Presenter: Date: Importance of Effective Independent Economic Regulation Cornel van Basten October 2008

Introduction  Network utilities – essential input, crucial importance to economic growth and international competitiveness  Naturally monopoly elements create need for economic regulation  Why then the need for independent economic regulation?  Protection of customers from potential market power abuse  Implementation of government policies  Facilitation of investment – creation of a level playing field especially where SOEs are operating – need transparent process to attract private capital  Important in the SA context - need to attract private capital for infrastructure investment (investors need to be satisfied that incumbent will not receive any special treatment)

Questions & Purpose  Evidence suggests that “success” of independent economic regulation in developing countries – debatable, because of half finished reforms, conflicts of interest, uncertainty wrt political commitment & capacity issues  So, in SA context – wrt network utilities:  Are there clarity about and completion of industry reforms?  Are there any conflicts of interest? (Conflict between policy statements & legislation?)  Are there uncertainty wrt political commitment?  Capacity issues?  Purpose of presentation: In this context what is important for a regulator to be effective & efficient?

 Regulatory failure is not a concept that is often raised, however it is a real threat  Concepts that affect the ‘success’ of economic regulation: o Institutional context – regulatory framework o Information asymmetries o Investment subject to a threat of delays/cancellations o Regulatory capture o Effectiveness (doing what it is supposed to do) and efficiency (least cost) o Competition where possible and regulation where necessary Regulatory failure – a real threat

Economic regulation – how? (1)  Controlling market forces – this is invariably unsuccessful in the long-term  Facilitating market forces in the public interests. It follows that: o Where market forces operate freely regulation is not required e.g. wellhead pricing in USA o Where market forces cannot operate freely regulation is required e.g. networks Dimensions associated with the facilitation of market forces: Access to the market and transparency

 Results of facilitation of market forces: o Investment is facilitated o Abuse of dominance is mitigated o Customer choice (competition) with lower prices and better service o Optimal use of resources e.g. small gas fields, small power stations can be exploited Economic Regulation – how? (2)

 IEA regulatory principles – good guideline: o Rule of law o Transparency o Neutrality o Predictability and consistency o Independence (industry/consumer/political) o Accountability (performance & funding) o [Resources in terms of human skills, expertise and financial resources]  How are SA regulators faring against these principles? What is good regulation?

 Industry/sector/multi-sector regulators  Important to consider regulation in a co-ordinated and coherent fashion, e.g. resources, costs, characteristics and synergies across industries and sectors: o Human resource limitations? o Costs of number of regulators vs. single multi-sector regulator? o Decisions affecting one industry also affect others? o Importance of consistency in regulatory approaches? o Compliance, resource and time related costs involved for regulated entities o Consumer participation in regulatory processes o Possible improvement in effectiveness and efficiency if multi-sector entity? o Concern that smaller industries might not receive sufficient focus in a multi-sector entity? o More/less potential for regulatory capture? o Power to resist political interference? Breadth of economic regulation (1)

 Conclusion re. breadth of economic regulation o SA Regulators established in silos → difference in organisational structure, conduct and legislation o What was the main reason for creation of independent economic regulators in SA – promotion of investment and competition o Should there be a rethink as to the design of regulators? Breadth of economic regulation (2)

 Various ‘independent economic regulators currently exist – similar objectives but divergent in nature  Difference ito clarity & application of regulatory principles  Legislation generally focuses on necessity of competition and private sector involvement. Is this still the thinking?  1980s: Security of supply because of sanctions - controlled by gov officials  1990s: Followed world trends into liberalisation & private participation  2000s: Security of supply because of global issues - controlled by gov officials (will not attract private investment) The South African situation (1)

Some general occurring themes regarding SA regulators’ performance: o Policy clarity and coherence – clearly defined roles & responsibilities essential as is demarcation between policy and implementation  Unusual for regulators not to write regulations  IEA on role of SOEs – SOEs should not be involved in policy except as a general stakeholder The South African situation (2)

o Regulatory independence (political/consumer/industry)  What does it mean? Definitely not that the regulator can do what it wants. It must be able to make binding decisions within legal framework of limitations and requirements without fear/favour  Currently – different levels of independence, e.g. NERSA, Ports and Telecommunications.  What is the advantage of having an independent sector regulator? Minister sets the framework and the regulator administers the framework – any court cases to be dealt with by the regulator The South African situation (3)

o Regulatory certainty  Important role for independent regulators are to create a climate of investor comfort through explained regulatory decisions  SOEs will continue to be a considerable force in the development of infrastructure – important to create an investor-friendly climate for all potential investors while still protecting captive customers o Competition where possible and regulation where necessary – role for RIAs o Regulatory capacity The South African situation (4)

o Regulatory transparency – overall improvement – especially energy:  Consultation, Public meetings, comment phase, decisions with reasons  Important especially because of SOEs dominance – perceptions can be created that regulator will decide in favour of the SOE if no transparency  Disappointing participation by stakeholders o Regulatory governance  Vary across network industries – part-time/full-time/combination  Distinct differences in regulatory governance approaches The South African situation (5)

Regulatory constraints/pitfalls  Importance of policy clarity, demarcation of policy and implementation  Lack of “trust” in regulators  Piecemeal sector-by-sector development of regulators  “Strong” incumbent monopolies vs. “weaker” regulators

Conclusion  Regulation is complex and is a balancing act – affordable and accessible services vs. economic growth and investment  Have to deal with: industry structure, conflicts of interest, uncertainty wrt political commitment & capacity issues  Multi-sector regulator makes sense, BUT other models can also work. What is essential – compliance with basic regulatory principles should be non-negotiable, e.g. transparency, explained decisions and rule of law.  Regulatory framework should fit the local circumstances (e.g. where lack of capacity) – therefore learn from international experiences but keep local circumstances in mind (adopt, adapt and reject according to local circumstances). IEA regulatory principles – good guidance  SA in need of improved service delivery, competitive prices and investment in network industries – SOEs will not be able to do it alone – important to ensure a conducive investment climate while protecting captive customers