I’ve come here today to talk about regulatory innovation and collaboration in a dynamic environment – what has been achieved and where to from here.
We are reminded on a daily basis, just how dynamic our environment is – in the past few weeks alone we have had wide ranging market and regulatory changes recommended by the ACCC’s Pricing Inquiry report and then AEMO’s inaugural Integrated System Plan, has outlined a plan for what investment our market might need to deliver secure, reliable and affordable power into the future.
Next month CoAG Energy Council will be considering one of the most important policy reforms since the market started – the National Energy Guarantee.
After months of work and consultation, the Energy Security Board has finalised its advice for Ministers – outlining the law and rule changes that will be needed to deliver the policy certainty our market needs.
And on the regulatory front there are a range of changes and refinements such as improving the guidance on the Regulatory Investment Tests, revising the Rate of Return guideline and a review of corporate tax (to name just a few).
Transformation of the energy market
These policy and regulatory changes are occurring because of, and in the context of, significant technological and consumer change.
The Australian energy market is currently undergoing a seismic transformation, and how that will play out, nobody knows for sure. The future is inherently uncertain.
What is certain though is that the cornerstone principles of our energy market - efficiency, effective competition, good governance, adaptive regulation and strong consumer protections are now more important than ever.
Equally important, though perhaps not as explicitly recognised as often as it should be, are the behaviours that we need to demonstrate as a sector.
Transparency, respectful engagement, genuine openness to new ideas, understanding of other’s position and inclusiveness are essential as we and our market are transformed to deliver affordable, secure, reliable and low emissions power.
Since I spoke to you last year, the AER has released its Strategic Statement – our commitment to engage actively with those affected by our work – consumers, businesses, investors and other stakeholders.
We consider we have a responsibility to help make our energy market fit for purpose and able to cope with future challenges. We are independent, open and accountable and stand ready to explore the boundaries of regulation and take considered risks, where necessary.
Five strategic objectives
In that statement, we clearly set out our five strategic objectives.
- Drive effective competition where feasible
- Provide effective regulation where competition is not feasible
- Equip consumers to participate effectively and protect those who are unable to safeguard their own interests
- Use our expertise to inform debate about Australia’s energy future, the long term interest of consumers and the regulatory landscape, and
- Take a long term perspective while also considering the impact on consumers today.
These objectives are the basis of our approach to regulatory collaboration and innovation and we hope they will contribute to driving the successful transformation of the energy sector.
At last year’s seminar, I commented on the highly adversarial culture around energy regulation in Australia. I noted that I was quite shocked at the intensity of that culture when I arrived and it’s been a conscious effort of mine to move away from it.
Changing that adversarial culture has been a focus of our work over the past 12 months and I think we have made significant progress.
I am going to talk about some of the changes that I think have been positive and identify areas where, together, I think we can do further work. I will also share with you some of the further changes we are working on within the AER to help us delivers for all our stakeholders.
But first I want to set out some of the challenges I see for corporate responsibility and governance in the network sector and why it is so important that proper attention is paid to it.
There are real challenges for network boards’ in ensuring they effectively replicate the discipline of operating in competitive markets. This is absolutely essential in achieving the best outcomes for their consumers.
In naturally contestable areas, effective competition disciplines performance, aligning business self-interest with customer needs, almost as if some invisible hand were at work, guiding affairs.
Fail to deliver what the customer needs, and you lose them. Lose the customer and you lose their revenue; as the revenue dries up, so do earnings, the analysts’ reports turn sour and stock prices fall.
But for those businesses operating in areas characterised by natural monopoly – where customers are dependent on one company and cannot choose an alternative – the discipline imposed by competition is missing.
Regulation and the regulator, have been used as substitutes for the competitive discipline needed to ensure that that the business’ values and behaviour align with the customer’s needs.
I think that boards need to be seen as playing a greater role in delivering this consumer value. Businesses need to be able to demonstrate they understand what their consumers want and that they are totally committed to delivering that – this has to be lead from the board of directors.
Consumers want the confidence that their interests are as important as shareholder interests. They want to be confident that network businesses are doing everything they can to deliver the services needed at an affordable price. They want the confidence that the businesses are taking the responsibility for driving that themselves – not because they are being forced to by regulation.
Developing this confidence will improve trust between consumers and network businesses and will be vital in ensuring the transformation of the sector happens and delivers positive outcomes for consumers, businesses and the community more widely.
I think our incentive based regulatory framework provides companies with opportunities to demonstrate this discipline. When we are reviewing proposals we count on the incentive regime to encourage businesses to move towards efficient costs. We, of course, couple that with other tools at our disposal such as benchmarking and predictive modelling. Having the Consumer Challenge Panel and consumer groups at the table also helps provide that discipline.
But I also think that considering a business’ corporate governance can help reassure consumers that their interests are being considered alongside those of shareholders.
Regulatory process and business operations
The board of director’s role is not just about providing debt and equity holders with confidence, it is also necessary to increase the confidence of other stakeholders, including customers and regulators.
There’s a very old saying that goes: help us to help you. Good regulatory processes can be an important way that businesses can demonstrate to their customers they understand what is wanted and needed and they are doing everything they can to deliver that.
We know that competition disciplines performance so that a business’ self-interest is aligned with customers’ needs. This discipline manifests in the boardroom – where directors, supported by shareholders, guide corporate strategy and review annual budgets and business plans.
The regulatory process is an opportunity for businesses to demonstrate they understand and are operating with that same type of discipline.
I’ll quote here from a decision made by the Ontario Energy Board a few years ago:
“As a regulated monopoly, a core element of the network business is its engagement with the regulatory process. The business needs to integrate the regulatory environment fully into its operations, and not consider it to be an artificial obstacle to the business’ pursuit of its business goals. Compliance with and participation in the regulatory process needs to be built into its processes, not grafted onto them.”
Good corporate governance is a significant contributor to network performance and an important indicator of a business’ capability in achieving the expectations embedded in this dynamic environment.
We want to better understand how the board has considered the risks, costs and benefits, customer impacts and alternatives to capital projects included in proposals that are put to us. How has the board worked to align its values with what is best for its consumers.
Regulation and corporate governance have a lot of natural alignment - better corporate governance will lead to better regulatory results. Analysing corporate governance practices is happening to a greater extent worldwide and is a legitimate area of consideration for regulators.
Both focus on strategic objectives, ensuring strong processes, monitoring results, managing risk and taking corrective action when required.
If we can be confident in the corporate governance of the businesses we regulate, then we can have greater confidence in the quality of business planning, investment and operations.
A company’s board is responsible for the integration of regulatory process and business operations. Working through their senior management, they need to ensure that their entire business, including any regulatory proposal, is directed toward genuinely meeting customers’ needs. They need to ensure they have processes in place to develop a deep understanding of those needs.
They need to set a strategic direction for their business that aligns with those needs and then ensure that senior management are delivering on that strategic direction every day – including through its regulatory proposal.
And they need to be able to demonstrate this in an ongoing, transparent way, to customers.
Customers want to know that regulatory proposals are being driven by a strategy that is commercially and customer-outcome focussed. That it engages appropriately with risk and demonstrates proper cost/benefit analysis. They want to be confident that they are being asked to pay no more than they need to, for the services they want.
At times, in the past, it has felt like that the AER, as the regulator, was asking the questions that the board should have been asking. Questions like –
- Where is the business case for this proposed investment?
- What have you done to find alternatives to this level of investment?
- Where is the risk assessment – why have you assumed that there is a 100% likelihood of this occurring despite the fact it hasn’t happened before?
If those matters had already been considered by the board, then it wasn’t obvious in the material provided to us and consumers through the regulatory proposal.
This is a missed opportunity – instead of the business providing customers with the confidence their interests are at the heart of the proposal, it raises doubts.
Businesses have a range of regulatory tools at their disposal that can be used to provide consumers with confidence that all network investment is necessary, prudent and efficient.
Network investment planning processes such as the Annual Planning Reports and Regulatory Investment Tests can demonstrate to consumers and the market how hard networks are working to try and minimise capital expenditure to only that which is necessary.
In these uncertain times, consumers are looking for evidence that the networks are being creative and looking for solutions that reduce the risk that their money will be invested in assets they won’t need in the future.
While we have been doing a lot of work to improve these processes – more needs to be done.
Networks need to be providing robust information to the market, identifying future network needs, in a timely way. This means that other service providers will have time to develop genuine alternatives and to be able to propose those during Regulatory Investment Tests.
Consumers, and other market players, can be sceptical about how genuine networks are about alternatives to capital expenditure – these processes can demonstrate an openness to these alternatives.
The Demand Management Incentive Scheme provides the opportunity to demonstrate a preparedness to innovate – delaying or replacing capital expenditure through purchasing demand management services.
At this stage, I don’t think some networks are using this tool as effectively as they could. Our report on the Demand Management Innovation Allowance published last week shows that networks have only spent about 40% (on average) of their allowances. Customers will be expecting networks to do better in this area, particularly with the new scheme commencing in the next regulatory period.
A new tool that will enhance consumer confidence will be our report on network profitability. This annual report will provide an important opportunity to build trust with consumers as it will support greater transparency about issues that consumers have been very concerned about. Network businesses will be able to engage with their customers and help them understand the results.
Reflecting early engagement with consumers and the AER back into regulatory proposals demonstrates responsiveness to consumer views.
New processes we are undertaking, such as the capital deep dives, provide just such an opportunity. The idea of capital deep dives is a good one: you spend time working through capital forecasts before you file your proposals with us. The deep dives involve detailed discussions on proposed capital expenditure. I think on the whole they will be useful in giving stakeholders such as consumers (and the CCP) and the AER a good understanding of the capital cost forecasts prior to submitting a proposal.
They can give networks a good feel for where our concerns may lie with what they were proposing to put forward and give them an opportunity to address these issue before the formal process begins.
You can bring the CCP and other consumer groups into the process. And we can work with you on this. It is challenging, but hopefully an ultimately rewarding process.
In a recent interview, Professor Cary Coglianese, Director of the Penn Program of Regulation at the University of Pennsylvania defined regulatory excellence as having three core attributes:
- utmost integrity,
- stellar competence, and
- empathic engagement.
While he was commenting more specifically on regulators, I think those attributes are equally relevant to regulatory systems, as well as individual players.
I also think, that until quite recently, our system has been a long way from this ideal.
In the year since I spoke to you last – a year since AER 2.0 – we have begun our move away from an adversarial regulatory approach to one were we are all truly focused on putting consumers at the centre of the regulatory process.
We know that we will not be doing our job properly unless we understand all interests and effectively explain the reasoning behind our decisions. We don’t just do consultation on the papers any more – the world has moved on a long way from there.
We are trying to embed more diverse forms of engagement, better opportunities for collaboration and innovative solutions, into our regulatory processes.
The Consumer Challenge Panel continues to mature, adding value in greater and more varied ways all the time. They are being supplemented by, as well as assisting in the development of, our use of consumer reference groups in some of our more significant and complex processes.
In our Rate of Return guideline process, we also have an investor reference group as well as deeper engagement with network businesses. We used concurrent evidence sessions to maximise the value and input of all our technical consultants.
We have established an independent peer review panel to consider our process in developing the Rate of Return guideline – to improve transparency and increase the robustness of our decision making.
We are not alone in introducing changes to support better engagement.
Network businesses are making real progress by bringing consumers not only into the room, but by really listening to what they have to say, and it is beginning to flow through to the proposals coming to us.
There has been significant improvement in areas of consumer engagement and responsiveness to consumer concerns. Early engagement is getting more sophisticated – providing consumers with real opportunities to affect proposals.
Consumer groups have a great range of expertise and regulatory experience and are working together to effectively bring this into processes. Many representatives have invested significant time in developing their knowledge, so they can challenge the networks and the AER.
This is leading to materially better proposals and decisions, greater accountability and transparency.
The New Reg project and the AusNet trial – which many of you know about, or are even participating in – are good examples of the move toward a productively collaborative approach.
My colleague Mark McLeish will discussing this later today, so I won’t steal his material. However, I will say that I have been very heartened by the goodwill shown through these projects – the effort, the commitment and openness demonstrated by all those involved in the projects so far has been remarkable.
It has shown that we are able to work together – discussing, disagreeing, listening, agreeing, trialling, assessing, refining, developing and then starting all over again on the next issue – to try and achieve regulatory excellence.
This is how we move away from the adversarial culture of the past, through working together and then sitting down afterwards and considering, well, that was useful, how can we improve the process for next time? What worked, and what didn’t? What’s a new way of doing things we could try next time?
When we hit bumps in the road – as we will – we need to go over them, not have them turn into road closures – driving us back down paths that aren’t going to get us anywhere.
The AER is currently undertaking a program of work to help us as an organisation achieve regulatory excellence – our strategic transformation program.
I am going to borrow very heavily on Professor Coglianese’s articulation of the 3 core attributed of regulatory excellence.
I think most of us understand the significance of stellar competence. Excellent regulators must deliver substantive outcomes that maximize public value - promoting effectiveness, efficiency, and equity. We must be knowledgeable and well-trained.
We also need to be honest, so I suspect most people readily see the importance of utmost integrity too—although, for a regulator, integrity entails much more than merely a lack of corruption; it also demands a consistent commitment to delivering public value, following the law and staying even-handed.
The third attribute, empathic engagement, is a concept that may not seem as obviously important.
Simply staying on top of the technical aspects of regulation—maintaining competence—can be so demanding that it seems to leave little time or energy for active listening and engagement.
Regulation is fundamentally a social enterprise. It is all about trying to influence what people do in their businesses and other regulated activities, all in the service of still other people in society.
For this reason, regulatory excellence requires what he calls “people excellence.” That is, it depends vitally on regulatory professionals who themselves are constantly striving to maintain and strengthen integrity, competence and ability to engage empathically with others.
It also depends on regulatory organisations that have the necessary resources, training, clarity of mission and overall management vision articulated by leaders who themselves uphold the values of integrity, competence and engagement.
Recognising the importance of empathetic engagement (though we didn’t use that term then) started us on the AER 2.0 path and continues to drive our work through our strategic transformation program.
I don’t have time today to provide details of the program, but we will be sharing our thinking and process with you in the coming weeks – starting with our new organisational structure.
Our new structure will enable a new approach to engagement with stakeholders and enhance our ability to communicate more effectively with consumers, businesses and broader stakeholders. It will position us to more actively participate in the policy debate and the design of the regulatory regime.
I can assure you, the AER is working hard to achieve our goal of regulatory excellence.
Consumers will be looking to the network businesses to demonstrate their commitment to putting their customers’ interests at the centre of their corporate responsibilities. They will be looking for evidence of utmost integrity, stellar competence and empathetic engagement. The regulatory processes provide businesses with that opportunity.
I very much look forward to working with you all to achieve a system of regulatory excellence that places consumers at its heart.
Paula Conboy, AER Chair
Energy Networks Australia Regulation Seminar 2018
State Library of Queensland, Stanley Place, South Brisbane.