Regulatory independence: how to achieve it and how to maintain it

When 69 Member Nations of the World Trade Organization (WTO) agreed to open their markets to companies from other WTO Members in 1997 they also adopted a document that was unique in the annals of international trade negotiations – the Reference Paper on Regulatory Principles. The Reference Paper was negotiated based on an understanding of the nature of telecommunications markets – in particular that, even when opened to competition, it is essential that the market be regulated in order to allow new entrants to compete with entrenched incumbent operators (referred to in the Reference Paper as “major suppliers.”)

One of the core elements of the Reference Paper is the requirement for “independent regulators.” The text of the Reference Paper on independent regulators is only two sentences (the entire Reference Paper is barely more than three pages long). But these two sentences represent a critical baseline for effective regulation of telecommunications markets around the world:

It was both possible, and necessary, to negotiate the Reference Paper in 1997. First, it was possible because at the same time that governments from around the world were negotiating the WTO Agreement on Basic Telecommunications, there was an unprecedented wave of market openings, notably in the European Union, Japan, Canada, the United States, and other regions of the world, just as the industry was rapidly expanding and transforming. The political momentum toward telecommunication liberalization made the market opening and regulatory reform that the WTO negotiations sought to unleash possible.

At the same time, WTO members understood that, to make market opening effective, they needed to commit to measures that would ensure all market participants would have a fair chance to compete. The other substantive elements of the Reference Paper include prevention of anticompetitive practices by “major suppliers;” guarantees of reasonable interconnection with “major suppliers;” transparent and competitively-neutral universal service programs; public availability of licensing criteria; and transparent and non-discriminatory procedures for allocation of scarce resources, such as spectrum and numbering. Overseeing all of these disciplines would be the aforementioned independent regulators.

In almost every country, the “major supplier” was then a state-owned monopoly provider of fixed and wireless telecom services. In such a situation, the need for the regulatory body to be “separate from, and not accountable to, any supplier of basic telecommunications services” was particularly acute. As a monopolist, of course, the incumbent obviously had market power – the ability to determine the price or supply of a service. Indeed, the definition of “major supplier” is “a supplier which has the ability to materially affect the terms of participation (having regard to price and supply) in the relevant market for basic telecommunications services.” Beyond this, which would be true even if the incumbent were not state-owned, the incentive for the government – as regulator – to intervene in favour of the incumbent would be strong. When the government owns a telecommunication company, the government has an incentive to promote the economic success of that company. This can lead the government to pursue regulatory policies that protect the incumbent and limit opportunities for rivals to compete. In addition, state-owned operators were typically an arm of the sectoral ministry, and the ministry employees who might regulate the industry often had close personal and professional relationships with the employees who would operate the telecommunication company. At a minimum, these close relationships created an appearance of a conflict of interest that could discourage competitive entry.

It is important to note that regulatory independence is not absolute – nor should it be. As a public institution that exercises significant and substantial powers that can affect billions of dollars in investment, a regulator, even though independent, must also be accountable. Unlike a minister, the independent regulator is not accountable to voters – at least not directly. Therefore, laws that create independent regulators should also establish methods of holding the regulator accountable, including requirements to conduct transparent public consultations; a process for review of the regulator’s decisions, often by a court; and legislative oversight of the regulator’s conduct.

An independent regulator, although still an unfamiliar concept in some countries, has a long heritage. In the United States, the first independent regulatory body, at the federal level, was the Interstate Commerce Commission (ICC), which was created by Section 10 of the Interstate Commerce Act of 1887 for the purpose of regulating interstate commerce by rail.^[1] Despite its age, the Interstate Commerce Act remains a good example for international best practice in establishing regulatory independence.

The ICC was only the first of literally dozens of independent regulators in the United States – and now in many other countries. Most relevant among U.S. regulators here is the Federal Communications Commission (FCC), established in 1934, which regulates both telecommunications and broadcasting (see below) as well as other specialized regulatory agencies at the federal level.^[2] In addition, every U.S. state has a multisector utility regulator that typically has jurisdiction over electric utilities and local telephone companies.^[3]

The Interstate Commerce Act does not specifically say that the ICC was to be independent, but as established, the ICC did not report to the president or any cabinet member, nor could commissioners or employees of the ICC have any professional or financial connection to a regulated company. A number of characteristics of the ICC included in Section 10 of the Interstate Commerce Act would go on to be hallmarks of independent regulatory bodies in the United States and in other countries as well.

• The ICC consisted of five commissioners who were to be appointed by the president “by and with the advice and consent of the Senate.”
• The commissioners’ terms were staggered so that not more than one commissioner’s term ended in a given year;
• A commissioner could be removed from office by the president only for “inefficiency, neglect of duty, or malfeasance in office.”
• No more than three of the five commissioners could be members of the same political party;
• Commissioners were not allowed to engage in any other business or employment.

These are some of the characteristics that help to ensure that a regulatory body is independent. Not all of them must apply in all cases, and other safeguards can also protect independence. Nevertheless, the factors listed above are worth bearing in mind when drafting legislation to create (and protect) an independent regulator. When the FCC was established in 1934, it took over authority that Congress had given to the ICC, beginning in 1911, to regulate telephone companies. The FCC was also given power to licence and regulate broadcasters that had been exercised by the Federal Radio Commission beginning in 1927.

As a result of liberalization of telecommunications markets in Europe, Member States of the European Union also established independent regulatory agencies. In Germany, for example, the telecommunication regulator is now known as the Bundesnetzagentur (BNetzA) – the Federal Network Agency.^[4] Although BNetzA is located within the Federal Ministry of Economics, it functions independently. The ministry does not approve or review the regulator’s decisions (which can be challenged in the courts). BNetzA is managed by a president and two vice-presidents who are appointed by the President of the Federal Republic of Germany on the recommendation of the Bundesnetzagentur’s Advisory Council, a group composed of representatives of the federal parliament and of the states.

Appointment power

The Interstate Commerce Act protected the independence of the ICC by dividing the responsibility for appointing commissioners. Members of the FCC – and other U.S. federal regulatory agencies – are appointed in the same manner as ICC commissioners were.

It is worth noting that, under the Constitution of the United States, the president is only able to exercise certain powers “by and with the Advice and Consent of the Senate.” These powers include making treaties with foreign nations, appointing judges to the Supreme Court, and appointing other officers of the U.S. government, such as cabinet secretaries. The Advice and Consent provision of the Interstate Commerce Act (and similar laws adopted later) limited the president’s authority over the ICC in important ways. The act thus divided the power to appoint commissioners and thereby reduced the degree to which commissioners might feel indebted to the president. In addition, by requiring that the Senate approve the individual appointments, the act constrains the president to nominate commissioners who are broadly acceptable, not simply political loyalists. Similarly, the requirement that no more than three of the five commissioners may be members of the same political party – typically, the president’s party – promotes a diversity of viewpoints and prevents the commission from being loyal exclusively to the president.

The constitutional structure of the U.S. government provides a convenient mechanism – the advice and consent of the Senate to various presidential appointments – that Congress incorporated into the Interstate Commerce Act, the Communications Act of 1934 that created the FCC, and many subsequent laws that created other regulatory commissions. Other governments do not have similar legal requirements; indeed, in a parliamentary system dividing authority between the prime minister and their parliamentary majority might have little effect on regulatory appointments. Nevertheless, dividing the appointment power in some fashion is a useful tool to protect independence. As noted above, the leaders of the German regulator, BNetzA, are appointed by the president based on recommendations of the Advisory Council.

Staggered terms

The provision of the Interstate Commerce Act that requires that not more than one commissioner’s term ends in any given year may have been intended more to ensure the ICC’s continuity than its independence. FCC commissioners are also appointed for staggered terms. Indeed, maintaining a stable membership of the commission guarantees that the regulator maintains institutional memory, which is important to making a regulator effective and encouraging consistency in its application of the law. At the same time, however, staggered terms prevent the president from appointing all or a majority of the members of the Commission at one time and thus increases the separation between the President and the regulator. Indeed, there is often an overlap between commissioners who were nominated by the current president and commissioners who were nominated by their predecessor.

Removal

Perhaps the single most important protection of a regulator’s independence is the prohibition that a member of the commission may only be removed for limited reasons that are specified in the law. In the case of the Interstate Commerce Act, the causes for removal from office are “inefficiency, neglect of duty, or malfeasance in office.” Other statutes, including the Communications Act of 1934, do not provide any mechanism for removing a commissioner – not even for “malfeasance.”

Admittedly, the terms “inefficiency, neglect of duty, or malfeasance in office” are imprecise at best and open to interpretation – at least initially by the president who would decide to remove a commissioner from the ICC for one of the specified reasons. If the president is so inclined, they could abuse their discretion and claim that a commissioner was “inefficient,” for example, and order their removal. Nevertheless, several points are worth emphasizing.

• First, although the Interstate Commerce Act made the ICC independent, it must also be accountable. The power of the president to remove a commissioner for limited reasons was one means of holding the ICC, and individual commissioners, accountable, even though it may limit independence.
• Second, laws necessarily assume that officials who are entrusted with governmental power will act in good faith. In giving the president the authority to remove commissioners, Congress implicitly assumed that the president would not abuse their discretion.
• Finally, although the Interstate Commerce Act does not specifically provide a remedy for a commissioner who believes they have been wrongly removed from office, other similar officials who have been removed from office have challenged their removal in court. The U.S. Supreme Court has held that the president may not remove officials, such as independent regulatory commissioners, that are not subject to their supervision except for reasons specified in the law.

Ultimately, although the Interstate Commerce Act gives the president some authority to remove commissioners, it also makes clear that they cannot remove commissioners because, for example, they disagree with their disposition of a particular regulatory matter. This made the commissioners’ protection from removal an essential protection of the commission’s independence.

Partisan affiliation

No more than three of the five ICC commissioners could be members of the same political party. Typically, this means that the president’s political party has a majority of the members of regulatory commissions. Although the president could only remove a commissioner for cause, it has been traditional for the chair of regulatory commissions to resign when a new president is elected, particularly if the new president is from the opposite party to the previous president. As a result, regulatory commissions typically advance the overall philosophy of the president’s party, but the commissions are not subject to the president’s direction. The requirement that no more than three of the five ICC commissioners could be members of the same political party promoted a greater diversity of viewpoint among the commissioners and limited the president’s political influence over the ICC.

Outside employment

The foregoing protections were designed to limit the political influence of the president over the ICC. Equally important, however, is the prohibition on outside employment, which was intended to prevent regulated companies from having undue influence over the ICC.

There are other methods of protecting the independence of regulatory commissions, such as funding the regulator from a dedicated source. Laws in different countries incorporate some or all of the measures discussed above in order to ensure that regulators are able to exercise independent judgement without undue political or industry influence.

Creating an independent regulator, however, is only the first step. Maintaining the regulator’s independence may be more difficult.

Threats to independence

A law can establish a regulator as “independent,” but, especially in the early stages of the regulator’s operation, government or industry may be able to undermine the regulator’s independence.

One threat to independence is a lack of clarity in the text of the organizing law. For example, if the law leaves it unclear whether the board of directors or the management of the regulator should exercise the powers of the regulator, this can be an invitation for the ministry or industry to seek to undermine the independence of the regulator. It is essential that roles are clearly spelled out – ideally not only as between a board of directors and the management, but also between the regulator and the ministry. Generally, it is advisable to give more power to management if the members of the board of directors are only part-time employees of the regulator. This is because part-time directors will likely meet infrequently and will not be in a position to develop deep expertise in the matters that come before the regulator.

Similarly, a lack of clarity in procedures for appointment and removal of board members and management officials can compromise the effectiveness and the independence of regulator. This is especially problematic if conditions for removal from office are not clear because officials will not know what might be cause for termination. In these circumstances, the regulator will have an incentive to act in a way that is calculated to please the person with the power to remove them from office, even if this is not objectively the “right” action.

Many laws specify qualifications that one or more members of a commission should possess – such as expertise in engineering, law, accounting, and so on. These can be reasonable criteria for ensuring that the regulator has appropriate experience in order to carry out its functions. It is dangerous, however, to be too prescriptive in specifying qualifications, especially if members of the board or commission are only part-time employees. For example, requiring that one or more members of the board of directors come from the ministry or from the regulated industry, while it may ensure that they have relevant experience, will certainly impair the regulator’s independence from the ministry or the industry.

Finally, it is often difficult for government to agree to cede powers to the regulator and there may be a temptation to retain authority over matters that will have major economic implications, such as the opening of the market to new entrants. Not only will competition imperil the commercial prospects of the incumbent operator, but competitive entry is generally expected to generate substantial revenues for the government and it may argue that these are matters of “policy” to be decided by the ministry or cabinet, rather than “regulatory” issues to be resolved by the regulator. If the government succeeds in limiting the regulator’s power in these areas, however, it will seriously weaken the regulator’s independence and may, as a result, weaken the confidence of potential market participants in the fairness of the regulatory process. This is likely to slow the growth of the industry and reduce the revenues that the government can expect to receive.

Conclusion

The reasons for establishing an independent regulator are well understood. First, the regulator should have the power to exercise expert judgment, free from undue political influence. Second, independence – particularly as defined in the WTO Reference Paper – promotes fair competition by ensuring that the regulator is “separate from, and not accountable, to any supplier of basic telecommunications services,” especially the incumbent. Independence thus increases the confidence of market participants that they will be treated fairly and thereby promotes the growth and vitality of the industry.

As we have seen, there are many legal tools that can protect the independence of regulators – both from the government and from industry. These commonly include statutory provisions concerning the process for appointment and removal of officials of the regulator; conflict of interest rules; clear roles for the regulator and the sector ministry; and dedicated sources of financing, among others.

Creating an independent regulator is thus a fairly straightforward task – a variety of statutory provisions as discussed in this section can give the regulator independence. Maintaining independence, however, requires that all stakeholders – the regulator, the government, the legislature, and the industry – are committed to abiding by the terms of the law and upholding rule of law principles in general.

Notes:

1. The ICC, the first U.S. regulatory commission, was abolished effective January 1, 1996. ↑
2. These include the Federal Trade Commission, which, among other things, has a consumer protection mission; the Securities and Exchange Commission, which regulates the sale of stocks and other securities; and the Nuclear Regulatory Commission, which licenses and regulates nuclear power plants. ↑
3. For example, the California Public Utilities Commission regulates privately owned public utilities in the state of California, including electric power, telecommunications, natural gas, and water companies. The industries regulated by similar commissions in other states vary. ↑
4. The Bundesnetzagentur now has authority over postal service, electricity, and railways in addition to telecommunication services. This model is similar to the multisector regulators in U.S. states and is based on the similarities among these various networked industries. ↑