House of Lords - Regulators

Select Committee on Regulators First Report

CHAPTER 2: BACKGROUND

The history of the regulators

2.1. Most of the regulators with which this report is concerned were founded in the 1980s or even earlier.[1]

2.2. The privatisation movement in Britain, which began under the Conservative governments of the 1980s, provided the main impetus for the growth of economic regulation in the last two decades of the 20^th century and the early years of the twenty first century. Most of the nationalised industries had statutory monopolies and, when privatised, retained monopoly power, or, depending on the new structures, established some elements of monopoly power, which required regulation to prevent abuse of that power via higher prices and/or lower standards of service than there would have been in competitive markets.

2.3. The relevant Acts of Parliament established independent sector-specific regulatory offices. The regulators, who were appointed by government usually for a five year term, were given specific statutory duties and powers, but the activities of the regulators were otherwise free from the direct political intervention that had been frequent under nationalisation. Companies subject to regulation were issued with their original licences by the government, setting out their rights and obligations, and had the safeguard that changes to licence conditions proposed by the regulator were subject to appeal to the Monopolies and Mergers Commission (now the Competition Commission).

2.4. Although the statutory duties set out in the Acts of Parliament which privatised the industries differed to some extent from sector to sector, regulation as it evolved tended to have common features. In particular, it is recognised that the "natural monopoly"[2] sectors of the utilities (for example, the networks of pipes and wires used to transport wholesale gas and electricity supplies to retail customers) have to be regulated for the foreseeable future to avoid the companies exploiting monopoly power. However, in the remaining parts of the industries, pro-competition regulation is required, but only as a temporary measure until potentially competitive sectors become actually competitive. Thus the scope and size of the regulatory offices were expected to reduce over time as the parts of the industries which had become effectively competitive became subject only to general ex ante competition regulation.

2.5. The first utility regulatory office was the Office of Telecommunications (Oftel), set up to regulate the telecommunications industry when 50 per cent of British Telecommunications was sold by public offering in 1984, in the first major utility privatisation. Other regulatory offices soon followed—the Office of Gas Supply (Ofgas) in 1986, the Office of Electricity Regulation (Offer) in 1989, the Office of Water Services (Ofwat) in 1989, the Office of the Rail Regulator (ORR) in 1993, all with Directors General. The Postal Services Commission (Postcomm) which regulates postal services (where Royal Mail is still in government ownership), came later, in 2000.

2.6. The Civil Aviation Authority (CAA) is different from the utility regulators in that it was in existence before the privatisation in 1987 of the nationalised British Airports Authority, having been established in 1972. The task on privatisation was therefore not to establish a regulator but to remodel the existing one, by adding the economic regulation of airports to its functions. Another important difference as between airport regulation and regulation of the privatised utilities is that the CAA does not have a duty to promote competition (this difference may be associated with the fact that it was thought that—short of divestment—the scope for competition among airports was constrained).[3]

2.7. The two financial service regulators were founded more recently. In May 1997, the government announced its intention to create the Financial Services Authority (FSA) as a single financial services regulator, independent of government, responsible for both financial services prudential regulation and the conduct of business regulation. The regulator's duties and powers were set out in the Financial Services and Markets Act (FSMA) which came into force in 2001. The FSA does not have a duty to promote competition in the industry nor to regulate prices since the regulated companies already operate in competitive markets. However, the regulator is required to meet its statutory objectives in ways consistent with facilitating and maintaining competition (internationally and domestically) and minimising adverse effects on competition from regulation. The Pensions Regulator (TPR), which replaced the Occupational Pensions Regulatory Authority, was created by the Pensions Act 2004 and began work in April 2005. Its role is to regulate work-based pension schemes with the objectives of protecting the interests of scheme members, promoting good administration and reducing the risk of claims on the Pensions Protection Fund.

2.8. The two competition authorities considered in this report—the Monopolies and Mergers Commission (now the Competition Commission-CC) and the Office of Fair Trading (OFT)—which regulate UK companies generally to maintain competition and prevent abuse of market power, were already in existence by the time the privatisations of the 1980s began.[4]

2.9. There have been some significant changes to the regulatory regime in the last twenty years though and, apart from the railways, the changes have been primarily evolutionary. The incoming Labour government of 1997 carried out a review of utility regulation which reported in 1998.[5] The new government retained the main elements of the previous regime, including the independence of the regulators.

2.10. However, following the review, a number of changes were made, including mergers of regulatory offices, most notably of the two energy regulators, Ofgas and Offer, into the Office of Gas and Electricity Markets (Ofgem) in 2000 and of the various communications regulators including Oftel into the Office of Communications (Ofcom) in 2002. The original organisational structure of a regulatory office, with an individual (Director General) responsible for regulating the relevant industry, was also changed. Newer regulators have been established with Board structures and the original statutes have been amended so that there are Board structures for all the regulatory offices (normally with a Chairman, Chief Executive and several executive and non-executive directors), and for the two competition authorities, the Competition Commission (previously the Monopolies and Mergers Commission) and the Office of Fair Trading. The Competition Commission was for a time separated into two parts, one of which was the Competition Appeal Tribunal (CAT). The CAT is now an independent body which, inter alia, hears appeals from decisions of regulators and the OFT.

2.11. The greatest changes have taken place in rail regulation, which has always been rather different from regulation of the other privatised industries because of the continuation of substantial government subsidy which has resulted in ongoing government involvement. But since privatisation there have been significant changes to the rail industry which have also changed the regulatory system—for instance, the abolition of the Office of Passenger Rail Franchising (OPRAF) which used to run the franchising system for the Train Operating Companies; the creation and subsequent abolition of the Strategic Rail Authority (SRA) which had been charged with formulating a strategy for the railways; the move of franchising (previously OPRAF) and strategic functions (previously SRA) to the Department of Transport; the replacement of the original network owner, Railtrack, by Network Rail (a not-for-dividend company) in 2001; and the transfer of health and safety functions to the ORR. Together these represent major changes to the system of regulating the railways, with much more government involvement than in the other regulated utilities.

The Formation of this Select Committee

2.12. This Committee was set up on the recommendation of the House of Lords Constitution Committee in their 2003 Report entitled The Regulatory State: Ensuring its Accountability.[6] The Report concluded that Parliament was crucial to ensuring the accountability of regulators and that, at that time, parliamentary scrutiny of the regulatory state was not sufficiently extensive, consistent or co-ordinated.

2.13. The Constitution Committee therefore recommended that a "dedicated parliamentary committee should be established to scrutinise the regulatory state".[7] Furthermore, they recommended that such a committee should "preferably be a joint committee of both Houses"[8] and should focus its work around "the annual report and the published RIAs"[9] of each regulator.

2.14. In their response to the Constitution Committee's Report the Government noted that "These recommendations [were] for the House Authorities to take forward as they deem[ed] appropriate".[10]

2.15. Accordingly, Lord Holme of Cheltenham, the then Chairman of the Constitution Committee, took a proposal for a sessional[11] joint committee on regulators to the Lords Liaison Committee.[12] The Committee considered the request, and agreed that the "subject was important" but reminded Lord Holme that the Committee was, at that time, "reluctant to commit resources to the establishment of additional permanent sessional committees".[13] The Committee agreed to approach the Commons informally to discuss the possibility of setting up a joint committee but found that enthusiasm in the Commons was lacking.

2.16. Consequently, at the next meeting of the Liaison Committee Lord Holme returned with a new proposal for an ad hoc[14] select committee on regulators to be formed solely of Lords members. The Committee heard the proposal and recommended the "establishment … of an ad hoc select committee on the regulatory process, to be known as the Select Committee on Regulators".[15]

2.17. In line with the Liaison Committee's recommendation this Committee was appointed on 23 November 2006. We were appointed with a broad remit—"to consider the regulatory process".

What this Committee set out to achieve

2.18. Presented with such a broad remit and only one parliamentary session in which to operate we were forced to set clearly defined limits on the scope of the work we wished to complete. At our first deliberative meeting, we therefore agreed to narrow down the scope of our inquiries by deciding to focus on regulators rather than regulation. We also agreed to look only at the economic regulatory work of the major UK economic regulators. We have not looked at all regulators operating in Northern Ireland and Scotland. There is no universally accepted "list" of the major UK economic regulators so, for the purposes of our inquiry, we made clear that we would be considering the work of Ofwat, Ofgem, the ORR, the CAA, the FSA, Postcomm, Ofcom, the Pensions Regulator, the OFT and the CC.

2.19. Our first Call for Evidence, released in December 2006, outlined the four areas of inquiry that we intended to focus on, namely:

Regulators' working methods and their effectiveness;

Regulators and the public interest;

Regulators' promotion of competition within domestic industries and the regulators' effect on the UK economy's international competitiveness; and

Regulators' use of Impact Assessments.

2.20. With our Call for Evidence released we set out to take a substantial amount of oral evidence from the regulators themselves, representatives of the regulated industries and other interested parties.[16] A second Call for Evidence, expanding on some of our economic lines of questioning, was released in May 2007.[17]

2.21. August and September 2007 brought a liquidity crisis at Northern Rock, which ultimately led to the first run on a bank in Britain since 1866.

2.22. Inevitably, the Northern Rock crisis casts a new light, and indeed casts doubt, on the claims of financial regulators to prioritise effectively their supervisory activities, especially for such major financial institutions as Northern Rock. It also raises questions of the effectiveness of joint working between the FSA, HM Treasury and the Bank of England.

2.23. We have not been able to consider these events in this Report. Neither time nor our self-imposed terms of reference would have permitted the full examination that their importance required. Furthermore, in September 2007, the Treasury Select Committee in the House of Commons launched an inquiry into Financial Stability and Transparency and began to take evidence on the Northern Rock crisis. To date, the Treasury Select Committee has taken oral evidence from the Bank of England, the Financial Services Authority, Northern Rock and HM Treasury. That Committee will publish its Report in due course. Meanwhile, evidence taken can be found on their website. [18]

Structure of this Report

2.24. In Chapter 3 of this report we consider the nature of the regulators' various statutory remits and make a judgement on whether or not any re-writing needs to be done.

2.25. Chapter 4 looks at how regulators work in terms of self-discipline and self-evaluation. We consider the extent to which regulators provide value for money, make use of light-touch, risk-based or principles-based regulation and take seriously the process of carrying out Impact Assessments (IAs).[19]

2.26. Chapter 5 examines regulators' relationships with their regulated industries and end consumers. We take a close look at how consumer interests are considered by regulators and we summarise our findings on the concept of the "public interest".

2.27. Chapter 6 covers regulators' relationships with each other and with their sponsoring departments. We look at the extent to which best practice is shared between them and consider the effectiveness of concurrency arrangements.

2.28. Chapter 7 brings together our inquiry and looks in detail at competition and competitiveness issues. We ask whether regulators have successfully promoted competition in the sectors they regulate and whether, having done so, they are de-regulating in areas where it is proper for them to do so. We also look at the issue of competitiveness and consider the extent to which regulators, collectively, impact on the competitiveness of the UK economy. Lastly we ask whether it will ever be possible for sectoral regulators to disappear completely and transfer their essential functions to the competition authorities.

1 The dates of formation of the existing regulators and the names of predecessor organisations are listed in Chapter 3. Back

2 Where natural monopolies exist, entry by competitors, even if free, is unlikely to be effective because of economies of scale enjoyed by the incumbent. Back

3 C.Chataway, 'Airports and Airport Regulation' in M.E.Beesley (ed.) Major Issues in Regulation, Institute of Economic Affairs, 1993. Back

4 At that time the OFT was formally the office of the Director General of Fair Trading. The Enterprise Act 2002, required that the office of the DGFT was known as the OFT. Back

5 DTI, 'Fair Deal for Consumers: Modernising the Framework for Utility Regulation-the Response to Consultation', July 1998. Back

6 6th Report, Session 2003-04, HL Paper 68 Back

7 ibid, para 199 Back

8 ibid, para 200 Back

9 ibid, para 203 Back

10 The Regulatory State: Ensuring its Accountability: The Government's Response, 12th Report, Session 2003-04, HL Paper 150, para 48. Back

11 i.e. permanent Back

12 The Liaison Committee's terms of reference are: "To advise the House on the resources required for select committee work and to allocate resources between select committees; to review the select committee work of the House; to consider requests for ad hoc committees and report to the House with recommendations; to ensure effective co-ordination between the two Houses; and to consider the availability of Lords to serve on committees". Back