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Smarter Regulation: Optimising price reviews to drive investment

Writing a guest post for GIIA, member Fingleton flags the key issues with current price review processes in the UK and what can be done to fix them

The UK government is acutely aware of the need to ramp up investment in infrastructure. It has to deliver on core commitments and ambitions, including the UK’s goal to reach net zero emissions by 2050 and the upgrading of the country’s infrastructure, to meet demographic and climate demands.  

International investment is key to delivering these commitments and ambitions, and to facilitating sustainable economic growth. However, according to the Global Infrastructure Investor Association’s (GIIA) latest pulse survey, the UK’s ability to attract international investment in infrastructure has declined. The survey reveals that a key barrier to investment in the UK is the unattractiveness of its regulatory regime. This is remarkable: UK regulation used to be seen as a valuable asset that attracted international investment.  

However, there is scope for optimism. The government’s consultation on Strengthening the economic regulation of the energy, water and telecoms sectors contains some sound proposals and has kick-started a much-needed public conversation. 

Price reviews are a central feature of the UK’s regulatory regime. They will continue to be the primary gateway that controls the flow of investment into regulated network infrastructure. In this article we take a closer look at the shortcomings of price reviews and offer recommendations that build on the government’s proposals. Getting these changes right could decisively contribute to improving the attractiveness of the UK’s regulatory regime and unlock significant infrastructure investment opportunities.  

Price reviews are designed to focus on the short run

The ultimate objective of price reviews is for the regulator to determine how much customers should pay for a regulated service, and it does so by setting the regulated price. This follows a detailed scrutiny of the regulated company’s business and investment plan, and the regulated price remains broadly fixed [1] for the duration of the control period: in general, five years. 

While regulators increasingly require companies to think beyond the next price review period when developing their plans [2], this is insufficient to overcome short-termism. The reality is that price cap decisions are confined to five-year periods and, absent structural solutions that require regulators and regulated companies to take a longer-term perspective, there remain strong incentives to focus on the short run at the expense of the longer run.

[1] Note that regulated prices can change during the price control period based on detailed formulae defined by regulators as part of the price review decisions. 
[2] For example Ofwat mandates that water companies publish business plans that go well beyond five years.

Price reviews are open to excessive political influence

The statutory regimes of UK regulators are more complex today than ever before. Regulators’ duties and remits have significantly expanded over time, reflecting a political desire for regulators to achieve a broader range of social policy outcomes. As a consequence, the boundaries between regulators and government are increasingly blurred. Regulators find themselves having to balance and trade off an increasing, and more complex, number of duties when making decisions.  

Given the deep societal effects that price reviews can have, and the enhanced presence of policy objectives in the regulators’ duties, today’s price review decisions are more likely to respond to the political imperative of the moment than ever before. A clear example of this is the growing tendency to focus on short-term consumer outcomes, motivated at least in part by cost-of-living concerns, potentially at the expense of longer-term priorities and planning.

Price reviews have become increasingly complex and inconsistent

A growing number of regulatory requirements have been imposed on regulated companies via the price review process. These requirements have profound implications, not just for their ability to deliver their service commitments but also their underlying economics. For example, there is a growing perception among investors that the rewards provided by regulators are not enough to compensate regulated companies for the risks that they are asked to manage. This undermines incentives to invest.  

In addition, there appears to be significant inconsistencies between decisions taken by different regulators. A case in point is how market-driven parameters of the costs of capital vary across price review decisions without any clear justification.

Key recommendations to government and regulators

Building on the government’s proposals on strengthening economic regulation, we offer four recommendations to address current shortcomings and to improve the attractiveness of the UK’s regulatory regime.   

  1. The National Infrastructure Commission (NIC) should undertake a holistic assessment of the infrastructure investment needed in regulated sectors. This will help to set regulatory decision making in a longer-term timeframe. Crucially, regulators and industry should engage with the NIC’s assessment and commit to embed the resulting findings into the price review processes.   

  1. The government should provide greater clarity to regulators regarding the discharge of their duties via targeted use of Strategic Policy Statements (SPSs). This could include directing regulators to align their price control decisions with the findings of the NIC’s assessment. Alternatively, the government could provide additional clarity through the introduction of a new statutory duty that requires regulators to align their price control decisions with the findings of the NIC’s assessment.  

  1. Regulators should be held accountable for facilitating the required investment. This could include a requirement to report to the government on how their price review decisions are aligned with the SPSs and the NIC’s assessment.  

  1. Regulators should take steps to ensure greater consistency in price review decisions. For example, all regulators should use exactly the same methodology to determine the market-driven parameters of the costs of capital. Greater consistency and certainty in the cost of capital decisions (across sectors and over time) will give investors a clearer view of the financial viability of their investment decision.  

Price reviews are fundamental to the attractiveness of UK regulated infrastructure to global investors. Longer-term thinking and greater clarity will go a long way to driving the investment that is needed.  

This article was authored for GIIA by member Fingleton.

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