Who Guards the Guards?

Richard Baker
16 April, 2018

Government regulation plays an important role in productivity growth. It matters.

The design and intent of regulation is visible and contestable. Commentators analyse and debate the merits of a policy from development to enactment.

What is less clear, but equally important, is how well the regulator enforces the rules.

Many things affect a regulator’s performance; the structure of decision making, use of discretion, skills and experience, the resources available and incentives and disciplines at play.

The Productivity Commission’s 2014 report, Regulatory Institutions and Practices, concluded that regulators’ governance structures were ad hoc rather than based on sound governance principles. But recommending changes at specific regulators was outside its remit.

The New Zealand Initiative has released Who Guards the Guards? Regulatory Governance in New Zealand by Roger Partridge and Amy Thomasson. This report takes up where the Productivity Commission left off.

It concentrates on New Zealand’s three economic regulators; the Financial Markets Authority (FMA), the Reserve Bank (RBNZ) and the Commerce Commission.

The report assesses the regulators’ structures and processes against established governance principles. Its authors asked 200 New Zealand businesses to rate and rank the regulators across 23 performance criteria. They also interviewed consumer groups, regulatory staff, government officials and subject experts.

Governance orders the regulator’s decision rights, structures and processes. Its structure affects the regulator’s decisions, for better or for worse.

The quality of governance arrangements matters.

For the three regulators, key questions are who decides, what structures clothe this decision making and what processes check the quality of the decisions.

The report is clear that the FMA is the top performer. It uses the corporate board model of governance with an executive reporting to an independent non-executive board.

A CEO and staff, fully accountable to a non-executive, skilled and independent board, administer the regulation.

This is mainstream governance practice. Separating oversight from management provides role clarity and focus.

Good structure guards against poor performance, without guaranteeing good decision making or superior performance. For example, mandatory regular reporting to an independent board makes it harder for a maverick CEO to run amok. An effective CEO makes it harder for a board to interfere in day to day matters.

This FMA structure contrasts with that of its predecessor, the Securities Commission. Its structure did not separate management from control. Its board of commissioners had a dual oversight and management role. The Chair was also the CEO of the board. The board was accountable to itself.

This did not ensure that the board assessed management against goals and legislation. The organisation lost focus and ignored fundamental purpose. Many investors in finance companies of the period will agree.

The survey data on the FMA reinforced this regeneration from the Securities Commission. 81.1% of responses agreed or strongly agreed the FMA performs better than the Securities Commission.

Across the performance criteria, respondents rated the FMA well. Salient feedback was that board roles in the new organisation attracted qualified candidates.

Not so the Commerce Commission which attracts criticism in the report. It too employs a commissioner panel model and lacks the internal accountability mechanism of the corporate board model. The Commission Chair and de facto CEO structure conflates executive management and board oversight into the one role.

Only 39.9% of survey respondents agreed or strongly agreed that the Commission met each of its key performance indicators. This compared to 60.8% for the FMA.

The Commerce Commission fared poorly against the FMA on transparency of appointments, commercial knowledge, consistency and predictability and leadership expertise.

The RBNZ uses yet another model of decision making, the single-member regulator. The Governor of the Reserve bank is this single person. All decision-making power vests in the single member and stays there, notwithstanding any consultation or delegation.

This structure sought to depoliticise the implementation of the government’s monetary policy goals. The Reserve Bank Governor is fully accountable for implementation decisions. Its board’s oversight role is remarkably limited.

This structure means that the board does not exercise effective oversight of the Bank’s administration of prudential regulation (with which the report concerns itself). That lack increases the potential for error, idiosyncratic or erratic decision making.

In the ratings the RBNZ fared worse than the Commerce Commission. Just 28.6% agreed or strongly agreed that it met its key performance indicators. Its worst comparative scores related to expertise and respect, commerciality, consultation, willingness to learn from mistakes and internal accountability.

Only the FMA passes and passes well in structure, operation and market reception. Both the RBNZ and the Commerce Commission face challenges with their organisation and decision making. Most worrying is the extent of lack of trust and respect amongst those surveyed.

The report makes three key recommendations.

First, all regulatory agencies should adopt the board governance model.

Secondly, the Productivity Commission should report on the FMA, RBNZ and Commerce Commission. This should be done every three years as an external monitor.
Thirdly, a new body should ensure that all regulatory appointments are subject to independent scrutiny and a standardised process.

If we guard our guards well, then long may they guard us even better.

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