term 44%

12% It will deteriorate in the short to medium term 4%

2% It will deteriorate in the long term

0%

31% It will remain unchanged 23%

4% Don't know

2%





Will this be the case? Strengthening the regulatory body and its staff, for one thing, is critical if relationships are to improve and trust to be expanded. “The keys to building trust ultimately will be to improve the skill set of the regulator and to ensure transparent processes,” believes Mr Motlana, himself a senior regulator.

At the institutional level, the overall policy framework requires clarity, and regulators need the requisite authority and power of enforcement and sanction. Such power should, however, not be unbridled. “There is nothing wrong with power,” says the regulatory manager of an Australian energy provider, “but you don’t want power without accountability”.

The aim of better policy frameworks, expanded resources and greater commitment to improving the skills of staff managing operator-regulator relationships must be to improve the understanding of both sides toward each other’s core objectives. “Each party needs to recognize the institutional legitimacy of the other’s activity and goals,” confirms Lord Carter.

Operator respondents are adamant that regulators must achieve a greater appreciation of business operations and risks. Regulator respondents, for their part, insist that operators gain an improved knowledge of regulatory and policy objectives. The development of real trust between them hinges on the development of such mutual understanding.



Appendix Survey demographics

The global survey of 213 senior executives closely involved with operator-regulator relationships was conducted by the Economist Intelligence Unit in January-February 2009. The spread of respondents is outlined below.



Respondents by region

Asia-Pacific

North America

Western Europe

Eastern Europe

Middle East and Africa

Latin America 8%

12%

9% 20%

23%

28%

Respondents by region


Role within industry

Regulator

Operator

23%

77%

Role within industry


Operator sectors

Post

Power

Telecommunications

Transport

Water 10%

9% 8%

16%

57%

Operator sectors


Number of sectors regulated by respondents’ regulators��

1 industry

2 industries

more than 2 industries

41% 39%

20%

Number of sectors regulated by respondents’ regulators


13 Responses were gathered from both operators and regulators



We would like to thank the following people who graciously gave their time to be interviewed for this publication:

• Lord Carter of Barnes

• Patricia De Suzzoni, Commission de Régulation de l’Énergie (CRE)

• Paul Foran, American Water

• Karabo Motlana, The Independent Communications Authority of South Africa (ICASA)

• Nkateko Nyoka, Vodacom

• Lew Owens, ETSA Utilities

• Michael Pollitt, University of Cambridge

• Steve Smith, Ofgem

• Julie Veach, Federal Communications Commission (FCC)

• Sean Williams, BT

As well as those who declined to go on record.

We would like to thank contributors this project from the Economist Intelligence Unit, including Denis McCauley, the editor of the report, and Guy Zibi, its author.

Thanks also go to KPMG firms ’ contributors to this publication, including: Tim Aldrich, Pablo Bernad Ramoneda, Jamie Carstairs, Sean Collins, Alan Finder, Mark Hartley, Keith Lockey, Daniel Singer, Lisa Thomas and Ted Tolfree.


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kpmg.com

David Thomas Global Head of Communications Regulation KPMG in the U.K. +44 7801 310 811 [email protected]

Sean Collins Global Chair, Communications and Media KPMG in Singapore +65 6372 3300 [email protected]

Michiel Soeting Global Chair, Energy and Natural Resources KPMG in the U.K. +44 20 7694 3052 [email protected]

Ashley Steel Global Chair, Transport KPMG in the U.K. +44 20 7311 6633 [email protected]

Or your local KPMG contact.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis -à -vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. Printed in the United Kingdom.

KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

Designed and produced by KPMG LLP (UK) ’s Design Services

Publication name: Building Trust

Publication number: RRD -152640

Publication date: August 2009

http://www.kpmg.com

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Building trust in regulation: A global study of operator-regulator relationships

Business

Transcript of Building trust in regulation: A global study of operator-regulator relationships