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Explanatory statement and Notification of proposals on BT’s SMP status and charge controls in narrowband wholesale markets

Summary

1.1 Wholesale narrowband interconnection services provided over BT’s core network have been one of the key enablers for competition in the UK telecoms market. We are currently approaching the end of the second of two four-year charge control periods (known as the network charge controls (“NCCs”)) using the widely acknowledged RPI-X mechanism. These controls have managed to ensure that the UK remains one of the lowest cost interconnect regimes in Europe while at the same time incentivising BT to continue to improve the efficiency of its core network.

1.2 This document is a consultation on the revision of the RPI-X controls which are proposed to be effective for a four-year period commencing on 1 October 2005. It also proposes revisions to the assessment of BT’s market power in two specific interconnection economic markets, and, as a result, proposes to deregulate and reduce regulation respectively in those markets. The proposals are in accordance with the principles set out the in Second Phase of the Telecoms Strategic Review (“TSR”).

Proposed new charge controls

1.3 NCCs limit BT’s ability to set charges in wholesale markets in which it has a dominant position, also known as Significant Market Power (“SMP”). The NCCs are a remedy imposed on BT owing to its SMP in the markets covered in this document. BT’s dominance in those markets was last assessed in 2003 by Oftel, in accordance with the requirements of the legal framework of EC Directives.

1.4 Ofcom proposes that the following NCCs imposed on BT should run for four years from 1 October 2005.

Service	Current controls 2001-5	Proposed controls 2005-9
Call termination	RPI – 10%	RPI - (2.25–6.25)%
Call origination	RPI – 10%	RPI - (0.5–4.5)%
Single transit	RPI – 13% for combined basket	RPI - (11–14)%
Local-tandem conveyance		Safeguard cap of RPI – 0%
Interconnection circuits (ISB)	RPI – 8.25% for combined basket; RPI + 0% sub-caps for each of ISB & PPP	RPI - (1.5–5.5)%
Product management, policy and planning ( PPP )		RPI - (2.5–6.5)%
DLE FRIACO	RPI – 7.5%	RPI - (7.5–11.25)%
Single Tandem FRIACO	RPI – 8.75%	RPI - (8.5–12.25)%
Inter-tandem conveyance and Inter-tandem transit	Safeguard cap of RPI – 0%	No control as no SMP

1.5 For the proposed NCCs, Ofcom is consulting on a range of values - rather than a single value - because some relevant issues are still being resolved. These issues include the determination of an appropriate cost of capital as part of the NCC cost base, on which Ofcom is currently consulting separately. Ofcom proposes that the final values take into account the results of the consultation on the cost of capital. The ranges of X also incorporate the basic features of our proposals as described in this document.

1.6 Some of the proposed values of X are considerably below current levels. This is due to, among other things, lower BT starting super-normal profits for these services (which means a lower value for X will be sufficient to eliminate super-normal profits) and forecast falls in traffic volumes on BT’s network (which means a lower value for X because BT’s average unit costs will be higher).

1.7 Ofcom’s proposal that the charges run for a period of four years minimises regulatory risk and promotes an environment in which communications providers can make forward-looking decisions. This is consistent with proposals in the TSR to allow regulated business and the wider market to plan against a predictable regulatory environment for the period in question.

1.8 The TSR also proposed Ofcom’s main considerations when regulating the returns BT makes from providing wholesale access to different parts of its network. These are: the incentives to invest; the likelihood of competition; and the need for direct consumer protection where competition is not effective or sustainable. The network charge controls proposed in this document will apply to a period of transition including the migration of BT from its current public switched telephone network (“PSTN”) to its proposed 21st Century Network (“21CN”). Ofcom’s analysis is therefore designed to meet these considerations on a forward looking basis.

1.9 In order to achieve this, Ofcom has adopted a technology neutral model to determine the average unit costs of narrowband PSTN services over the period to 2009. This is a way to cope with the uncertain speed of traffic migration to the 21CN, and to incentivise efficient migration of that traffic. It also has the effect of using hypothetical levels of PSTN capital expenditure during a period when it is expected that BT will move from PSTN to IP investment as part of its proposed 21CN deployment. Ofcom has assumed that BT will continue to improve its PSTN efficiency levels in line with historical experience and international benchmarks and as such has attempted neither to forecast efficiency gains that BT might reap from its 21CN deployment nor to take into account BT’s forecast parallel running costs of running down its PSTN capability while migrating to 21CN. It is expected that 21CN efficiency gains will be considered if and when Ofcom is required to determine a price for 21CN interconnect services and in any future NCC in the period from 2009 onwards. In adopting this approach Ofcom has sought to make a forward-looking trade off between incentivising efficient investment, promoting competition and passing on cost savings to consumers.

1.10 For three markets – call origination, call termination and single transit - Ofcom is satisfied that there has been no material change in those markets and that the degree of change is not sufficient to warrant the level of analysis that Ofcom has performed for the two markets set out below. In such circumstances, Ofcom is proposing to use its powers under the Communications Act 2003 (“2003 Act”) to set all the proposed SMP services conditions to impose the new NCCs by publishing its Notification (see Annex 5) for consultation in the UK as well as at a European level (to the European Commission and other national regulatory authorities).

De-regulation

1.11 In the TSR Ofcom proposed a number of principles including that Ofcom should withdraw from regulation as soon as competitive conditions allowed. In performing its initial assessment of changes in market conditions, Ofcom observed that in two economic markets (inter-tandem conveyance and transit and local-tandem conveyance and transit) there was prima facie evidence that BT’s level of market power has been reducing. Ofcom therefore has conducted in-depth analysis on these two markets, using the same processes followed in 2003.

1.12 This document explains where Ofcom’s proposed market definitions for those markets differ from those in the European Commission’s Recommendation on relevant product and service markets. In assessing SMP, Ofcom has also taken due account of the European Commission’s Guidelines on market analysis and the assessment of SMP (“SMP Guidelines”).

1.13 Based on evidence available, Ofcom proposes that:

• BT still has SMP in the market for local-tandem conveyance and local-tandem transit in the UK (excluding the Hull Area); and
• BT no longer has SMP in the market for inter-tandem-conveyance and inter-tandem transit in the UK (excluding the Hull Area).

1.14 As a result of its proposal that BT does not have SMP in inter-tandem conveyance and inter-tandem transit, Ofcom is proposing that all obligations on BT in relation to that market to be revoked. This is a legal requirement that follows from the proposal that BT does not have SMP in this market. The current NCCs for this market are ‘safeguard caps’ (i.e. BT is restricted to raising prices for these services by RPI-0%).

1.15 In the market for local-tandem conveyance and local-tandem transit, Ofcom considers at present that there is sufficient potential for competition over the period of the proposed NCCs due to the demonstrated ability of other operators to interconnect with BT’s local exchanges, either using their own infrastructure, or by leasing dedicated transmission capacity from BT. On this basis Ofcom therefore proposes to reduce regulation, by moving to a safeguard cap on BT’s charge increases, to no more than inflation. Also for that market, Ofcom proposes that BT should be able to change its charges at 28 days notice, rather than the current 90 days as this is more in keeping with competitive market conditions.

1.16 As Ofcom proposes that BT still has SMP in local-tandem conveyance and transit, Ofcom has considered all of the other SMP remedies that relate to BT’s SMP in that market, such as network access, and proposes to re-set all those remedies (except for the proposed change to the notification period for charges, terms and conditions, as mentioned above).

Implementation

1.17 When Ofcom has considered representations made within the period to 1 June 2005, including any made by the European Commission, we may give effect to our proposals, with or without modifications. Ofcom will do this by publishing a further Notification accompanied by a final Explanatory Statement. Thereafter, the identified services markets, market power determinations and the regulatory remedies that are imposed will be reviewed by Ofcom at appropriate intervals.

The full consultation is available below

• The Comparative Efficiency of BT in 2003 - A Report for Ofcom [pdf]
  By NERA Economic Consulting
• Review of BT’s network charge controls [pdf]
  Explanatory statement and Notification of proposals on BT’s SMP status and charge controls in narrowband wholesale markets - Full Print Version

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