Last year, respect for the Commerce Commission sank to a new low. The New Zealand Initiative’s 2022 report, Reassessing the Regulators: The Good, the Bad and the Commerce Commission, revealed the Commission had lost the respect of the businesses it is tasked with regulating.

The report disclosed a worrying decline in regulatory performance generally. Yet, compared with the performance of its peer regulators, the Commerce Commission was a basket case.

On average, only 29.9% of survey respondents agreed that the Commerce Commission met 23 key performance indicators for good regulatory performance. This was a stark contrast with the ratings for the Commission’s peer regulators. More than 50% of survey respondents agreed that each of the Financial Markets Authority and the Reserve Bank of New Zealand met the KPIs.

A new beginning?

2022 ended with the appointment of economist Dr John Small as the new Commerce Commission chair. Small had been a Commerce Commissioner since 2020, so was not exactly a new broom. But he came equipped with an impressive CV, including a stint as the head of the University of Auckland’s Department of Economics. At least on paper, Small had all the attributes needed to turn around a Commission marred with doubts about its predictability, expertise, accountability and commercial judgment.

Unfortunately, hopes that Small’s appointment would mark a turning point for an out-of-sorts Commission swiftly proved to have been wishful thinking.

The Commission’s big project for 2023 is its “Input Methodologies” review. This dry-sounding topic is an important one. It covers the rules and processes that underpin the Commission’s price control and monitoring powers under Part 4 of the Commerce Act 1986. The powers extend to electricity lines companies, airport charges, and gas pipeline services.

The Input Methodologies apply to key components of the Commission’s regulatory regime. These include rules on how to value assets, allocate costs and determine acceptable returns. Together, the rules determine how regulated businesses are compensated for their investments. 

A key objective of the rules is to provide clarity and certainty about the Commission’s approach to regulating prices under the Act. That is an important goal. The industries covered by Part 4 are critical to the economy – and therefore to the country’s prosperity. 

Take electricity lines companies, like Auckland’s Vector or Wellington Electricity. These businesses play a crucial role in the country’s response to climate change by facilitating the transition to renewable energy. As electricity demand increases, lines companies estimate $30 billion of infrastructure investment will be required by 2035 in their industry alone.

Likewise, the country’s airports facilitate economic growth by supporting trade and tourism and enabling efficient cargo movement. While the scale of airport infrastructure investment required over the next decade is lower than for the electricity industry, it nevertheless runs well into the billions.

Getting the rules governing how these industries can charge their customers right matters. Poor decision-making creates business risk and uncertainty. This can reduce the incentives for them to innovate and hamper productivity-enhancing investment. The outcome would be lower productivity, lower economic growth and a less prosperous nation.

Consequently, we all have a stake in the Commission’s performance.

Same old problems

The Commission must review its Input Methodologies every seven years. The purpose of these reviews is to assess whether any changes are necessary to the Commission’s regulatory approach.

Given the scale and long-term nature of investment in the industries covered by Part 4, consistency, predictability and sound commercial judgment from the Commission is critical.

Yet, in key respects, these qualities are troublingly missing from the Commission’s draft Input Methodologies decision.

Released in June, the draft decision is a huge piece of work. It extends over 1,000 pages of highly technical analysis. But criticisms about the quality of this analysis are troubling.

Submissions by the electricity lines companies point to the Commission:

• Lowering the proposed return permissible by electricity lines companies without providing any supporting expert opinion or analysis.
• Suggesting that funding shortfalls caused by the revised regulatory framework can be addressed by equity investors foregoing dividends. However, a loss of dividends is hardly likely to create the incentives for investment needed in the industry.
• Ignoring expert opinion and international regulatory best practice where it differs from the Commission’s own view.
• Unexpectedly departing from prior statements focusing on the value of investment in the long run and focusing instead on short-term prices to consumers.

Of course, regulated entities can be expected to criticise the Commission’s approach when it is contrary to their interests. But it is the nature of their criticisms – pointing to a lack of predictability and consistency in approach – that is concerning.

Similar inconsistencies arise with the approach in the draft decision to airport cost of capital. The outcome is a conclusion on the systemic riskiness of New Zealand airports that is at odds with the Commission’s prior decision – despite the Commission staunchly defending its earlier decision in court.

Whether the Commission’s revised approach is right or wrong, for industries required to make massive, long-term investment decisions, predictability and consistency in decision-making are critical.

A lack of predictability creates paralysing uncertainty. It leaves businesses and their investors second-guessing what approach the Commission might come up with at its next review if it does not like the answer it gets from its previous approach.

What can be done?

Research from the New Zealand Initiative suggests changes to the Commerce Commission’s governance are needed to improve its regulatory performance.

Drawing on the demise of the former Securities Commission and its rebirth as the much more respected Financial Markets Authority, a change to the Commerce Commission’s internal governance should be the starting point.

The change needs to introduce a substantial separation between the regulatory decision-making “Commissioners” and those exercising governance oversight over the Commission’s regulatory strategies and approach.

At the same time, the Commission’s skillset must be broadened to address its lack of commercial expertise and business acumen.

In a 2018 report, Who Guards the Guards? Regulatory Governance in New Zealand, the Initiative recommended a series of reforms to achieve these objectives. Introducing an FMA-style board governance model – with robust and transparent appointment processes for the new governance roles – would be the most straightforward way.

Better external monitoring would also help. The Australian Parliament has recently strengthened the external monitoring of its two financial regulatory agencies (APRA and ASIC). New Zealand would be well-advised to do likewise – and to extend the external monitoring to the Commerce Commission.

Unless the Government tackles these challenges, the Commerce Commission will continue to play havoc with investment decisions and the country’s productivity and prosperity.

To read the article on the NZ Herald website, click here.