Select Committee on Constitution Minutes of Evidence

Annex 1

Speech by Callum McCarthy to a conference on "the Politicisation of regulatory policy" organised by the Regulatory Policy Institute, 6 November 2002

"Why do differences arise and how should they be resolved?"

  1.  If I were asked to define the most politically complicated and sophisticated relationship between regulator and politician in Britain today, I would without doubt say it is that between the governor of the Bank of England and the Chancellor of the Exchequer—and that goes back to the creation of the Bank in 1964. So I do not find it strange that such a recent development as utility regulation, which goes back only until 1984 with the creation of Oftel, and has such recent manifestations as Postcomm in 2000, has not settled down to one simple and agreed model. We should be neither surprised nor particularly fazed.

  2.  Nor am I surprised that there is a strong tide running among politicians which regrets the extent to which important decisions have been deliberately delegated by Parliament to bodies over which there is no direct day to day political control. I have been struck in conversations with friends among MPs by the extent to which they are thoughtful and regretful at just how much has been transferred—something which reoccurs frequently in discussion of the work of the Governor and of the Monetary Policy Committee, but has also been expressed, quite explicitly for example by Peter Hain when in Opposition, in relation to energy matters. I am also struck by the fact that we now have a generation of officials who have dealt with the present arrangements, but have either no or only distant memories of the previous regime. They are therefore and understandably conscious of the pressure points in the present arrangements (they, for example, often have the unenviable task of mediating between the ambitions of ministers and the independence of the regulatory organisation), but remember less well the problems which they had to face when a large swathe of difficult decisions—technically demanding, and often politically contentious—had to be made directly by government rather than by regulatory organisations. So for various reasons I am not surprised by the renewed interest in the interface between political ambitions and regulatory duties.

  3.  Nor do I think we should be surprised that there is friction between political priorities and regulatory priorities. It is sometime represented that any lack of alignment between these priorities represents something that has failed in the regulatory system. This is clearly wrong. It is important to remind ourselves that a principal objective in the delegation of powers to independent regulatory organisations was to create barriers between day to day political objectives on the one hand and whatever objectives are laid down for the regulatory organisation in the statute, reflecting Parliament's considered views, which sets it up on the other. The very purpose of independent regulation was to dampen the effects on regulatory decisions of the rapid and often transitory changes in political objectives and priorities which occur, and which had caused such problems for the nationalised industries and such a waste of resources for the UK economy. That is not to say that political objectives, strongly and properly held, have ceased to exist—as clearly they do and should exist. What is the case is that the creation of delegated powers given to independent regulatory organisations guarantees the potential for friction between political priorities and statutory duties in a way that could not previously occur—so that the Monetary Policy Committee is criticised for not lowering interest rates further, or Ofgem is criticised for withdrawing from all end price controls, or for price controls over the natural monopolies which are represented as disadvantaging the interests of trades unionists employed in the companies concerned (though rarely, I would point out, is Ofgem criticised by trades unionists in companies which would have benefited from more stringent price controls), or for various other actions and inactions. It is sometimes represented that this lack of alignment is actually undemocratic. This is the inverse of the truth, which is that the creation of independent regulatory organisations, governed by statute, was designed to establish a longer-term framework different from that dictated by shorter-term political priorities. If the system of independent regulation is working, it is inevitable in all but the most fortunate of coincidences that there will be friction. That friction should be regarded not as a measure of failure, but of the system working. Indeed, if there were never divergence between political priorities and regulatory duties, it would be hard to justify having created the separate organisations in the first place.

  4.  I make these points because the way in which we approach differences between the priorities of Ministers and officials on the one hand and of a regulatory organisation on the other will clearly differ if we regard them as being unexpected, unhelpful and unwarranted events which should not occur; or alternatively as events which are to be expected if the systems are operating as they should operate. Unfortunately, too much of the discussion—and sometimes too much of behaviour as well as discussion—is based on the first set of assumptions, namely that in a properly functioning world there would never be friction between political and regulatory priorities. Or, since this position is mostly held by politicians, regulators would do what politicians want. This model is profoundly unhelpful: it represents all differences as mistakes of some sort or another. It suggests that differences should be eliminated. It often assumes that, provided Ministers express their wishes clearly enough, regulatory decisions will fall in line and that, if this does not occur, it is a failure due to the obstinacy or bad judgement of the regulator. I should add that, when the regulatory duties are vested in an individual rather than a board or authority, this line is particularly easy to follow. But even with a regulatory organisation a degree of unhelpful personalisation is not unknown.

  5.  Let me put aside this unhelpful model, and consider the actual model, which is more constructive. It is that a regulatory organisation has only two foundations for its legitimacy. The first is its own behaviour and professionalism; the second, on which I want to concentrate today, is the statute which establishes it, the result of the democratic process. Parliament decides the regulatory powers and duties, and the regulatory organisation is bound by them. This may seem so obvious as to be trite, but I am often struck by the extent to which this is ignored. Ofgem, for example, is quite often attacked for having failed to promote British national champions in the energy sector. But nowhere in the various Electricity, Gas and Utilities Acts which define Ofgem's powers and duties is such an objective, function or duty mentioned—as distinct from clear objectives in terms of protecting the interest of consumers, present and future, wherever practicable by promoting competition. Similarly, it is misplaced to criticise Ofgem, as some have done, for not having regard to Social and Environmental Guidance which, more than two years after the Royal Assent for the Utilities Act which provided for such guidance, has still to be enacted. You must expect a regulatory organisation, which is so dependent on its statutory basis for legitimacy, to treat the statute very seriously indeed. Others should do the same. Parliament could have given Ofgem powers and duties other than those we have—and had it done so Ofgem would have responded to those. But it didn't and Ofgem must, and others should, respect the law as it stands at any moment.

  6.  Note that Parliament, in setting Ofgem's objectives, powers, functions and duties has deliberately—I think deliberately—made a decision as to the mutability of these responsibilities. It was open to Parliament to make Ofgem's responsibilities open to change other than by new primary legislation—by secondary legislation subject to some degree of Parliamentary control; or by Ministerial instruction. It chose not to do so, subject to one new arrangement, namely the provision for the Secretary of State to give guidance, to which Ofgem must have regard. I'll return to this in a moment. It is worth dwelling on whether this relative immutability, subject to new primary legislation, is sensible. I believe it is, for to make the regulatory objectives too flexible would undo the distancing from political priorities which is an essential purpose of the regulatory model. Were the Monetary Policy Committee to be subject to changes in duties, or were its decisions capable of being overruled, the benefits of having it would be severely eroded. Similarly, a power of rapid change in regulatory duties would be deeply damaging to regulatory certainty. Let me illustrate this from energy. There is an argument advanced by some commentators that security of supply in electricity cannot be left to the market, because at some stage wholesale prices will rise, it is argued very sharply, with harmful consequences for retail prices which will inevitably—it is argued—lead to political intervention to limit the price rises which are needed for investment in generation to ensure security of supply. Now there are all sorts of points to be made about this thesis: the relative impact of wholesale prices on retail prices; the effect of long term contracts; the willingness or otherwise of companies supplying gas and electricity to make rapid adjustments to prices (when wholesale prices in gas doubled, retail prices went up about 10 per cent). For these and other various reasons, I think the original argument is wrong on analysis. But there is also a quite different point to be made, namely that the Government, short of primary legislation, has no means of intervening in the way which it is often asserted will occur. That is the effect, as it is the purpose, of establishing regulatory independence: political pressures are deliberately suppressed—and regulatory certainty is enhanced. The benefits of this should not be underrated. It is clear, for example, that the deliberate obstacles Parliament has placed in the path of political intervention are an important contributor to the low cost of capital (and hence lower prices for consumers) for the regulated energy companies—just as they are for the low interest rates enjoyed under the reign of the Monetary Policy Committee.

  7.  Although Parliament did not choose—very sensibly, in my judgement—to give the Secretary of State power to change Ofgem's duties and powers other than by new primary legislation, the Utilities Act 2000 contained a new provision, namely the power for the Secretary of State from time to time after consultation to give guidance on social and environmental matters, to which Ofgem must have regard. As I noted above, no such guidance is yet operative, although it now is in the final stages of enactment. Ofgem will, of course, consider the guidance once it is enacted: we have a legal duty to have regard to it, which we will discharge as carefully and as comprehensively as we can. But I do not believe that the guidance will eliminate the potential for differences between political and regulatory priorities. There are many reasons for this, but the central reason is that the existence of a specific point of guidance does not eliminate the need for Ofgem to consider its duties in the round—including other specific points of guidance which may lead in differing directions. Again, this is not accidental: Parliament could have given the Secretary of State a power to issue directions, rather than guidance; or the Secretary of State might have chosen to make her guidance more concentrated on particular issues rather than covering the wide ground now covered—but Parliament and the Secretary of State did not do so, and it is important, and legally necessary, that we do not misrepresent the position. It will be useful and helpful to have the guidance; it would be more useful and more helpful to have more focussed guidance; but guidance does not and cannot eliminate the possibility of tension between political and regulatory priorities.

  8.  I should add that I see great advantage in there being a clear hierarchy of duties for the regulatory organisation. I think the Monetary Policy Committee benefits greatly from having a clear inflation objective; and that Ofgem benefits from having a principal objective—the protection of consumers of gas and electricity, present and future, wherever practicable through promoting competition. Clarity of objective does not necessarily mean that the decisions on how to reach an objective are easy or non-contentious: that is obvious, both for the Monetary Policy Committee and for Ofgem. But the decisions would be—and are—much more difficult insofar as there are multiple objectives. And when there are multiple objectives, which involve important value judgements, I do not believe it possible—or correct—for these to be left to an appointed regulatory body. In the context of energy, therefore, I do not believe such politically charged questions as—in 1997-98—the future of the coal industry in Britain or—in 2002—whether nuclear should play a long term part in electricity generation in Britain should or can be determined by a body other than Parliament or a Government directly accountable to Parliament. In this, I strongly support the Government's position, set out in the White Paper and successive statements, that environmental and social policies with significant costs are for Government to introduce by legislation, not for regulatory initiative.

  9.  I have, I hope, established that the existence of tension between political and regulatory objectives should not surprise us; nor should our objective be to eliminate such tension. There will always be the probability of such tension so long as Parliament gives the regulatory organisation fixed and only marginally amendable powers and duties, short of new primary legislation. And, since this degree of consistency is needed for regulatory certainty, another way of expressing this is to observe that regulatory certainty means the potential and indeed the probability of such tension. If this is so, the question changes: it is not should there be tension, but how do we manage the tension when it occurs, as it inevitably will occur? I think both the regulatory organisation and Government departments—and others—can contribute to improving this process.

  10.  The first step is for all concerned to stop treating the tension between the legal powers and duties of a regulatory organisation and political priorities as a disaster, or a mistake, or bad faith but as something to be expected. This would require officials to be clearer than they often are in explaining to Ministers that decisions, which used to be theirs, are no longer theirs—and that this has advantages as well as disadvantages. It means, for example, that when lobbied by special interest groups on a decision, which is a decision for the regulatory organisation, the Minister can make the responsibility clear. I think officials could helpfully do more to remind Ministers where Parliament has transferred powers and duties to the regulatory organisation, and the benefits to Ministers of this. In the vulgar but effective advice I have heard given to a Minister about to meet a company arguing against an Ofgem price review: "Don't get between the dog and the lamppost". Second, it requires Government departments to recognise that, if their arguments are to carry weight, they must be weighty: the fact that an official or a Minister favours cause A over cause B is not of much help to a regulatory organisation which is trying to weigh and balance its legal duties; conversely an argument which is based not on a statement of Government objectives, but on compatibility with the regulatory organisation's legal duties will carry weight. To be effective, and to be helpful in allowing the regulatory organisation to take account of political priorities, these need to be translated into arguments capable of being weighed against statutory duties. Were a Minister to instruct his officials to contact members of an Authority to tell them simply that the Minister wishes a decision to go a particular way, he should expect the approach to have no constructive outcome—as his officials should no doubt warn him; were he to instruct them to do so by reference to the Authority's legal duties and with arguments as to why a particular decision would advance the Authority's duties, he would indeed influence the outcome. But simple statement of a political priority, or repetition of the case of a lobbying company or interest group is likely to raise more heat than light.

  11.  There is a third thing Government could do, which is to make the social and environmental guidance more focussed. At present, it is a list of many desiderata—each of which is worthy in itself—but totally lacks any weighting between the various desiderata, and hence any advice as to trade offs. This does not help Ofgem as much as more focussed guidance might. There is obviously the scope for action on one objective to run counter to another: the tension between additional costs incurred to meet environmental targets on the one hand and the problems this would cause, absent compensating actions, for the fuel poor on the other is an obvious but not unique example. The guidance contains nothing akin to the PIU recommendation that in setting priorities environmental objectives should prevail; it does not do something as useful as establishing what cost per ton of carbon the Government believes should be ascribed as an externality to carbon production; it gives no guidance on what the Government regards as "significant" costs. Clarity on these points would indeed be helpful.

  12.  The regulatory organisation can also help improve the process. It can work hard to defuse potential explosions by giving warning. A central objective during my time at Ofgem has been to attempt to avoid surprises for Ministers, on the basis that I want to be sure that Ofgem has given Ministers the opportunity to express their views, and Ofgem has taken the opportunity to think hard about them. To this end, I try to ensure that the DTI is fully briefed about future Ofgem activities; arrange to see the Energy Minister at least once a month; and regularly update him on Ofgem policies and initiatives. I should add that we also work hard at doing this more widely: we recently—to its surprise and welcome—volunteered to give evidence before the Enterprise and Lifelong Learning Committee of the Scottish Parliament, a very sensible offer given the importance of BETTA to Ofgem's activities over the next two years. It is just one example of a continuing effort to explain Ofgem's plans and actions, and to relate them to our legal powers and duties. Before Parliamentary Committees, and in all sorts of contexts, we work hard to explain, to justify and to avoid giving surprises.

  13.  Both Government and regulatory organisation can contribute to managing tension by avoiding any personalisation of the tension, when and if it occurs. Ofgem has never made any public criticism of the decision of a Minister: it has on occasion, and will no doubt in the future, point out where it differs on particular issues. It should have come as no surprise to anyone that Ofgem, which then had a principal duty of promoting competition, should not have supported the restricted gas consents policy, which was designed to restrict competition. Nor should anyone be surprised if Ofgem advocates an approach to environmental questions based on either a carbon tax or on emissions trading, rather on a plethora of special schemes, many of which are more expensive than a general approach. But we need to be able to handle differences in a grown up manner. I confess to something approaching despair when I read journalists I respect describing me as being furious or cross or incandescent with some reported Ministerial statement or position. It simply is not true, however, good copy it may make. There will be differences between political priorities and regulatory duties, and they need to be accepted and managed—by journalists as well as by Ministers, officials and regulators.

  14.  I should say that I regard the move from individual responsibility to corporate responsibility in terms of regulatory responsibilities entirely helpful to the sort of maturing process I am advocating. It should give all concerned—Government, politicians, consumers, companies—confidence that the important and often difficult decisions that a regulatory organisation is required to make are made without reliance on a single individual's judgement; it should end the unhelpful concentration on the individual who acts as a spokesman or spokeswoman for the regulatory organisation; it should eliminate the strange discussion of the transition from one chairman of a regulatory organisation to another (when, in less than a year's time, I step down from this job, as I have always made clear I would, it will represent a change of one member among the present 11 members of the Authority: the continuity will be more evident than the change); in a number of important senses it represents an important reinforcement of regulatory certainty.

  15.  The benefits of an institution—board, commission or authority—over an individual depend to a large degree of course on the qualities of those appointed. I think the record is clear, insofar as Ofgem is concerned. The non-executive members of the Authority have all been appointed under Nolan processes: they are meritocratic appointments. I can vouch for their independence, and they will bear witness to (and I believe vouch for) the full and complete way they are required to engage with the issues, and the vigour with which they do so. It is clearly and responsibility for me, as chairman of the Authority, to ensure that they are able to engage with the issues—that they are forewarned; properly and objectively informed as the issues; have time to consider them. I am clear that this process works: and I am clear as to the quality of the non-executives. I should also give credit to the Minister for Energy, who has recently re-appointed all the original Ofgem non-executives (save David Currie who had moved onto Ofcom). It is obvious that Ofgem has acted as an independent regulatory, and that on a number of issues this has obviously brought it into disagreement with political priorities. It would have been easy not to re-appoint Authority members; and it is greatly to the benefit of regulatory certainty, and of good decision-making in general, that that easy option was not followed.

  16.  Let me conclude. I have tried to show that conflict between short term political priorities and statutory duties is neither unexpected nor a bad event that we should abhor, but rather something to be expected; that the question is not how we avoid conflict, but rather how we manage conflict which is unavoidable; and I have made some practical—and I am sure mundane—suggestions as to what we should all—Government, officials, regulators, commentators—do differently or more or less of. In sum, my plea is that we all grow up, to live in the world which Parliament has chosen and defined—and which Parliament can, of course, change if it so desires. But until and unless Parliament does so, we should respect the laws we have.

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