Select Committee on Constitution Minutes of Evidence


Memorandum submitted by British Energy

  I attach a memorandum of evidence from British Energy plc in relation to the above inquiry. In addition to the main submission a brief background note (Annex 1) on British Energy is also provided.

Our submission is focused on the accountability of the energy regulator, the Gas and Electricity Markets Authority (the Authority) and its executive arm, the Office of Gas and Electricity Markets (Ofgem). Our main concerns are the inability to effectively challenge the majority of the Authority's decisions on the merits of the case and the absence of a coherent framework for reviewing the effectiveness and appropriateness of the regime and for ensuring that the actions of the Authority do not conflict with Government policy and objectives.

  There have been many fundamental changes to the industry structure since the basic framework for regulation of the energy sector was put in place over 13 years ago. Whilst the Utilities Act 2000 did make some changes, they were more to do with merging the gas and electricity regimes, setting up energywatch and providing enabling powers for the New Electricity Trading Arrangements than conducting a fundamental review of the overall framework.

  This inquiry is therefore a timely opportunity to review this whole area: to bring it into line with best regulatory practice, to ensure it if fit for purpose for the industries now being regulated, and to enable it to facilitate the delivery of the Government's energy policy. It is particularly timely, with the prospect of a new Energy Act as a vehicle for taking forward and implementing any changes recommended.

  BE believes it is essential that a better overall regulatory framework is developed which:

    —  provides the right incentives for Ofgem to operate in accordance with best regulatory practice as embodied in the five key Better Regulation Task Force (BRTF) principles of transparency, accountability, proportionality, consistency and targeting;

    —  ensures an appropriate level of parliamentary scrutiny;

    —  maintains the principle of independent regulation; and

    —  ensures the regulatory regime is managed in a manner which is consistent with and facilitates the implementation of Government policies.

  Such a framework would be the best way of protecting customers' interests. It would reduce regulatory risk, reduce the direct and indirect cost of regulation where appropriate and it would thereby restore confidence in the regulatory regime, particularly for existing and new investors. Without some fundamental changes in this area, there is a very real risk that lack of investor confidence could ultimately jeopardise security of supply.

  Ofgem aside, our generation and trading activities are subject to a significant number of other important independent regulators. These include the Office of Fair Trading, Financial Services Authority, Health & Safety Executive, Nuclear Installations Inspectorate and an increasing influence from Europe. With this in mind the overriding principle when considering issues of accountability should be the adoption of a consistent approach across all regulators incorporating regulatory best practice. Furthermore, this should be supported by the adoption of appropriate concordats between regulators to ensure the development of suitable communication channels, fit for purpose working practices/protocols and regulatory efficiency particularly in areas where there is an overlap in regulatory responsibility.

  We hope that our evidence (which includes this letter) will assist the Committee in its inquiry. We shall be pleased to help further in written response to any queries, or at our oral session scheduled for 9 April.

David Love

Head of Regulation

March 2003

SUMMARY OF RECOMMENDATIONS

  The following points summarise our main recommendations to the Committee.

    —  In considering the issue of the accountability of the regulatory bodies, the overriding principle should be to ensure the adoption of a consistent approach across all regulators incorporating regulatory best practice as espoused by the Better Regulation Task Force (BRTF) in its "Principles of Good Regulation".

    —  A new Select Committee for Regulatory Accountability (SCRA) should be created with a specific remit to monitor the effectiveness of the Authority and the interface between government policy and regulatory practice (as proposed by the EA). It is for consideration whether this should necessarily be a Committee of the House of Commons or whether it might be better as a Lords Committee.

    —  There should be periodic assessments of the scope and function of the Authority including the extent to which regulation can and should be withdrawn. Ideally, this would be carried out by the new SCRA. In addition, the Authority (in conjunction with licence holders) should be required to conduct an annual review of licence conditions with a view to removing any outdated obligations.

    —  Ofgem's budget should be capped annually at perhaps RPI 5. Any increase beyond this would have to be submitted and approved, ideally by the new SCRA. This would have many beneficial effects. It would enable Ofgem to properly prioritise its work against its statutory objectives. It would thereby ensure that the regulatory regime was efficient, targeted and proportionate, whilst not in any way undermining Ofgem's ability to carry out its key functions.

    —  The situation whereby most key decisions of the Authority are only capable of challenge by judicial review should be corrected. There should be a proper appeals process on the merits of the case to an independent body against all key regulatory decisions. If structured properly, this will provide one of the key elements of accountability currently missing from the regulatory regime.

    —  The Government should bring forward legislation that requires the Authority to carry out full and comprehensive Regulatory Impact Assessments (including cost-benefit and environmental impact analysis) for all major policy initiatives or decisions.

    —  Improvements in the transparency of the operation of the Authority are required. Agenda and minutes of Authority meetings (suitably amended to deal with any essential confidentiality issues) should be published. Ofgem should also be obliged to publish its annual accounts.

    —  The roles of Chairman and Chief Executive of the Authority should be separated.

THE ACCOUNTABILITY OF REGULATORS TO CITIZENS AND PARLIAMENT RESPONSE TO CALL FOR EVIDENCE

  This submission focuses on the accountability of the energy regulator, the Gas and Electricity Markets Authority (the Authority) and its executive arm the Office of Gas and Electricity Markets (Ofgem). In considering the issue of the accountability of the regulatory bodies, the overriding principle should be to ensure the adoption of a consistent approach across all regulators incorporating regulatory best practice as espoused by the Better Regulation Task Force (BRTF) in its "Principles of Good Regulation".

What are the legal bases for regulators; what are the nature of their powers and how do they exercise them; how could their powers be revoked; from where do they obtain their financial and administrative support

  1.  The legal basis of regulators is a statutory one established by legislation. For the Authority, the principle legislation is the Gas Act 1986 and the Electricity Act 1989 (as amended by the Utilities Act 2000). [1]These set down a number of wide-ranging duties of which the principle objective is the protection of the interests of consumers (of gas and electricity), wherever appropriate by promoting effective competition. The Authority also has significant powers (held jointly with the OFT) under the Competition Act 1989 to enforce the Chapter I and Chapter II prohibitions.

  2.  Most of Ofgem's powers are discretionary and the factors it takes into account when exercising them can vary. Currently the only way to revoke or amend the duties of the Authority is via legislation. There are no institutional mechanisms or review processes in place to determine whether regulation should be withdrawn from a particular industry or sector, in whole or in part (see paragraph 5).

  3.  Ofgem is the administrative office of the Authority. It is a non-ministerial government department. Its costs are funded by Treasury, but effectively recovered from electricity and gas consumers via the price controls on the monopoly network wires and pipes businesses. Ofgem's budget for the year 2003-04 is forecast to be £40.2 million (compared to £36 million in 2002-03 and £30.6 million in 2001-02). Comparison with other European regulators reveals Ofgem to be the most expensive energy regulator in Europe (even after allowing for differences in responsibilities).

  4.  We welcome the efforts made by Ofgem to introduce more transparency into its planning and budget setting process with the adoption of a three-year strategy. However, the lack of any direct incentive on Ofgem to control its costs and hence prioritise its work remains a cause for concern. Scrutiny by such bodies as the Trade and Industry Select Committee (TISC), the National Audit Office (NAO), the Public Accounts Committee (PAC) and the Treasury does not appear to have had any meaningful effect. In the absence of any incentives on Ofgem to withdraw from direct regulation of competitive markets, we therefore see little scope for Ofgem's costs reducing. We therefore propose that a new committee be established to carry out this function for both Ofgem and the other economic regulators (see paragraph 5 and 17 below).

By whom and how is the continuing need for regulators measured; how is their role changed or ended?

  5.  There is no formal or regular mechanism for assessing the effectiveness of and/or continued need for regulation. This is a clear deficiency in the current arrangements. Whilst the competitive markets have evolved to such an extent that we now have one of the most competitive wholesale and retail energy markets in the world (due to a significant extent to the efforts of the Authority and its predecessors), there has not been a corresponding lessening of direct regulatory control/intervention. Nor has there been the logical move from sector specific regulation to regulation solely under competition legislation.

  6.  Thus there should be a formal process for periodic assessments of the scope and function of the Authority including the extent to which regulation is in line with current best practice and whether any part of it can and should be withdrawn. This review could appropriately be carried out by the new Select Committee for Regulatory Accountability (SCRA) (see paragraph 17) in conjunction with the industry and consumer bodies like energywatch, perhaps assisted by the NAO and BRTF.

  7.  In addition, the Authority should be encouraged to actively adopt the principle of "targeted" regulation (as set out in the BRTF principles of good regulation). In particular, it should demonstrate that it is withdrawing from direct regulation of competitive markets and focusing instead on regulation of the monopoly businesses. Specifically, the Authority, in conjunction with licensees and bodies representing consumers, should be obliged to conduct an annual review of licence conditions with a view to removing or modifying any outdated obligations. This review should be presented to the new SCRA.

  8.  As indicated in paragraph 4 above the lack of direct cost control incentives on Ofgem remain a cause for concern. Whilst Ofgem's budget is subject to approval by the Treasury, there is no formal mechanism to incentivise Ofgem to control/reduce its costs. As such there is also no effective means of ensuring that Ofgem's workplan is effectively and appropriately prioritised. One potential way froward would be to formally cap Ofgem's annual budget at perhaps RPI -5. Any increase beyond this would have to be submitted and approved by the SCRA. This would have many beneficial effects. It would oblige/enable Ofgem to properly prioritise its work against its statutory objectives. It would thereby ensure that the regulatory regime was efficient, targeted and proportionate, whilst not in any way undermining Ofgem's ability to carry out its key functions.

Who are the members of the regulatory bodies; how are they appointed; are they adequately representative; do Nolan principles operate?

  9.  The move away from individual regulators to the creation of an Authority has helped to de-personalise energy regulation to some extent. However, we would question whether this has necessarily led to increased confidence in regulatory decision making, or the creation of a more stable regulatory environment as intended.

  10.  The roles of chairman and chief executive of the Authority should be separated in line with best practice for company boards in the private sector. We note that the consumer organisation energywatch set up as part of the new regulatory arrangements has adopted such a model.

  11.  With regard to whether the members are properly "representative", the Government appoints the members of the Authority. Whilst the present non-executive members of the Authority do seem to possess a broad and balanced level of experience, we have concerns regarding the ability of the industry and consumer groups to engage with them separately in a meaningful way. Thus there are questions as to the role and influence of these members in the Authority's work.

  12.  We would also question whether the Authority with a board comprising five executive and six non-executive directors is the right size. It may be that a smaller board, comprising perhaps four executives, three non-executives and a non-executive chairman may strike a better compromise between the need for broad expertise and the need to be effective and manageable.

  13.  So far as we are aware, Nolan principles appear to be upheld.

What are regulators set up to achieve; to what extent do regulators achieve their purposes without adverse consequences; how is their effectiveness assessed

  14.  The purpose, objectives, functions and duties of regulators are defined by statute. This typically requires the protection of consumers' interests (as is the case with the Authority) with the promotion of effective competition wherever possible.

  15.  The Authority has a broad and deep remit coupled with wide legal discretion and largely unfettered powers. As a consequence issues inevitably arise from the interpretation and application by the Authority of its various duties and functions, how it balances the various potentially conflicting requirements, and how it exercises its powers. For example, Ofgem's approach to the regulation of the monopoly network businesses has been to focus on the historic inefficiencies of such businesses. Whilst such an approach has undoubtedly removed inefficiencies, it does not necessarily create the right incentives on network operators for future investment to ensure security of supply in the long term.

  16.  The current lack of accountability of Ofgem and the absence of effective appeal rights combine to reduce confidence in the regulatory decision making process generally. This leads to unnecessarily high regulatory risk, which in turn feeds through into the cost of capital for new investment projects and thence ultimately to customer prices.

  17.  The Authority is required to report annually to the Secretary of State and is subject to occasional, largely ad hoc, scrutiny by various parliamentary committees and the NAO. This does not amount to a focused and robust assessment of its effectiveness. In other words, there is no institutional ownership of the task of evaluating the Authority's effectiveness. Given the importance and size of the utility sectors subject to economic regulation, we support the Electricity Association's (EA) proposal for the creation of a specific cross-sectoral Select Committee for Regulatory Accountability (SCRA) to carry out this function. We would however, question whether this should necessarily be a Committee of the House of Commons or whether it might be better as a Lords Committee.

To what extent are regulators both prosecutors and juries on an issue; what rights of appeal are there against decisions made by regulators?

  18.  Because of their obligations to investigate and enforce breaches under the regulatory regime regulators are by their very nature prosecutors and juries. This means that regulators must operate to very high standards in terms of consistency of approach and transparency of action. In some sectors (eg telecoms and financial services) the potential problem this creates is effectively balanced by the availability of appeal rights on the merits of a case (eg appeal tribunal under Financial Services and Markets Act 2000).

  19.  However, that is not the case for the energy sector where the lack of an effective appeal mechanism across the full range of regulatory decisions in respect of the Authority makes this situation unacceptable. Indeed, the existing appeal mechanisms in the energy sector are increasingly inadequate and out of step when judged against evolving standards of accountability and with the mechanisms available in comparable sectors.

  20.  With the exceptions of references to the Competition Commission in respect of certain disputed licence modifications and appeals to the Competition Appeal Tribunal in respect of decisions of the Authority when using its CA98 powers, most decisions of the Authority can only be challenged through judicial review. It is widely acknowledged that the JR process falls well short of a proper appeal on the merits of a decision. It is mainly a suitable means of challenging procedural failures or errors of law, but not of reopening substantive decisions on their merits.

  21.  In the energy markets, this position has been made more acute since the introduction of NETA. Previously, market participants in E&W had certain important commercial rights and recourse to the courts. These rights are no longer available due to the process of codification that was put in place for NETA. [2]This has meant the loss of important checks and balances within the commercial framework. We understand that DTI will be issuing a separate consultation on governance of the industry codes shortly which will feed in to your own review. [3]We do not therefore propose to cover this aspect in any detail here, but will be responding directly to DTI.

  22.  Fundamental accountability dictates appropriate checks and balances are built into the regulatory regime. As the BRTF observed for the energy sector "there should be a well publicised, accessible, fair and efficient appeals procedure". We therefore propose that all "significant" decisions of the Authority should be capable of appeal on the merits of the case to an independent tribunal such as exists within other regulated sectors. We recognise, however, that there are implementation issues that will need to be addressed. For example, ensuring that the process is not used as a way of frustrating or delaying legitimate change and defining appropriate appeal triggers. However, this should not be difficult provided lessons are learnt from the arrangements developed within the communications and financial sectors where such arrangements apparently work well.

How are regulators held to account by Parliament; what other accountability do regulators have to auditors, Government departments or other public bodies?

  23.  As a non-ministerial department the Authority is not "directly" accountable to Parliament. Instead, scrutiny falls to parliamentary committees who can make recommendations for change and suggest improvement to the regulatory arrangements (but these need not be taken up). Thus from a parliamentary perspective, the Authority is essentially free to do as it pleases within the bounds of its statutory duties (this is not a criticism of Ofgem, merely an observation of the current framework).

  24.   As a consequence, and as indicated in paragraph 17 above, there is currently no coherent system for assessing the effectiveness of the Authority or of securing meaningful accountability to Parliament. In particular, there is no effective scrutiny of how and to what extent the Authority's policies are consistent with and complement the framework of energy policy set by Government. The creation of a new SCRA would help ensure a holistic approach to energy regulation within the framework of Government energy policy. This would not replace or replicate the work of existing committees, rather compliment them. In particular, the valuable role of existing committees like the TISC in looking at specific projects/areas of Ofgem's work should continue.

How are regulators accountable to those whom they regulate; what is the impact of regulation on the economy; how transparent are their methods of working?

  25.  There is no effective accountability of the Authority to those it regulates. A number of factors contribute to this including the historic reluctance of the Authority to carry out Regulatory Impact Assessments (RIAs) in support of major policy initiatives and the lack of effective appeal rights. We have already commented on the latter and in respect of the former we welcome the Government's commitment to introduce a statutory requirement on the Authority to carry out RIAs for all major policy initiatives or decisions. However, this must ensure that the RIA is comprehensive, an integral part of the consultation process, includes a full cost-benefit end environmental impact analysis, and is conducted in accordance with best practice as set out in the NAO's report on regulatory impact assessments published in November 2001. [4]

  26.  Improvements in the transparency of the operation of the Authority are also required. For example, GEMA does not publish any documentation in relation to its meetings, nor does it produce annual accounts. It can also be difficult for the industry and consumer groups to engage separately in any meaningful way with the non-executive members of the Authority. Thus it is difficult to determine to what extent the Authority rather than Ofgem (using its delegated authority to make decisions on behalf of the Authority under its rules of procedures) actually determines strategy and major policy issues and what influence, if any, the independent members of the Authority have had.

  27.  Agenda and minutes of Authority meetings (suitably amended to deal with any essential confidentiality issues) should be published. Ofgem should also be obliged to publish its annual accounts.

  28.  The promotion of competition by Ofgem and its predecessors, combined with the operation of price controls has brought benefits to consumers in the form of greater choice and lower prices. However, the growing unease with the current governance arrangements (in particular the role and accountability of Ofgem in respect of industry code changes) and the way in which the Authority arrives at policy decisions is undermining investor confidence and increasing regulatory uncertainty. In the long term this increases the cost of capital for investment projects and hence to consumers. If not addressed, such issues could pose serious questions regarding the industry's ability to provide safe and secure energy supplies over the longer term.

How are regulators accountable to the public other than through Parliament; what opportunities do the public have to express concerns to regulators; how do regulatory bodies relate to their associated consumer watch-dogs?

  29.  Although not accountable to the general public Ofgem makes much information publicly available. It has in place a well-designed and informative web-site and issues a constant stream of information. In addition the public is free to respond to Ofgem consultations on issues of concern. In this sense therefore Ofgem is very accessible to the public.

  30.  The Gas and Electricity Consumer Council (energywatch) is the body through which consumer concerns are most likely to reach Ofgem. The Authority has a statutory duty to consult energywatch on its forward work programme and both are jointly required to draw up a public memorandum setting out the arrangements for co-operation between them.

  31.  Unlike in the water industry where WaterVoice explicitly represents the interests of all consumers large and small, energywatch only appears to actively represent domestic consumers. It could be that smaller commercial customers are therefore underrepresented.

How effective is public consultation by regulators; what opportunities do the public have to contribute; to what extent do the public make use of these opportunities?

  32.  Ofgem has a comprehensive consultation process in place that includes seminars and workshops to explain its proposals and decisions. However, its historic reluctance to employ full and proper RIAs as an integral part of its consultation process has undermined its credibility in this respect. There is also a suspicion that Ofgem sometimes has already pre-judged the final decision and is not receptive to criticism of proposals. Such behaviour fuels concerns that Ofgem often fails to achieve the essence of "true" consultation, and that consultation is merely a matter of due process.

To what extent do the needs or concerns of the public guide the work of regulators; are regulators instruments of Government or representatives of the public?

  33.  The Authority's principle objective is to "protect the interests of consumers wherever appropriate by promoting competition". Thus the needs of the public are the Authority's principal concern. But it is their interpretation of this requirement that shapes their approach and agenda.

  34.  There are growing concerns that Ofgem's approach relies too much on textbook economic theory, ignoring the realities of the markets it regulates. It is questionable to what extent such an approach benefits consumers.

How independent are regulators of Government; what factors do or might compromise their independence?

  35.  Whilst the regulators are appointed by Government and their duties and functions are defined by legislation, Government quite rightly takes no role in the day to day operations of them.

  36.  It is right that the Authority remains independent of Government. But there is a question as to how independent of Government the Authority should be given the need to ensure a coherent policy and regulatory framework and in light of the important role the Authority plays in helping to deliver the Government's energy, social and environmental objectives. In particular, it is imperative that decisions of the Authority do not conflict with overriding Government policy. Unfortunately it cannot be said that the current framework always achieves this (for example, the DTI has consulted separately on the impact of a GB market—particularly from the perspective of renewables development—of Authority's decision to introduce zonal losses in E&W). This reinforces the need for improved accountability of the Authority, not only from the perspective of regulated companies, but also by parliament along the lines described above.


1   The Authority was established by the UA2000 as the combined successor of the former separate offices of the Director General Gas Supply (established by the Gas Act 1986) and the Director General of Electricity Supply (established by the Electricity Act 1989). Back

2   The arrangements under the Pooling and Settlement Agreement and Master Connection and Use of System Agreement were replaced by the Balancing and Settlement Code and the Connection and Use of System Code. Back

3   See Energy White Paper, para 9.16, p.114. Back

4   Better Regulation: Making Good Use of Regulatory Impact Assessments-Report by the Comptroller and Auditor General HC 329 published 8 November 2001. Back


 
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