Regulatory appeals, the Penrose review, and the case for change

Fingleton’s Simon Oates discusses the potential implications for regulated companies of the Penrose Review of UK competition policy. Is the system of regulatory appeals in the UK about to be overhauled?

In September last year, the prime minister asked John Penrose to examine UK competition policy with a view to identifying how it should evolve to meet the government’s policy aim of promoting a dynamic, innovation-driven economy. The ‘Penrose review’, as it is called, is timely. The country has left the European Union and at the same time is urgently exploring a route out of the economic turmoil caused by coronavirus.

The Penrose review is broad in scope. And there are good reasons for this. Parts of the competition regime hitherto handled by Brussels are now being handed back to the UK to manage and own, such as large mergers and state aid. According to the government, the scope of the review will include antitrust and consumer protection policy, including tackling consumer rip-offs, bad business practices, and “supporting disruptors taking risks on new ideas”.

The review will also consider reform ideas advanced by outgoing Competition and Markets Authority (CMA) chairman Lord Andrew Tyrie, set out in his letter to then BEIS secretary Greg Clark in February 2019.

One eye-catching – and potentially controversial – suggestion in Lord Tyrie’s letter is his statement that, “there is a strong case for removing review of economic regulatory decisions from the CMA.  These could be consolidated in the Courts … this would simplify appeal arrangements across the regulatory landscape.”

This statement signals a major change to the way appeals could work. It suggests a removal of the current right to a “merit based review” of sector regulator’s decisions by the CMA – which exists in one form or another across most regulated sectors. His suggestion is to establish an alternative process where appeal cases would go straight to the Courts on judicial review grounds.

Is there justification for such a radical move, should regulated businesses and their investors care about such changes, and if so what can they do?

Today’s regulatory environment

UK regulators are responsible for setting the allowed: revenues, level of returns, and the scale and scope of investment for companies of considerable size and value. Critical pipes and infrastructure businesses – water, energy, and telecoms – alone represent over £35 billion of annual revenues. If we add in the revenues of other major UK regulated businesses, Royal Mail, NATS, Heathrow Airport and Network Rail, the combined annual turnover rises to more than £50 billion.

With the oversight of such significant economic activity vested in the hands of non-elected institutions, it’s essential that sector regulators are held accountable for their decisions through a range of clear and robust processes. At present, a range of methods combine to provide accountability, including:

• Corporate Governance requirements (notably: Boards with Independent Chairs / Non-Executives)
• Consumer representation (for example via statutory consumer bodies such as Citizens Advice Bureaux and Consumer Council for Water)
• Transparency arrangements (notably: a statutory requirement to consult on licence modifications)
• The ability for regulated companies to request references to the CMA / CAT for merits based review / appeals of major regulatory decisions (e.g. licence changes such as price reviews)
• Judicial Review
• Parliamentary Scrutiny via Select Committees

Two things leap out from this list. The first is that the only way a sector regulator’s decision can be reviewed – and potentially removed and replaced by an alternative outcome – is by reference to the CMA. Whilst the other processes provide strong incentives for high quality decision making, reference to the CMA is the only means by which the regulator’s final decision can be subjected to a merits based review – an assessment of whether the decision was ‘right and preferable’ based on evidence which supports a high quality decision.

The second is that, whilst most accountability measures are applied consistently, the approach to a merits based review varies significantly from sector to sector. This may explain Lord Tyrie’s call to simplify appeal arrangements across regulated sectors.

The table below summarises the current landscape (merits based reviews and appeals):

Is there a case for change?

The variation across sectors (illustrated in the table above) means that there are material differences in the detail of how each sector regulator is held accountable for the quality of their decisions.

These sector specific differences are largely a relic of history. Each one linked to the stage of maturity of their industry – when their sector specific legislation was established. The variation is not driven by any specific rationale, such as sector specific needs.

The Penrose review provides an ideal opportunity to re-evaluate the regulatory appeals framework and the CMA’s role within it. Full harmonisation across all sectors may not be desirable, but a fresh assessment of whether the existing differences across sectors remain appropriate – targeting  simplification where possible – would provide welcome clarity for regulated businesses.

What also seems clear is that any dilution in regulatory accountability, specifically the removal of a merits based review of decisions by an independent body, is unlikely to be the right answer. Any move to do so should be troubling to regulated businesses, their investors, and also the boards of independent sector regulators who value their credibility.

History shows regulators don’t always get it right the first time. There are many examples over the last two decades of sector regulators decisions being referred to the CMA, (or its predecessors the CC or MMC) and of errors being identified as part of the merits based review. Sometimes in the favour of companies, sometimes customers.

This year has been no different on that front. In February 2020, four water companies disputed their regulator’s, decision relating to the price review settlement, seeking a redetermination at the CMA. At the time of writing, the CMA, in its provisional findings, found some aspects of Ofwat’s decisions wanting. The CMA is currently consulting on upping the rate of allowed return for the water companies 0.54bps above Ofwat’s original figure as well as allowing each company a higher expenditure allowance (on average about 15 per cent above Ofwat’s settlement).  Without scope for a merits based review, a judicial review would be the only basis for appeal. And, the courts are limited in scope. They can only consider if the method by which a regulator took a decision was robust, not if the regulator was correct. Simply put, moving away from a merits based review process would leave companies unable to seek a review of whether the level of allowed return or expenditure allowances had been set at the right level, by their regulator, to underpin financeability.

Adopting a judicial review process is not just a bold move, it could hurt businesses, industries and consumers. Further still, it could undermine the accountability of independent regulators as well as trust in the sectors they oversee. All of which is problematic as the UK seeks to attract investment in critical infrastructure, the government charts a path to economic recovery following the Covid pandemic and seeks to tackle the major societal challenges to achieve net zero.

So what should happen?

We need sector regulators to continue to be accountable and we need a framework to make this happen. Any changes to the system must avoid dilution of accountability. A move away from a merits based review of regulators’ decisions would be a clear dilution.

Our hope is that Penrose will take this opportunity to provide businesses with additional clarity, and propose a  harmonised appeal process across the industry sectors.

What this appeals process looks like in practice is not a decision to be taken lightly. The CMA has the central role in ensuring consumers get a good deal when buying goods and services, and that businesses operate within the law. We know that its primary focus is to investigate mergers and entire markets, to take action against businesses and individuals involved in cartels or anti-competitive behaviour, and to protect consumers from unfair trading practices. But come January 2021, its plate will be full, as the effects of Brexit start to bite.  Inclusion in its remit to act as an appellate body for sector regulators price review decisions does seem an odd bed fellow in this context.

And, removing the review of sector regulators’ price review decisions from CMA’s remit would clarify its role as a decision taker rather than appellate body. What then for merits based review of regulator’s decisions? One option would be to channel them to the Competition Appeal Tribunal – a body which is well-versed in appeals based on the merits (the clue’s in the name).

Penrose’s report is expected this month and regulated companies and their investors are watching closely. At this stage, the Penrose review has not explicitly gone out to consultation or asked for responses from industry. Instead, it has opted to speak directly to deemed experts to gather views and insight. This does not stop a concerned company or its investors from writing to the review team to express their views, make their voice heard and help shape their regulatory future.

Simon Oates is the head of the infrastructure practice at Fingleton. Prior to joining the consultancy last year he spent seven years at Southern Water, latterly as director of corporate strategy, regulation and corporate affairs. He also spent two years at Thames Water.