Economic Regulation - IATA

REGULATORY FRAMEWORK
Effective economic regulation can provide both a carrot
and stick approach to improving productive efficiency.
The main mechanism through which this operates is by
the regulator setting a reasonable profile for performance
improvement over the next regulatory period.
This is based on the regulator’s judgement of feasible
improvements in efficiency, accounting for past
performance and planned investments. It then provides
an incentive for the company by allowing it to keep
additional profits from performing more efficiently than
anticipated by the regulator during the period, along with
the penalty effect of costs higher than anticipated not
being reimbursed by users.
However, the regulation framework needs to take
account of the following issues to ensure that such a
system provides effective incentives over time:
Regulatory game-playing.
In advance of each regulatory review both regulated
companies and their users have an incentive to negotiate
their view with the regulator rather than with each
other. Each side will try to convince the regulator of
an appropriate profile for costs, charges and returns.
Asymmetric information means that the airport or ANSP is
at an advantage in having a clearer picture of its true cost
base. The regulator must seek to overcome this barrier
through incentives to reveal information that allow for a
reasonable regulatory decision to be made (for example,
through differences in allowed returns based on how
close actual expenditure and investment outcomes were
to those put forward to the regulator).
Clear cost and service quality targets set.
The regulator should ensure that the targets set for
cost efficiencies and service quality improvements are
both clear and complementary. It should seek to avoid
any perverse incentives where advantage can be gained
by improvements in one area at the expense of service
quality elsewhere. Security costs are a key area where
an appropriate trade-off between cost and quality should
be sought, ensuring that the costs are met efficiently but
with enough flexibility (i.e. contingency planning) to cope
with shocks.
Flexibility for major external cost shocks.
The regulator cannot take account of all possible demand
or cost scenarios in setting a reasonable profile. As such,
a degree of flexibility is required that allows the system
to cope with major external shocks. Interim reviews
offer one possibility, though must be restricted in use to
ensure they do not reduce the credibility of regulation.
Alternative approaches (e.g. at Frankfurt and Hamburg
airports) provide a risk-sharing mechanism that allows
the burden of demand or cost shocks to be shared within
a regulatory period, without renegotiations of a regulatory
review or contracts.
Regulatory time-consistency.
The regulator does need to provide a degree of certainty
to the regulated company that it will not simply capture
all of the benefits of exceptional performance at the next
regulatory review. Of course, a company may benefit from
asymmetric information in outperforming the