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The Investor Behaviour Puzzle

Garth Crawford

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2008 ACCC Regulatory Conference

Infrastructure Consultative Committee – Regulatory Benchmarking Project

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The Investor Behaviour Puzzle

Garth Crawford∗ LEAD ARTICLE

… that was the sort of comparison which old Cato the Censor was dealing with when they asked him to indicate what he believed to be the most important activity on a country estate. ‘Raising cattle profitably,’ he said. Asked what came next, he answered, ‘Raising cattle fairly profitably.’ His third priority was ‘Raising cattle unsuccessfully.’ Only then came ‘raising crops’. Next, his questioner asked him what he thought of money-lending. But then he replied ‘You might as well ask me what I think about murder’.

- Marcus Tullius Cicero, On Duties (II) 25, 88

Stock prices have reached what looks like a permanently high plateau. - Irving Fisher, October 21, 1929 (Chancellor, 2000, p. 191)

Introduction

Some of the most difficult judgements at the heart of regulated infrastructure pricing decisions are around deceptively simple questions: what do investors expect when they invest, and how do they form these expectations? At their simplest, these are questions of human behaviour.

These questions have traditionally been answered by the co-option, and arguably coercion, of an elaborate set of assumptions and traditional financial theories to shed light on these imponderable questions. Getting accurate answers to these questions is so important, however, that practitioners should be constantly looking for new perspectives from economics and finance to understand what could be termed ‘the investor behaviour puzzle’.

The most important traditional theory applied has been the Capital Asset Pricing Model (CAPM), which in varying forms is used to set regulated access prices for infrastructure around the world. This model was built and refined from the 1950s. Since that time, however, theories of finance and investment have continued to develop.

One of the most important developments in the past generation has been the emergence of the field of behavioural finance, which examines the fallibility and foibles of actual investor behaviour. This field of finance is shaping investment product development, market behaviour, and ultimately – it is likely – the cost of capital itself. To date, there has been little consideration given to the interaction of this new field with traditional approaches to estimating the opportunity cost of capital.

Why is any ‘investor misbehaviour’ important?

Price based infrastructure regulation is fundamentally based on seeking to provide investors in infrastructure with the prospect of a sufficient return on their capital to underpin required investment. In fact, the theoretical application of the capital asset pricing model to access pricing is designed with the goal of making a potential infrastructure investor almost ‘indifferent’ as to whether to invest or not.

It is worth questioning whether the model is up to providing this level of precision, and examining what real world evidence tells us about investor behaviour. The CAPM, together with its assumptions about the investment world and individual investors, is the basis of the economic regulation of over $100 billion of infrastructure, including Australia’s ports, railways, energy networks, and telecommunications infrastructure.

Were the CAPM not used in this way, imperfections in the model’s descriptive or explanatory power would not really matter. Potential investors would either use the model, or alternatives they considered superior, and take their risks accordingly. Where CAPM theory underpins multi-billion dollar investment signals to essential infrastructure, however, it is a different story. Small errors in the theory are likely to have large economic and societal consequences and its accuracy as a tool should be of concern.

How does real investor behaviour match with traditional theory?

There is a rich vein on academic and anecdotal evidence around the realism of assumptions of the world of investing and the CAPM. Typically this has focused on the elaborate architecture of careful assumptions that underpin the CAPM, such as transaction cost-free trading, and unlimited borrowing opportunities.

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Less frequently examined is the difference between what the models say investors do, and evidence for how investors actually behave. That is, how much use is the Greek alphabet soup of betas, alphas, and gammas which CAPM contains if investors do not behave the way we expect?

There is a growing body of evidence that real world investors do not make the decisions quite the way models such as CAPM predict. Worse, investor behaviour in some areas is diverging.

Investor decisions as predicted by CAPM

So what does CAPM theory tell us about what we should expect to see when people invest?

• First, all investors should be holding combinations of debt, cash and a portfolio comprising of all assets in the market. Investors should be trading little, holding portfolios for the long term, and be broadly diversified within and across asset classes.

• Second, investors should care primarily about risk in the terms it is applied in the model. Risk under the CAPM approach is defined as the degree of dispersion – or instability – of returns on debt and equity.

• Third, investors are driven in predictable and rational ways in investment decisions, focusing on calculations of predicted returns and risks.

Investor behaviour in the real world

The evidence shows that average investors fail to live up to the rigours of traditional financial theories. Actual investors’ decisions do not follow the neat predictions of theoretical models. The departures of practical realities from theory can be stark.

Real investors cannot hold the market portfolio described in CAPM, but if investor practice followed the model even closely we would expect to see broad diversification amongst securities portfolios. This is not borne out by the evidence. A 2004 survey of Australian investors reported that 52 per cent had only one to three individual stocks in their portfolio (ASX 2004, p. 33). Investors are not even moving closer towards CAPM predictions of behaviour, with the average number of stocks in a portfolio falling from seven to six (ASX 2004, p. 33). Average investors also do not appear to be reliably calm or to hold securities over a long-term. In fact some studies have calculated that the risk horizon of the average equity investor is eleven months.

Investors’ portfolios are also significantly different from the relatively uniform mixture of debt, cash and market wide assets predicted by CAPM. Typically investors tend to not consider individual financial assets in relation to wider portfolio of assets, as CAPM would suggest, but as individual and independent elements of their financial life, often with complex and powerful emotional associations (Miller 1987, p. 15).

Investors also seem to fall short of the finance theory models in attitudes to risk. A recent study of the actual financial attitudes of investors, for example, surveyed the factors average Australian investors took into account prior to investing. The study reported that 66 per cent of respondents would not consider risk or return when selecting investments (Canberra Times 2007).

This should be an arresting fact, as critical investment decisions are based on models that not only assume clinically precise and linear relationships between risk and return, but that these two factors are the only factors investors care about. This result is all the more startling because dominant economic models such as CAPM prescribe the meaning of risk much more narrowly than many investors would. The third of those surveyed who did consider risk probably considered all kinds of risk that standard capital asset pricing models do not attempt to capture.

Risk in academic financial theory terms is defined as the standard deviation of the dispersion of investment returns. Commonsense and investor studies show that, in the real world, risk has different and far more visceral meanings for investors. Behavioural finance indicates investors are likely to consider a broader range of risks, such as the chance of a loss of principal, or having to explain to their spouse that holidays will be at home this year because of some nasty margin calls.

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Why do investors behave badly?

So why do investors so consistently fail to live up to the admittedly elegant predictions of the CAPM and finance theory?

At its most basic it’s probably because someone forgot to make the average investor a financial market economist. Yet it is also because human decision-making is driven by a wide set of impulses that have little to do with elusive searches for alpha, agonising about betas and ponderings upon gammas.

From the 1970s onward a new field of behavioural finance has set out to explore how humans approach economic and investment choices. The field has found a rich field of behavioural anomalies. So what are the biases that may undermine the precision and predictive value of the CAPM approach?

The bad news is there are many – over twenty – recognised biases affecting decision-making, and assessments of the probability of events.

One important bias is that investors stubbornly value gains and losses differently, for example, feeling the pain of a loss around 2.5 times more sharply than the pleasure of a gain in economic well being (Bernstein 1998, p. 272). Studies have also demonstrated that investors are also not always risk averse. In fact, where losses have been sustained, the assumption of risk aversion breaks down as investors engage in riskier behaviour to recoup losses. In gambling parlance, investors that have sustained a loss prefer a ‘double-or-nothing’ strategy over taking a loss. This has led some of the literature to posit that investors are actually loss-averse, not risk-averse.

Another well-known finding of behavioural finance is that investors are over-confident. This is well evidenced in a study of the trading records of 10 000 investors by Odean (1999). This study found that average investors trading on their brokerage account consistently destroyed value. Typical investors sold stocks that subsequently rose in value, and bought stocks that under-performed. Put simply, investors do not invest expecting average returns, though by definition that’s what most receive. A third important bias which probably affects investor behaviour significantly is the ‘anchoring effect’. This describes the natural human tendency to anchor on significant facts or numbers and give these undue weights in decision making. A well-known example of this is investors anchoring on the nominal purchase price of an asset, and an extreme reluctance to sell for less than this value. This is likely to systematically affect the prices investors are willing to accept for assets, in circumstances where financial theory suggests that investors should be valuing assets by a cold calculus of the net present value of expected future returns from the asset.

Just how smart is the ‘smart money’?

It is tempting to dismiss these biases and this failure of reality to match theory as limited issues affecting only amateur investors.

Even if individual investors do not always behave as CAPM predicts, this does not necessarily invalidate the model. Investors may be irritatingly irrational, but in a randomly distributed and predictable way. For example it is possible they are split evenly between incurable optimists (for example, technology stock day traders) and pessimists (central bankers). If this were the case, the model would still broadly be workable.

This approach is implicit in infrastructure regulators attaching weight to surveys of professional investors on issues of key cost of capital parameters. However, the idea that the investing worlds is divided into ‘smart money’ that apply something approximating CAPM and retail investors is not supported by the evidence. Behavioural experiments have found that professional investors are affected, sometimes more than average investors, by the biases discussed.

An example is that, on average, most professionally-managed US mutual funds held the lowest allocation to cash at the peak of the technology stock bubble in 2000.These same funds were largely underweight in equities during some of the most favourable periods for investment, such as the early 1980s (Prechter 2002, Figure 7.1). Study after study has shown that professional mutual fund investment advisers, the same investors sometimes surveyed for their insights into risk premia on debt and equity, routinely under perform benchmark equity and debt indexes (Bernstein 2007, p. 21).

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What are the implications for infrastructure regulation?

The implications of the interaction of behavioural finance theories for traditional models such as the Capital Asset Pricing Model are not clear-cut.

Investor behaviour will inevitably have implications for willingness to invest in risky enterprises. The mismatches between CAPM’s definition of risk and that of average investors could also be expected to affect decision-making and, at the margin, asset pricing.

One of the clearest lessons is the need to examine the embedded assumptions of traditional financial models, and potentially re-examine the concept of regulatory conservatism in applying these models. Conservatism should be applied not just to the inputs and application of the model, but also to expectations of its precision and outputs. Behavioural finance gives insights into the same core question which the CAPM poses and purports to answer – what investors expect when they invest.

Is human nature changing, or just prices?

Infrastructure regulators typically have, and arguably cultivate, a cautious and conservative self-image. It is an image that seems as far away from the what Keynes called the ‘animal spirits’ of speculative and volatile asset markets as is possible to imagine (Keynes 1936, p. 161). Yet it ought to be remembered that embedded in the calm formulaic text of each regulatory cost of capital decision is a speculative judgement about past, current and future asset prices.

For example, the judgement is embedded in assessments about the riskiness of utility assets (as expressed in the equity beta). Another key judgement is around the market risk premium, or the return required for investors to risk their capital in equity markets. Debates on this premium tend to be sombre analyses of historical trends and differing time series. A practical example of this in the regulatory sphere has been parties seeking to make the argument that the market risk premium has experienced a marked one-off decline.

In some senses, those putting the ‘one-off’ decline thesis can be seen as arguing with the unfortunate US economist, Irving Fisher, that equity markets have moved to a new permanently high plateau. This claimed reduction in premium is another way of saying that the old methods of valuation no longer apply. As participants in price bubbles, manias and crashes know all to well, some of the most dangerous phrases to watch for in a market are ‘this time it’s different’. Advocates of structure shifts in risk premia and valuations are never short of what may be seen as plausible arguments at the time of why old valuation relationships or levels of risk no longer apply. Yet behavioural finance theory should give pause at this point, by making decision-makers at least ask: is this evidence of the world changing, or human behaviour not changing?

This example provides only one partial insight into the ways that behavioural finance can and should be more closely examined and incorporated in decisions impacting on infrastructure investment. Providing another perspective on the assumptions and operation of traditional models such as the CAPM can do nothing but assist decision-makers see both their limitations and strengths in a more balanced way, and apply them more prudently.

The overall message for practitioners is clear – people are more complicated in how they make their financial decisions than models allow. Average investors are only human, and exhibit what only unkind economists would call a host of irrational tendencies at odds with their economic interests. Like Cato the Censor, some would prefer to be murderers than money-lenders, others would prefer to raise cattle unsuccessfully than to raise crops. Presumably, Cato would in modern investment parlance be a ‘high conviction’ fund manager.

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References

Australian Stock Exchange (2004) Australia’s Share Owners: An ASX study of share investors in 2004.

Canberra Times (2007) ‘Australians are cocky investors but naïve about risks’, 8 September.

Bernstein, P. (1998) Against the Gods: The Remarkable Story of Risk, John Wiley and Sons, New Jersey.

Bernstein, P. (2007), Capital Ideas Evolving, John Wiley and Sons, New Jersey.

Cicero, On Duties (Book.II) in Michael Grant (ed.) On the Good Life, Penguin Classics, London, 1971.

Chancellor, E. (2000) Devil Take the Hindmost: A History of Financial Speculation, Plume, New York.

Keynes, J. (1936) The General Theory of Employment, Interest and Money, First Harvest/Harcourt, Orlando.

Odean, T. (1999), ‘Do Investors Trade Too Much?’, American Economic Review, 89, pp. 1279-1298.

Miller, M. (1987), ‘Behavorial Rationality in Finance’, Journal of Applied Corporate Finance, 4, 4, pp. 6-15

Myers, S. (1972), ‘The Application of Finance Theory to Public Utility Rate Cases’, Bell Journal of Economics and

Management Science, 3, 1, pp. 58-97.

Myers, S. (1972), ‘On the Use of Beta in Regulatory Proceedings: A Comment’, Bell Journal of Economics and

Management Science, 3, 2, pp. 622-627.

Prechter, R. (2002), Conquer the Crash, John Wiley and Sons, New Jersey.

Walsh, J. (2007) The Keynes Mutiny, Random House, Sydney.

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Network CURRENT REGULATORY NEWS

2008 ACCC REGULATORY CONFERENCE – ‘REVISITING THE RATIONALE FOR REGUALTION’Program Day 1, Thursday, 24 July 2008 8:15 am– 8:45 am Registration/arrival tea and coffee 8:45 am–10:30 am Welcome: Graeme Samuel, ACCC Chairman

Session 1:

What do today’s regulators and regulated firms need to know? Looking broadly—Why and how do we regulate? What are the key skills and information sets that are needed by people working in the regulatory sphere?

Taking a specific focus—What are the key messages that a new regulator should be given? What should a regulator know about how to deal with the public, how to manage resources, how to interact with government and politicians? Do the requirements differ for regulatory staff of regulated entities? Do these answers differ between the UK and the USA?

Speakers

Professor George Yarrow Director, Regulatory Policy Institute, University of Oxford

Dr Mark Jamison Director, Public Utility Research Center (PURC), University of Florida

10.30 am–11:00 am Morning tea 11:00 am–12:30 am Session 2:

Does economics provide all the answers for regulation? Is economic regulation based on sound economics? Is there an agreed body of economic theory of regulation? Has there been a consistent evolution of this theory over the last decade? How has theory been used in selected OECD countries—does the practice differ across countries? What does this say about the relationship between theory and practice? Speakers Professor Paul Kleindorfer Professor Emeritus, Wharton School of the University of Pennsylvania Dr Russell Pittman Economic Analysis Group, Antitrust Division, US Department of Justice Dr Darryl Biggar Economic Consultant, ACCC

12.30 pm–1.30 pm Lunch 1.30 pm–3:00 pm Session 3:

What can we learn from economic studies of regulatory policies?With the major reforms in infrastructure in Australia and other OECD countries there is now more than a decade of experience in a more competitive and corporatised environment oversighted by economic regulation. What has economic regulation achieved? What empirical studies have been undertaken and what understanding can be gained from these empirical studies about the impact of economic regulation? Speakers Giuseppe Nicoletti Head of Structural Policy Analysis Division, OECD Professor John Cubbin Department of Economics, City University, London

Dean Parham Assistant Commissioner, General Research, Productivity Commission

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3:00 pm–3:30 pm Afternoon tea Breakout sessions 1 - 3.30 pm–5:15 pm ENVIRONMENTAL ISSUES IN THE REGULATION OF ENERGY

SOURCES OF MARKET POWER IN BROADBAND

Renewable (green) energy will play a growing role in meeting Australia's future energy needs. This session will focus on lessons from the international experience with renewable energy. What measures have been put in place to encourage renewable energy in OECD countries? Have they delivered the right outcome? What issues has renewable energy created for network regulation? Speakers Professor George Yarrow Director, Regulatory Policy Institute, University of Oxford Professor Paul Kleindorfer Professor Emeritus, Wharton School of the University of Pennsylvania

What, if any, are the sources of market power in broadband as new platforms become available for broadband provision? How important is speed as an issue, especially when comparing wireless and wireline alternatives? Is the current legislation establishing the telecommunication access regime the right tool for dealing with market power in broadband? Speakers Professor David Gabel Department of Economics, City University, New York; CEO, Gabel Communications Limited Rob Nicholls Consultant, Gilbert & Tobin Rod Shogren Member, Australian Communications and Media Authority; Consultant, Access Economics

6.30 pm–10.30 pm Conference Dinner

Dinner Speaker: Philip Collins, Head of UK Office of Fair Trading: Thirty years of change in competition law: some reflections. Program Day 2, Friday, 25 July 2008 8:30 am–9:00 am Arrival, tea and coffee Breakout sessions 2 - 9:00 am–10:30 pm ACHIEVING COMPETITIVE OUTCOMES IN THE URBAN WATER AND WASTEWATER SECTOR

REGULATING INTELLECTUAL MONOPOLIES

State, territory and federal governments have adopted, or are considering adopting, a wide range of policies to address Australia’s water ‘crisis’, including significant investment in infrastructure, tariff reform, recycling, third party access regimes, and water trading. What can we learn from the findings and implications of Ofwat's review of competition in the England and Wales water sector? What are the preconditions for achieving more competitive outcomes in the urban water and wastewater sector in Australia? Speakers Phillip Dixon Head of Competition, Ofwat Dr Hugh Sibly Department of Economics, University of Tasmania Geoff Swier Member of the Australian Energy Regulator; Associate of Farrier Swier Consulting

There is increasing discussion about the monopoly power conferred by intellectual property protection. Should this power be unregulated? Licence fees for patents are increasingly subject to antitrust scrutiny with regard to their impact on innovation markets. In Australia, with respect of copyright collecting agencies, there is now greater realisation of the potential competition effects of collective licensing arrangements, with the ACCC having a greater role in matters before the Australian Copyright Tribunal. In this environment, it is worth while considering what principles should guide the price regulation of intellectual property. How different is it from the regulation of natural monopolies? Speakers Dr Stanley M Besen Senior Consultant, CRA International Discussants Professor Joshua Gans Professor of Management (Information Economics), Melbourne Business School, University of Melbourne Dr Philip Williams Executive Chairman, Frontier Economics

Network CURRENT REGULATORY NEWS

10.30 am–11.00 am Morning tea Breakout sessions 3 11:00 – 12.30 THE CAPM—SHOULD REGULATORS BE LOOKING AT ALTERNATIVES?

THE ROLE OF COURTS AND TRIBUNALS IN PROVIDING GREATER GUIDANCE TO REGULATORS

The ACCC and other Australian regulators use a domestic capital asset pricing model (CAPM) to calculate the cost of equity capital in regulatory decisions. The CAPM, like any model, is based on a number of simplifying assumptions. These assumptions and the theory upon which the CAPM is based have been subject to an increasing number of criticisms. Is it time for regulators to consider alternatives to the CAPM for regulatory decisions? What might those alternatives be? How might they be applied in a regulatory context? Speaker Professor Ravi Jagannathan Financial Institutions and Markets Research Center, Kellogg School of Management, Northwestern University Discussant Professor Kevin Davis Director, Melbourne Centre for Financial Studies, University of Melbourne

There is now considerable experience of regulatory decisions before tribunals and various courts. In coming to their decisions the courts/tribunals provide their understanding of how the relevant laws should be interpreted. What guidance is being provided to regulators? Are the interpretations coming from the courts and tribunals able to be consistently applied to the regulated industries? The three speakers will discuss issues arising from decisions made in the different regulated sectors. Speakers Paul Hughes, Partner, Freehills Rachel Trindade, Consultant, Competition Law Justin Oliver, Special Counsel, Minter Ellison

12.30 pm–2.00 pm Lunch 2:00 pm–3:15 pm

Session 4

Panel members will make brief presentations about their reactions to the conference and respond to questions from the conference floor about issues raised by the conference Panellists Dr Mark Jamison Director, Public Utility Research Center, University of Florida Dr Stanley Besen Senior Consultant, CRA International Dr Russell Pittman Economic Analysis Group, Antitrust Division, US Department of Justice Dr Philip Williams Executive Chairman, Frontier Economics

Network CURRENT REGULATORY NEWS

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Registration and Further Information Conference registration should be lodged with the ACCC. Cost Per Person: $1000 (includes GST) Group discount (three or more): $800 (includes GST) RSVP by 30 May 2008—payment is due with registration Fax back registration: +61 3 9663 3699—one form per person. Or mail: Conference Organiser ACCC GPO Box 520 Melbourne VIC 3001 Conference information online Download information about the conference from the ‘Hot topic’ conference link on the ACCC homepage at www.accc.gov.au For any further information email: regconference2008@accc.gov.au General Information Accommodation The ACCC is not responsible for accommodations bookings. Delegates need to make their own bookings. A substantial block of accommodation has been set aside for conference delegates at the Surfers Paradise Marriott Resort and Spa with additional accommodation set aside at the Holiday Inn Surfers Paradise. There will be a free shuttle operating each morning from 7.30 am to 9.00 am every five minutes, between 5.00 pm and 7.00 pm on Thursday night and after the dinner on Thursday night between the Holiday Inn and the Marriott. To book this accommodation contact ‘Your Next Event’: www.nextevent.com.au Transport Transfers to and from Brisbane and Coolangatta airports are available as part of the conference registration fee. To book your transfers contact ‘Your Next Event’: www.nextevent.com.au

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Infrastructure Consultative Committee – Regulatory Benchmarking Project

The Infrastructure Consultative Committee Consultative committees are seen as a necessary formal mechanism for the ACCC to gain feedback from the

community. A clear gap in the consultative committee structure was filled with the formation of the Infrastructure

Consultative Committee (ICC) in 2006.

The ICC meets twice yearly and is chaired by Graeme Samuel with relevant Commissioners and AER board

members attending. The ICC’s membership was selected to be representative of the diversity of infrastructure

producer and consumer interests. Energy, telecommunications, water, rail, port and airport interests are on the

Committee and, where practical, industry associations rather than companies have been selected. Formal user

groups are represented, and Standard and Poor’s has accepted a position on the Committee.

Proceedings of the Committee are informal. Operational issues and the specifics of decisions that are before the

ACCC/AER are not the focus of this Committee. Rather, the focus is upon the big issues in infrastructure

regulation that cross sectors. Four meetings of the ICC have now been held. The ICC’s functions also include the

conduct of major research projects. The first research project of the ICC – on facilitating access negotiation – was

completed in June 2007, and the second major research project has now commenced.

The current project is on benchmarking international regulatory practices and processes across a number of

OECD countries. An Advisory Committee was established to help steer the project, and the work is being

undertaken by ACCC staff, with the assistance of external consultants as required. The project takes in topics

such as the role of users and industry groups in the regulatory process; the collection, storage and access

arrangements for confidential information; the ways that decisions are made and published and the appeal

processes in place. The project will focus on the regulatory context in the particular countries and on the way

different objectives (like transparency and timeliness) are traded off. The project should be completed in early

2009 and will, inter alia, be reported upon in future issues of Network.

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CRITICAL ISSUES IN REGULATION – FROM THE JOURNALS

Does Private Management of Water Supply Services really increase Prices? An Empirical Analysis, R. Martinez-Espiñeira, R. García-Valiñas, & F. Gonzãlez-Gómez, FEG Working Paper Series No 05/07, Faculty of Economics, University of Granada, November 2007. Although the economic and political environments differ, this paper nonetheless provides some indication of the complexities involved in measuring the effects of water privatisation on end-user prices. Martinez-Espiñeira et al examine whether higher average prices of domestic water supply among urban municipalities in Spain can be explained by their having been privatised (many others remain in public hands). The authors suggest that to test empirically whether privatisation leads to higher prices, the political pursuation of the municipalities must be controlled for (using a variant of Heckman’s ‘treatment effects’ model). The authors suggest this is necessary because ‘leftist’ municipalities are less likely to privatise water supply in the first place, making the sample of observed prices biased. The results indicate that private firms were more likely to show interest in municipalities where there was a greater perceived ease of extracting higher profits. Additionally, local governments appear more likely to privatise domestic water suppliers with more complex operations. Holding these factors constant, the paper concluded that on average private ownership had indeed led to higher prices. Despite controlling for these endogenous effects, the authors concede that further effects could explain higher prices, including the regulatory structures in place following privatisation. Capacity-based versus time-based Access Charges in Telecommunications, J. Calzada, Journal of Regulatory Economics, 32(2) October 2007. In 2001, the Spanish telecommunications regulator replaced the traditional time-based access system with a capacity-based access system, in its regulation of the country’s vertically-integrated telecommunications sector. Under a capacity-based access mechanism, entrants pay a flat charge per access-circuit for the incumbent’s interconnection circuits (priced in units of 64 Kbps of capacity at a certain quality level). The charge is independent of the traffic offered by the entrant, who is free to offer any kind of telecommunication service. The regulator’s reasoning for this approach is that peak-hour capacity cost is a principal driver of the incumbent’s network cost, and is independent of the length of access time provided to the entrant. Further, as the author points out, time-of-use access charges can give rise to several distortions in the market. The regulator also expects capacity pricing to allow entrants to commercialise bundles of different services and to give discounts that differ from the incumbent’s. This enables entrants to differentiate their services by varying e.g. peak and off-peak times and retail prices. The author notes that four years after the introduction of the capacity-based access system, most Spanish operators have adopted this system to contract all or most of their interconnection traffic. There is also a ‘great variety of pricing structures’ with a commensurate increase in consumer choice. The author’s modelling compares capacity-based to time-based access charges in vertically-integrated telecommunications sector, with a fringe of price-taking entrants. The model assumes there are capacity constraints at peak periods and that demand varies both between and within two pricing periods (peak and off-peak). The following key results arise from the model:

• The optimal capacity-based access charge is equal to the direct capacity cost plus the incumbent’s opportunity cost of providing access to the entrant, and a positive Ramsey-pricing term – this result is similar to that for a time-based access mechanism.

• Where consumers must buy peak and off-peak telecoms services from the one firm, both regulatory mechanisms are largely equivalent under some general conditions. Both allow the incumbent to recover its fixed costs and can promote the same pattern of entry, and, importantly, both mechanisms allow an entrant to offer the same amount of peak and off-peak calls at the same costs.

The model does not account for demand uncertainty. The author concedes that demand uncertainty might give rise to different entry patterns under the two access systems, because ‘in the [capacity-based] case, the entrants have to determine how many interconnection circuits they require, while with a time-based system the incumbent is responsible for determining the number of circuits that will be needed in the future.’

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CRITICAL ISSUES IN REGULATION – FROM THE JOURNALS The Contamination Problem in Utility Regulation, F. Camacho & F. M Menezes, School of Economics Discussion Paper, No. 253, University of Queensland, 2007 Camacho and Menezes examine the effects of allowing regulated utilities to diversify into unregulated industries. More specifically, the paper looks at the ‘contamination effect,’ which is the impact on a regulated business’s cost of capital from diversification of its operations into unregulated industries. Their model indicates that given the methodologies used by ratings agencies, which generally determine their cost of debt funding, diversification increases the regulated division’s cost of capital, and decreases that of the unregulated division. The authors suggest this indicates there is a trade-off in diversification between the benefits from lower costs in unregulated industries and higher costs in the regulated market, which is ultimately paid for by end-users. Camacho and Menezes contend that whether or not a regulator should impose ring-fencing on regulated utilities, preventing diversification, depends on the breadth of welfare measured. If the regulator is only concerned with regulated industries, then ring fencing is always desirable (assuming ring fencing costs are small enough). However, if the regulator optimises welfare beyond regulated industries, then ring fencing may not be an efficient solution. Additionally, the authors suggest once implementation costs associated with ring-fencing are included, the number of situations where the broader measure of welfare is improved, could be smaller even still. Testing the Waterbed Effect in Mobile Telephony Christos Genakos & Tommaso Valletti, CEP Discussion Paper No 827, October 2007 The ‘waterbed effect’ describes a phenomenon where a reduction in mobile termination charges could cause an increase in retail prices (subscription and outgoing calls). This has been suggested on many occasions by mobile carriers as a reason for not regulating mobile termination rates. The term has also been used in relation to grocery prices, for example where the exercise of buying power by one group of buyers could lead to higher prices for others. Genakos and Valletti explore the nature and magnitude of the waterbed effect across different countries, with the aim of examining the impact of regulatory intervention to reduce mobile termination call rates, particularly from fixed lines. The author’s arguments are both qualitative and empirically driven. The study utilised data on a wide cross-section of countries, with the exception of the United States. The US operates under a Receiving Party Pays system in which carriers do not use mobile termination charges. The empirical results indicate that a relatively prevalent and strong waterbed effect exists. The study found evidence that the introduction of regulation and the subsequent lowering of termination charges resulted in an average waterbed effect of ten per cent, indicating the effect is not ‘full’ or one-to-one. The waterbed effect was also found to be stronger in markets with more intense competition and where there are high levels of market penetration and high termination rates. The authors’ results indicate that profits are positively related to prices and therefore that mobile firms are adversely affected from cuts in termination rates. As with many other countries, Australia has intervened through regulation to address the competitive bottleneck caused by mobile operators that would otherwise have the incentive to extract maximum rents from fixed users, and damage efficiency and competition in fixed-to-mobile and mobile markets. This paper – which has actually been introduced into the Australian regulatory debate – would suggest some caution. According to the authors, the waterbed effect exists and is significant, and therefore needs to be considered in any welfare analysis or regulatory intervention of termination charges. A Re-examination of the Historical Equity Risk Premium in Australia Tim Brailsford, John Handley and Krishnan Maheswaran, Accounting and Finance, April 2007 This paper looks at the historical equity risk premium over both bills and bonds (short- and long-term debt, respectively) in Australia over 1882-2005. The paper provides a historical estimate of the equity risk premium, finding that it is substantially less than other widely cited historical studies. The difference is largely due to lower estimates of stock returns prior to 1958. The authors find the historical equity risk premium relative to bills averaged 6.6 per cent (per annum) over the entire period from 1883-2005 and 6.8 per cent over the period 1958-2005. Relative to bonds, the equity risk premium averaged 6.2 per cent over 1883-2005 and 6.3 per cent over 1958-2005.

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CRITICAL ISSUES IN REGULATION – FROM THE JOURNALS

The authors suggest that any estimates of the historical equity risk premium using data prior to 1958 should be treated with caution due to concerns about data quality. This paper could support the use by regulators of a market risk premium of 6 per cent if one considers that ex-post returns have historically exceeded ex ante expectations at the time investments were made. However, the study could also be used by regulated firms to argue for a market risk premium higher than 6 per cent, on the basis that past observed returns are an unbiased estimate of future expectations. Arbitrage in Energy Markets: Competing in the Incumbent's Shadow G. Kupper and B. R. R. Willems, Tilburg University, CentER Discussion Paper No. 2007–94, November 2007 In many parts of the world structural policies have led to a functional separation of formerly vertically integrated electricity providers into three parts: generation, retail and network services (transmission). While in many cases competition has been successfully introduced in the generation and retail segments, transmission infrastructure largely remains an essential facility. This raises the question whether access to transmission capacity should be open and non-discriminatory. For example, should transmission capacity allocated through a competitive auction? The authors consider whether open access to transmission increases welfare. The starting point of the paper is the realisation that open access to transmission acts as an arbitrage facilitator: electricity will be exported from low price areas into high price areas. Thus, arbitrage between two regions through transmission has the effect of undermining third degree price discrimination, form of which is to charge different prices in different regions). It is well appreciated in the economics literature that third-degree price discrimination has ambiguous impacts on welfare: On the one hand, it may increase consumption (since it may lower the price to some customers so that they buy the product). Taken on its own, this output effect – where it occurs – increases welfare. On the other hand, price discrimination can decrease welfare and allocative efficiency, because goods might no longer be consumed where their valuation otherwise exceeds the cost to society. Third degree price discrimination is feasible only if arbitrage between customers can be prevented. In electricity markets, competitive access to transmission capacity establishes the possibility for arbitrage and undermines third degree price discrimination between regions (up to the capacity of the transmission network). However, the welfare effect of competitive access to transmission capacity goes beyond the trade-off between the output and allocation effects: Kupper and Willems show that productive efficiency may also be reduced by arbitrage. The authors establish their result in a theoretical model, but illustrate the key intuition of their result in a simple example. In this example a monopoly generator is active in region 1 (high generation costs, high willingness to pay, WTP) and region 2 (low generation costs, low WTP). Without competitive access to transmission between the two regions, the monopolist will use transmission to import electricity into region 1, charging a higher price there. If it is assumed that demand is linear, then price discrimination does not alter output and consequently decreases overall welfare.

Competitive access to transmission will partially reverse the allocative inefficiency, because arbitrageurs will buy (cheap) electricity in region 2 and sell it (at a higher price) in region 1. The monopoly generator will react to arbitrage by reducing the price in region 1 and increasing it in region 2. In the linear example with relatively small transmission capacity, arbitrage does not affect output but decreases productive efficiency: less electricity is generated in the low cost region and more in the high-cost region. This illustrates, that, even in a case where price discrimination by the monopoly generator decreases welfare, arbitrage facilitated by competitive access to transmission capacity might decrease welfare further. Kupper and Willems show in their model that the welfare impact of arbitrage depends on the regional differences in demand and generation costs and on transmission capacity. Based on their analysis, the authors conclude that competitive access to transmission capacity is only unambiguously welfare enhancing, if a sufficient level of investment in transmission is ensured and/or the retail market power of the incumbent (the vertically integrated generator) is broken in at least one market.

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CRITICAL ISSUES IN REGULATION – FROM THE JOURNALS Consumer Surplus as the Appropriate Standard for Antitrust Enforcement Russell Pittman; Competition Policy International, 2007 Should competition authorities, in applying the competition law, seek to prohibit behaviour that harms consumers, whether or not the behaviour can be shown to be good for the economy as a whole? Or should competition authorities seek to promote standard economic concepts of welfare, allowing conduct which might harm consumers if the overall economic benefits outweigh the costs? This is sometimes cast as the question whether or not competition authorities should seek to maximise the economic notion of ’total surplus’ or merely ’consumers' surplus’. Conventional economic thinking comes down squarely on the side of promoting total surplus. Yet, at least in the US, the long-standing convention has been that merger analysis should focus solely on the prices and choices faced by consumers. Mergers which raise prices are blocked. Efficiencies can only justify a merger when they are large enough to lower the post-merger prices. This apparent rejection of conventional economic notions of welfare has long puzzled antitrust economists. In this paper, Russell Pittman attempts to address this puzzle. He questions the convention that equal weights be placed on the welfare of producers and consumers in the welfare calculus. After all, if the owners of the merging firms are uniformly wealthier than the consumers or owners of the downstream buyers, and if the marginal utility of income is declining, the welfare of consumers should be weighted higher than the welfare of producers. He points out that firm ownership is concentrated on those individuals with the highest net worth, so owners of firms are likely to be significantly better off than the average consumer. Of course, many (if not most) mergers occur between firms which sell to other firms (rather than to final consumers). Pittman argues that price increases of intermediate goods are largely passed on to final consumers, so even in the case of intermediate-goods mergers, final consumers suffer in the end. Opponents of the consumer welfare standard often point out that a concern for lower prices for consumers would imply a tolerance or even encouragement of buyer cartels, whereas in practice buyer cartels are treated as harshly as cartels of competing sellers. Here Pittman argues that monopsony in intermediate goods will not be passed on to final consumers so in this case at least, buyer cartels do not, in fact, benefit consumers. Furthermore, Pittman argues that if the acquiring firms are not even able to determine whether or not a merger is in their own interests (based on economic evidence that acquiring firms do not on average benefit from a merger) estimates of merger efficiencies prepared by the acquiring firms should not be trusted. Finally, he argues that the structure of the US antitrust agencies leads to a bias against challenging a merger, which would be further exacerbated by a switch to a total welfare standard. Overall, the suggestion is that current focus on consumers' welfare yields outcomes which adequately promote overall economic welfare. Pittman's defence of the consumer welfare standard remains within conventional economic thinking. But perhaps the key underlying issue is not whether a consumer welfare or total welfare standard should be adopted – perhaps the underlying economic rationale for competition law enforcement has not been fully understood. For example, what if a merger increased prices to some consumers and lowered them to others, in such a way that consumers as a whole were better off by the conventional welfare standards? Is there any surety that such a merger will never be blocked? Perhaps there is a need to look further than conventional economic concepts of welfare and deadweight loss to find the underlying rationale for competition law.

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CRITICAL ISSUES IN REGULATION – FROM THE JOURNALS Regulation and the Option to Delay, F. T. Camacho and F. M. Menezes, School of Economics Working Paper, University of Queensland, February 2008. Camacho and Menezes consider the potential role for real options pricing in natural monopoly regulation. In particular, the relationship between price regulation and investment timing decisions, emphasising the enhanced demand risks for network industries because of irreversibility of investments. That is, the very low resale value of investments in, for example, fibre optics or copper that has been installed underground. The authors model a network's decision to undertake a new investment (rather than marginal investments, such as in better quality or in augmentations to an existing network). Their modelling first establishes that in the absence of regulation, a minimum price exists that would induce the network to undertake the investment in an earlier period under demand uncertainty, rather than in the second period, when the demand uncertainty has been resolved (including this option value is denoted the Option to Delay Price Rule, or ODPR). The essence of the problem is that the minimum price necessary for the firm to undertake early investment includes a 'premium' over the actual costs, which is the value of the option to delay. This premium is a transfer from consumers to the investor. The authors point out that if the weights given to consumers are larger in the social welfare function, then policy makers might reconsider whether earlier investments are actually worthwhile overall. With the assumption that early investment is preferred, the paper demonstrates that a minimum price exist for which the firm will be willing to undertake the investment in the first period, rather than to delay until uncertainty has been resolved. The authors propose a tension between price regulation and the minimum price required to induce early investment. The efficient investment decision may be induced and welfare is higher relative to an unregulated industry, if the regulator could set contingent prices that include the option premium that are to apply ex post (requiring full knowledge of demand uncertainty and costs). However, if the regulator cannot commit to such ex post prices, the investment will not being undertaken at the earlier date. The regulator's preference for prices that enhance welfare ex post, means that the minimum investment incentive-preserving price cannot be assured. The paper also examines a typical one-way access pricing problem, where a vertically integrated incumbent faces the prospect of being required to allow access to the investment for downstream competitors (the downstream market is for homogenous products that are perfect substitutes). The authors compare ODPR to the Efficient Component Pricing Rule (ECPR) and find that in addition to preserving investment incentives, the ODPR weakly dominates the ECPR in terms of overall welfare, when downstream entrants are both more and less efficient. The paper also addresses the question of the applicability of real option pricing for access regulation, since entry only occurs in the high demand states. Interestingly, their model does not assume non-negative profits for the incumbent in both the low demand states, so that if the entrant is more efficient than the incumbent there will be entry, even if the low demand eventuates. This suggests there might be a role for the inclusion of the option to delay value in the access price in certain circumstances, as a means to facilitate the efficient investment timing decisions.

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Austria: Price Commission examining Grocery Prices The Austrian Price Commission will meet to examine recent price increases for many food and other products in the country. Competition authority chief Theo Tanner has noted that price-fixing by businesses is a felony offence that harms not only consumers but also businesses that engage in it. He added that price increases as a result of the combined market share of supermarket chains Billa and Spar were completely unacceptable. Confirmation of such a development, he warned, could lead to proceedings against the chains by the competition or cartel authority. He added that retail supermarket chains and energy firms would be the focus of his attention in the coming months. Canada: New CRTC rules may increase Telcecommunications Competition The Canadian Radio-television and Telecommunications Commission (CRTC) has established a new framework for wholesale services in which it will divide services into 6 categories, with more than a third of non-essential services scheduled to be phased out and deregulated by the end of 2012. The CRTC says the framework is designed to increase competition in the telecommunications industry. Canada: Light-handed Regulatory Approach Adopted for Wholesale Telecom Services The Canadian Radio-television and Telecommunications Commission (CRTC) has announced a new framework for wholesale services. Under the plan, which applies a relaxed regulatory approach to the market, telcos will continue to have access to the services they need, as well as the incentives to innovate and invest in competing networks. Incumbents will still be obliged to provide interconnection services to competitors. While wholesale services used to provide services that are in the public interest will continue to regulated, it is expected that a third of other wholesale services will be deregulated by the end of 2012. CRTC Media Release, Mar 3, 2008 EU: Break up of Energy Networks Unavoidable European Union Competition Commissioner Neelie Kroes is open to various measures to enforce free competition in European energy supplies, and a crackdown on providers monopolising networks or demanding hefty transmission fees is unavoidable, she told Austrian newspaper Kurier in an interview. ‘We have learned that in 25 (of 27) E.U. member states, competition doesn't function properly’, Kroes was quoted as saying. ‘Both consumers and companies are paying too much.’ Kroes blames European energy providers for blocking third-party suppliers from access to their networks, or simply preventing price competition by charging overly high fees for interconnection transmission. ‘We have to find a construction that will alleviate our competition fears permanently’, Kroes told the newspaper. ’I therefore suppose we need to force through a break up of the networks.’ Kroes also said the two planned gas pipelines, Nabucco and South Stream, enjoy the support of the commission, but must abide by the EU regime of free and fair competition. EU: The United Kingdom set an ‘Ambitious’ Green Energy Target

Forty per cent of Britain's electricity will have to be generated from wind, wave or plant energy by 2020 as a result of a legally-binding new European Union target. British officials described the target for renewables to be divided up between all EU 27 member states as ’ambitious’, because it will mean a rapid increase from the five per cent of electricity generated from renewables at present. It is likely to mean a six-fold increase in the amount of onshore wind turbines in Britain and a 50-fold increase in the number of offshore wind turbines, according to industry sources. This is because the 20 per cent target for renewables applies to energy across the board, including transport and heating where the scope for renewables is less. This suggests the electricity sector might have to do more. Officials were explaining the implications of the announcement, expected on Wednesday, as the President of the European Commission, Jose Manuel Barroso, warned that the package would not be ‘cost free’.

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EU: Germany - Paper examines interconnection of IP-based Networks Germany's utilities regulator, the Federal Network Agency (FNA), recently issued a discussion paper on the key issues regarding the interconnection of IP-based networks. The publication examines the interconnection possibilities offered by such networks in allowing for the development of Next Generation Networks (NGN). IP-based networks are expected to significantly increase efficiency and cost reductions, thus encouraging innovation and competition. According to the FNA, "The decisive factor here will be that the NGN-specific separation between service and transport will be transferred to interconnection services, which are required for voice services". EU: Countries Propose Energy Unbundling France and Germany will unveil a proposal for introducing more competition to Europe's energy markets without forcing the break-up of dominant companies. According to published reports, the draft proposal will recommend that Europe allow companies that have energy production and distribution systems to move parts of the network to subsidiaries with separate management. Nine countries are said to have endorsed the proposal. The proposal comes in response to Europe's long-stated goal of creating a single continental energy market, in part by unbundling so-called ‘national champion’ companies that control both the production and distribution of energy in member states. The legislation, introduced as the result of a two-year DG Comp inquiry into the sector, would help remove energy companies as gatekeepers to networks and replace them with national energy regulators-opening markets to competition and lowering consumer prices, DG Comp has said. In doing so, the European Commission gave companies and national regulators a choice: either break-up companies so that energy production and distribution are owned separately, or transfer part of the vertical network to an independent operator. When the proposals were released last September, competition specialists questioned whether France and Germany would be receptive to the Commission's recommendations. Germany's largest energy company, E.ON Ruhgras, has opposed the measures, and Germany's Federal Cartel Office has suggested that European regulators should try operational unbundling, rather than divestments. ’…depending on the specific behavioural remedies proposed, these might prove costly for many companies to implement,’ says Jostein Kristensen, senior consultant at economics consultancy Oxera. Although the debate is currently between the commission and member states, Kristensen says it will be interesting to see whether companies themselves would adopt the proposals or voluntarily opt for full ownership separation of transmission networks, which may be more cost-effective. ‘Whatever the form of unbundling, companies will need to weigh the costs of complying with the regulations against the potential benefits in terms of access to an integrated European market,’ Kristensen says. ‘Right now, it is not clear how this stacks up.’ EU: Carriers Must Decrease International Roaming Charges – EC Europe's Telecommunications Commissioner, Viviane Reding, has warned the mobile telecommunications industry that it must reduce the cost of text messaging and mobile Internet use abroad, or face the imposition of a mandatory price cap. The mobile telecommunications industry is expected to lower its roaming charges substantially by 1 July 2008. The EU has calculated that the cost of sending a text message abroad can be as much as 20 times higher than sending one within the EU. The GSM Association (GSMA) is opposed to the introduction of regulation on data roaming, maintaining it could be harmful to innovation in the sector. The GSMA opposes regulation to force data-roaming price cuts, claiming that prices are already falling and that regulation would adversely affect new data offerings for roaming. Access Viviane Reding's speech here. EU: Telecom Italia commits to Operational Separation Announcing its decision to proceed with operational separation, Telecom Italia (TI) says it plans to establish a new internal division called Technology and Operations to separate responsibilities from its basic network and technological infrastructures. The new division, which will have a staff of around 20,000, will comprise TI's open access, network, IT, and technical infrastructures operations. TI says that the move has been taken to improve efficiency, lower costs and develop new products. Italy's telecom regulator, AGCOM, had earlier indicated it would impose separation on Telecom Italia, if it did not institute the change voluntarily.

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France: Deregulation proposed for Fixed Telephony Retail Markets France's e-communications regulator, ARCEP, has issued a proposal for deregulating fixed telephony retail markets and focusing solely on access and interconnection (access to the telephone network, call origination and termination). ARCEP says that with significant competition achieved in the fixed telephony markets, it can now progressively ease regulation. ARCEP estimates that in 2007, broadband telephony communication accounted for about 44 per cent of the total volume of calls made on fixed lines in the residential market, compared with just 2 per cent in 2004. Hong Kong: Internet Service Providers (ISPs) to provide Information on Performance Levels A group of Hong Kong ISPs have agreed to make pledges regarding their broadband service provision levels. An initiative of both industry and the Office of the Telecommunications Authority (OFTA), the idea is to improve the ISPs' transparency of broadband service performance. The five ISPs will publish information concerning their performance levels in areas such as network reliability, service restoration time, technical performance, customer hotline performance and customer complaint handling. Link Mexico: CFC starts fixed-line phone market inquiry The Federal Competition Commission (CFC) has formally commenced four separate probes into competition in Mexico’s fixed-line telephone market (local, long-distance and wholesale) over the next 45 days. The CFC is simultaneously conducting an inquiry into the wireless industry. Link Singapore: IDA announces RFP for Open Access Next-Gen NBN The Infocomm Development Authority (IDA) of Singapore recently announced the Request-For-Proposal (RFP) for Singapore's open access Next Generation National Broadband Network (Next Gen NBN). Although scheduled for launch in 2015, IDA says that services such as high-definition video conferencing, telemedicine, grid computing-on-demand, security and ‘immersive’ learning applications will be available on the Next Gen NBN from around 2010. The IDA says that the RFP to construct the network will provide for structural separation of the passive network operator from the downstream operators. IDA Media Release, Dec 11, 2007 Spain: CMT Publishes new Next-generation Access Guidelines Spain’s telecommunications regulator, CMT has published guidelines on next-generation access that permit reduced obligations to share access to fibre optic cable networks, permit geographically segmented markets, allow access to passive infrastructure, unchanged regulation of the legacy network and preventing functional separation of networks in the short term. The guidelines will ensure that market leader, Telefonica and other operators will not be required to share access to their new fibre optic cable network with competitors, in order to guarantee investment in the new infrastructure. Switzerland: Federal Communications Commission reduces Swisscom's Interconnection Fee The Federal Communications Commission (ComCom) has determined that Swisscom's interconnection prices for the years 2004 to 2006 will be reduced by 15 to 20 per cent for usage-dependent interconnection services, and by about 5 to 15 per cent for non-usage prices. ComCom determined that in the years 2004 to 2006, Swisscom Fixnet charged its contractual partners excessively high prices for various interconnection services. ComCom established that the prices did not fully comply with the required statutory regulations. Access Swisscom's reaction to ComCom's decision here. UK: Deregulation of wholesale broadband market supported by EU The European Commission has announced that it will endorse UK telecom regulator Ofcom's request that it be allowed to deregulate the wholesale broadband market in approximately 65% of all UK homes and businesses. Ofcom's request is "the first time that a national telecoms regulator in the EU has identified different broadband markets in different geographic areas within a country and proposed lifting regulation in those geographic areas now characterised by effective competition". For more information, click here.

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United Kingdom: Competition Commission releases Provisional Remedies on Grocery Retailing The Competition Commission (CC) has published for consultation its proposals designed to remedy its competition findings in UK groceries retailing. These include a recommendation for the inclusion of a ‘competition test’ in planning decisions on large grocery stores and measures to prevent exclusivity arrangements and restrictive covenants being used by retailers to restrict entry by competitors; the creation of a new strengthened and extended Groceries Supply Code of Practice (GSCOP), and a recommendation to establish an independent ombudsman to oversee and enforce the Code. In its provisional findings report published in October 2007, the CC concluded that, whilst UK grocery retailers are in general delivering a good deal for consumers, action was needed to improve competition in local markets and to address relationships between retailers and their suppliers. Along with the report, the CC outlined a number of possible remedies to address its competition findings. Since then the CC has been discussing those possible remedies with retailers, suppliers, trade associations, the Office of Fair Trading (OFT), other government departments and interested parties. Following these discussions, the CC is now proposing a package of measures which it considers will be practical and effective in addressing its competition findings to the benefit of customers. These are set out in more detail in the four Proposed Remedies documents which are available on the CC’s website at www.competition-commission.org.uk. UK: Ofcom pre-empts EC on international roaming review Ofcom CEO Ed Richards has commented on the cost of international roaming post the EU-wide regulation of mid 2007. He points out that the cost of sending a text and using data services while roaming remains too high and that there are 'hidden charges' for voice roaming that can push up bills by as much as 20 per cent. On this last point, he believes that waiting for the European Commission (EC) to review the legislation in 12 months' time as planned could be too late, and is investigating the possibility for early action using Ofcom's national powers. Richards' comments on SMS and data could be seen as an attempt to put pressure on the industry to trigger further reductions to avoid intervention at the EU level. Richards' comments come ahead of intentions by operators to renegotiate at the wholesale level the prices they charge each other for data. The EC is likely to carefully evaluate all of these factors before making a decision a year from now. United Kingdom: Recommendations from the Ofwat Water Competition Consultation Following the conclusion of the first part of Ofwat's consultation in September 2008, the commission has published its recommendations. These focus on proposed changes to the Water Supply Licensing (WSL) regime and a way forward on accounting separation. A second phase in its consultation is considering recommendations concerning wider changes to industry. The key recommendations in the latest report are: • To remove the Costs Principle from legislation and replace it with a set of general criteria for access

pricing; and • To reduce the thresholds and increase the size of the contestable market. The removal of the Costs Principle represents an end to the mandated retail-minus approach in water regulation in the UK, which had been widely criticised for preventing the entry of competitors. The report also foreshadowed that the second phase of Ofwat's review will examine the assumptions behind the maintenance of vertically-integrated monopolies and those behind household competition. United States: FCC considers Network Management Practices The Federal Communications Commission (FCC) held an En Banc (full commission) hearing on broadband network management practices on 25 February 2008, in Cambridge Massachusetts. The hearing related to claims that networks have been blocking or degrading consumers' access to the Internet by distinguishing between certain peer to peer applications. The allegations have also included that such practices have not been transparent. In a statement to the hearing, FCC Chairman Kevin Martin, said ’Network operators claim they employ "reasonable network management" in the operation of their broadband networks. The question is: What are reasonable network practices?’ The hearing forms part of the FCC's continuing inquiry into Broadband Market Practices, which began in March 2007.

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REGULATORY DECISIONS IN AUSTRALIA & NEW ZEALAND ACCC / AER ACCC sets reasonable terms of access to Unconditioned Local Loop Service (ULLS) & Line Sharing Service (LSS) On 18 January 2008, the ACCC published its final determinations made in the arbitration of disputes over access to the ULLS and the LSS. The decisions were initially made on 20 December 2007 and were published following a compulsory legislative consultation period after publication. Link AER approves increased investment in the Victorian Electricity Transmission Network The AER has issued its final decision on the transmission determination applicable to SP AusNet's Victorian electricity transmission network for the regulatory control period 1 April 2008 to 31 March 2014. Link Final Determinations for four Mobile Terminating Access Service (MTAS) disputes On 24 January 2008, the ACCC published final determinations for four access disputes relating to the MTAS, which were initiated on 20 December 2007. The disputes relate to the charges payable for carrying the portion of a call that terminates on the mobile networks of Telstra and Optus. The terms of the final determination, which apply the MTAS Pricing Principles Determination for the period 1 July 2007 to 31 December 2008, include a price for the MTAS of 12 cents per minute from 1 January 2007 - 30 June 2007, and a price of 9 cpm from 1 July 2007 - 31 December 2007. Link Consultation Starts on Telstra’s Exemption Application from Standard Access Obligations regarding Optus’s HFC Network The ACCC has commenced a public consultation on Telstra's exemption application in relation to Optus's HFC network with the release of a discussion paper. On 18 December 2008, Telstra applied to the ACCC for exemption from providing access to its networks in the same areas where Optus has its own cable network. Issues that the ACCC raises in the discussion paper include the extent to which Optus uses regulated access to Telstra's fixed line network within its HFC footprint, and the technical and economic factors relevant to Optus' ability to upgrade its HFC network within its current footprint. Access the discussion paper here. For other related documents, click here. Telstra challenges ACCC’s Final Determination for ULLS & LSS Charges Telstra has applied to the Federal Court for a judicial review of the ACCC’s final determination for the LSS for Amcom, Adam Internet, Agile, Primus, Network Technology and TPG and the ULLS final determination for Primus. The ACCC specified a LSS monthly charge of $A2.50 per month per service. In addition, the ACCC specified charges ’for which LSS services are connected or disconnected, either individually or as part of a “managed network migration” of bulk ADSL services to the LSS’. The decision follows an access dispute between Telstra and Adam Internet over Telstra's proposed LSS rental charge of $A9 per service per month. In relation to the ULLS determination, the ACCC specified a ULLS rental charge of $A14.30 per service per month in metropolitan band 2 for 2007-08. Telstra had proposed a $A30 per service per month ULLS rental charge in all bands. Link ACCC rejects G9 Undertaking for FTTN network On 17 December 2007, the ACCC released a report setting out its draft decision on FANOC's (a company created by the G9 consortium) 15-year special access undertaking (SAU) for its proposed fibre-to-the-node (FTTN) network upgrade. G9 proposed initial access prices of up to $A29-A50 per month (depending on the speed offered) for the first three years. The ACCC rejected the G9's SAU to build a FTTN network due to a need for more detail in respect to future price and non-price terms. However, the regulator broadly supported the G9's proposed prices and access terms. The Minister for Broadband, Communications and the Digital Economy, Senator Stephen Conroy, noted that the report ‘...provides greater clarity to all parties interested in working with the Government in developing a high-speed broadband network.’ Access the ACCC draft decision on the FANOC SAU here and the ACCC position paper on possible ULLS variation (Dec 07) here.

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ACCC to consider Revised Rail Access Undertaking from Australian Rail Track Corporation (ARTC) On 20 December 2007 the ARTC submitted a revised voluntary rail access undertaking to the ACCC for assessment under Part IIIA of the Trade Practices Act 1974. The undertaking is a revised version of an undertaking lodged with the ACCC on 8 June 2007 but subsequently withdrawn by ARTC on 15 October 2007. The revised undertaking contains a number of changes to the June undertaking. As part of the assessment process, the ACCC has distributed an Issues Paper to stakeholders identifying and asking for comments on the changes to the undertaking. New Zealand - Commerce Commission Final Decision on Unbundled Bitstream Access issued by the Commerce Commission On 13 December 2007, the New Zealand Commerce Commission issued the final determinations for unbundled bitstream access. The Commission has set prices for a Basic UBA service and three Enhanced UBA services with different settings for quality of service. The Commission adopted the same price for the local loop as proposed in the draft determination for the Unbundled Copper Local Loop (UCLL) service issued in July 2007. The prices range from $NZ27.44 for a basic service with POTS (plain old telephone service), to $NZ84.62 for a rural service without POTS. The Commission also now requires Telecom to sell a basic wholesale naked DSL to its competitors for $NZ47.28 for urban customers and $NZ64.07 for rural customers. For more information, click here. Telecom Operational Separation Update On 23 December 2007, the NZ Communications and IT Minister David Cunliffe called for public submissions on Telecom’s Amended Separation Plan. Mr Cunliffe has also updated his Determination of further requirements for Telecom’s Operational Separation. The Amending Determination addresses a number of matters designed to improve the workability of the separation regime, as well as modifying the requirements in respect of Wholesale staff incentives and IP interconnection. Commission concludes Telecom’s Bundle was not Anti-competitive The NZ Commerce Commission recently concluded its investigation into claims that Telecom New Zealand had ‘squeezed’ the margins of its competitors – through bundling and a price discount – which affected their ability to compete. The decision relates to Telecom's 2004 offer of a $NZ10 discount for customers who purchased all of a bundle of telecom services. The regulator found that the Telecom did not breach New Zealand's Commerce Act 1986, because the bundle was not anti-competitive. However, the Commission says it will ‘continue to monitor bundled discounting closely to ensure that bundles benefit consumers without damaging competition’. Link Telecom submits amended Separation Plan New Zealand's Communications and Information Technology Minister, David Cunliffe, recently announced that Telecom had submitted an Amended Separation Plan. Mr Cunliffe has called for public submissions on the Plan, noting that Telecom ‘has made a number of improvements and other changes that will be of interest to industry stakeholders’. Telecom's CEO, Dr Paul Reynolds, noted that Telecom ‘has already committed to the accelerated rollout of fast broadband that will deliver next generation speeds and services to all towns and cities with more than 500 lines. Ninety-nine per cent of these lines will be capable of supporting speeds of up to 10Mbps, while around 50 per cent will be capable of up to 20Mbps’. Industry Groups oppose Telecom’s amended Operational Separation Plan InternetNZ (the Internet Society of New Zealand) argues that the New Zealand government should not accept Telecom NZ's amended operational separation plan. In its submission to the Minister for Communications, Internet NZ maintains that the Amended Determination allows group incentives for the Telecom Wholesale Manager and places operational separation ‘at significant risk’. Link

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Standard Terms Determination (STD) Processes initiated for Subloop-related Services On 21 December 2007, the Commerce Commission announced that it had commenced standard terms determination (STD) processes for the sub-loop related services, which will allow access seekers to supply telecommunications services from Telecom's distribution cabinets. The regulator says that providing access to Telecom's cabinets will have a number of benefits, such as increasing competition in broadband service markets and enabling alternative market participants to offer innovative retail services over shortened copper loop lengths. Link National Competition Council No relevant decisions or releases over the period covered by this issue. ACT Independent Competition and Regulatory Commission Feed-in Tariff Discussion Paper – Commission comments In December 2007, the ACT Government issued a Discussion Paper on a possible model for and operation of a feed-in tariff (FiT) arrangement. Such arrangements could apply to prices paid to smaller renewable energy sources providing energy into the grid. A copy of comments from the Independent Competition and Regulatory Commission (ICRC) on the Discussion Paper is below. ICRC Submission - Feed-in Tariff New South Wales Independent Pricing and Regulatory Tribunal Reforming Port Botany’s Links with Inland Transport On 18 March 2008, the Independent Pricing and Regulatory Tribunal (IPART) released its final report on Port Botany. The report contains 18 recommendations for dealing with current congestion at the port and for providing road and rail transporters with a more efficient system for moving cargo through the port. IPART’s report recommends a new two-tiered vehicle booking system to enable road transporters to buy guaranteed slots in a market-based auction. The report is available on IPART’s website here. Northern Territory Utilities Commission Review of NT Electricity Ring-Fencing Code The Utilities Commission has published a Proposed Variations Paper relating to some significant changes to the Territory’s ring fencing requirements. One aim of the proposed changes is to better facilitate entry into the NT energy market. Following consideration of any submissions, the Commission will release a final Draft Code for comment.

Electricity Ring-fencing Code – Proposed Variations

Queensland Queensland Competition Authority No relevant decisions or releases over the period covered by this issue.

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South Australia Essential Services Commission of South Australia Amendments to the Electricity Transmission Code On 24th October 2007, the AER requested the Essential Services Commission of South Australia (ESCOSA) to consider amending the Electricity Transmission Code to facilitate the deferral of 3 projects within ElectraNet's proposed capital works program for the regulatory period July 2008 - June 2013. The AER is presently conducting a revenue cap review for ElectraNet for that period. More detailed information from the AER can be accessed here. Inquiry into Water and Wastewater Pricing Processes - Issues Paper ESCOSA has published an Issues Paper regarding an inquiry into the processes followed by Government in setting the 2008/09 water and wastewater prices, with submissions due by Friday 4 April 2008. The 2008/09 Transparency Statement (which outlines the factors considered by the Government in setting the prices) can be accessed here. The Issues Paper can be accessed here. Victoria Essential Services Commission Feed-in tariffs On 31 January 2008, the Essential Services Commission (ESC) released a draft guidance paper relating to legislation that requires retailers to purchase electricity from small renewable energy generators at fair and reasonable prices (also known as feed-in tariff offers). The discussion paper can be accessed here: Feed-in Tariffs Final Guidance Paper Tasmania Office of the Tasmanian Energy Regulator No relevant decisions or releases over the period covered by this issue. Western Australia Economic Regulation Authority See report under ‘Notes on Interesting Decisions’

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Inquiry into competition in Western Australia’s Water and Wastewater Services sector

The Economic Regulation Authority of Western Australia received a reference from the Treasurer to undertake an inquiry into competition in the water and wastewater services sector.

The Terms of Reference required the Authority to consider matters such as:

• ways to enhance the efficiency of future water source procurement;

• market structures;

• third party access to water and wastewater related infrastructure; and

• water trading arrangements.

The Authority released its Draft Report in December 2007. The major finding was a recommendation to establish an entity separate from government and the water utility with responsibility for procuring future potable water sources. The independent entity would receive from government a designated ‘security of supply’ requirement which it would meet by seeking bids for water supply from the water utility and the private sector. The intention of the recommendation was to increase competitive pressures in the identification and development of potential sources of bulk water.

Other recommendations related to:

• establishing a State based third party access regime;

• stressing the importance of finalising Statutory Water Management Plans to facilitate water trading;

• altering pricing arrangements within irrigation cooperatives to allow for external trade by individual members;

• exploring further the possibility of scarcity based pricing; and

• a potential reconfiguration of regional and remote operations by combining water and wastewater operations with the electricity utility servicing these areas.

hereThe Draft Report is available .

In developing these recommendations, the Authority also commissioned reports on a range of matters including economies of scale and scope in the water and wastewater industry, bulk water market design, real options approaches to bulk water procurement, and water trading issues. These reports are also available on the Authority’s web page.

After considering the submissions, and undertaking additional research and analysis, the Authority will deliver its final report to the State Government by 31 March 2008, after which the Government will have 28 days to table the report in Parliament.

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The New National Standard for Irrigation Delivery System Efficiency

Contributed by Tony Chafer, CEO, Ord Irrigation Co-operative

One of the interesting decisions made in 2007 relates to the introduction of a national reporting framework

(National Water Report) for irrigation providers including a revised delivery system efficiency target of 90% and

an industry standard methodology for calculating delivery system efficiency that is subtly different to the model

used for urban providers

Whilst irrigation providers subscribe to the overall objective of increasing efficiency and reducing losses, the

target of 90 per cent could be problematic for open channel systems. In fact 90 per cent delivery system

efficiency has proven to be a difficult achievement for urban piped schemes.

In 2006, Sydney Water first achieved the 90 per cent target, reporting a system efficiency of 91.5 per cent.

Urban water supply schemes in Australia apply the International Water Association’s (IWA’s) ‘standard’ to

measure delivery system efficiency which allows them to account for things like meter inefficiencies, water

theft and operational practices (such as mains flushing), Details of how Sydney Water arrived at 91.5 per cent

are set out below.*

The irrigation provider model is much simpler and items 4, 5 and 6 below cannot be accounted.

For irrigation providers that compete with urban schemes for access to bulk water, efficiency is likely to be a

factor in determining how water is shared where schemes are competing for a limited source when allocation

exceeds supply.

* Sydney Water’s 2006 bulkwater usage was 526,851 megalitres and the delivery system efficiency rating of

91.5 per cent was calculated by adding:

1. Billed metered consumption (466,482)

2. Billed unmetered consumption (3,416) – based on an estimate of the usage of the unmetered

properties.

3. Unbilled metered consumption (284) – Sydney Water owned properties

4. Unbilled unmetered consumption (4,211) – operational water including firefighting, testing of

firefighting systems, mains flushing, tank dewatering and a variety of other operational requirements

that consume water.

5. Unauthorised consumption (527) – water theft, WSAA default value of 0.1 per cent of total supply.

6. Customer meter under registration (7,026) – this figure is calculated using statistically-based sampling

and meter testing and applying this across the age range of meters in service.

The total of these figures is 481,946 which represents a loss of 44,906 or 8.5 per cent of 526,851 (figures are

rounded to zero decimal places).

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New Regulatory Legislation Proposed for New Zealand

On 13 March 2008 the government introduced a Bill focused at reforming economic regulation of infrastructural industry in New Zealand. Titled the Commerce (Regulated Goods & Services) Amendment Bill, it is aimed at providing better incentives for infrastructure investment. In the first instance the sectors to be regulated include electricity distribution businesses, the electricity transmission business, gas distribution and transmission businesses and major international airports.

Key clauses of the Bill introduce a new and consistent Purpose Statement for the all the regulatory parts of the amending legislation including a specific sub-clause expressly addressing the requirement for the regulator to ensure that incentives to invest and innovate are in place for regulated businesses.

The Commission will be required to set input methodologies (economic principles and guidelines – WACC; Asset Valuation; Cost Allocation; Regulatory Tax; and pricing principles and regulatory processes and rules covering matters such as pass through costs, etc.) up front as binding determinations, subject to appeal on the merits to the High Court.

New forms of regulatory control are introduced:

• information disclosure (alone or in combination with other forms of regulation)

• a negotiate:arbitrate regime (commercial ‘fairness’ criterion) to create incentives to commercially agree price and services matters;

• establishment of default price and quality paths based around benchmarked total factor productivity and the ability for individual proposals to be put to the Commission for consideration of a different price-quality path (one opportunity for a successful application during any regulatory period)

• individual price-quality regulation (bottom up building block type control, or other forms of regulation as recommended by the Commerce Commission)

Part 4A is to be repealed and replaced with a default-customised price/quality and information disclosure control regime with consumer-owned businesses (cooperatives, trusts etc) being exempt from the key provisions, subject to information disclosure only.

Gas pipelines businesses would also be subject to a default-customised price/quality and information disclosure control regime. The existing pipeline businesses subject to Part 5 Control Authorisations will continue to be subject to those controls.

Airports (currently Auckland, Wellington and Christchurch International Airports) are subject to an information disclosure and price monitoring regime with a view to placing disciplines on the current price/service negotiations which occur on a five-year basis between the major service acquirers and the airport suppliers of these services.

Each of these is now a full control regime with penalties and remedies whereby a breach is a breach of the law and not simply a screening device for further inquiry.

New Zealand High Court Decision: Powerco Limited and Anor v. Commerce Commission

Commerce Commission recommendations to the Minister of Energy as a result of a substantive Part 4 Inquiry resulted in two regulated businesses, Powerco Limited and Vector Limited; having their gas pipeline distribution services placed under regulatory control to take effect August 2005. They took action against the Commerce Commission and the Minister of Energy respectively by way of judicial review of the processes leading to the particular decisions made. They challenged the Commission's recommendation to the Minister of Energy and the Minister’s decision to accept the recommendations and declare control. The key issue related to the cost-benefit analysis conducted by the Commission and its various components, such as the choice of the net acquirers benefit test, the calculation of regulatory tax allowance; and the treatment of common costs.

Cost benefit analysis

Powerco challenged the Commission’s use of a net acquirers benefit (NAB) test (and thereby valuing wealth transfers as a benefit) rather than NPB test (where wealth transfers are not valued) in determining the benefits, and costs, of control. Powerco argued that the Act is primarily concerned with promoting competition and in particular, workable or effective competition, which allows for excess profits. Powerco maintained that the relevant legal standard that the Commission should have used in assessing for control is

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that of an efficient new entrant in a market characterised by effective and workable competition. It was also alleged that the Commission erred in law and/or acted unreasonably in using TCR (transfer cost ratio) and in over-estimating the redistributive benefit of control to end consumers, by an assumption of pass-through.

Justice Wild found that:

(i) s 1A (the Act’s purpose statement) does not apply to Part 4 of the Act and that it was permissible to interpret ss 52 and 56 without regard to s 1A (para 148) .

(ii) the interpretation of s 52 was one reasonably open to the Commission and that it was entitled to rely on the NAB test and to value wealth transfers (para 153, 155).

(iii) TCR was a legitimate and helpful expression of the Commission’s weighing of the benefits, against the costs, of control (para 161).

(iv) The Commission was entitled to assume that price reductions by gas retailers to end-consumers would occur, given that it had the power to enforce pass-through on gas retailers through price control (para 168).

Regulatory tax allowance

Powerco challenged the Commission’s use of acquisition value rather than ODV when calculating the regulatory tax allowance. Vector challenged the use of historic data in the costs benefit model used to calculate an NAB.

Justice Wild considered that the companies had early notice of the Commission’s proposed approach to calculating regulatory tax expense and that the approach adopted was one of a number of options open to the Commission (para 294).

Common costs

Justice Wild did not accept Powerco’s position that its operating expenditure should be modelled for its gas distribution business on a stand-alone basis. Justice Wild states (at para 305) that:

But insofar as that business incurred costs common to Powerco’s gas distribution business, the existence and extent of those costs must be relevant to the Commission’s inquiry into Powerco’s gas distribution business. I am not attracted to the alternative that the Commission must ignore the existence of Powerco’s electricity lines business, and proceed with its Gas Inquiry in respect of Powerco on a basis that does not reflect its actual business.

Process – reasons and consultation:

Powerco argued that the Commission failed to give adequate reasons in relation to wealth transfers, its conclusion that Powerco’s distribution prices could be reduced by up to 12.2 per cent and Vector’s by up 18.5 per cent and the TCR. It also argued that the Commission failed to consult or proceed without probative evidence in respect of pass-through, its recommendation for control and the tax value.

These process arguments were not upheld by the judge. He found that:

• the Commission had laid out its reasoning regarding wealth transfers in its Draft report and debated it at the conference. (para 327);

• the Commission’s reasoning in relation to pass-through, although not explicit in the Final Report, was well-known to all involved. (para 332);

• Powerco could easily have obtained the relevant calculations and figures regarding the possible reduction in prices from the Commission. (para 333); and

• selecting a point on the continuum between 0.17 and 0.30 for TCR was ‘ultimately a matter of judgment to be exercised upon considerations which the Commission did explain in the final report’. (para 337).

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Relationship between the Act’s s 1A purpose statement and other sections of the Act

Justice Wild found that, while the promotion of competition in s 1A is the primary aim of the Act, it is not the only aim. In considering argument that the Commission was acting contrary to the s 1A purpose statement, the judge found that the general wording of the Act’s purpose statement cannot override the ‘clear and specific wording’ of a section in the Act. The clear wording ‘must be given effect, even if it is at odds with the s 1A purpose’. (para 152) The clear and specific wording, however, may be open to more than one interpretation. Justice Wild concludes that the Commission’s interpretation of s 52 is one reasonably open to the Commission.

Further Aspects

Justice Wild’s approach to matters that were complex and specialised was that the Commission was the expert body tasked with the functions set out in the Act, and that it performed those functions subject only to the orthodox Wednesbury unreasonableness. The judge stated (para 229) that the plaintiff was required to:

…demonstrate that the Commission’s approach to the regulatory tax allowance is one which no regulatory authority exercising the Commission’s powers, could, after due inquiry, have adopted.

Powerco argued that ‘the Commission placed excessive reliance on stripping our excess profits’. (para 156) Justice Wild states that:

I do not consider this is a proper ground for review. At least under s 56(2), both the choice of factors and the weight it gives to them is not a proper ground for review (para157). Under s 56(2) both the choice of factors and weight are for the Commission, subject only to the constraints of relevance and reasonableness. (para 157)

Justice Wild considers that data selection and questions of materiality are matters for the Commission. Vector claimed that the Commission’s use of historical data, including a one-off revaluation, is an error of law in that the Commission factored in the irrelevant consideration of historic data, acted irrationally in terms of regulatory principle and economic methodology, and unreasonably in the administrative law sense. (The Commission’s approach used a mixture of historical data and forward-looking assessment). In reply, Justice Wild said (para 28) that‘Data selection is an area where the Commission has a broad discretion’. He also found (para 140) that:

Questions of materiality, like questions of weight are for the expert regulator, and the Commission’s view as to the materiality of Powerco’s 17 per cent TCR cannot be categorised as unreasonable in administrative law terms (para 140)

Justice Wild’s comment in relation to the Commission taking a different approach on a matter than it did in the past is also helpful. He considers (para 156) that:

… the Commission must be able to alter and develop its thinking to adapt to the changing landscape of the New Zealand economy e.g. it must be able to confront the existence of long run excess profits in the gas distribution industry, or in any other market to which s 52 applies.

The judgment also provides guidance moving forward in relation to evidence that the Commission has taken a matter into account. Although not accepting the substance of Vector’s submission (in relation to the calculation of tax depreciation), the Commission did alternative modelling adopting Vector’s suggested approach and provided the results in footnotes in its Final Report. (paras 276-277) The judge found that the Commission had thus shown that it had taken Vector’s submission on that point into account.

Overseas comparators

Being able to point to overseas comparators assists in addressing claims of irrationality or unreasonableness. In considering the issue of the appropriate method of calculating the regulatory tax allowance, Justice Wild states (para 294):

While overseas comparisons need to be made with appropriate allowance for the difference between regulatory regimes, the fact that other regulators use the approach proposed by the Commission renders the plaintiffs; submission that it is irrational/unreasonable approach difficult indeed.

On the other hand, the Court was of the view that pointing to overseas regimes as a reason for the Commission’s approach has little persuasive value. When the plaintiffs contrasted the Commission’s approach in valuing wealth transfers with that taken by overseas regulators, the judge was not persuaded

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He (para 158) accepted the Commission’s submission that: the overseas decisions are made under legislative schemes which have a presumption that control should be imposed on monopolistic companies in infrastructure sectors.

Credibility of regime

Justice Wild considered that the credibility of the regime is a relevant consideration for the Commission. He states (parra 173) that:

I consider the credibility of Part 4 is a relevant consideration under s 56(2). I consider the Commission is entitled to view the integrity and effectiveness of the Part 4 control regime as a ‘desirable’ matter.

Consideration of the credibility of the control regime under Part 5 requires consideration of the purpose of that regime, which is inextricably linked to that of Part 4 and the mandatory relevant considerations in s 70A. In relation to Part 4, Justice Wild’s view (para 174) was that:

…it would be relevant where the level of long run excess profits is such that a decision not to impose control would challenge the credibility of Part 4.

Consultation/Reasons

While the plaintiffs made a number of complaints about the Commission’s processes in relation to inadequate consultation and a lack of reasons, none were upheld by the Court. Justice Wild did make, however, a number of statements about the standard required for consultation and reasons:

(a) consultation involves:

§ giving early and prior notice of a particular view or proposed treatment on a matter and providing adequate opportunity to respond;

§ stating a proposal not yet finally decided upon, listening to what is said, considering their responses, and then deciding what will be done

§ having an open mind, which is not the same as a blank mind, devoid of any tentative views;

§ Less exacting requirements with well informed, knowledgeable and sophisticated (para342).

(b) reasons are required, however:

§ only in sufficient detail to enable the reader to know what conclusion has been reached on the ‘principle important controversial issues’;

Less explicit reasoning is required when dealing with an informed reader.