Speech

Andrea Coscelli: our work in the regulated sectors

Speech given by Andrea Coscelli, CMA Acting Chief Executive, at the Utility Week Congress in Birmingham.

Andrea Coscelli

Introduction

As the UK’s lead competition authority, the Competition and Markets Authority (CMA) has a UK-wide responsibility for promoting competition across all sectors of the UK economy. The regulated sectors are a particularly important part of our work, not least because they represent a sizeable proportion of the economy as a whole. Indeed, the various services that are regulated in the UK – including basic utilities like heat, lighting and water, or financial services such as banking and insurance – are estimated to account for around 25% of UK GDP. Furthermore, they are relied upon by every household and every business in the country and are essential to people’s well-being.

We see a significant value in promoting competition in the regulated sectors. Traditionally, as many of these sectors involved nationalised monopolies, they were subject to direct ‘ex ante’ regulation under which the normal protections for consumers that are offered by a competitive market were achieved by a statutory regulatory regime. Over time, many of these markets have become increasingly competitive – notably as a result of the work of the sectoral regulators using direct regulation to open up markets to competition, for example, by opening up access to natural monopoly infrastructure. As a result, questions have arisen as to whether better outcomes for consumers (for example: lower prices, enhanced quality, increased efficiency and innovation) could sometimes be more effectively achieved by normal competitive processes (as in other parts of the economy that were not previously monopolies), including through the application of normal competition law to correct anti-competitive practices and market abuses.

While direct regulation is likely to continue to play an important role in promoting competition in the regulated sectors, there are benefits associated with competition law, including that it can offer a less prescriptive approach for businesses, allowing them the space to develop their own business models and may provide greater scope to foster a more entrepreneurial, innovative culture that benefits consumers and helps modernise industries. The recognition of these benefits was a key driver for the reforms of the concurrency arrangements a few years ago that I will refer to later.

It also explains why the CMA sees great importance in undertaking work in the regulated sectors and in working with the sector regulators. That is reflected in our portfolio to date which encompasses a variety of different cases across the full range of the CMA’s tools.

Whenever we work in regulated sectors we work in partnership with the relevant regulators. These are complex sectors with rules and regulations that were put in place for a reason when they were introduced. It is essential that in order to achieve good outcomes for consumers, we leverage the knowledge and expertise that sits with other public authorities in these areas.

I’d like to take this opportunity to give a flavour for the range of issues that we have tackled with those various tools, particularly looking at our work in the energy and water sectors that are the focus of this conference.

Markets regime

The CMA’s markets powers enable us to conduct studies and investigations looking broadly across particular markets which may not be working well for consumers, taking an overview of regulatory and other economic drivers and patterns of consumer and business behaviour. We may also undertake more informal discretionary markets work, such as our recent policy project which examined the benefits that greater competition between train operators on certain intercity routes may deliver for passengers. The striking point to note about the CMA’s markets work is that 2 of the most important pieces of work undertaken by the CMA in its first couple of years have been in regulated sectors: energy and banking.

Energy

Energy markets are vital to the economy and the well-being of households and businesses. Energy costs are a major burden on domestic customers reaching almost 10% of overall expenditure for the poorest households. At the time of referral, both gas and electricity markets were facing considerable challenges, including substantial regulatory change, political uncertainty and a notable lack of trust between operators and customers. There were public concerns about rising energy prices (1 - see footnotes at the end). There were also concerns about the levels of profitability of gas and electricity companies. An important reason for the reference was to ‘clear the air’ through an independent, authoritative market investigation.

Our investigation identified several aspects of the market that are working well for customers. In the wholesale markets we found no evidence that companies are able to exploit market power. In retail energy markets, the last few years have seen a sustained period of growth for new entrant suppliers outside of the 6 large energy firms, and their combined market share now stands at around 13% in both gas and electricity.

We also found that several areas of prior concern have not had a harmful effect on competition or customers. In particular, at the time of the reference there were widespread concerns about the anti-competitive effects of vertical integration, and calls for the 6 large energy firms to be broken up. In practice, we have not found that such concerns are supported by the evidence.

Our investigation has, however, identified substantial problems in the energy markets, which require significant intervention. The problems we have found fall into 3 main areas:

  • The demand side of retail energy markets – in particular, a lack of engagement in the markets on the part of many customers, which suppliers are able to exploit by charging high prices.
  • The supply side of both wholesale and retail energy markets – a combination of regulations and technical constraints that restrict competition, to the detriment of customers.
  • The broader regulatory framework – the system for regulating the energy sector, which hinders the timely development of policies and regulations that would be in the interests of customers.

The competition problems we have identified in this investigation are having a substantial detrimental impact on customers. For example, we estimate that domestic customers as a whole paid an average of £1.4 billion a year more than they would have done under well-functioning retail markets over the period 2012 to 2015, reaching £2 billion in 2015.

The ultimate output of our work in market investigations is remedies – where we find markets are not working well, and we are able to impose a wide range of remedies which are generally designed to promote competition. We can either impose our own remedies by order, or we can make recommendations to other bodies that are better placed to implement and monitor any remedies which we put in place. In the case of the energy market investigation, Ofgem will have an important role in the implementation and monitoring of our remedies. We welcome Ofgem’s statements that it supports our remedy package and expects the remedies to deliver benefits to consumers (2).

In regulated sectors in particular, remedies can be complex because often problems in markets will be caused by existing regulation or market rules which have been put in place for one purpose, but have unintended consequences for competition. Regulation and competition need to work well together. Sometimes they do not as circumstances change. Regulation can either reduce the incentives to innovate or to compete dynamically for customers, or in some cases it can remove the ability to compete effectively.

In the case of energy, we have a range of remedies both to promote competition and to remove some of these unintended regulatory barriers. Our review has concluded with the removal of some of Ofgem’s retail market remedies which were designed to simplify the market and promote competition, but which our analysis suggested have had the opposite effect, by stifling market dynamics.

We are also proposing to ‘push’ the market through other means – giving competitors access to a database of disengaged customers to whom they can offer savings, unlocking the rules so that price comparison websites can compete with one another to offer the best deals, and creating a more competitive market for microbusiness customers will all improve competition and market activity.

The theme through all our remedies is to make competition work better – that is the real aim of our remedy packages in this case. We may have powers to set rules but the objective of our work is often to unlock competition in markets. At the same time, sometimes our investigations find that additional customer protections are required. In the energy market we are therefore implementing a price cap for prepayment customers. The prices in this particular market segment were higher than they would be in a well-functioning market and were not justified by the extra costs of serving these customers. Supply-side restrictions meant that prepayment customers were not able to get the deals other customers could – so even if they wanted to switch they couldn’t get a good price. There were no immediate actions we saw to use competition to resolve our concerns, so more direct intervention was necessary. We expect bills for these vulnerable customers to fall as a result, by an average of around £75 per year per household.

In this case our price cap is intended to be an interim measure while our other remedies take force, including the roll out of smart meters. This is why we have time limited the cap, and limited its scope to prepayment meters, where we saw structural problems that will take time to resolve. We thought hard about whether to extend the price cap to all standard variable tariff customers in view of the high prices they are paying. There were different views in this debate but the final decision was that trying to control outcomes for the substantial majority of customers would run excessive risks of undermining the competitive process and would lead to worse outcomes for customers in the long run.

Retail banking

The retail banking sector has been subject to many reviews in the past, and there have been longstanding concerns about the health of competition in these important markets – ranging from:

  • concerns about the size and number of banks in particular in light of the mergers and acquisition during the financial crisis; to
  • whether there is a level playing field for ‘challenger’ banks in particular in respect of regulation and funding; and
  • to the impact of the so-called ‘free if in credit’ pricing model in personal banking.

In August we published our final report following our in-depth market investigation where we looked at both current accounts for personal customers and the market for banking services to small and medium-sized (SME) businesses. There have been a number of positive recent developments in these markets including new entry with some new entrants adopting new business models offering specialist products and exploiting opportunities offered by new technologies such as digital only banks.

Despite these welcome developments, we found that there were big problems: banks are not working hard enough to win and retain customers and it is hard for new and smaller providers to attract customers. Customers are not able to easily compare prices and service quality between banks because charging structures are complex, with the prices paid by customers being dependent on their usage, and customers seeing little to gain from searching or switching. These failings are having a particularly pronounced effect on overdraft customers, customers with large credit balances and smaller businesses.

Similar to the energy investigation, the focus of our remedies is to make competition work better, with the obligations we are introducing on banks and providers of SME lending focused on boosting competition. To this end we are introducing a range of measures that will help customers engage in the provision of these retail banking products, and to find and access better value services allowing them to take more control of their finances. Our measures will also enable new entrants and smaller providers to compete and increase the opportunities for new business models to develop. Technological transformation, through ‘open banking’, is a foundation of our package of remedies. It has the potential to transform how personal and business customers engage with their banks and manage their finances, helping them to find the current account which suits them best and helping to avoid overdraft charges by moving cash into an account if it dips into the red.

On overdrafts, we are introducing additional measures to help overdraft users to take more control. We are requiring banks to alert their customers when they go into an unarranged overdraft; we are requiring banks to inform customers of a ‘grace period’ during which they have an opportunity to avoid charges, and we are requiring banks to set a ceiling on their unarranged overdraft charges. Banks will have to disclose this charge, so that customers are fully aware and can use it to compare providers.

We also spent a lot of time looking at whether the structure of the market was a problem that required direct intervention, for example, to break up the biggest banks. Whilst the largest banks still have high market shares, we did not find clear evidence that the size or number of banks was a problem – at its core, bank customers not being empowered to engage in the market, and therefore banks’ limited incentives to compete, are at the heart of the problem, not the size of any particular bank.

Merger control

One of the CMA’s core duties is to investigate mergers, including in all regulated sectors that have the potential to substantially lessen competition.

We have undertaken merger reviews in a wide range of regulated sectors. Although most regulators do not have a formal role in merger control, we often ask sector regulators to play an important advisory role given their sectoral knowledge and access to industry data.

In the telecoms sector, the CMA unconditionally cleared the merger between BT and EE earlier this year. This was a challenging case in terms of the complexity of the issues (with the parties operating across different markets and at different levels) and the degree of interest from third parties and the wider public. The case also gave rise to challenges and innovations regarding our own processes.

The investigation gave us the opportunity to continue the traditions of working closely with the European Commission and drawing on expertise from regulators. While not having a formal role in merger control, as the telecoms regulator, Ofcom played an important advisory role as the expert across a number of areas – particularly in relation to backhaul and spectrum.

This year also saw a relatively rare move by the European Commission to block a proposed merger – the acquisition of O2 UK by CK Hutchison Holdings. The CMA and I strongly support the commission’s decision, which came after months of close liaison between the CMA, Ofcom and the commission on substance and possible remedies.

In the aviation sector, we provided advice to the European Commission in relation to IAG’s acquisition of Aer Lingus. The Civil Aviation Authority assisted us in preparing submissions to the commission and was able to offer valuable data and market insights, particularly regarding the position of the airlines at Heathrow and Gatwick and the suitability of the commission’s proposed commitments to remedy the competition issues.

In the water sector, there has been a special merger control regime for many years. The CMA’s role in water mergers is to assess whether the merger has a negative impact on Ofwat’s ability to make comparisons of costs and service standards between water companies.

The Water Act 2014 made changes to this regime following consultation. Most significantly, the Act removes the need for all water mergers above a certain size to be automatically referred for an in-depth phase 2 investigation – as was historically the case. It gives Ofwat a statutory role and places the water merger review more in line with the general merger regime by giving the CMA the power to clear the merger at phase 1 – or to accept undertakings in lieu of a reference to a phase 2 investigation.

We published guidance last year to provide clarity to the industry, and other interested parties, on what procedures the CMA will follow and the approach it will take for its analysis under the new regime.

In May, we published our first phase 1 clearance decision for a water merger after reviewing the anticipated non-household retail water and sewerage services joint venture between Severn Trent and United Utilities Group. The merger was entered into in preparation for the opening of the English non-household retail water and sewerage sector to full competition from April 2017. Given upcoming reform, we assessed the effects of the merger in England relative to what may have happened absent the merger following market opening. In Scotland, where the non-household retail water sector has been open to competition since 2008, we assessed the merger relative to the existing conditions of competition.

In England, we found the parties’ current shares of supply to be of limited relevance as ahead of reform in April 2017 they are not reflective of competition for the supply of retail water and sewerage services. Evidence from third parties and internal documents indicated that the parties have the potential to be close competitors, but not uniquely close. A significant number of other suppliers indicated that they would be active in targeting all types of non-household customers after market opening, and the majority of third parties, including Ofwat, were not concerned by the merger. In Scotland, the parties’ combined market share was only around 10%, with one large competitor and many other smaller competitors remaining after the merger. Overall, we found that these constraints when taken together were sufficient to ensure that the merger did not give rise to any realistic prospect of a substantial lessening of competition.

The CMA remains the sole decision-maker in water merger cases, but will work closely with Ofwat on such investigations, and the working relationships between the 2 agencies is set out in the guidance and a statement of intent. Ofwat has also published more guidance on its role in mergers in the sector.

One important feature of the UK merger regime is that it is independent of government. The Secretary of State has no powers to intervene in the CMA’s decision-making process other than where a merger gives rise to certain specified public interest concerns regarding issues of national security; media quality, plurality and standards; or financial stability.

Following a comprehensive review of the Hinkley Point C project, the government recently announced that it will impose a new legal framework for future foreign investment in Great Britain’s critical infrastructure. This will include a review of the public interest regime in UK merger control and the introduction of a cross-cutting national security requirement for continuing government approval of the ownership and control of critical infrastructure. The definition of ‘critical infrastructure’ has yet to be announced and we are in discussion with government regarding the proposed reforms.

Competition law enforcement

The CMA has powers to investigate individual businesses to determine whether they have breached UK or EU competition law. However, unusually in the UK, the power to enforce the competition prohibitions is in the hands not just of the CMA, but also the regulator responsible for the sector concerned (for example, Ofgem, Ofwat, Ofcom, Financial Conduct Authority etc). This system is known as concurrency and is a contrast to most other major competition law systems.

That system of concurrency was recently enhanced (in 2014) in order to strengthen co-operation between the CMA and sector regulators, with a view to greater competition law enforcement activity in these sectors. These changes resulted from concerns expressed by the government that in the regulated sectors ‘competition law may not be being enforced as proactively as it could be’ (3). The government could have abandoned concurrency, but decided to persist with it on the basis that there were benefits resulting from the complementarity of skills between the regulators’ sector-specific experience and expertise and the CMA’s in-depth competition experience and economy-wide perspective.

The new concurrency arrangements are designed to achieve a number of different purposes. They are in part directed at reducing the risks of inconsistent application of the competition prohibitions in the regulated sectors. They seek to do this by strengthening co-operation on case work.

The new rules involve a process for allocating cases between the CMA and the relevant sector regulator with the CMA having the power to decide who should handle the case in the event of a dispute. The factors taken into account in deciding how to allocate the case include the sectoral knowledge of the CMA and relevant regulator, the experience of dealing with the companies and issues involved in the case and whether there are any policy reasons why the CMA should handle the particular case. In addition, there are provisions for information to be shared on cases between the CMA and the relevant regulator and for the ongoing involvement of the authority to which the case was not allocated.

Once allocated, it is possible for cases to be transferred between the CMA and the regulators (and, in certain circumstances, the CMA can direct a regulator to transfer a case to it). Earlier this year, Ofgem agreed with the CMA to transfer the investigation that it had launched (following allocation of the case to Ofgem) into a suspected breach of competition law by some price comparison websites that offer energy tariff comparisons in relation to paid online search advertising. Ofgem’s reason for seeking the transfer was that it had become aware of action that it had taken prior to the investigation that risked calling into question its impartiality in continuing with the case. In June, the CMA took over the case and, with the benefit of Ofgem’s expertise, notably through the provision of secondees, continued to investigate it until recently when the CMA announced that it had decided to close the case on administrative priority grounds.

So what’s been our experience of competition enforcement in recent years since the new arrangements came into effect? Overall, we think that there have been many positive developments, notably in the increase in good and productive co-operation between the CMA and the sector regulators, aided by the UK Competition Network, which we chair. Such co-operation is not limited to casework; for example, we are supporting Ofwat’s November launch of its competition enforcement guidance, in light of the non-domestic water market opening to competition next year.

In terms of competition enforcement activity, there was a noticeable uptick in the number of new competition cases in the first year of the new arrangements with a drop off in the second year. Some of the drop off in the second year may be explained by the fact that regulators were focused on the delivery of their increased portfolio of cases, but nonetheless we would like to see a higher number of cases going forward and are working with the regulators on this. That said, a narrow focus on the numbers of Competition Act cases undertaken risks ignoring other work being undertaken to promote competitive outcomes in the regulated sector.

Regulatory appeals

The CMA also has a very different role in another aspect of regulatory decision-making: we are the appeal body for all price control decisions and some other regulatory decisions made by economic regulators. While in some sectors (particularly telecoms) appeals have been frequent, the overall number of appeals and therefore their cost as part of the system has been relatively small, in the context of the amount of resources dedicated to the underlying regulatory decisions. Over the last 10 years the CMA and its predecessor, the Competition Commission, have undertaken around 2 regulatory appeal decisions a year. In the last 18 months we have reviewed decisions in respect of Bristol Water, Electricity Distribution (from British Gas and Northern PowerGrid) and retail superfast broadband regulation (BT and TalkTalk). We’ll shortly begin assessing an appeal brought against Ofcom’s price controls on leased lines by CityFibre and TalkTalk.

Bristol Water contested a very large reduction in allowed costs by Ofwat relative to its plan, under the redetermination regime where the objective is that the CMA provides an independent view on the appropriate level of the price control as a whole, rather than arbitrating between the company and the regulator. Our decision could improve or worsen the price control settlement from the perspective of the company. We prepared our own benchmarking model, which we considered worked well in estimating Bristol Water’s costs over the period. We also prepared our own analysis of all aspects of the cost of capital for Bristol Water. The decision took into account representations from both Ofwat and Bristol Water. At the end of the process, the CMA’s decisions resulted in a small increase in both costs and the allowed return, but the numbers were similar in scale to those identified by Ofwat under its own approach. In such redeterminations, our approach can provide alternative economic models and regulatory assumptions. It is for the sector regulator to consider and decide whether they are relevant for future reviews.

The energy and telecoms cases were appeals where we focused only on the issues challenged by the parties. Northern PowerGrid claimed Ofgem’s benchmarking included a number of adjustments that made the settlement too low. British Gas challenged Ofgem’s approaches to price control design in 5 areas where it concluded the approach was too generous to the companies. We concluded both parties had identified one error in the control, where we removed or reduced Ofgem’s adjustments to its modelling to reflect the evidence we were provided by the parties. In the telecoms case, we reviewed a number of challenges to Ofcom’s approach in implementing a new retail margin squeeze control. We found in all but one case that the appeals did not demonstrate that Ofcom was wrong in its approach.

The rationale for these regimes is clear – they ensure that regulated firms, and in some cases, other interested parties, have a mechanism to challenge regulatory decisions to ensure the confidence of companies, their investors and consumers in the predictability of the regulatory regimes.

Commentators have seen references and appeals as playing an important role in holding regulators to account and an essential part of the regulation of utilities after privatisation. For example, the Chief Executive of one of the UK’s electricity distribution companies described the CMA’s recent decision as ‘important for the confidence of investors’. Moody’s has noted that ‘the existence and judicious use of an appeals mechanism contributes to the stability and predictability of the regulatory regime’(4). This stability and predictability encourages long-term investment in the UK economy and is ultimately beneficial to consumers.

The rationale for the CMA, rather than, for example, the courts or the Competition Appeal Tribunal as the specialist competition tribunal, dealing with these cases is less clear. In our experience, however, the fact that these cases can call for a review of substantive matters as well as procedural issues, and that they consider financial and regulatory issues, means that in practice, they are well suited to being decided by a body with the economic and financial, business and legal expertise that we have in the staff and CMA panel members. The structure of the CMA panel system in particular means it is well suited to reaching evidence-based decisions independent of specific interests and, where appropriate, set precedents (for example as to the assessment of the cost of capital, or review of price control models) which can give valuable guidance across sectors. As Graham Shuttleworth recently said, ‘By demanding a better link to evidence, the CMA will encourage regulators to make decisions more rigorously and more consistently, which should lead to better decisions, without the CMA itself having to provide alternative values or decisions’.

Concluding remarks

It has been a busy year for the CMA, regulators and businesses in the utility sectors and, in my opinion, a successful year in terms of injecting more competition for the benefit of consumers.

We used our formal markets powers to drive improvements for consumers in the energy and banking sectors and discretionary policy work to influence government to move towards delivering greater competition in passenger rail services. We strengthened our engagement with sector regulators to enforce competition law. We continue to work closely with sector regulators, not only where they have concurrent powers, but across our markets, merger and policy tools. Separately, we maintain an independent role in hearing appeals against certain decisions made by sector regulators.

At the end of September, we launched a market study into digital comparison tools (DCTs) to see how they are working for consumers, businesses and the economy. The CMA’s reviews of sectors such as private motor insurance, energy and banking have highlighted how these tools can play a powerful role in increasing competition and helping consumers to find better deals and switch. This new study, which builds on the UK Regulatory Network’s (UKRN) work on price comparison websites, will consider how to maximise the potential benefits of DCTs for consumers, and reduce any barriers to how they work. It will also consider the concerns sometimes expressed about DCTs.

And there is plenty more to do. Not least, following our investigations of banking and energy, the year ahead is crucial. In turbulent political times, where consumers’ trust was low and facts were in short supply, people looked to the CMA to assess the available evidence. Following lengthy reviews, we now know where the competition problems lie, and we have carefully thought-out interventions mapped out to fix them which, with others, we are now putting in place.

Those solutions are not always populist, or necessarily intuitive, but over the long term, competition works. Evidence shows that competition, and competition policy interventions, boost productivity by increasing the need for firms to be innovative, be efficient and meet their customer demands. As we look to implement those remedies from our banking and energy investigations, 3 things are vital. First, that government continues to stand resolutely behind the independence and analysis of its competition authority. Second, that sector regulators feel empowered and supported to take forward the competition challenge we have passed on to them. And third, that companies take the opportunity that is now in front of them to deliver what customers want and by so doing to rebuild trust.

With those ingredients in place, these crucial sectors have a positive future ahead.

Footnotes

  1. Between 2004 and 2014 average annual domestic gas prices rose by around 125% and domestic electricity prices by around 75%.
  2. See, for example, Ofgem’s press release of 3 August 2016 which sets out its proposed approach to the CMA’s remedies.
  3. Department for Business, Innovation and Skills, ‘Growth, competition and the competition regime – Government response to consultation’, March 2012, paragraph 8.1.
  4. Moody’s Investor Service sector comment September 2015.
Published 18 October 2016