On 25 July, the Joint Regulators Group (the
"JRG") adopted a common approach to
discounting in cost-benefit analyses which involve private
investment for a public benefit.
The use of a cost-benefit analysis is common when a regulator is
considering intervening in a market in which there is no profit
incentive for firms to invest but where investment would bring
benefits to consumers or the wider public. In such
circumstances, the JRG members agree, regulators' analysis of
costs should include a discount for all costs, including the
investing firm's financing costs. The common approach
therefore takes into account the cost to the firm of financing its
capital outlay. The level of this discount is based on the
firm's own Weighted Average Cost of Capital.
For certain regulators, including Ofcom, this marks a change in
approach to cost-benefit analyses. Ofcom have traditionally
excluded financing costs from discounting when weighing up the
costs of investment. The comparative effect of the new
approach will generally be to reduce the net present value (for
discounted cash flow purposes) of an investment, a figure which can
play a crucial role in the decision as to whether to
intervene.
The JRG is composed of regulators from a wide range of sectors
including rail, energy, aviation, communications and post.
The statement issued by the JRG is for guidance; as always,
regulators must have regard to their own duties and the particular
context of their sector. It is worth noting that the common
approach to discounting is based on the methodology employed by the
water industry regulator, Ofwat. Ofcom have been known to
depart from common regulatory practice led by Ofwat in the past and
have been supported by the Competition Commission in doing so (see
the Competition Commission's recent determination in British
Telecommunications plc v Office of Communications Competition
Appeal Tribunal case number 1187/3/3/11). The impact of the
best practice guidance in any given sector therefore remains to be
determined.
The JRG statement can be viewed here.
This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq
Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.
The original publication date for this article was 03/08/2012.