Viewpoint Note No. 129 October 1997 Utility Regulators-Decisionmaking Structures, Resources, and Start-up Strategy Warick Smith Governments creating specialized regulatory Number of decisionmakers agencies must make decisions on a wide range of issues. Questions relating to the indepen- Many countries entrust decisionmaking author- dence and responsibilities of such agencies are ity to a commission or board of three to five considered in two companion Notes.' This Note members; others prefer a single individual. Each focuses on a third set of issues, relating to approach has its strengths and weaknesses, and decisionmaking structures, resources, and start- the choice often depends on a country's tradi- up strategy. Like the other two Notes, it em- tions and conditions (table 1). Agencies respon- phasizes the situation of developing countries. sible for several industries usually choose a commission. Decisionmaking structure Selection of regulators The design of an agency's decisionmaking structure encompasses issues relating to the When agencies are to be independent, the goal number of decisionmakers. the basis for select- should be to select regulators with the personal ing them, the roles accorded to stakeholders, qualities needed to exercise independent judg- and the regulatory and appeals processes. ment and resist improper pressures or induce- ments. The selection is critical, particularly for new agencies that have yet to establish a repu- TABLE 1 DECISIONMAKING STRUCTURES-INDIVIDUAL tation for competence and reliability. VERSUS COMMISSION Strengths and weakniesses Qualifications and disqualifications for appoint- ment are usually set out in the law establish- ing the agency. Disqualifying factors generally Characteristic Individual Commission include having a financial interest in regulated firms, which creates a conflict of interest and, Speed of decisionmaking El El in some countries, being related to the presi- Accountabilityfordecisions El Cl dent or ministers. A common qualification re- Resource demands El E quired is significant experience or training in Predictability of decisions El El economics, finance, law, public administration, Inulnerability to individual preoccupations E ] or industry. Invulnerability to improper invfluences El ElIt is sometimes suggested that some or all ap- Potential to reflect multiple perspectives Cl E pointees should have industry-specific techni- Potential to stagger ternsto enhance cal expertise or long experience in the regulated stability and weaken links with particular industry. But this requirement is unnecessary govemments l El and in some cases undesirable. It is unnecessary because such technical expertise will be avail- Note: The I indicates which structure is stronger on each characteristic. able from agency staff or consultants. It is un- desirable if it ends up excluding professionals WN The World Bank Group . Finance, Private Sector, and Infrastructure Network WN Utility Regulators-Decisionmaking Structures, Resources, and Start-up Strategy with broader perspectives relevant to economic legislature often also has a role, such as in con- regulation or if it unduly restricts the pool of firming appointments. Involving both branches candidates. It is particularly inappropriate for of government is especially important in sys- multi-industry regulators, because requiring ex- tems in which the executive does not neces- pertise in each industry be represented on the sarily control the legislature; it provides a check commission could crowd out appointees with against partisan appointments and helps to le- broader perspectives. It could also result in the gitimize regulators' authority. expert for each industry becoming the de facto regulator for that industry and thus the loss of Stakeholders' roles the potential benefits of a commission approach. To ensure that a regulatory agency makes de- Another view is that the decisionmaking body cisions that are well informed and accepted as should be composed of representatives of fair and legitimate, consumers, regulated firms consumers and regulated firms rather than tech- and other stakeholders must have the oppor- nical experts. Although it is important for stake- tunity to present their views. For the reasons holders to participate in the regulatory process, noted above, their participation in the decision- there are several reasons why including them making body is inadvisable. But there are sev- on the decisionmaking body is inadvisable: eral other options. * In most industries, attempting to identify single representatives of consumers and the Open regulatory processes. Those with a sig- industry is not feasible. Residential, indus- nificant interest in a regulatory decision are usu- trial, and rural consumers all have different ally permitted to present their views to the and sometimes conflicting interests, and in- agency before the decision is made. In the terests are likely to vary within these groups United States, the process for doing so is usu- across regions or income classes. Regulated ally formal hearings, often criticized for being firms can also have different and sometimes too legalistic, costly, and slow. Regulators in the conflicting interests in regulatory decisions. United Kingdom initially adopted much more So, a representative approach can result in informal processes, but the trend now is toward pressures to create very large decisionmaking greater formality. Countries such as Argentina bodies, which would increase delays and and Bolivia are experimenting with open pro- reduce individual accountability. cesses that more closely reflect local traditions. * Decisions of representative bodies hinge on their composition and voting rules. if the Consultative or advisory bodies. Some countries composition and voting rules favor one in- have created special consultative or advisory terest over another, decisions can be expected bodies, usually organized on an industry-specific to be biased accordingly. If the interests of basis, to advise the regulator and other public consumers and utilities are equally balanced, authorities. These bodies are usually part-time and the casting vote is left to a representa- and composed of representatives of consum- tive of the government, short-term political ers, utilities, and industry experts. Special con- considerations can be expected to dominate sumer councils can be especially important in regulatory decisionmaking. countries that lack effective advocacy of con- * Representative bodies internalize bargaining sumer interests. and the exchange of concessions between interests, at the expense of a more open and Regulatory process transparent evaluation of competing social interests. Decisionmaking processes range from formal hearings, as in the United States, to more in- The executive branch usually plays the domi- formal processes, such as those in the United nant role in the appointment process, but the Kingdom. Wherever the balance is struck, the focus should be on transparency in decision- law, and engineering, and the character and making, which reduces opportunities for im- integrity to resist improper pressures and in- proper influences and underscores the fairness ducements. People with these attributes are and legitimacy of decisions. scarce in many reforming countries, and those who do have them will often receive attractive The regulatory process usually involves three job offers from privatized utilities. So, to at- main steps: providing people with an interest tract and retain well-qualified staff often re- in a decision opportunity to present their views, quires exempting agency staff from restrictive publishing the decision and the detailed rea- civil service salary rules. sons for reaching that decision, and providing stakeholders an opportunity to challenge the There is no magic formula for determining the decision through an appeals process. number of staff required by an agency. It all depends on the responsibilities of the agency, The appeals process is important to ensure that the climate in which it must discharge those re- the regulator does not stray from its mandate sponsibilities, and its strategies for performing and that it remains accountable. Two closely those tasks. In the United States, staff size ranges related issues need to be considered in design- from less than 40 in the public utilities commis- ing an appeals process. sions responsible for multiple industries in the smaller states to more than 1,000 in the Federal Appellate body. If the regulatory agency is to Energy Regulatory Commission. As a general be independent, the appellate body should also proposition, "small is beautiful." Overstaffing can be independent. In most countries, appeals of dilute an agency's professional focus and in- regulatory decisions go straight to the courts. crease the direct costs of regulation. It can also But, in some countries, there is an intermediate increase the indirect costs of regulation if staff step in which appeals go to a body that is ex- make unnecessary demands on utilities to jus- pected to have more technical expertise than the tify their jobs. For these reasons, a sound gen- courts and that may also be able to respond more eral principle is to keep the permanent agency quickly. In the United Kingdom, for example, staff as small as possible, engaging consultants the antitrust agency hears appeals relating to to assist with specialized tasks. license amendments. In Bolivia, a special super- intendency hears appeals from sector regulators. Regulatory agencies increasingly contract out tasks to private firms or consultants, such as Grounds of appeal. The grounds of appeal are the analytical work underpinning tariff adjust- usually limited to errors of fact or of law, in- ment and similar decisions and the compliance cluding failure to follow a required process. audits of regulated firms. But the agency must Appellate bodies are generally not permitted retain-and be seen to retain-responsibility to reconsider the merits of the decision and for its decisions, to avoid undermining the legit- substitute their own judgment. imacy of its actions. It must also ensure that the contractor is not subject to improper influ- Resources ences or inducements from regulated firms or other sources. An agency's effectiveness is determined largely by the adequacy of its resources, both human Funding and financial. Regulatory tasks, like other government func- Human resources tions, were traditionally funded from general tax revenues. Now, most regulatory agencies ob- Utility regulation requires personnel with a mix tain their income from levies on consumers. of skills in such fields as economics, finance, These levies may be charged to consumers di- Utility Regulators-Decisionmaking Structures, Resources, and Start-up Strategy rectly, but are more often collected indirectly with political authorities, regulated firms, con- by imposing a levy or license fee on regulated sumers, and other stakeholders. In countries firms and allowing them to pass the cost on to in which the requisite skills are scarce, regula- consumers through tariffs. In OECD countries, tory experience is limited, and there is little this approach is usually seen as part of a cost- tradition of independent public institutions, the recovery strategy: it reduces demands on gen- challenges can be daunting. And life is not eral tax revenue and imposes the financial costs made easier for a regulator if privatization re- of regulation on the primarv beneficiaries (con- mains politically contentious and if the first pub- sumers). In many developing and transition lic evidence of its effects is a price increase economies, by contrast, earmarked funding is allowed by the regulator. often viewed primarily as a means of ensuring that agencies have a reliable source of income To meet these challenges, regulators must have and thus as a safeguard of agency independence. adequate training-not only in such traditional disciplines as law, finance, and economics, but To prevent levies from becoming too burden- also in negotiation analysis, media relations, some, the law establishing the agency usually and the like. Regulators may also need techni- sets a cap on levies, often defined by reference cal support during the first months in office. to industry turnover or some other indicator. Such support is often provided by consultants The cap is 0.5 percent for telecomnmunications acting to some degree as "shadow" regulators. regulators in Argentina, Peru, and Venezuela; VieWpoint iS an open 1 forum intended to 1.0 percent for the energy regulator in Colom- No less important, newly appointed regulators encourage dissemina- bia; and 2.0 percent for the water regulator in benefit from contacts and exchanges with more tion of and debate on Peru. The cap establishes the maximum levy, experienced regulators from other countries. ideas, innovations, and best practices forex- and actual levies are set each year to cover a Some of these contacts occur on an ad hoc panding the private budget approved by the legislature. When an basis, through visits and participation in con- sector. The views pub- agency is responsible for more than one ferences. But there is also an encouraging trend lished are those of the authors and should not industry, a different levy is usually set for each toward systematizing such contacts, for ex- be attributed to the industry that covers the costs of its own regu- ample, through a "twinning" arrangement be- World Bank or any of lation and contributes to costs shared across tween a new regulator and a more experienced its affiliated organiza- tions. Nor do any of the industries, foreign regulator. These arrangements can pro- conclusions represent vide a basis for exchanging staff and materials official policy of the Start-up strategy or providing other forms of support and ad- World Bank or of its Executive Directors vice. There has also been a recent trend to- or the countries they Utility regulators should be established as long ward creating "networks" of regulators, such represent. before privatization as possible, even if their as the International Forum for Utility Regula- To order additional formal powers do not come into effect imme- tion sponsored by the World Bank. copies please call diately. This allows regulators time to familiar- 202-458-1111 or contact ize themselves with their new responsibilities, 'arick Smith, Utility Regulators-The Independence Debate' Suzanne Smith, editor, Room FP-1188, to establish their offices, and to undertake any (Viewpoint # 127, October 1997) and "Utility Regulators-Rotes The World Bank, necessary training. It also provides assurance and Responsibilities" (Viewpoint # 128, October 1997). 1818 H Street, NW, to consumers that their interests will be pro- Washington, D.C. 20433, or Internet address tected after privatization and gives potential in- Warrick Smith (Wsmito3worldbank.org), ssmiihl@worldbank.org. vestors an opportunity to assess the regulatory Private Participation in Infrastructure Group The series is also system before formulating proposals. available on-line (www.worldbank.org/ html/fpd/notes/ Most new regulatory agencies can expect a notelist.html). challenging infancy. Besides mastering com- 8 Printed on recycled plex technical issues, regulators must define paper. new, and often difficult working relationships