Working in a regulated framework Presented by Phil Caffyn, Utility Consultants Ltd .

Working in a regulated framework

Presented by Phil Caffyn,

Utility Consultants Ltdwww.utilityconsultants.co.nz

Introductory remarks

Subject matter isacademic - Melaniealways gives these

ones to me !!!

On thespeaker evaluation form,

please don’t say “Tooacademic”

Discussion topics

What isregulation ??

Whyregulate ??

Whoregulates ??

How do formallymandated bodies

regulate ??

Who enforcesregulation ??

Three importantcharacteristicsof regulation

Discussion topicsWhat are somekey regulatoryoutcomes ??

How can wecreate compliant

outcomes ??

Conclusions Questions

How canassets be

regulated ??

Challengesof working in areg. env’ment.

What is regulation ??

Some definitions

Oxfordcontrol by rule,

moderate

Baumolprotect the interests

of the great bodyof the people

Caffynintervention in an

activity that changesbehavior

Broad components

Three broadcomponentsto regulation

Transaction oractivity occurring

Potential forthat transaction to

damage a party or thewider society

Intervention bya third party on behalf

of those who maysuffer damage

Why regulate ??

Yeah - why regulate ??

To create socio-economic outcomes that organisations

would not normally be motivatedto produce because of self-

interest or other issues

To simulateoutcomes such as pricing,service breadth and depth,

and resource allocation thatmay not normally occur

in a free market

Some key reasons

Five keyreasons forregulating

Prevent monopoly pricing

Promote universal service

Prevent self-destructivecompetition

Fairly allocate scarce resources

Protect public frominappropriate behavior

Example #1 - monopoly pricing

Prevailingtechnologies have resulted

in monopolies

Potential for networkutilities to extractexcessive profits

Regulator intervenes to limit either price or

profit

Example #2 - universal service

Expensive to serveremote rural areas due to

low customer density

Incentive to serve onlyhigh-density areas

Regulator may requireservice to be provided at

an average price

Example #3 - prevent dominance

Industry with strongprice-competition basis

deregulates

Price wars mayforce some players out,

creating dominance

Regulator mayimpose a price floor to

prevent losses

Example #4 - allocate resourcesIndustry future

depends on sustainableallocation of finite

resources

Player self-interestcould unfairly exploit

resources

Regulator mayallocate resources to

specific players

Example #5 - protect public

Public well-beingdepends on the conduct

of industry players

Player self-interestcould expose public

to danger

Regulator mayprescribe standards

of behavior

Two contrasting outcomes

Two contrastingoutcomes of

regulation

Example #1Create free marketoutcomes such ascompetitive pricing

Examples #2 - 5Prevent free market outcomes

such as competitor exit andunsustainable resource

consumption

Three important characteristics of

regulation

Three characteristics

Threecharacteristics

Regulatorylag

Regulatorycreep

Regulatorycycles

Characteristic #1 - lag

Lag between theneed for regulationand implementation

Generallyresults in industryplayers enjoying a

period of selfinterest

Becominga more common

occurrence


Key causesof regulatory

lag

Slow paceof regulatory

processes

Rapidtechnology

advancements


Newly privatisedindustries have a profit

motive from day one

Developinga robust regulatoryregime takes time


Utilities contest theregulators determinationsin the State and Federal

Courts

Legal process takesyears to work through,

during which time the utilityenjoys the status-quo


Motor VehiclesDealers Act 1975 required

cars to be sold at a physicalpremise

Dealer got intotrouble trying to sell carsusing an (0800) number


Technologyfor GM and cloningis advancing almost

daily

Regulationgoverning such activitiesis falling further behind

all the time

Characteristic #2 - creepContinual

modification ofregulations thaterodes benefits

Often makesindustry players

unwilling to createfurther gains

Maybenecessary to rein

in unforeseenbehavior

Characteristic #2 - creep

Regulatorycontrol period of 5 years,at which time a one-offadjustment is made and

a new X is set

Industryplayer withhold initiativesuntil after the review, to

get 5 years worth ofbenefits

Characteristic #3 - cycles

Regulation tendsto be cyclic - varies

over time

Tends toreflect the degree ofindustry self-interest

Can giverise to regulatory

lag


Nationalisation

Commercialisation

Corporatisation

Deregulation

Privatisation

Re-regulation

Can be quick

Usually takes a few years at least

Depends on regulatory pressure

Generally takes a long time


Nat. Nat.Re-Reg.Prvt.Dereg.

We didn’t really think of the industry as regulated

Lo

Hi

Who regulates ??

Who regulates ??

Two broad typesof regulatory bodies

Those withformally mandated

authority

Those witha degree ofrecognition

Formally mandated bodies

Formallymandated

bodies

Formallyappointed by anofficial process

Formalauthority over a specified

jurisdiction

Maybe ableto impose legally binding

penalties

Informal bodies

Informalbodies

Generally emergein response to a perceived

or real injustice

Cause is oftenunclear or extreme

Tactics tend tobe civil disobedience, or

name & shame

Political preference

Right-winggovernments

Left-winggovernments

Preferencefor free markets withminimal regulation

Preferencefor state involvementand central regulation

How do formally mandated bodies

regulate ??

Two means of regulation

Two keymeans ofregulation

Prohibition

Supervision


Prohibition

Explicitlyprohibits certain

conducts oractivities

Generallyprovides for

punishing non-compliance


Supervision

Usesthreat of interventionto influence conduct

or activities

Maybeprovision for

punishing non-compliance

Hierarchy of legislationConstitution

Acts

Regulations

COP’s

Standards

By-Laws

Local Govt. Act

Regs or COP’s may provide for standards to be

adopted as mandatory

Maybe two tiers eg. federal &

state

Types of Acts

GeneralActs

Industry-specific

Acts

Organisation-specific

Acts

Situation-specific

Acts

Types of Acts

GeneralActs

Broad(universal) in its’

application

May beused to streamline

existing laws

Providesa general legal

framework

Types of Acts

Industry-specific

Acts

Appliesto participants in

a specificindustry

May includereferences togeneral laws

May requireparticipants to

be licensed

Types of Acts

Organisation-specific

Acts

Appliesto a specifically

named body

Ad-hoc, andare gettingphased out

Usuallyrelates to a

specific activity

Types of Acts

Situation-specific

Acts

Appliesto a specific

situation

Generallyvery ad-hoc

Maybeused to correct

an inequity

Regulations

Regulations

Act providesfor a lesser body

to make Regs.

Tend togovern industry

specificsituations

Generallymore detailed

than Acts

Codes of practice

Codes Of Practice(COP)

Regs. providefor a lesser bodyto make COPs.

Tend togovern very

specificsituations

Generallymore detailed

than Regs.

By-laws

By-laws

LGA providesfor TLA’s to make

by-laws

Probablyrelate to each

TLA’s situation

Maybegeneral or

specific

Standards

Standards

Generallypromulgated by

a technicalbody

Regs orCOP’s may require

a standard to beadopted

Notmandatory inthemselves

Who enforces regulation ??

Who enforces ??

Formallymandated

bodies

Informal bodiesthat have a degree

of recognition

Protest organisations

The media

Self-governing bodies

Formal regulatory bodies

Protest organisations

Don’t haveformal authorityor jurisdiction

Do getnoticed, and they

do regulatebehavior

Mayrepresent very

narrowinterests

The media

Don’t haveformal authorityor jurisdiction

Threatof unfavorable

coverage

Generallyhave left-wing

tendencies

Self-governing bodies

May haveformal authorityor jurisdiction

Recognisethat self-regulation

is in their owninterest

Mayrepresent very

narrow, specificinterests


Usuallygranted authority

by an Act

Generallyhave formal powers

to prosecute

Scopeof jurisdictionmaybe wide


Three keyattributes

Functionaljurisdiction

Geographicaljurisdiction

Basis ofempowerment

Basis of empowerment

Basis ofempowerment

Could be a dedicatedAct Of Parliament

Could be an Act OfParliament relating to an

industry or activity

Geographical jurisdiction

Geographicaljurisdiction

Pan-national

National

State

District or county

Functional jurisdiction

Functionaljurisdiction

Could be wide,and cover a range ofgeneral activities or

industries

Could be narrow,and cover a specificactivity or industry

In practice…

May be aninteraction betweenmultiple regulatory

jurisdictions

May requirea single organisationto deal with multiple

regulators

Some examples

Geographical jurisdiction

Functional jurisdiction

Narrow Wide

Wide

UN Security Council

European Commission

NZ Commerce Commission

FERC

California PUC

HCC By-Laws

How can assets be regulated ??


Assetexistence canbe regulated

Types ofasset

regulation

Assetoperation (activity)can be regulated

Asset existence

Existenceof radioactive

material is closelyregulated

Asset operation

Existence ofcoal is (at least in

small amounts) notregulated

Burninglarge amounts

of coal, is howeverregulated

Asset life cycle

Planning Design

Construction

OperationMaintenance

End of life

Planning phase

Planning

Subject toregional & district

plan provisions

May also besubject to specific

legislation

Probablywill require someform of consent

Design phase

Design

Subject torelevant standards

and COP’s

May requireverification by aregulatory body

May evenrequire specificallycertified designers

to be used

Construction phase

Construction

Subject toHealth & Safety InEmployment Act

May also besubject to other

Acts & Regs.

Operation phase

Operation


Probably alsosubject to Resource

Management Act

Likely tobe subject to many

detail Regs also

Maintenance phase

Maintenance


Likely toinvolve technical

standards

May involvescrutiny by a

regulatory body

End of life phase

End of life

Subject toResource

Management Act

Likely toinvolve technical

standards

May involvescrutiny by a

regulatory body

Operation phase

Assetsgenerally spend most

of their time beingoperated

Importantto understand how

asset operation maybe regulated

Regulating operation

Two keymeans of regulating

asset operation

Outcome

Prescriptive

Regulating operation

Specifiesbroad matters, usually

end products

Specifiesquite detailed matters,

generally relates toinputs

Prescriptive Outcome

Prescriptive regulation

Limit on thenumber of hours that

can be driven ina day

Specifies aninput - the number of

hours per day thatcan be driven

Outcome regulation

Axle loading

Specifies anoutput - the weight

on each axle

Emphasise - two ways !!

Two ways

Outcome

Prescriptive(Inputs)


Outcome

Price

Performance

Deploymentof service

Example #1

Incentiveprice control

Limitsprices toCPI - X

Focusesstrictly onoutcomes

Example #2

Performancerequirement

RequiresSAIDI target to

be met


Example #3

Deploymentof service

Requiresservice provision

levels to bemet



Prescriptive(Inputs)

Profit

Disclosure

Deploymentof assets

Example #1

Regulationof profits (cost

of service)

Limitsprofits to about

WACC

Focuseson inputs

Example #2

Regulationby disclosing

results

Enablescomparisonof players

Focuseson inputs


Prescriptive Outcome

Sup’vs

Pr’hbt

Disclosure

Profit

Pricing

Limiting deployment

Performance

Boundaries are a bit blurred

But in practice ….Obviously

going to be morecomplex than thesimple delineation

shown hereLikely to

be bits of all sortsof regulatorytechniques

Likely tochange over time

as players respondto regulatory

changes

What are some key regulatory outcomes ??

Regulatory outcomes

We haveexamined five

reasons forregulating

Use thesereasons to identify

some desirableregulatoryoutcomes

Guiding principle

Does thepublic interest

outweigh the costof the imposedregulation ??

Someorganisations are

quite literally groaningunder the weight of

regulation !!

Getting it right

Time

Too much

Not enough

Just right

Nobodywill ever agreeon what is just

right

Getting it right

Politicalpreference

Driversof regulatory

variation

Social norms

Technology

Regulatory lag

Asset life

Outcome #1Ensure

pricing that reflectswhat a free market

might deliver

“Fair”pricing or

profits

Ensure profitsthat are closely tied

to the WACC

Generallyeither Incentive or

Cost Of Service

Outcome #2

Ensure basic levelof service regardless

of location

Universalservice

Likely toinvolve averaging or

subsidisation

Example isthe Kiwi Share

Obligation

Outcome #3Ensuring

that enough playersremain to maintain

competition

Preventingmarket

dominance

Likely tooccur in oligopolistic

industries

Maintainprices to preventplayers exiting

Outcome #4Ensuring

that players don’texploit finite

resources

Sustainableallocation of

resources

Social wellbeing relies on

continued access toresources

Examplesare radio spectrum

and fish quota

Outcome #5Ensuring

that the public areprotected from poor

conduct

Protectthe public

Requiresproviders of certain

services to beregistered

Generallyprovides for censure

and publicity

How can we create compliant outcomes ??

Compliance program

Createcompliant outcomesby establishing and

maintaining acompliance

program

Involvesa comprehensive

review of all possibleActs, Regs & COPs

that may apply

Compliance program

Thefollowing slides

are not intended aslegal advice !!!

Thefollowing lists of

legislation are notexhaustive - these

are just theActs !!!

Corporate governance

CompaniesAct 1993

FinancialReportingAct 1993

TrusteeAct 1956

SecuritiesAct 1978

TakeoversAct 1993

ReceivershipsAct 1993

Corporate governance

Income TaxAct 1994

InsolvencyAct 1967

Market behavior

CommerceAct 1986

ConsumerGuarantees

Act 1993

Fair TradingAct 1986

CustomsAct 1966

Sale OfGoods

Act 1993

HirePurchaseAct 1986

Employing staff #1Employment

RelationsAct 2000

ARCIAct 1992

HumanRights

Act 1993

NZ Bill OfRights

Act 1990

ProtectedDisclosures

Act 2000

Privacy Act 1993

Employing staff #2

JuriesAct 1981

HolidaysAct 1981

RaceRelationsAct 1981

HarassmentAct 1977

Equal PayAct 1972

CoronersAct 1988

Using the environment #1

ResourceManagement

Act 1991

ToxicSubstances

Act 1970

HS&NOAct 1996

ConservationAct 1987

BiosecurityAct 1993

PesticidesAct 1979

Using the environment #2

CrownMineralsAct 1991

Coal MinesAct 1991

PetroleumAct 1937

Transportation

TransportAct 1962

CarriageOf GoodsAct 1979

CarriageBy Air

Act 1967

Owning property

BuildingAct 1991

DangerousGoods

Act 1974

TrespassAct 1974

HistoricPlaces

Act 1974

OccupiersLiabilityAct 1974

FencingAct 1974

Intellectual property

Trade MarksAct 1953

CopyrightsAct 1994

PatentsAct 1953

DesignsAct 1953

Specific industries

MeatAct 1981

MilkAct 1988

GasAct 1992

ElectricityAct 1992

Coal MinesAct 1991

Telecomm.Act 1987

Specific occupations #1

BushWorkersAct 1945

EngineersRegistration

Act 1924

ArchitectsAct 1963

AuctioneersAct 1928

DieticiansAct 1950

MedicalPractitioners

Act 1995

Specific occupations #2

MotorVehicle Dealers

Act 1975

MusicTeachersAct 1981

NZ SocietyOf Accountants

Act 1958

NursesAct 1977

VeterinariansAct 1994

Challenges of working in a regulated environment

Another dimension...

Addsanother dimension

of pressure to runningthe business !!!

Another dimension of pressure

Characteristics

Oftenunpredictable

Changesover time

Divertsattention

Consumesresources

Strategies

Strategiesfor managing

regulatoryissues

Comply

Appeal

Reduceexposure

Strategies

Comply

Involvescontinual compliancewith more and more

regulations

Regulatorycreep will usuallyalways erode any

gains made

Strategies

Appeal

Carriesthe risk of

losing

Oftenviewed as poorsportsmanship

May providea window in whichstatus-quo can be

enjoyed

Strategies

Reduceregulatoryexposure

Migrateto anotherfunctional

jurisdiction

Migrateto another

geographicaljurisdiction

Conclusions

Conclusions

Regulationinvolves intervention

in an activity that changesbehavior or conduct

Regulationis usually on behalf

of a third party that wouldbe likely to suffer loss

or damage

Contraryto popular belief,

free-market outcomesmay not always

desirable

Regulationtends to be cyclic,

following variationsin industry self-interest

Conclusions

Regulatorybodies may have formal

authority, or simply adegree of informal

recognition

Degreeof regulation is usually

inter-twined withpolitical preferences

Regulationcan be either by prohibition

or by supervision

Regulatorylag is likely to become

increasingly common astechnology advances

Conclusions

Regulationcan be enforced either

formally by law, orinformally by influence

Operationis generally the phase of

an asset’s life that issubject to the most

regulation

Key meansof regulating operation

are prescription andoutcome

Regulationis based on a hierarchy

of acts, regulations, codes,by-laws and standards

Conclusions

Benefitsof any regulatory regimemust outweigh the costs

for it to provide netteconomic value

Complianceis a real mine-field,and needs serious

legal advice

Acknowledgements

Assoc. Prof. BarryBarton from Waikato

University for commentson the hierarchy of

delegated legislation

Acknowledgements

For more information !!!

Utility Consultantsclient newsletter “Pipes

& Wires” regularly reviewsissues effecting the gas,

electricity and waterindustries

Availableto all industry participantsby contacting us - email,phone or see Phil during

the conference

For more information !!!

Specificlegal advice canbe obtained fromyour solicitor !!

Questions ??

Working in a regulated framework Presented by Phil Caffyn, Utility Consultants Ltd .

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