Select Committee on Constitution Minutes of Evidence

Evidence from the Electricity Association

  1.  The Electricity Association (EA, or we) welcomes the Constitution Committee's decision to conduct an inquiry into the workings of regulation, looking in particular at the accountability of government-appointed regulators, their scrutiny by Parliament, their accessibility to the public, and their responsibility to the citizen. The EA believes that these issues have significant implications for the effective functioning of the British economy. It is pleased to contribute this evidence to the Committee's inquiry on behalf of all categories of licence holder in the electricity supply industry.

  2.  We are aware that the issues of concern to the Committee are relevant to the regulation of numerous important industrial sectors, including the utility companies, the broadcasting media, and the financial and service sectors. However, given the EA's role as a trade association for the electricity supply industry, our evidence will focus on the position and activities of the Gas and Electricity Markets Authority and its executive arm, which operates under the name of the Office of Gas and Electricity Markets, otherwise known as Ofgem. (In the rest of this paper, the terms "Authority" and "Ofgem" are used interchangeably except where noted.)

  3.  The Authority, as the principal regulator of the gas and electricity industries, has general supervision and control over one of the largest (by value) and most essential (by function) sectors of the British economy. In this role, it exercises significant power in relation to companies and individuals, and this is clearly evidenced by the sheer volume, importance, range, and scale of the decisions that it regularly makes.

  4.  The Committee's questions are addressed below in the order in which they were set out in its call for evidence. This response includes our covering letter.

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

  5.  The Authority has a statutory basis. It was established, under the Utilities Act 2000, as the combined successor to the former separate offices of the Director General of Gas Supply (under the Gas Act 1986) and the Director General of Electricity Supply (under the Electricity Act 1989) Its primary function is to regulate the activities of the licensed entities within the gas and electricity industries in Great Britain in accordance with its principal statutory objective. That objective is to protect the interests of the consumers (respectively) of gas and electricity, wherever appropriate by promoting effective competition, and with regard to the need to secure that all reasonable demands for supply are met and that licensees are able to finance their activities.

  6.  Ofgem is a non-ministerial government department whose functions (see section one of the Utilities Act 2000) are performed on behalf of the Crown: its employees are civil servants. Its statutory powers, under the amended gas and electricity legislation, are a patchwork of executive functions (such as the power to issue licences or modify their conditions), legislative functions (such as the power to make statutory instruments, in some cases without ministerial consent), and judicial functions (such as the power to determine disputes or impose financial penalties).

  7.  In performing those functions, Ofgem's accountability to Parliament or citizens is, at best, blurred and indirect. A Key reason for this is the broad discretionary nature of the statutory framework for utility regulation, a characteristic that it shares with the wider British administrative system, of which regulation forms an expanding part. That is why the EA believes that the weak political accountability of regulators needs to be counter-balanced by a more effective framework of legal accountability. This concern is amplified in other parts of this paper.

  8.  Regulatory powers, being endowed by statute, can only be changed or revoked by subsequent legislative intervention. There are no institutional mechanisms to enable government to determine whether regulation should be withdrawn from a particular industry or sector, in whole or in part.

  9.  If, conversely, the Committee's question about the revocation of regulatory powers springs from a concern about the terms of appointment of regulators, it should be noted that a significant mark of their protected status is the limited statutory power of dismissal which applies to their office. In Ofgem's case, the members of the Authority are appointed for five years, there is no limit on the number of terms for which they may be reappointed, and they can only be removed on the grounds of incapacity or misbehaviour. However, although the criteria for dismissing members are laid down by statute, the law is silent on the criteria for their appointment.

  10.  Ofgem's costs (and those also of the Gas and Electricity Consumer Council) fall within the general class of public expenditure, where they are funded by the Exchequer through the parliamentary vote procedure. This expenditure is then recovered under the price control arrangements as a pass-through element in the network charges levied on suppliers by monopoly licence holders—the transmission and distribution companies in electricity, and the transportation companies in gas. The costs of regulation are therefore borne, ultimately, by the general body of gas and electricity consumers.

  11.  While these costs have stabilised to some extent in recent years, they increased in each year of the previous decade at a rate well in excess of inflation, and remain high by comparison with the costs of energy sector regulation in Europe. There is no direct incentive on Ofgem to reduce its costs, and little evidence that standard Whitehall reporting requirements or the scrutiny of the Treasury and National Audit Office have been particularly effective in constraining its expenditure.

  12.  The EA believes that the whole framework for the financial accountability of energy regulation is insufficiently transparent, and requires fresh thought. It seems wholly inappropriate, for example, that Ofgem is under no legal duty to publish annual accounts, and that its service delivery agreement with the Treasury says nothing about the desirability of reducing the real costs of regulation.

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

  13.  In principle, the role of those regulators, such as Ofgem, which are creatures of statute should be changed or ended only by new primary legislation. This may indeed be the case in relation to fundamental changes or regulatory policy that are instigated by government. Under the Utilities Act 2000, for example, the responsibility for gas and electricity regulation—previously vested in two separate statutory personalities (see paragraph five above)—was transferred to a new corporate body, the Authority. At the same time, the primary legal duties of those persons, including the requirements to promote competition and ensure that licence holders can finance their activities, were subordinated to a new and over-arching objective of consumer benefit.

  14.  In practice, however, the discretionary nature of utility regulation which we have noted above means that quite large incremental changes can take place in the role of regulation without explicit legislative intervention. Ofgem, in particular, tends to claim that most of its work is mandatory, and that large parts of the energy market are no longer subject to regulation. However, even a glance at its corporate plan will reveal that much of the work is obviously discretionary. Ofgem appears to have no disciplined review process to work out which measures will be effective in protecting customers in both the short and longer term. At the same time, the energy market—despite the recent removal of gas and electricity supply price contols—remains heavily administered, and virtually no rule change can take place there without Ofgem's approval.

  15.  Moreover, the ubiquity and intrusiveness of the regime are part and parcel of a more general growth of regulatory pressures in recent years. In addition to regulation by Ofgem, the gas and electricity industries are also now subject to regulatory intervention of one kind or another by the Department of Trade and Industry, Office of Fair Trading, Competition Commission, Financial Services Authority, Gas and Electricity Consumer Council, and Health and Safety Commission. Nor can the industries ignore the growing impact of European Commission requirements, which are mostly binding on and directly enforceable within member states.

  16.  The Cabinet Committee system incorporates a Ministerial Panel for Regulatory Accountability, consisting of the Chancellor of the Duchy of Lancaster, the Secretary of State for Trade and Industry, the Chief Secretary to the Treasury, and the Minister of State at the Cabinet Office. It is required by its terms of reference to tackle cases where progress to regulatory reform is blocked, and to call ministers to account for new regulation and their performance in addressing the burden of existing regulation. This body seems ideally placed to take a strategic overview of the UK regulatory system, including measuring the continuing need for regulators and regulatory intervention.

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

  17.  The Authority is a body corporate which, by law, must comprise a chairman and at least two other members appointed by the Secretary of State—who is required to consult the chairman about the appointment of the other members. We have already noted (see paragraph nine) the entrenched status of Authority members, and the failure of government to give statutory guidance on qualifications for membership, or to establish a mechanism for scrutinising candidates prior to appointment.

  18.  In its present form, the Authority's members include Ofgem's three managing directors (of regulation and financial affairs, competition and trading arrangements, and customers and supply), as well as Ofgem's chief operating officer, who are all civil servants. However, these executive members are outnumbered by the Authority's non-executive members, so the composition of the Authority actually exceeds the current good corporate governance principle that 50 per cent of board membership should be non-executive. We welcome this, and have seen no evidence that Nolan principles are not applied to the appointment of members.

  19.  As to "representativeness", while this is always an elusive concept in the British administrative system, we note that the present non-executive members of the Authority do seem to bring a broad and balanced level of experience to the table, reflecting a wide rage of business, energy sector, social, financial, and academic expertise and interests. A more important issue, however, is the actual role and influence of these members in the Authority's work. We address this point at paragraphs 37-38 below.

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

  20.  As we have already noted, Ofgem's principal statutory objective, in carrying out its functions, it is to protect the interests of gas and electricity consumers. All other issues and considerations—including even the duty to promote competition—are, as a matter of law, secondary to the enhancement of consumer benefit. In Ofgem's case, therefore, the old idea that the aim of regulation is to balance the different interests of the relevant stakeholders in the regulated sector—consumers, producers, shareholders, employees, new market entrants, and so on—is only relevant to the extent that such a balancing exercise can be shown to serve the interests of consumers.

  21.  With such a broad mission, underpinned by wide legal discretion, it is inevitable that achievement of the purposes of regulation may have some adverse consequences. For example, since the ground-breaking privatisations of gas and electricity, Ofgem's approach has been a narrow focus on the inefficiencies of monopoly networks, where the remedy has been to sweat the assets and other inherited resources, and a more recent emphasis on the need for new arrangements for gas and electricity trading and more competitive market structures in generation and supply.

  22.  While these policy tools have served consumers better than the old pubic sector methods, they have also produced relatively higher costs of capital for the monopoly operators and inherently unstable markets at both the wholesale and retail level. These adverse consequences may now be an obstacle to the reinvention of energy policy that is necessary to deal with the emerging new imperatives of environmental protection, networks investment, and longer-term security of supply.

  23.  There is currently a number of layers of parliamentary and political oversight of Ofgem's activities: the Treasury, National Audit Office, Public Accounts Committee, Environmental Audit Committee, Select Committee on Trade and Industry, and Better Regulation Task Force. While all of this may generate an impression of accountability, the downside is a lack of any real institutional "ownership" of the task of measuring Ofgem's effectiveness. Ofgem does not measure its own effectiveness in any robust way, and has not usually published regulatory impact assessments of its major projects, despite government recommendations that it should.

  24.  All utility regulation is complex and difficult, and, in view of the economic and social significance of these industries, it is important that there should be some focused and co-ordinated mechanism, preferably at parliamentary level, for assessing regulatory effectiveness in the round. This is a task that could be taken forward by the new cross-sectoral Select Committee that we advocate at paragraph 34 below.

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

  25.  The whole of the regulated utility sector suffers from the absence of effective rights of appeal against regulatory decisions. This is unacceptable, because any public authority, such as a sectoral regulator—no matter how competent, well informed, and properly motivated it may be—will sometimes make decisions or pursue policies that are flawed or mistaken.

  26.  The problem of the lack of adequate mechanisms for ensuring that regulators' decisions are properly scrutinised, in an appropriate legal forum, is particularly acute in the field of gas and electricity regulation. This is because the Authority, in regulating the sector, makes decisions in a range of different roles—as policy setter, law maker, arbiter of disputes between various parties, and enforcer of certain legal provisions.

  27.  Sometimes the Authority must enforce and/or arbitrate on laws that it has itself made (and can remake). It will in other cases be required to perform, in relation to the same subject matter, a mixture of roles akin to those of investigator, prosecutor, and judge. Moreover, the Authority, while frequently exercising its discretion within a framework of statutory duties, is at other times required to function in a capacity in which those duties have no place.

  28.  In short, as well as being substantial in both scale and effect, the role of the Authority is also complex, because it involves a range of different types of legal activity. It is not characterised by the separation of functions that, for the reason of ensuring good process and the protection of fundamental rights, is common to most other examples of law-making, adjudication, and enforcement.

  29.  In these circumstances, adequate scrutiny of the Authority's decisions by means of an appropriate appeals mechanism is both necessary and desirable. Most of those decisions are currently challengeable only through judicial review, since, in relation to most of the Authority's functions, there are no specific statutory rights of appeal. As is well known, the judicial review process falls far short of a form of 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.

  30.  The EA believes that this aspect of regulatory accountability requires reform more urgently than any other. It is true that gas and electricity licensees are sometimes able to trigger references to the Competition Commission (a de facto form of appeal) by rejecting proposals from Ofgem for new or amended licence conditions with which they disagree. However, this right has been restricted by the Utilities Act 2000, and is no longer available to licensees who are in a minority of objectors falling below a certain threshold set by secondary legislation. Also, with the exception of references where the subject matter is a broad economic condition, such as a price control or market abuse measure, the Commission is an inappropriate forum for resolving most issues of dispute between the gas and electricity industries and Ofgem.

  31.  It is sometimes claimed that providing new rights of appeal against regulatory decisions would increase investment uncertainty and so raise the cost of capital. We acknowledge that the cost of capital is increased by real, or perceived, regulatory risk. However, it is strongly arguable that risk itself is most likely to be increased by the absence of appropriate appeals mechanisms, leaving companies exposed to potentially unfair or erroneous regulatory decisions that are very difficult to challenge. Where appeals do prove to be necessary, uncertainty would be reduced by a swift and effective appellate process—the opposite of that presently provided by the options of Competition Commission references and judicial review.

  32.  The EA therefore supports the recent conclusion of the Better Regulation Task Force that "there should be a well publicised, accessible fair, and efficient appeals procedure" against regulators' decisions. We strongly recommend the Constitution Committee to endorse this principle when it reports the conclusions of its inquiry. In the case of gas and electricity regulation, the implementation of the principle would immediately ensure that Ofgem can be held accountable for its actions and decisions in the only way that really matters in the end.

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

  33.  We have already noted the various layers of parliamentary and political oversight to which Ofgem's (and other regulators') activities are subject (see paragraph 23 above). It is worth adding here, however, that these do not, in our view, add up to a coherent system for securing the accountability of regulators to Parliament. Ofgem, which has no established formal accountability to Parliament, is no different from any of the other utility regulators in this respect. Parliament needs an ongoing, effective means of measuring regulators' performance, and should be given greater powers to do so.

  34.  It might be possible to achieve this through a Select Committee for Regulatory Accountability, dedicated to the purpose and with a specific remit from Parliament to monitor the interface between government policy and regulatory practice. Monitoring at this cross-sectoral level, perhaps tracking the work of the existing government panel mentioned at paragraph 16 above, is particularly important, since utility regulators such as Ofgem now exercise powers and duties for which ministers would previously have been answerable to Parliament and the public. We would expect the existing layers of oversight to be rationalised and reduced as a result of this new committee's role.

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

  35.  Ofgem is not ultimately accountable to the companies that it regulates. Under the Utilities Act, the customer has been placed at the centre of regulation, diminishing in law the interests of licence holders. Despite this, Ofgem has made greater and more sustained efforts in recent years to engage with the industries' concerns, and its listening and communication channels have improved. As we have noted above, however, there is a lack of credible appeals mechanisms for holding Ofgem accountable in law for its decisions, and a longstanding reluctance on Ofgems's part (though this may be changing now) to justify projects and policies by publicly setting out their costs and benefits in the form of a regulatory impact assessment.

  36.  Such assessments make the facts and assumptions behind regulators' proposals more transparent, help to facilitate consideration of possible alternative options, and are a crucial part of any good regulatory process. We therefore welcome the government's proposal, in its recent Energy White Paper, to provide statutory backing for regulatory impact assessments through primary legislation.

  37.  We should add that Ofgem's internal governance arrangements compound its lack of accountability to those that it regulates. Essentially, the Authority is the board of Ofgem, and certain matters are reserved for decision by it alone under its rules of procedure. Reserved matters include the Authority's work plan, the policies behind price control proposals, the setting of financial penalties, enforcement proceedings, and the making of statutory instruments. These are all fairly high-level items. By default, therefore, the scope of non-reserved functions—that is, matters which are delegated to Ofgem as the Authority's executive arm—is very wide.

  38.  The practical effect of this is that it is exceptionally difficult for licensees (even when acting collectively) to get their own strategic concerns presented to the Authority (as distinct from Ofgem), or to appear before it to articulate a case on specific issues. Furthermore, no Authority agendas or minutes are published, and industry contact with members is not encouraged. In the absence of transparency regarding its proceedings, it is impossible to establish to what extent the Authority, rather than Ofgem, determines strategy and major policy issues at other than the most superficial level. In short, the accountability of regulators to those being regulated may actually be diminished under the board-type structures now favoured by government.

  39.  Regulation of such a vital sector as energy supply inevitably impacts the wider economy. The implicit energy required to procedure the goods and services that we consume is very great, and the sector is a key driver of industrial and commercial progress. Stricter regulation of core activities may lead groups to diversify into non-regulated activities, both at home and abroad, for example, or make it difficult for the core businesses to raise substantial capital sums for infrastructure investment.

  40.  The risk of major economic effects from regulation is particularly acute where the regulator's primary duty is to promote consumer welfare, since this may incentivise an ongoing shift of economic value from the regulated firms to the consumer, reducing their market capitalisation below the regulated asset value.

How are regulators accountable to the public other than through Parliament: what opportunities do the public have to express particular concerns to regulators: how do regulatory bodies relate to their associated consumer watchdogs?

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

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?

  41.  Our impression is that Ofgem is more accessible to the public than many other government departments and public bodies. Its website, for example, is well designed and informative. Ofgem also sponsors public workshops, and issues a constant stream of consultation papers, decision documents, reports, and press releases.

  42.  However, this is not the same as being accountable to the public, and it would also be incorrect to say that Ofgem's consultations are particularly effective, either for the pubic or for licensees. With only rare exceptions, the procedures do not achieve what the courts have defined as the essence of consultation, namely the extending by a pubic authority, with an open and receptive mind, of an invitation to other parties to provide advice about its proposals at a formative stage, before its mind has set.

  43.  The best opportunity for the public to express particular concerns to Ofgem is through the statutory consumer watchdog, the Gas and Electricity Consumer Council. This body has a broad remit to keep itself informed of consumer views, to resolve their complaints against licensed gas and electricity companies, and to provide advice and information to the Authority and government about the interests of consumers. Ofgem has a duty to consult the Council about the Authority's forward work programmes, and both bodies are jointly required to draw up a pubic memorandum which sets out the arrangements for co-operation between them.

  44.  Ultimately, utility regulators are instruments of government, not representatives of the public in any practical sense. This is because government sets the policy framework for regulation and enshrines it in legislation. In the case of energy regulation, in particular, this is only to be expected, because of the overriding importance of gas and electricity supplies as a precondition of modern life. The roots of energy policy are always political, requiring choices that only governments, not markets, can make and calling for elements of national co-ordination and strategic planning. Ofgem therefore represents the public only in the sense that society as a whole, in relation to this sector, is a stakeholder whose interests must be protected above all others'.

How independent are regulators of government: what factors do or might compromise their independence?

  45.  It is desirable, in principle, for regulators to be independent of government. In Ofgem's case, the legislation seeks to give effect to this by providing only very limited powers of intervention to ministers: they are able to veto licence modifications, and can also give guidance to the Authority on its social and environmental responsibilities, but they cannot direct the performance of its functions. However, ministers have concurrent duties and objectives under the legislation, and, in addition, as we have noted above, the Authority's functions are performed on behalf of the Crown.

  46.  In practice, therefore, it seems unlikely that Ofgem, or any utility regulator, can operate fully independently of government. What utility industries do, and how they are regulated, will always be political issues, because they affect such a large number of citizens and voters. The inter-dependency of regulation and government should be explicitly recognised in sectoral statutes in the form of specified grounds for ministerial intervention, subject to both transparency of process and rights of appeal.

Electricity Association

March 2003

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