Return to independents?

18 Jun, 2021

The Competition and Markets Authority has a lot on its plate. Brexit has increased its merger caseload; it is home to the new Digital Markets Unit; and it is in the midst of a debate about whether the competition policy framework is fit for purpose. It cannot help that it is also repeatedly asked to adjudicate between sector regulators and regulated companies.

In the past two years there have been multiple appeals covering water, energy and aviation. In each of these appeals, allowed returns have been a central issue, and sometimes the only issue. Companies repeatedly argue that regulators have made material errors in estimating the weighted average cost of capital.

This is perhaps not surprising. Changing just one number (even one that rests on multiple assumptions) can have a huge impact on company revenues. But what is odd is that the arguments and hence the answers are frequently similar if not identical.

We have several different regulators carrying out largely the same analysis. They reach subtly different conclusions which are then revisited by the CMA. The overall process is lengthy, expensive and disruptive.

We need to fix this if the UK is to remain an attractive investment destination and at the forefront of regulatory thinking. This does not mean changing the standard of appeal, but the Government’s consideration of reforms to economic regulation provides an ideal moment for a radical solution.

One option would be an independent body to determine allowed returns. Modelled on the Office for Budget Responsibility, it would provide an input to the price control processes of the sector regulators. There would be a different figure for each sector and the figures could be updated and applied regularly.

The sector regulators in turn would determine cost allowances, performance commitments, penalties and rewards in a way that was consistent with the relevant WACC figure.

Why would this help? First, it would avoid duplication, create a focused centre of expertise and potentially reduce the number of appeals. Second, the independent body could consider macro-economic factors such as the wider benefits of investment as well as micro-economic ones. Third, allowed returns could track market conditions more accurately, avoiding the pitfalls of fixing a figure today that becomes out of kilter tomorrow.

And fourth, a respected independent body could relieve some of the pressure on the CMA.

A version of this article appeared in May's print edition of Utility Week.

Mark Caines leads Flint’s competition and regulatory team. Before joining Flint, Mark was a senior policy director at Ofcom and prior to that he had a career in economic and strategy consulting. Mark’s advice draws on over 25 years’ experience of regulation, competition and policy development. To find out more about how Flint can help you navigate the risks and opportunities of these developments get in touch

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