Consideration must be given... Section 18 and Chorus

I’m not at the High Court in Wellington so all I know about the case Chorus is bringing against the Commerce Commission is what I’ve read in the papers, but so far it’s quite fascinating.

Chorus’s argument hinges on whether or not the Commerce Commission misread the law with regard to its determination of the price of wholesale access to copper lines (known as the UBA service).

Chorus says the Commission chose too narrow a group of comparison countries and didn’t take into account the requirements of a new section of the Telco Act (section 18) which was added after we, among others, argued against having a regulatory holiday.

The first part is easily disposed of. There really aren’t too many countries around the world that have a similar regulator system to ours, and so in the end the Commission was stuck with just two – Denmark and Sweden.

That’s a problem – one the Commission acknowledged early on – but seeing that the determination has to be based on benchmarking, and that the law allows for a Final Pricing Principle if that’s not considered satisfactory, it’s hard to see how the Commission could have done anything differently. We’re benchmarking against two countries, if you don’t like it you can ask for an FPP. Chorus didn’t like it, so it did, and we’re working through that process now.

The second part is trickier.

For those with long memories, cast your minds back to the Telecommunications Amendment Bill introduction in 2010. You’ll remember it was pretty straightforward, including a number of provisions relating to the UFB deployment and the requirements for any winner to be a wholesale supplier only: no retail service was allowed.

The minister of the day, Steven Joyce, then introduced a Supplementary Order Paper (SOP) that ran to more pages than the bill itself and included a brief mention of a regulatory “forbearance period” which would free the winning company from having any Commerce Commission oversight for a period of ten years.

After having fought for many years to get a regulator to oversee the industry, and having seen how well the regulator could both encourage good behaviour and enforce it when needs be, TUANZ wasn’t about to stand idly by and let the regulator be benched for a decade.

Ultimately political manoeuvrings saw the clause struck out, but in its place Section 18 was introduced.

It’s not a long section – just four brief paragraphs. The first says the section is designed “to promote competition in telecommunications markets for the long-term benefit of end-users of telecommunications services within New Zealand” through regulation.

That’s good – that’s in keeping with the role of the Commerce Commission and the Commerce Act and indeed with the Telco Act itself.

The second paragraph is dull legalese that says you must consider whether any regulation will result in, or block, the  “long-term benefit of end-users of telecommunications services within New Zealand”.

Good to see – we’re all about that as well, so I’m happy with that.

The third paragraph is the meat of this matter, however. I’ll quote it in full for you.

“To avoid doubt, in determining whether or not, or the extent to which, competition in telecommunications markets for the long-term benefit of end-users of telecommunications services within New Zealand is promoted, consideration must be given to the incentives to innovate that exist for, and the risks faced by, investors in new telecommunications services that involve significant capital investment and that offer capabilities not available from established services.”

I’ve bolded the important bit. Consideration must be given to those investors who are putting money in to new services. This is the first time the Telco Act has talked about protecting investors in this way – it’s untested until now and frankly, it’s not a lot to go on.

The Commerce Commission’s thinking around S18 is quite straightforward. Nowhere does S18 say the Commission must change its methodology. Nowhere does it say the Commission must override its existing processes and approaches to benchmarking and the like. It doesn’t say anything other than “consideration must be given”, not to the investors themselves, but to the incentives and risks those investors face.

Given that, the Commission looked at its benchmarked countries and chose the most expensive one instead of picking a point somewhere in between the two, as it would have done in the past. Section 18 doesn’t really have the detail that Chorus (and indeed that the government that introduced it) is saying it does. I don’t see any other approach that the Commission could have taken with so little guidance.

Chorus’s lawyer is also arguing that the Commission must surely have seen the writing on the wall when the share price began to fall – but that’s just a bit of theatre for the papers. Nowhere does the law require the Commission to consider a company’s share price as an input into this process and if it did I for one would be marching in the street in protest. It’s quite a strange measure of regulatory worth and really wouldn’t stack up against the rest of the Telco Act or the Commerce Act itself for that matter.

But it does raise an interesting question. Chorus clearly wasn’t expecting a price cut of this magnitude, despite all the signs (such as Steven Joyce giving the company three years to get ready for the introduction of the new price), and argues that it puts the UFB deployment at risk.

Yet when you look at another High Court ruling – this time in an appeal against a Commerce Commission ruling (Wellington Airport et al vs the Commerce Commission), you’ll find an opposing view from the court on such cross subsidisation.

“[1480] The idea that greater revenues produced by higher allowed earnings on past investments (ie on the initial RAB) provide the wherewithal for more future investment is contrary to rational investment choice. Those existing higher earnings, once earned, are a given. The source of funds for future investments does not influence the riskiness of future investments; nor, therefore, does it influence their attractiveness. If anything, an abundance of capital is likely to lead to wasteful investment.”

I take that to mean if you make money from one source, you can’t then cry foul in another arena if that funding dries up. Past earnings are not guaranteed and you can’t rely on them.

The whole case is quite fascinating, pitching the Commission against (in essence) every regulated utility you care to think about, and its role in the current fight will no doubt come out in time.

Today, the Commerce Commission’s lawyers will have their say and then it’s over to the court to determine what happens next. Either way I’m sure we’ll see an appeal and then probably an appeal to the Supreme Court itself.

All that will take time and drag this out for years to come – ironically proving the value of letting the Commerce Commission make the call on such things. Legal actions in the telco sector have in the past taken so long to resolve the products have long since been withdrawn. Sadly, all this is far from over.