Review of Industry-Led Regulation: Discussion Paper - Part 2: Evaluating Effective Industry-Led Regulation

The previous section has shown the relationship between an effective regulatory environment, including alternative and complementary regulatory schemes, in creating an environment in which consumers transact with confidence. This section of the paper takes the analysis a step further, and sets out a framework to consider the assumptions underlying an assessment of whether a regulatory instrument is successful and the features of an effective industry-led scheme.

The aim of the framework is to provide a tool to empower consumers and industry in understanding the effectiveness of industry-led regulation. For example, the framework provide a means of gathering and organising evidence to demonstrate the effectiveness, or non-effectiveness, of a particular scheme.

Evaluation Framework

The evaluation of a scheme begins with considering the objectives of the scheme. A well functioning market satisfies the economic, social and environmental needs of all market participants. If there is a problem in the market, one solution might be regulation. That is, regulation needs to be in response to an identified problem in a market or to promote a particular outcome. This has been identified in the Guide to Preparing Regulatory Impact Statements[9] in the case of government regulation, and this purpose is equally true of industry-led regulation.

Once the scheme's objectives have been identified, the scheme must be designed appropriately to meet those objectives. In this way, the scheme will address the identified problem or promote its particular outcome. This assumes that the objectives of the scheme meet consumers' reasonable expectations and provide incentives for consumers to transact confidently with scheme members, and that the scheme is enforced and operated effectively so that traders comply and, in case of non-compliance, consumers have access to redress.

However, it is not enough that the scheme simply meets its own objectives. As mentioned previously, effective industry-led regulation forms part of the regulatory environment along with government regulation. This means that, for the scheme to be effective, the structure of the market must be conducive to industry-led regulation so that the scheme integrates with the rest of the regulatory environment. This will lead to consumer confidence in market rules and institutions.

Having established that the scheme effectively addresses its objectives, and that it successfully integrates with the regulatory environment, we can conclude that that scheme contributes to an environment in which consumers transact with confidence.

If an element in the framework is not satisfied, it does not necessarily follow that the scheme is detrimental to consumers; it simply means that the scheme does not provide any benefits over the alternative of no regulation.

While this framework focuses on the conditions that lead to effective industry-led regulation, it must be remembered that there are also consumer protection laws which provide the underlying legal environment. Successful industry-led regulation will depend on effective enforcement of consumer protection law. This issue is being addressed by the Ministry in the project Consumer Protection Law Enforcement.

Elements of Effective Industry-Led Regulation

The framework above identifies a number of elements which underlie the evaluation of whether an industry-led regulatory scheme is effective and the features of a successful scheme. The elements of effective industry-led regulation outlined in the framework are:

The following sections set out these elements in more detail. The information provided has been drawn from previous work undertaken by the Ministry[10], as well as studies from overseas.[11]

This project will apply the framework developed in this paper in a case study analysis of selected schemes to test whether these features are present in schemes operating in New Zealand. If they are found not to be true, we can conclude that the scheme is not an effective means of creating confident consumers. The evaluation template summarises the issues that are relevant in evaluating whether a self-regulatory scheme is effective.

Discussion Questions

Is the framework a suitable mechanism for evaluating industry-led regulation?

Does the framework accurately describe the process/concepts for evaluating industry-led regulation?

Does the framework incorporate the appropriate elements for evaluating the effectiveness of a scheme?

Market Structure and Industry Circumstances Conducive to Effective Industry-Led Regulation

The framework recognises that effective industry-led regulation requires more than just the scheme itself. A crucial question is whether the market structure and industry circumstances are conducive to effective industry-led regulation. Even if a scheme is designed following best practice guidelines, if the market is not conducive to effective industry-led regulation, then the scheme will fail to encourage consumers to transact with confidence.

The Ministry has previously considered the design of self-regulatory schemes in the Guideline for Developing a Code of Practice. This Guideline considered the costs and benefits of a code of practice, but did not formally consider which market structures and industry circumstances are likely to be conducive to effective self-regulation.

Although these issues have not been studied in New Zealand, some guidance can be obtained from studies conducted overseas, such as the Australian Taskforce on Self-Regulation,[12] and the UK Better Regulation Taskforce.[13]

Market Structure

Since industry-led regulation requires some centralised organisation, it is likely to be more effective when it is led by a strong industry association or code champion. The industry association can galvanise action and provide leadership. The ability and willingness of an industry to organise itself collectively can demonstrate its capacity to undertake self-regulation and the commitment necessary to ensure self-regulation succeeds.

As with a strong industry association, industry-led regulation is likely to be more effective in a market which is cohesive. For example, large businesses with multiple retail outlets and smaller, niche firms may have different interests, such as their relationships with customers and suppliers. Where industry players have similar interests they can more likely agree on common rules to follow, and are more likely to comply with those rules.

Wide coverage is also an important factor in ensuring effective industry-led regulation. If a substantial part of the industry does not belong to the scheme, then it cannot be said that that scheme is delivering good results for all or most of the consumers in the market.

As with any form of regulation, by setting common rules a scheme can have a tendency to reduce competition and the incentive for firms to innovate and create new products or services. It is therefore important that the industry scheme takes into account the potential effects on competition, and includes safeguards to ensure that members are not constrained in their ability to compete for new customers on price, quality and product and customer service standards. In terms of market structure, therefore, industry-led regulation is likely to be more effective in a competitive market, where there already commercial incentives for firms to be responsive to their customers.

Similarly, in a mature market where there is little differentiation on price or product quality, firms are forced to compete on customer service. Membership of a scheme, and agreeing to uphold the standards of the scheme, provides an opportunity for members to demonstrate their commitment to high standards of customer responsiveness, and is therefore a clear commercial advantage for members.

However, industry-led regulation may also be effective in a new market which is trying to build consumer confidence in the industry by providing guidance and reassurance for potential customers about the standards they can expect from members.

Extent of Market Failure or Potential Harm

The type of regulation which is appropriate in any given market will depend on the nature of the market failure, including the extent of harm which may potentially be suffered by consumers.

Self-regulation is likely to be less effective where there is a high risk of serious harm to consumers. Where there is a threat to public health or safety, compulsory regulation through government intervention may be more effective to ensure that all firms obey appropriate standards of behaviour.

However, industry-led regulation can still be effective if, by nature of the market structure and incentives for traders to join, the scheme enjoys de facto compulsory membership, so that, in effect, the entire industry is subject to appropriate standards.

Incentives for Firms to Participate

A scheme will only be effective if firms join and comply with the scheme. It is important therefore that the scheme provide incentives for firms to join and comply. There are a number of incentives that could motivate an industry to develop a scheme or a firm to join a voluntary scheme. These will often depend on the objectives the scheme is trying to address.

For example, the industry may be motivated to adopt self-regulation where it is seeking to achieve a common goal. Many industry schemes seek to improve consumer confidence where it is currently inadequate, such as in areas of new technology or where there have been problematic industry practices.

For individual firms, an incentive to join an industry scheme could be where there is a clear commercial advantage to membership, such as where the scheme allows a firm to differentiate from its competitors on the basis of customer service.

Another incentive to join could be the possibility of adverse consequences from non-participation. Self-regulation can be developed by industry as a first step to prove to government that the industry can regulate itself. Non-participation could signal that the scheme is unlikely to be successful, and may lead to government regulation.

Consumer Recognition/Public Confidence

Along with incentives for firms to join and comply, a scheme must also work to establish consumer confidence in the scheme and the industry. To be effective in promoting consumer confidence, a scheme must provide additional benefits to consumers above those already available under the law. Confidence in the scheme will depend on consumer recognition of the advantages of dealing with a scheme member.

The scheme must be more than just a marketing campaign for the industry. Businesses have a relationship not just with their current customers, but also with the wider community. Recognition of this relationship in the scheme gives the industry an opportunity to develop a reputation for social responsibility.

The failure of industries to act in a manner consistent with society's broad social objectives can have a damaging effect on their overall reputation and profitability. Introducing effective industry-led regulation can be an important factor in improving their corporate image.

Discussion Questions

In your experience, which markets and industries in New Zealand have successfully operated effective industry-led regulation?

What market structures and industry circumstances characterise these industries and lead to the success of industry-led regulation?

Does the framework incorporate all the elements necessary to describe the market structure and industry circumstances which are conducive to effective industry-led regulation? What other elements should be considered?

Content of the Scheme - Meeting the Reasonable Expectations of Consumers

This element of the framework refers to the need for the scheme to be designed appropriately so that it encourages behaviour from firms which meet the reasonable expectations of consumers. This is essential in ensuring that consumers have confidence in the scheme, and are encouraged to transact with the industry and with scheme members.

This framework builds on the Ministry publication Guideline for Developing a Code of Practice, which assists industry in developing a code of practice, including practical guidance on the content of the code.

Type of Scheme

As mentioned earlier, alternatives and complements to government regulation encompass a wide range of regulatory structures, with different levels of complexity, cost, obligations, responsibilities and expectations.

There is no "one size fits all" approach to self-regulation. The most effective type of scheme will depend on the market structure and industry circumstances. For example, a complex customer dispute resolution mechanism may not be justified if the scheme receives only a few complaints per year. The costs involved in administering such a scheme may be translated into higher prices for consumers. Industry-led regulation will be more effective where the type of scheme adopted is suited to the industry.

Objectives, Scope and Rules

Effective industry-led regulation should be clear about its purpose, scope and requirements. The scheme should describe the objectives it is seeking to achieve, the parties to which it applies, and the behaviour which is expected of scheme members.

The scheme's objectives should be given effect to in clear rules. The rules should specify what actions must be performed and when. Rules may be more effective when they are not restrictive in prescribing how actions must be performed, but are flexible enough to allow for individual innovation. To ensure compliance, rules should provide for some measurable performance standards.

It is also important that the rules be clear, and that the scheme documentation, such as a code of practice or terms of reference, set out the rules in a manner easily understood by all participants, including traders and consumers.

Consumer Participation

Consumer participation is necessary in the development of effective industry-led regulation. A scheme will be more effective where it is developed in partnership with the community. This will work to ensure that consumers accept the scheme.

Consultation is an exchange of perspectives and an exchange of knowledge to identify problems and develop decisions which have the best chance of providing solutions which work and meet the terms of the problem. If consultation is to meet its purpose then it must be a genuine exchange of views between people who have the knowledge and experience to confront the issues.

Further information on consulting consumers can be found in the Ministry's publication Consumer Representation: Consulting Consumers, June 2004.[14]

Discussion Questions

In your experience, which types of schemes have successfully operated effective industry-led regulation?

What content (e.g. objectives, purpose, scope, rules) characterises these schemes and leads to the success of industry-led regulation?

What scheme development processes lead to effective industry-led regulation?

Does the framework incorporate all the elements necessary to describe the content of a scheme which is conducive to effective industry-led regulation? What other elements should be considered?

Operation and Enforcement of the Scheme

Administration and Monitoring

A successful scheme will include a body to administer and monitor the operation of the scheme. Administration and monitoring has the ability to detect and report on systemic issues. This can indicate areas where the entire industry needs to lift its performance, and this could be addressed by amendments to the scheme.

Ideally, the scheme should set out the performance indicators against which it can be reviewed and monitored. This will provide a simple means of assessing whether the scheme has met its objectives. As well as the objectives set out in the scheme, the performance indicators also need to assess the ongoing level of consumer satisfaction with the scheme, and with the behaviour of scheme members and the industry as a whole. This will show whether the scheme is successful, or whether some other form of regulation would be better for the industry.

Integral to the monitoring of the scheme is the publication of the results in a way that is understood by, and accessible to, consumers. This may give consumers the ability to assess whether the scheme is successful, and promotes transparency and accountability.

The scale of administration and monitoring to be undertaken depends on the type of scheme and the nature of the industry. Regardless of the scale of administration and monitoring, there will be costs for scheme participants. The administration body must be adequately resourced to enable it to undertake appropriate administration and monitoring.

Appropriate resources are also important to ensure operational independence so that the administration body is not subject to interference and withholding by scheme members.

Publicity and Awareness

A scheme should engage in publicity and awareness raising. This should be directed at both consumers and traders. By raising awareness of the scheme with consumers, it will help consumers become aware of their rights under the scheme, and let them know where to go to complain. Awareness raising and training is also important for traders to make them aware of their rights and responsibilities under the scheme, and to help them better deal with their customers.

Independence and Consumer Representation

The scheme must be operated independently of the industry participants who are members of the scheme. This is essential to promoting consumer confidence in the scheme. One means of ensuring independence is to have equal representation by consumer representatives on the scheme's governing board.

As with consumer participation in the development of the scheme, consumer representation is essential in ensuring that all issues are considered, and that the scheme continues to deliver outcomes that encourage consumer confidence.

Enforcement and Sanctions

An effective scheme will provide for rigorous and appropriate enforcement to ensure compliance by scheme members, including disciplinary procedures with a range of sanctions against non-complying members. Effective sanctions can raise the level of credibility and consumer confidence in a scheme.

As discussed above, there must be incentives for members to join and comply with the scheme. This will mean that sanctions have teeth, as members will lose their competitive advantage if they simply withdraw from the scheme when faced with adverse sanctions/consequences.

Sanctions must be scaled so that they do not lose their threat. For example, if expulsion is the only sanction available, members may feel that they are able to indulge in minor breaches of the rules, as they will not be hit with expulsion. A range of sanctions must be available to deal with all kinds of breaches.

Sanctions and disciplinary proceedings should also be published. As the scheme is a source of competitive advantage as a way of differentiating members from the rest of the industry, consumers need access to information about scheme members and their compliance with the scheme rules.

Complaints Resolution

While enforcement by the scheme administration body and sanctions for non-compliance act to deter future conduct by industry participants, the scheme must also consider redress for individual consumers who have been harmed by scheme members.

As a minimum, the scheme should require members to adopt internal complaints handling processes to deal with consumer problems fairly and in a reasonable time. If a consumer is dissatisfied with the business's internal processes, the business should provide the consumer with information about how to access other avenues of redress, such as an external complaints resolution body or the Disputes Tribunal.

Depending on the objectives of the scheme and the nature of the industry, it may be appropriate for the scheme to include a complaints resolution body to provide appropriate redress for consumers when scheme members breach the agreed standards of behaviour. The need for a complaints resolution scheme cannot be judged solely on current complaints in the industry. For example, the number of complaints may be low if it is difficult for consumers to complain, or they don't think it is worth complaining.

The form of the complaints resolution body will depend on many factors, including the size of the industry, the extent of problems in the market, the complexity of complaints, etc. At the more interventionist end of the spectrum, the scheme could provide for an external dispute resolution scheme. This may be appropriate where businesses are dealing with a large number of complaints and/or dealing with complaints of a more serious nature.

Regardless of its scale, the complaints resolution body should be designed in accordance with the principles of accessibility, independence, fairness, accountability, efficiency and effectiveness.[15]

Discussion Questions

What operational processes (e.g. administration, monitoring, review, etc) lead to effective industry-led regulation?

What enforcement processes lead to effective industry-led regulation?

What types of sanctions are necessary to ensure effective industry-led regulation?

What types of complaints resolution processes are necessary to ensure effective industry-led regulation?

Does the framework incorporate all the elements necessary to describe the operation of a scheme which are conducive to effective industry-led regulation? What other elements should be considered?

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