Economic Regulation - IATA

• Second, an airport can still exploit asymmetrical
information to increase its profits, beyond the level
expected by the regulator, by expanding and goldplating
its asset base.
• Third, in imperfectly competitive markets, firms have
sometimes used new investment as a strategy to deter
any possibility of future competition (e.g. the rapid
expansion of capacity at London Stansted airport in the
1980s resulted in a poor commercial return, but may
partly have been driven by an objective to deter the
threat of new investment at Luton airport).
Nevertheless, there are constraints to be addressed when
using the regulatory framework to assess investment
needs, timing and expenditure:
Discrete large-scale projects.
The large scale of many investment projects lead
regulated companies to seek to reduce their risk through
an assurance that their commitment to a large-scale
project will receive a sufficient return from future users. In
some cases, an investment project can be of higher value
than the existing asset base. For large projects, such as a
new runway, the decision, design and timing of the project
is best implemented through a long-term strategic plan
involving all stakeholders, including governments where
necessary. However, the regulator also has a role to
play. It needs to provide an appropriate balance between
providing sufficient assurance to the regulated company
about its long-term approach to rewarding investment
and ensuring it does not provide too strong a regulatory
commitment that simply transfers all of the risk of the
project to users.
Heterogeneous nature.
The complexity of individual investment projects
means there are few, if any, similar examples against
which expenditure and project management can be
benchmarked. As such, in benchmarking investment
projects a regulator can focus on the process rather than
the level of inputs. This could involve sharing best practice
on the approach to procurement and risk-management,
rather than a comparison of unit costs.
High gearing levels.
The use of debt rather than equity finance means that
the regulated company and its external finance providers
will typically adopt a more risk-averse approach. This may
lead to less ambitious designs and a more incremental
approach to investment. However, it may also result in
firms looking to place more of the investment risks on
to customers through, for example, pre-financing or
protection against cost shocks. A regulator should help
to ensure that risk is shared appropriately, not simply
passed on to users.
For example, the UK CAA released a press notice during
the takeover bid by Ferrovial for BAA Plc stating that it
“will set caps on airport charges in accordance with its
statutory duties and not in order to accommodate any
particular financing arrangements adopted” 26 . In effect, it
was stating that the risk posed by a high gearing level
would not influence the efficiency and charges targets in
their regulatory review.
Risk-averse nature of the regulator.
But regulators must also be wary of being too risk-averse
themselves. Regulators want to avoid the risk of regulated
companies being unable or unwilling to finance necessary
new investment, but also the risk of the regulated
company earning significant excess profits. The regulator
may be too risk-averse towards the latter – resulting in a
trade-off of a higher risk of the former occurring.
Airline intransigence.
Regulators should also recognise that airlines can, in
some cases, be risk-averse or unsupportive towards new
investment. Slots at capacity constrained airports can
represent an asset, with airlines setting fares to reflect
the shortage of capacity. In such cases, airlines may be
less incentivised towards an increase in user charges to
deliver longer-term increases in capacity for all airlines.
As such, regulators need to take account the needs of all
existing and possible future airline users when evaluating
investment plans.
26
CAA (2006), “Possible Offer for BAA plc: CAA Statement”.