Finance: New rules needed for privatised industries: Roger Trapp reports on recent suggestions for more openness and transparency on accounting policies

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The Independent Online
AMID all the fuss about the privatisation of Britain's utilities, little attention has been given to their accounting policies.

Nevertheless, 130 people - including Sir Bryan Carsberg, Director General of Fair Trading, as well as representatives of regulators, regulated industries and their advisers - were sufficiently interested to attend last week's conference on the subject at the headquarters of the Institute of Chartered Accountants.

The event, organised by the institute and the Centre for the Study of Regulated Industries, grew out of a report earlier this year that called for greater transparency in this area of accounting.

The high level of interest in a complex and highly technical field possibly lends support to the belief that there is growing realisation that current approaches are storing up potential long-term problems, particularly in relation to the valuation of the assets held at the time the companies were sold off.

Indeed, it is apparent that some tension is developing within the regulated industries about the policies to be adopted. Many financial managers recruited since privatisation are anxious to move towards a more usual commercial business, while others adhere to the old ideas of public service. In some companies the division is between top-level managers - many of whom were recruited from the private sector - and the more traditional utility managers.

Something of this tension is apparent in the study's discoveries about how the regulatory regime works in practice. At the heart of the report - Accounting for Regulation in UK Utilities, by Anthony Carey, Martin Cave, Rachel Duncan, Graham Houston and Kevin Langford - is the idea that there is an implicit contract between the companies and their regulators.

This is necessary to protect customers from monopolistic exploitation and to reassure shareholders that their assets will not be expropriated through the regulatory system. But the authors believe the public interest requires a number of reforms.

As publicly quoted companies, the regulated businesses - or the organisations that own them - are required to prepare statutory audited accounts, with rules laid down by the Accounting Standards Board and its predecessor, the Accounting Standards Committee. But they must also issue special regulatory accounts.

Since, for example, the water companies have diversified into unregulated areas, these accounts only relate to particular parts of their businesses and are sometimes prepared to detailed specifications set by the regulator.

They are required because statutory accounts may not give the regulator enough information if, say, they do not look at the regulated business as a whole. And in a monopoly situation the accounts may be influential in setting prices.

There are signs, however, that the regulators are developing a third system of accounts. These 'private' accounts are typically derived from the regulatory accounts but adapted to reflect the regulators' interpretation of the basis on which the companies were privatised and are regulated.

An important example of this involves the valuation of assets on which the companies are entitled to make a rate of return. Since many were sold at a discount to the replacement cost of their assets, letting them make the allowable rate of return could give a substantial capital gain to shareholders at the expense of customers.

The problem with this approach, suggest the report's authors - who are drawn from the institute, the Government, academe, consultancy and the investment community - is that it leaves regulatory policy uncertain.

The most obvious area for the regulators to open up is price-setting. In particular, they should specify the determinants of the current pricing formula and the factors that they believe will affect the outcome of future reviews.

Transparency of this kind would have four potential benefits, the report says.

First, it would better ensure that the regulator is acting fairly and in line with the proper procedures.

Second, it would enhance the role of the regulatory accounts as the 'public memory' of the regulatory system, and so make it less likely that future regulators would overturn commitments.

Third, it would reduce the regulated companies' cost of capital if the market perceived that it would produce a greater degree of consistency in the regulators' actions, and hence less risk.

Fourth, transparency may help to educate investors about the basis on which utilities are regulated.

Having analysed the situation in the British airports, electricity supply, gas, telecommunications and water industries, the authors - who stress that they are not speaking for their respective organisations - have recommended a fundamental overhaul of the reporting system.

Noting that accounting in this sector differs from the norm chiefly because of the effects of privatisation, the relative lack of conventions and standards concerning current-cost accounting and the special significance of accounts for price-setting, they say that the core information for regulatory decision-making should be in audited regulatory accounts.

These should be required to show a true and fair view and be prepared on a current-cost basis, applying financial capital maintenance principles. This means that accounts are based on the preservation of the purchasing power of the shareholders' equity, as opposed to the concept where profits are calculated after leaving sufficient capital in the business to maintain its capacity to operate at a given level.

While regulators will still need to receive some information on a confidential basis, a cost-benefit test should be used to check that this is justified.

Perhaps most important, regulatory standards should be drawn up to deal with general issues, allowing for differences between industries. These would be set by a body under the joint auspices of the Accounting Standards Board and the industry regulators or established by the regulators with the ASB approving the result.

Giving the industries representation on the standard-setting body and making regulatory accounts subject to the Financial Reporting Review Panel, the watchdog that ensures compliance with ASB standards, would complete the bringing into line of statutory and regulatory accounts.

At a time when disclosure is the watchword of the ASB in its battle to curb abuses of the system, the report's authors are confident that 'more transparent accounting practices would promote investor and public confidence in the regulatory process'.

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