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Estimating the cost of capital for implementation of price controls by UK regulators

The UK Regulators Network (UKRN) has today published a report written by an independent study team into aspects of the way in which economic regulators set allowances for the cost of capital in price controls. The study has been sponsored by Ofcom, Ofgem, the Northern Ireland Authority for Utility Regulation (NIAUR) and the Civil Aviation Authority (CAA). The terms of reference for the study, agreed between the UKRN participants, are included as Appendix L to the report.

As set out in the UKRN Cost of Capital Principles, we recognise the benefits of using market and other evidence to inform our work and so welcome this report as a valuable contribution to advance regulatory understanding of how to set the allowed cost of capital. This is part of our commitment to take an effective and efficient approach in setting the cost of capital in the sectors we regulate and facilitate and promote collaboration within our membership, in line with the UKRN’s strategic objective.

The purpose of the study is to explore some of the issues that face regulators when they set allowances for the cost of capital in price reviews, especially those that arise from significant changes in capital markets over recent years. It is not intended to identify a preferred approach or common view on estimating the cost of capital.

The authors of the report (Stephen Wright, Phil Burns, Robin Mason and Derry Pickford) make a number of recommendations to economic regulators. However, there are important issues where the authors have not reached a common position.

We support the report’s approach of explicitly recognising areas of difference. This reflects the complexity of the issues, limitations in available evidence and the debate in the wider literature. We consider that recognising differences in view is helpful as it helps to better understand the issues and differences in interpretation of evidence and illustrates the challenges facing regulators in making price review determinations,

The authors state an expectation that the areas of agreement and disagreement will lead to further dialogue between regulators and other interested parties and that further work will be required in some areas. The report does not base its recommendations on evidence drawn from the sectors of all participating members, nor does it consider how these recommendations would vary to reflect the differing priorities and statutory duties of each regulator. Therefore it is for each regulator individually to consider how to take account of the findings from this report in alignment with their duties and circumstances of their sectors.

We are not requesting any feedback but if you would like to share any comments on the report please forward them to Ian Rowson.

Report: Estimating the cost of capital for implementation of price controls by UK Regulators