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16 | 7 Th - 13Th NovEmbEr 2014 | UTILITY WEEK Policy & Regulation Market view C learer, simpler, fairer". That is the stra- pline of Ofgem's Retail Market Review (RMR). It describes how the regulator would like energy suppliers to deal with their customers. Ofgem, however, rarely takes its own medicine. RMR has generated dense volumes of new regulation, much of it written in a tortured form of legalese. Yet RMR is also notable as Ofgem's first serious attempt to dangle its feet in the waters of "principles-based reg- ulation". According to its chief execu- tive, Dermot Nolan, speaking at the recent Utility Week Congress, this is the way of the future. So what does it mean, and why does it matter? Ever since regulation became a major fea- ture of the UK political and economic land- scape, academics and commentators have been seeking to impose theoretical struc- tures on it. Many of these are near worthless; some are actively harmful. "Light touch regu- lation", for instance, was much in vogue in the financial services sector before the crash. You don't hear so much about it now. Principles-based regulation is a more per- sistent, and substantial, idea. The phrase itself is not very revealing – is any regulatory system not based on principles? However, it stands for an important policy choice – an approach to regulation that, instead of pre- scribing detailed rules to be observed, works by settings and enforcing high level stand- ards of behaviour. Buried in the morass of RMR licence con- ditions is a reasonable example of this; one condition (the Standards of Conduct) has the core requirement that energy suppliers must "carry out any actions in a fair, honest, trans- parent, appropriate and professional man- ner". This, says Nolan, is the way to go. The first thing to note about principles- based regulation is that, aside from the label, it is nothing new. The Advertising Standards Authority has regulated on a similar basis ("legal, decent, honest, truthful") for dec- ades. Equally, as all companies which have had to write a consumer contract, carry on sales activity or handle personal data should know, modern European Union consumer law is also based on high level principles of fairness. So there is nothing inherent in this approach that cannot be done or, in other contexts, has not been made to work. The second point is that the attractions of principles-based regulation to any regulator are obvious. Instead of sitting in an office in Whitehall trying to guess what undesirable activities might be taking place out there in the real world and writing rules to prevent them, why not simply rely on general princi- ples to which no-one can sensibly object and use them to challenge poor practice when you see it? For Ofgem, using principles-based regula- tion offers several advantages. Prescriptive rules are hard to write in a sector as complex as energy. They can be prone to loopholes and they depend on having both good indus- try knowledge and a sense of expert policy judgment as to what needs to be controlled and what does not, each of which may be in short supply. In contrast, a principles-based approach takes less effort up front and is more or less guaranteed to avoid major policy gaps – "fairness", for example, covers a lot of ter- ritory. It lets a regulator be reactive rather than proactive, waiting until events occur and deciding whether or not they are accept- able. It demands no detailed knowledge of the industry and, by reducing the need for prescriptive rules, it allows regulations to be slimmed down, shiing primary respon- sibility to the companies to the right thing, both of which can be presented as virtuous. What's not to like? Unsurprisingly, not everything in the gar- den is rosy. The starting point for all law is that anything that is not prohibited is permit- ted. On this basis, we all go about our busi- ness, free to do what we think right unless there is a specific law preventing it. This is a key element in what is usually called "the rule of law". Principles-based regulation undermines this on three counts. First, the principles in question are extremely broad. Second, in consequence, they are open to a wide range of interpretations. Third, it falls to Ofgem to enforce its inter- pretation, and in our legal system it is allowed extensive discretion to do so before any court will intervene. The risk, then, is that principles- based regulation becomes both subjective and retrospective. That is, it turns on Ofgem's judgment, made only aer the event, as to whether conduct falls within its idea of compliance with the relevant principle. That is good for Ofgem's ability to stop things it does not like and impose financial penalties. It also has the genuine merit of placing responsibility on the companies for thinking carefully about how they behave and for acting ethically. However, it is much less good at promot- ing either regulatory certainty or compliance with consistent standards across the indus- try. For this reason, many principles-based systems need to supplement their regula- tion with volumes of guidance as to how the principles will be interpreted, which can undermine the benefits of adopting the prin- ciples-based approach while still not over- coming all of its deficiencies. Ultimately, like any other strategy for regulation, a principles-based approach has a proper role in the regulatory toolkit, but it is no panacea. Used sparingly and well, it can be a clearer, simpler and fairer method of regulating. Used excessively or unwisely, it can be the very opposite. In support of principles-based regulation Nolan says that he wants chief executives to "think long and hard" about the approach taken by their organisations. Quite right. And so should he. John Cooper, partner in Public Law & Regulation, Wragge Lawrence Graham & Co LLP It's the principle of the matter Moving from prescriptive to principles-based regulation may make life easier for Ofgem, but it could make life very much harder for companies unless it is done right. John Cooper writes. "Light touch regulation was much in vogue in the financial services sector before the crash. You don't hear so much about it now" "