Deputy Secretary for Economic Services, Hong Kong

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In this presentation, I should like to share with you Hong Kong's experiences in regulating a number of sectors of our economy. These sectors have been characterised in the past as natural monopolies but there is a growing tendency not now to so regard them. Competitive markets, albeit with some regulation for dominant operators to smooth the competitive way, is the order of the day.

In my presentation, I will guide you through Hong Kong's regulatory framework for electricity supply, gas supply and telecommunications. But first a few general words about competition policy in Hong Kong. Hong Kong prides itself on being a highly competitive economy and we regularly come out at or near the top of surveys of competitive economies. The Government is committed to the promotion of fair trade and competition and subscribes to the view that market forces and minimum Government intervention is the best formula for enhancing competition and efficiency on the one hand and keeping cost and prices down on the other.

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Power Supply

Status of Power Companies

In Hong Kong, electricity is supplies by the China Light and Power Company Limited (CLP) and the Hong Kong Electric Company Limited (HEC). Both are investor-owned companies. Each company has in practice its own geographical supply area. Neither company has any franchise or other exclusive rights from the Government to supply electricity in the territory.

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Need for Regulation

Because Hong Kong is a relatively small electricity market and there is a huge investment required to build, operate and maintain power stations and provide the necessary transmission and distribution systems, there are no competitors setting up rival power companies in Hong Kong. As such, the Government considers that the two power companies enjoy de facto monopolies. The Government therefore accepts that it has an obligation to provide a monitoring and control facility to prevent them from exploiting their de facto monopoly positions.

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Nature of Regulation

The Government has entered into a formal Scheme of Control Agreement (SCA) with each of the two companies. These are voluntary agreements.

The current SCAs with CLP and HEC commenced on 1 October 1993 and 1 January 1994 respectively and will last for 15 years, up to the year 2008. They set out the obligations and rights of the companies and of the Government on behalf of the consumers. The agreements provide the framework for monitoring the companies' affairs to protect the interests of consumers.

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Scheme of Control Objectives

The objectives of the Scheme of Control are:

1. to ensure that consumers get a reliable and efficient supply of electricity at a reasonable price;
2. to ensure that the companies' shareholders get a reasonable return on their investment, so as to encourage them to continue to make the investments required to ensure sufficient supply of electricity to meet increasing demand;
3. to facilitate the companies' efforts to raise funds in the financial markets when needed;
4. to ensure that the companies avoid serious financial difficulties; and
5. to achieve these objectives with no direct subsidy from public funds and a minimum of interference.

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The main provisions of the SCAs include:

1. the submission by the companies of financing plans covering several years ahead and annual auditing review of the current plan;
2. annual review of tariff adjustments proposed by the companies;
3. the fixing of a maximum level of permitted return to the companies. The permitted return is 13.5% of the company's average net (i.e. depreciated) fixed assets plus an additional 1.5% for those assets financed from shareholders' investments since 1 October 1978 for CLP and 1 January 1979 for HEC;
4. the establishment of a "Development Fund", so that any profit in excess of the permitted return can be retained and used either to fund future expansion or to make up any shortfall in profits in future years, thus reducing future tariff increases; and
5. provision for interim reviews of the terms of the SCAs.

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Achievements

Experience has shown that the SCAs serve the purposes of safeguarding the interests of consumers and allowing the companies to remain committed to supplying the community's needs for electricity. Significantly, the electricity charges are now about 45% cheaper in real terms than they were in 1983 and our electricity charges are among the lowest in South-east Asia, whilst the electricity supply is one of the most reliable. Both power companies have received an average net return of 12% on the company's average net fixed assets over the past ten years.

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Shortfalls

A major shortfall of the SCAs is that there is no express provision to address the issue of excess reserve capacity �� which is significant because the companies' permitted rates of return are determined on the basis of capital employed. The Government will take the opportunity of the coming interim reviews scheduled to commence towards the end of 1997 to address this.

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Potential for competition

In line with our policy to introduce competition where feasible and beneficial to the consumer, we shall commission a study of the role that enhanced interconnection capacity can play in creating competition opportunities in the Hong Kong context.

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GAS SUPPLY

In Hong Kong, fuel gas is supplied for domestic, commercial and industrial uses. Three main types of fuel gas are available: towngas, distributed by the Hong Kong and China Gas Company Limited (HKCG); liquefied petroleum gas (LPG), supplied by six oil companies; and natural gas, supplied by pipe from a field in the South China Sea.

The principal uses of towngas and LPG are for cooking and water heating in the domestic sector and catering and heat processing in the commercial and industrial sectors. In this respect, it is in competition with electricity, although it has to be said that Chinese consumers prefer gas for cooking as Chinese cooking tends to use open flame. Natural gas is solely supplied to the China Light and Power Company for power generation.

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Market Shares

We exclude natural gas from the competition analysis as it is supplied only for power generation for the moment. The gas market is perceived as a mature market. In 1996, HKCG had the largest market share of the gas market, standing at more than 70%, with LPG having some 30% of the market share.

LPG experienced a drop in demand from 1993. This is mainly due to the recent decline in demand for LPG from the industrial sector and the shift in demand from cylinder LPG to piped towngas.

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HKCG in dominant position

The dominant market position currently enjoyed by HKCG is a result of market forces and the growth strategy taken by the company. The company is not enfranchised and there is no control over its finances or tariff rates. Yet the price of towngas remains competitive as compared with that of LPG and electricity. Over the past ten years, HKCG has achieved some productivity gains and its rates of return are in line with the two power companies which are regulated. There is no evidence that the company is abusing its dominant position in the market.

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Strategy

The Government considers regulation of HKCG to be unnecessary at this stage. Yet, in view of the strong likelihood of the company increasing still further its dominance and the further unease likely to generate in the community, the Government has take steps to encourage the company to increase its transparency and is studying the possibility and means of promoting competition in the gas market.

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Increasing Transparency-Consultation Agreement

HKCG has, voluntarily, entered into a formal Information and Consultation Agreement with the Government on terms and conditions that are mutually acceptable in April 1997. The main purposes of the agreement are to increase the transparency of HKCG's tariff setting mechanism and the justification of its proposed tariff increases. HKCG has agreed to.

1. to disclose annual financial and operational information of the company previously not available to the public; and
2. to consult the Government and, upon request, provide briefings to the Legislative Council on any tariff adjustments, major system additions or changes in other service charges.

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Promoting Competition �� common carrier study

In September 1996, the Government commissioned a consultancy study of the feasibility of introducing a common carrier system for gas supply. The aim of the study is to examine the feasibility of adopting such a system in Hong Kong for transmission and distribution of gas with a view to promoting competition in the existing gas market through arrangements which are in overall interests of consumers and equitable to existing gas suppliers. The study is near completion. The Government will conduct public consultation on its findings.

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Telecommunications

Background

The telecommunications industry in Hong Kong has always been in the hands of the private sector. The Government does not invest in telecommunications business. Its role is to create and maintain a fair operating environment conducive to investment in the telecommunications infrastructure and services. We have a separate government department, the Office of the Telecommunications Authority (OFTA), to be the regulator of the telecommunications industry. We adopt a light-handed regulatory approach. We allow market forces to work as far as possible and the regulator only intervenes when it is necessary to protect the public interest.

We have had progressive deregulation of the telecommunications industry, with the result of increasing levels of competition in the market. We have now one of the most liberal and competitive telecommunications markets in the world. The operation of public mobile services and value-added services has always been in the competitive sector of the industry. We introduced competition in the local fixed network telephone sector in 1995. The only remaining monopoly is an exclusive licence valid until 2006 held by Hong Kong Telecom International Limited (HKTI) for certain international circuits and voice services.

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Local telephone services

Public telephone services within Hong Kong used to be operated as a monopoly by Hong Kong Telephone Company Limited under an exclusive franchise. In 1995, we opened up this market by not renewing the franchise upon its expiry. Four operators of local "fixed telecommunication network services (FTNS)" were licensed as from 1 July 1995. These included the incumbent operator and three new operators.

We were aware that merely issuing additional licences would not guarantee that competition in the market would develop to enhance consumers interest. The new operators need time to roll-out their networks. Therefore for the time being, the incumbent operator still commands considerable market power in the supply of local telephone services. As competition in the market has not yet fully developed, we cannot rely entirely on market forces to protect the interest of the consumers. Some intervention by the regulator in necessary. The aim of such regulation is to ensure that the incumbent operator, which is the "dominant operator" in the market, would not unfairly use its market position acquired during the monopoly era to thwart the development of competition in the market.

Through legislation and licence conditions we have implemented a number of measures to ensure that healthy competition can develop in the market.

The prices of the dominant operator are subject to approval of the Telecommunications Authority (TA) and the dominant operator is not allow discount its prices without TA's approval. On the other hand, the non-dominant operators need only to publish their charges and may freely give discount. The prices of the dominat operator are subject to an overall price control arrangement which is now based on an incentive regulation mechanism, i.e. a cap on the annual increase permitted at a specified level below the general inflation rate.

Interconnection is important for competition to develop. Without a fair interconnection regime, the new operators would be unable to develop their services and compete with the incumbent operator. The interconnection regime in Hong Kong is again a market-driven one, relying as far as possible on commercial negotiations between operators, but the regulator has reserve powers under the law to make determination on the terms and conditions of interconnection if commercial negotiations fail or if it is in the public interest to do so. Commercial negotiations on interconnection are always difficult because of the conflicting commercial interest. The TA facilitates this process by issuing guidelines to give the industry clear signals on the likely considerations and the preferred positions of the TA in making determinations. Such guidelines firmly establish that the interconnection charges should be based on the reasonable relevant costs.

Apart from the conventional interconnection between networks, interconnection to the local loops is allowed to enable the benefits of competition to flow to consumers as early as possible while the new operators are rolling out their networks.

Sharing of facilities is essential for the development of competition. In the Hong Kong environment, it would be difficult to duplicate all facilities such as ducts crossing roads, equipment room and cable risers within buildings. Thus a fair arrangement is necessary for all operators to have access to these essential facilities on a non-discriminatory basis. Under the conditions in the operators' licences, the TA may direct sharing of these so-called "bottleneck" facilities on public interest grounds. He is also empowered to determine the fair terms for such sharing.

The fair administration of the numbering plan is of critical importance to the development of competition. For this reason, the Government took over the control over the numbering plan in 1993 from the then monopoly operator of the local telephones services.

The development of competition would be hindered if customers have to change their telephone numbers when they change networks. The TA has therefore mandated "operator number portability" which means that the customer can opt to retain their telephone numbers when they change to another telephone company. Hong Kong is the first city in the world to implement general operator number portability. We are now considering number portability in the mobile sector.

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International services

On the international side, we are constrained on the introduction of competition by an exclusive licence granted to HKTI. To honour the terms of the licence, we are not seeking to modify this arrangement unilaterally. The Government is holding bilateral discussions with HKTI on how the international telecommunications sector should be developed to maintain Hong Kong's position as a regional telecommunications hub. Meanwhile, areas in the international's sector outside the exclusivities of HKTI are subject to competition. They include callback services, self-provision of circuits to send and receive messages within a group of companies, "virtual private network" (VPN) services and "international simple resale" (ISR) for fax and data.

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Conclusion

In conclusion, I wish to say that our approach to regulating natural monopolies is to query whether such monopolies really exist and whether they should. In the case of telecommunications, we have concluded that there is no need for a monopoly and have been determined to introduce competition as soon as we have been able to do so under the constraints of previous exclusive franchises. In the case of gas supply, we have enhanced the transparency of the dominant player and are considering the feasibility of a common carrier approach. In the case of the electricity supply industry, the two de facto regional monopolies are regulated through voluntary agreements to safeguard the interests of the consumers, the investors and Hong Kong generally.