Economic Regulation - IATA

OPTIONS AND REGULATORY PRINCIPLES
TO INCENTIVISE INVESTMENT
IATA’s preference is for effective and independent pricecap
regulation, where the benefits of regulation are greater
than any resource or behavioural costs it may impose. It
provides greater incentives for cost-effective investment
than price monitoring or rate-of-return regulation.
Contractual negotiations can lead to effective investment
plans but, with the existence of asymmetric information,
requires a fair and transparent approach to negotiations
from both sides that does not always exist. As such,
price-cap regulation can provide additional support to
negotiations by providing an independent arbitration role
towards investment plans in the event that commercial
agreement cannot be reached.
Price-cap regulation can provide sufficient incentives for
new investment. However, there are additional options
that can be implemented within the overall regulatory
framework to provide further support for new investment
or to reduce the burden of regulation on the overall
investment decision.
Potential options include:
Support for commercial negotiations.
Airline users should be closely involved in the planning,
design and timing of new investment decisions. Regulators
can allow commercial negotiations to take the lead but
provide regulatory oversight to ensure discussions can
proceed on a fair and transparent basis. The success of
this mechanism will be highly dependent on the amount
of information the airport or ANSP is willing to reveal and
on credible incentives to ensure agreed investment plans
are delivered cost-effectively. As such, the regulatory
structure should include a mixture of carrot and stick
measures that provide incentives to engage users in a
constructive manner, with appropriate penalties where this
is not the case. Airline users and regulators can both have
an important role in determining precise and measurable
outputs and timescales for the investment process, as
well as oversight of the level of resource inputs.
Mitigating regulatory uncertainty.
Certain tools can be used to help reduce the uncertainty of
returns on major investments without transferring too much
of the risk on to users. For example, realistic contingency
margins can be built into investment estimates and shared
between the regulated company and users if they are not
needed. Trigger mechanisms can also be used, allowing
for a gradual increase in user charges for discrete largescale
investments (e.g. Heathrow Terminal 5), based upon
agreed project milestones being met, rather than a very
large increase once the project is completed. However,
the degree of pre-financing involved in the use of trigger
mechanisms must be minimised.
Increasing the potential rewards
in return for bearing greater risk.
Allowing a premium to be earned on the cost of capital
in return for bearing greater risk could influence both the
nature and financing of investment projects. For example,
a split cost of capital – providing a higher return for new
investment than for the current asset base – can increase
the incentive for equity-financed new investment,
while ensuring that the cost of capital is appropriate to
remunerate past investment. Ring-fencing of high-risk
elements within an investment project could also be used.
However, careful consideration should be given to ensure
that premiums for investment projects do not leak through
into higher returns for all assets once an investment is
completed and added to the overall asset base.