Part 1: Regulatory Context

• Confident Consumers, Economic Development and the Regulatory Environment
• Regulation
• Definitions
• The Regulatory Pyramid
• Relationship between Regulation and Confident Consumers
• Industry-Led Regulation
  • Advantages and Disadvantages of Industry-Led Regulation
  • Types of Industry-Led Regulation
    • Firm-Based Service Charters
    • Aspirational Code
    • Model Contracts
    • Accreditation/Quality Assurance Scheme
    • External Dispute Resolution
    • Standards
    • Legal Codes/Co-Regulation
    • Other Types
• Discussion Questions

Confident Consumers, Economic Development and the Regulatory Environment

The primary role of the Ministry of Consumer Affairs is to promote an environment in which consumers transact with confidence.[2] This recognises that:

• when consumers' expectations about a transaction are met, transactions are successful and, collectively, successful transactions generate confidence;
• market rules and institutions influence the confidence of consumers; and
• consumers have a reasonable expectation that effective redress is available.

These objectives build on the wider government goal of growing an inclusive, innovative economy for all,[3] as well as contributing to the strategic framework of the Ministry of Economic Development (which is focused on improving New Zealand's rate of economic growth) through, in part, the promotion of competitive and dynamic markets.

Consumers have a vital role to play in the development of such markets through making decisions between products, services and suppliers, and demanding new and better products and services. Optimal participation in these markets over the long term depends on confident consumers.

The Ministry of Economic Development's Statement of Intent outlines the critical role that regulation plays in shaping the business environment in which economic activity takes place. The goal of this strategic priority is to ensure that regulation is well designed and implemented to foster achievement of economic objectives, while also ensuring that social and environmental objectives are met.[4]

There has also been much international work on the quality of government regulation, and the effects of regulation on innovation and economic growth. In particular, the OECD has been active in promoting a program to encourage reform of regulations that raise unnecessary obstacles to competition, innovation and growth, while ensuring that regulations efficiently serve important social objectives.[5]

Regulation

It is helpful at this point to define what we mean by the terms regulation, self-regulation, co-regulation, industry-led regulation, etc.

Regulation is the process of making rules which govern behaviour.[6] This is broader than legislation imposed by government on industry, and encompasses a range of mandatory and voluntary instruments from a variety of sources. What is important is that the regulatory instrument sets standards for the behaviour of market participants (businesses, consumers and government), and influences compliance with those standards. Influence may be brought to bear through government enforcement or through voluntary acceptance by the firm.

While not regulation, there are also other means of influencing the behaviour of market participants. For example, government and/or industry information and education campaigns to raise consumer awareness and enhance consumer and trader understanding of acceptable trading standards. A competitive market may also adopt a "hands off" approach, where the decisions of consumers drive trader behaviour and adoption of acceptable trading standards.

Definitions

Self-regulation refers to those regulatory schemes which obtain their legitimacy through voluntary adoption by industry, rather than being imposed through the coercive power of the state.

However, it is more accurate to think of schemes where industry, rather than government, takes the lead role in setting regulatory standards and enforcing compliance as industry-led regulation.

Self-regulation usually has no or little government involvement. However, it is important to note that where industry is, in effect, regulating itself, there is not a total absence of government regulation. In consumer markets, businesses are subject to the Fair Trading Act and the Consumer Guarantees Act, as well as various other laws of general application that apply in areas such as companies, contracts and competition, which set a basic legal framework within which self-regulation must operate.

Industry-led regulatory schemes may also be thought of as alternatives and complements to government regulation. Effective industry-led regulation builds on the existing law, as well as addresses specific issues in the particular industry, and is supported by information and education activities for both traders and consumers.

A code of practice is the most common form of industry-led regulation. A code sets out the rights and responsibilities of both businesses and consumers. A code may also include an industry-based consumer dispute resolution mechanism, which provides a low cost, informal alternative to the court system for resolving disputes between businesses and consumers. For convenience, this paper refers to an industry-led regulatory tool as a scheme.

The Regulatory Pyramid

The Regulatory Pyramid

The regulatory environment can be modelled in terms of a pyramid,[7] showing the increasing level of intervention in a particular market. The pyramid also shows the extent to which regulation is binding on market participants.

At the lowest levels, the regulatory pyramid implies only a limited role for intervention in a market. Businesses are a part of society, and as such, they are motivated by the impulse to "do the right thing". However, it may be necessary to educate businesses and consumers on their respective rights and responsibilities.

The lower levels of the pyramid also take into account the effect of competition in influencing trader and consumer behaviour. Competition acts to constrain any bad behaviour from firms. Through their choices about suppliers and products, consumers drive the promotion of dynamic and efficient markets. In a competitive market, firms must respond to customer demand if they wish to continue in business. Where competition is not sufficiently present, for example the market is subject to a monopoly or duopoly, further intervention may be necessary. This could be in the form of general anti-competition legislation, such as the Commerce Act.

The pyramid shows that market interventions should build on each other to achieve the appropriate mix. Where social mores, combined with education, in a competitive market, are not sufficient to create an environment in which consumers transact with confidence, regulatory intervention in the market will be needed.

Industry-led regulation begins to appear in the middle of the pyramid. Codes of practice are a means of setting out the relationship between businesses and consumers in a more formal way.

"Aspirational codes" refer to those schemes which set out the standards industry will strive to achieve, but do not provide any effective methods for enforcing the code, or holding firms to those standards. While aspirational codes have a role in influencing the behaviour of firms, there are no mechanisms for compelling compliance with the scheme.

The next stage up the pyramid involves stronger intervention in the market. The distinction between aspirational codes and enforced codes is on the extent to which the regulatory scheme is binding on market participants, rather than the process by which the scheme was developed. The difference between an enforced code and an aspirational code refers to whether there is a mechanism for hearing complaints or enforcing the scheme in such a way that decisions are binding on scheme members. This could be through an industry-run scheme (such as the Banking Ombudsman) or it may be through a co-regulatory scheme, where there is some government involvement in enforcement.

Where industry-led tools are not effective in a market, it will be necessary for the government to take action to promote an environment in which consumers transact with confidence.

Mandatory requirements of general application covers those laws and standards which apply generally to all businesses, such as the Fair Trading Act and the Consumer Guarantees Act. These provide a legislative safety net for consumers, but do not necessarily address the specific problems in particular markets.

The top point of the pyramid involves legislation governing a specific market. This stage is the most powerful tool in the regulatory pyramid for influencing the behaviour of market participants. Examples of specific law to deal with particular problems in a market include the Motor Vehicle Sales Act, the Credit Contracts and Consumer Finance Act, and the Product Safety Standards (Cigarette Lighters) Regulations.

It must be remembered that the appropriate mix of regulatory tools will depend on the circumstances of the specific market. In particular, whether industry or government is better placed to set regulatory standards and enforce compliance will be an important consideration in choosing the best regulatory tool. The purpose of this paper is not to set out the factors that influence the decision on whether to undertake government regulation or industry-led regulation. Rather, once a decision has been made to undertake industry-led regulation, the framework outlined in this paper will assist industry and consumers in developing and evaluating the scheme.

Relationship between Regulation and Confident Consumers

Regulation has an influence on the behaviour and decision making of consumers and firms. To encourage consumer participation in markets, consumers and firms need to have confidence in their integrity and effectiveness. The regulatory environment is an important factor in creating consumer confidence in the integrity of the market.

Consumer confidence also feeds back into the design of the regulatory system. As confident consumers enter the market, their purchasing decisions, in particular the choices they make between different products and suppliers, will influence the behaviour of firms to become responsive to consumers' concerns. Confident consumers will exert their rights, and expect firms to follow those rights. Confident consumers will also seek out redress mechanisms. This will also put pressure on firms to be seen to be doing the right thing by their customers, such as by joining a self-regulatory scheme and agreeing to a code of practice. Firms will seek out these schemes as a means of differentiating themselves from their competition.

As firms voluntarily conform to fair trading standards in response to consumer behaviour, there is less need for government intervention in the market. This in turn promotes industry-led alternatives and complements to government regulation.

Relationship between Effective Regulation and Confident Consumers

The regulatory environment also has an important impact on promoting economic growth. By influencing the decisions of firms, it impacts on the overall level of economic activity, the ability and willingness of firms to choose the most efficient means of producing, the allocation of resources in the economy to their most productive uses, and the rate of productivity improvement over time through innovation.

It is important that the right regulatory tool is chosen in order to advance the goal of an innovative, inclusive economy for all. In some cases, this might be government regulation; in other cases the market circumstances might be such as to support an industry-led regulatory structure. Consideration must be given to social and environmental outcomes, as well as economic outcomes. Regulation will be appropriate where it is necessary to protect consumers, or to otherwise enhance the market. This means balancing the rights and responsibilities of all market participants - businesses, consumers and government.

Industry-Led Regulation

As mentioned earlier, the focus of this paper is not on determining the best form of regulation in a particular market. However, it must be remembered that industry-led regulation sits between government regulation and no regulation in a market. As such, industry-led regulation can have some advantages over these alternatives, and also some disadvantages.

Advantages and Disadvantages of Industry-Led Regulation

Industry-led regulation can have a positive role in creating an environment in which consumers transact with confidence:

• It can promote good practice and target specific problems within industries. With regard to consumers' expectations, it can add to the existing broad rights and responsibilities of consumers and businesses under the law by providing specific guidance that is tailored for the particular market.
• It can have a role in promoting consumer confidence in market rules and institutions by promoting awareness of consumers' rights and allowing for consumer participation in rule making.
• It can provide access to quick and informal complaint handling and redress mechanisms. Schemes developed by industry can set agreed quality standards of work that serve as benchmarks in settling disputes. Sanctions developed by industry may be more appropriate for the particular circumstances than sanctions imposed by government.
• It can be less costly for government, as the industry is responsible for enforcing the scheme. The industry will have incentives to minimise these costs, thus benefiting firms and consumers.

However, industry-led regulation can also have disadvantages:

• Industry-based dispute resolution may lack teeth. For example, businesses that have signed up to a scheme may choose to withdraw if faced with a sanction or enforcement. Industry enforcement of the scheme may not align with consumers' or government's priorities.
• Insufficient coverage within the industry may result in some consumers being without protection.
• Constraining the actions of firms through a self-regulatory scheme may limit competition and reduce the incentive for firms to innovate for the benefit of consumers.
• It may be quite costly for an industry to establish and operate a scheme.

Types of Industry-Led Regulation

As "alternatives and complements" to government regulation, industry-led schemes can encompass a diverse range of regulatory structures with different objectives, costs and benefits.[8]

As mentioned earlier, regulation consists of setting standards and influencing compliance with those standards. Different types of schemes will approach these tasks in different ways, and may be more successful in some respects than others. A particular scheme may incorporate elements from several categories. It is important to ensure that the scheme is designed appropriately to work in the particular market it is situated.

Firm-Based Service Charters

This is where a firm voluntarily sets out what it is going to do for its customers. It may involve an internal complaints handling procedure. The charter is voluntary, and creates no legal rights for consumers.

Aspirational Code

This is where an industry comes together to set out a voluntary code of practice. It is often written in "aspirational" terms, and does not provide a dispute resolution procedure. It is intended to raise awareness or promote industry reputation. It is often accompanied by an information campaign.

Codes can be either institutional (i.e. applying to firms in a particular industry) or functional (i.e. applying to firms conducting a particular activity).

Model Contracts

Model contracts provide an opportunity for industry, consumers and (where appropriate) government to agree on standard terms for the supply of goods and services. Model contracts will usually be appropriate where the goods or services being offered are largely identical between suppliers and competition is on the basis of price and service standards. Industries considering model contracts should be careful to ensure that they do not breach the law against anti-competitive conduct.

Accreditation/Quality Assurance Scheme

This is where an industry body accredits participants to advertise that they are members of the scheme or have complied with certain standards. It is voluntary, so there is no legal requirement for a person to obtain accreditation in order to participate in the industry. However, the industry association often has considerable reputation, and accreditation is a big advantage. It is more involved than an aspirational code, as the industry association has a monitoring role in ensuring that members comply with the standards set by the association.

External Dispute Resolution

This type of scheme establishes a formal external dispute resolution service or ombudsman. It may set standards for behaviour in a code of practice, or it could operate solely as a dispute resolution service. The scheme usually provides that the service is free for consumers, and that the decision of the ombudsman is binding on the firm.

Standards

Standards are consensus-based documents which set out minimum technical or performance requirements in areas such as safety or consumer protection. They are often developed by the industry, or a subset of the industry, for example a committee convened by Standards New Zealand. Standards may have legal force through incorporation in legislation, or may be voluntary.

Legal Codes/Co-Regulation

These are codes that have some backing by legislation. This may include codes which are developed by industry but which have some government enforcement. It may also include schemes where membership of a code is mandated by government but it is left to industry to develop the detailed rules of the code.

Other Types

Other approaches to industry-led regulation have been developed in a number of jurisdictions. These mechanisms involve government partnership with industry in regulating.

In the UK, codes of practice can be approved by the Office of Fair Trading. Approval is only granted where the code has been developed in accordance with rigorous requirements to ensure it effectively addresses consumer concerns in that market. Code approval conveys a reputational advantage on members. There is no enforcement of the code by the OFT, however approval may be withdrawn if the code sponsor fails to ensure members comply with the code.

In Australia, codes of practice which don't fit under sector specific legislation can be prescribed under the Trade Practices Act. Prescribed codes can be mandatory (that is, binding on all participants in an industry) or voluntary (that is, only binding on those businesses which formally subscribe to the code). The criteria for prescribing a code include issues such as whether self-regulation has been examined and demonstrated to be ineffective, whether any systemic enforcement issues exist, the benefits of the code to the community as a whole, and whether the code is the most effective means for remedying an identified market failure or promoting a social policy objective. Codes which are prescribed under the Trade Practices Act are enforced by the Australian Competition and Consumer Commission.

[2] Ministry of Consumer Affairs, Creating Confident Consumers: The Role of the Ministry of Consumer Affairs in a Dynamic Modern Economy, May 2003.

[3] DPMC, Key Government Goals to Guide the Public Sector [link to DPMC website].

[4] Ministry of Economic Development, Statement of Intent 2005-2008 [link to MED website], p34.

[5] OECD Regulatory Reform Programme [link to OECD website].

[6] Ministry of Consumer Affairs, Guideline for Developing a Code of Practice, July 2000

[7] This pyramid is adapted from Ian Ayres and John Braithwaite, Responsive Regulation: Transcending the Deregulation Debate, Oxford University Press, 1992 and Australian Consumers' Association, Submission to Australian Competition and Consumer Commission Discussion Paper "Guidelines for Developing Effective Voluntary Industry Codes", October 2003.

[8] There have been several attempts to categorise the types of industry-led schemes. For example, Australian Government, Taskforce on Industry Self-Regulation in Consumer Markets [link to Consumersonline.gov.au website], August 2000; UK National Consumer Council, Models of Self-Regulation [136 KB PDF] [link to NCC website], November 2000.