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Rules and regulation – are competitive markets at risk of extinction?

Across a range of industries, we have seen regulators alternately tightening or relaxing the rules in an effort to increase competition. Energy network companies within the utility sector, for example, have recently gained greater control over their own destiny. In contrast, industries that have traditionally experienced a lighter hand – such as energy trading – are seeing more rules. As a result, many talented people find themselves absorbed with writing, examining and finding out how to work with the new regulations.

Yet rules alone are no way to guarantee success. By their nature, they regulate for what has already happened – not what is over the horizon. ‘Gaming’ the rules – not delivering consumer benefits – can become the primary aim for many. They can also create distortions in markets and behaviours where ‘just enough’ is good. This leads to convergence, which stifles innovation and customer choice and raises barriers to new entrants. As Rick Waugh, former CEO of Scotiabank, said: “[Rules have] crimped banks’ ability to lend to the wider economy without necessarily insulating them from risk”. 

Regulators can protect consumers better and drive competitiveness by looking beyond one-size-fits all regulation. Options include adopting more innovative forms of regulation, working more closely with the consumer, and ensuring compliance with outcomes aligned to what consumers want. 

Exploring a more innovative approach

Regulators should look to introduce binding undertakings that are proportionate to the power of the company, letting competition decide how its regulations should evolve.

In the UK utility sector, regulators have allowed companies to propose their own view of the outputs they should deliver. In UK electricity and gas, for example, Ofgem’s new RIIO model enables network companies to set a business plan with stakeholders before submitting to the regulator for tariff approval.

A similar approach is being adopted in the water industry for the next round of network tariff setting. Ofwat’s approach to its Price Review 2014 (PR14) is another regulatory initiative that has moved away from micro-management to hand some responsibility back to business. They have done this, however, with an eye to consistency and strong incentives and enforcement where companies do not hold to their side of the deal.

Compare these approaches to the capital adequacy rules which meant many banks held exactly that – adequate capital. Or compare them to the rules to open the ‘last mile’ telecommunications network that did little to allow innovation and competition to flourish.

Working more closely with the consumer

Super-complainants help ensure the regulator is controlling the market in line with what consumers actually want. If a super-complainant raises an issue on behalf of consumers, their complaint is fast-tracked by the Office of Fair Trading. In the UK, for example, the government has made it possible for consumer bodies designated by the Treasury to make super-complaints about financial services to the Financial Conduct Authority (FCA). Once a designated super-complainant has brought a super-complaint to the FCA, the regulator will have a duty to respond within 90 days.

Further educating the consumer as to what they should expect companies to do, and not to do, will improve the effectiveness of regulation. With the speed and prevalence of social media we can see how informed consumers can be a powerful force. Take for example where in the recent energy price rise announcements, we saw informed consumers rapidly communicating with other to encourage them to switch their contract from the supplier who raised the prices by 10%.

Ensuring compliance

In the absence of hard coded rules, industries need performance principles and standards coupled with the real and tangible threat of enforcement action with consequences for companies and individuals. This requires regulators to be smarter in building evidence of a misdemeanour and bold in pursuing those who fail to deliver, either with financial or reputational impacts.

Regulated businesses should work more closely with regulators to rebuild trust. They should develop mechanisms that allow more tailored remedies and undertakings, preserving the benefits of a competitive market in innovating and delivering customer benefits. They should focus efforts on anticipating market, policy and regulatory trends to avoid future interventions that create more rules – and the additional burden of implementing and monitoring compliance with more rules.

To find out more about our thinking in energy and water regulation and policy, contact us now.

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