1.1 This consultative document is the fourth stage of consultation on new arrangements for setting interconnection charges from August 1997. It covers the structure of the new controls, the cost methodology to be used and how the starting values for the new arrangements will be set. Oftel is also consulting on draft modifications to BT's licence to give effect to the new controls; on draft Guidelines to inform the industry on how the new arrangements will work; and on how disputes about interconnection charges or other contractual terms will be resolved under the proposed new system.
1.2 Previous consultation on interconnection charge controls was included in the December 1995 and March 1996 consultative documents and the June 1996 Statement on Pricing of Telecommunication Services from 1997 which also included Oftel's proposals for price control of BT's retail prices.
1.3 The proposals contained in this document have been developed in the light of responses to the previous stages of consultation and ongoing discussions with the industry. Oftel would welcome responses to this document by 31 January 1997. There will then be a two week period to 13 February during which any comments on the responses received in the initial period can be made. All comments will be made publicly available in Oftel's library unless respondents specify that their responses or parts of them are confidential. (See inside front cover for details of consultation arrangements.) Throughout this consultation and subsequently, Oftel will continue to work with the industry to refine its proposals and will publish a further consultative document in March 1997. A Statement of Oftel's final proposals and the texts of licence modifications and Guidelines will be published for formal statutory consultation in May 1997. If BT agrees to these modifications, the new charge control arrangements will be effective on 1 August 1997, simultaneously with the start of the new retail price controls (licence modifications for which were made on 1 October 1996). If BT does not agree, the Director General would make a reference to the Monopolies and Mergers Commission.
1.4 Establishing the right arrangements for setting BT's interconnection charges is probably the most important element in the competitive framework in telecoms. Interconnection charges - the charges operators pay BT for use of its network - can account for up to 50% of other operators' costs. BT is also required to 'charge' itself, through transfer charges between its businesses, the same rates it charges other operators for its own use of its network. It is, therefore, vitally important that BT's interconnection charges are soundly derived from appropriate costs and give proper economic signals to other operators to guide their investment decisions.
1.5 The development of competition in the UK telecoms market is of concern to both consumers and the industry itself. But this document will be of interest primarily to the industry and those interested in regulatory treatment of interconnection: it is dealing with detailed arrangements for the setting of BT's wholesale charges to other network operators. (Controls on BT's retail prices from 1997 have already been settled and, as noted above, the relevant provisions are already in BT's licence.)
1.6 Currently Oftel itself sets most of BT's interconnection charges. Each year it specifies the charge for each service on BT's standard list of interconnection services on the basis of BT's fully allocated historic costs. These costs are drawn from the Financial Statements - regulatory accounts -which BT is required to produce and publish and which show the activities of BT Network as a business separate from BT Retail and other regulatory businesses. BT is required to attribute network costs to unbundled components of the network according to the principles set out in published Accounting Documents. The unbundled component costs are set out in the Financial Statements which also show how the costs of interconnection services are built up from them.
1.7 This system was introduced as part of the framework of Interconnection and Accounting Separation set up in March 1995. It has provided the industry with greater transparency and confidence in the setting of interconnection charges and has provided a firmer basis for tracking cost allocations. It has been a necessary step in the development from a duopoly market towards a competitive, multioperator market. But it requires Oftel, as the regulator, to be centrally involved in fixing charges and provides little scope for allowing market forces to set charges as competition develops. Oftel considers, and the industry agrees, that the present arrangements are not appropriate for the future. As the industry becomes more competitive at the network level, detailed regulatory intervention in setting charges should be withdrawn.
1.8 Oftel's proposals are for a move to a system of interconnection charge controls for the period August 1997-July 2001 which will:
· for competitive services: BT will be free to set charges (subject to the generally applicable provisions of the licence).
· for prospectively competitive services (those which are likely to become competitive during the period of the controls): Oftel will set a safeguard cap of RPI+0% so that charges can't rise in real terms. This will essentially be a backstop provision - if services are becoming competitive, prices will be driven down below the safeguard level.
· for bottleneck and noncompetitive services: charge caps will be introduced on 2 separate baskets of interconnection services to ensure that charges reflect efficiencies BT could be expected to achieve in reducing its network costs. The weighted average charge for services in the baskets will be allowed to increase by no more than RPI-X each year. These charge controls follow the same principles as the familiar retail price caps. There will be one basket for call termination services and a separate one for general network services.
· for interconnect specific services (which BT provides to other operators but does not use itself): specific controls are needed because BT here has little incentive to keep costs down.
1.9 This document is not proposing changes to the structure of the proposals set out previously in the June Statement. It is clarifying details of how the arrangements will work, exposing issues still to be resolved and setting out an agenda for discussion with the industry over the next few months. Oftel hopes to have resolved most of the outstanding issues on the operation of the new controls by the time of the next consultation document in March 1997 so that the licence modifications included in that document will be in near final form. The Statement and formal statutory consultation in May will then be concerned primarily with the values of the Xs and starting values for interconnect charges in the baskets and for interconnect specific services on 1 August 1997.
1.10 There have, however, been some important changes in Oftel's proposed approach to dealing with certain issues. These and other key issues which are developed further in this document are:
Starting Values for Certain Charges
1.11 In the June Statement Oftel proposed that BT would be free to set starting charges for services in the charge cap baskets within an overall allowable revenue constraint set by Oftel. At that time Oftel considered that up-to-date figures based on BT's interim 96/97 accounts would be available in time to enable Oftel to set starting values for the total revenues of basket services and for BT then to announce sometime in late April/early May the charges which they would be setting from 1 August 1997. This would then have given other operators the 90 days' notice of changes to charges in the baskets which Oftel regards as necessary for these noncompetitive services. It is, however, now clear that the audit of the figures from the interim 96/97 accounts will not be available before early May. It is unlikely that licence modifications giving effect to the new controls will be in place before mid-July.
Oftel is now, therefore, proposing that it will itself set starting values for the charges for the basket services and for the interconnect specific services at 1 August 1997. BT will be free to change these to meet charge cap requirements as soon as it chooses, subject to giving 90 days' notice. It could give notice of future changes as soon as the licence modifications were made.
Incremental Cost Methodology
1.12 Oftel and consultants NERA have taken forward with the industry work to develop the incremental cost models - the 'bottom up' model, based on an economic/engineering approach to the costs of a network, and the 'top down' model, based on costs derived from BT's Current Cost Accounts. A detailed analysis of differences between the models has led to a reconciliation between them which produces 'hybrid' figures as the best available measure of the relevant incremental costs. This work has been widely discussed with the industry and, on 31 October, Oftel held an industry workshop further to promote understanding of the models and methodology. The two models and the reconciliation have been prepared on the basis of 1994/95 costs. The adjustments to the topdown model to derive hybrid figures will be incorporated in later versions of the top-down model. BT will be producing figures on this basis for 1995/96 and for the half-year 1996/97 to provide the basis for the starting values of network charges from 1 August 1997 and for use in the financial model to determine X for the baskets and appropriate indices for the interconnect specific charges. It is intended that these figures will be audited to a robust standard. Other operators at the 31 October Workshop expressed concern about the confidence they could have in the figures produced. Oftel fully recognises the importance of a strong audit statement on the figures and is considering what additional work could usefully be carried out.
NERA's latest report on Reconciliation of the Top Down and Bottom Up Models 94/95 will be published shortly. Oftel also intends to publish BT's detailed documentation on the top down model early next year.
Setting X
1.13 This document does not set out any specific ranges for values of X for the network charge control. It examines the parameters Oftel will consider in arriving at a value of X and explains how the financial model will be used. Details of modelling work were discussed at the 31 October Workshop and Oftel set out in some depthhow the model works using indicative values. Oftel is prepared to arrange further workshops on this if the industry would find it helpful.
As part of its consideration of the potential efficiency improvements in network costs Oftel is embarking on a consultancy study of BT's network operations.
Floors and Ceilings
1.14 In previous consultative documents Oftel proposed that floors and ceilings based on incremental costs should provide firm guidelines for when an interconnection charge could be expected to be anticompetitive or not. If a charge was between the floor and ceiling for a service then there would be a presumption it was not anticompetitive and it would be for an operator who was concerned to show otherwise. If, on the other hand, BT proposed a charge below the floor or above the ceiling it would have to justify it. Oftel now proposes that floors and ceilings should not be used so deterministically. They will be the main yardsticks which Oftel will use as a first test to consider whether a charge is anticompetitive or not. Other factors will also be considered.
Burden of Proof
1.15 Oftel now proposes that under the new arrangements BT will set charges, having satisfied itself that they meet any charge control rules and are fairly derived from costs. When BT introduces a change to an interconnection charge it will be required to publish details of the component costs and routing factors which have been used to make up the charge for the service. If an operator was concerned about the charge it would need to make a case to Oftel for investigation. BT will be required to maintain sufficient, uptodate and disaggregated financial information to be able readily to provide justification for the fairness of the charges set. This broad requirement will be specified in the licence and the Guidelines will set out what type of information will need to be kept. Oftel is seeking the industry's views on what level of detailed information would be required and what would need to be covered in the Financial Statements in future.
Prior Consent
1.16 Oftel indicated in the June Statement that BT would have to seek prior consent from Oftel for introduction of certain types of changes in interconnect charges which had clear potential for anticompetitive use (eg varying charges by the enduse of the service involved). Requiring prior consent, however, would mean continued detailed regulatory involvement in some cases where there were, in the event, no concerns about anticompetitive behaviour. Oftel, therefore, is now proposing that BT, aware that such charges would be closely scrutinised by others, should satisfy itself that the proposed charges were fair and should then give notice of the changes. If Oftel received a complaint it would investigate, or it could choose to launch an investigation on its own account. It would then have power to delay introduction of the charges until after it had completed its investigation. The required period of notice (28 days or 90 days depending on the service) would then need to be given subsequent to the investigation. This arrangement would apply for enduse charges and for changes that meant the decoupling of the network tariff gradient from the retail tariff gradient for services other than competitive services.
Retail Prices
1.17 Oftel intends that BT should continue to be required to seek prior consent for certain retail price changes. Condition 24F currently works to prevent BT giving itself a favourable deal on interconnection charges for network components used in retail services. If the Director General agrees to a retail price which involves lower interconnection charges than those currently available then these lower charges must usually also be available for other operators. Oftel intends to maintain the stucture of Condition 24F but to change the threshold for prices which need prior consent: these will in future be those which fail to cover the fully allocated costs of retail elements plus the previously notified transfer charges of underlying components.
Interconnection Specific Services
1.18 These are services BT provides to other operators but has no need to use itself and therefore has arguably less incentive to keep pressure on costs. These services comprise access to BT's numbering information system, interconnection circuits and some data management amendments. These services were not dealt with substantively in early consultations. Oftel now sets out here proposals for deciding how starting charges will be set and how charges for the different services should be indexed over the period of the controls. The idea of a third charge cap basket for these services - which was considered in an earlier document - is not now thought to be a helpful approach for practical reasons.
Private Circuits (paragraphs 2.5-2.8)
1.19 Oftel made clear in the June Statement that it considered provision of IPLCs to be covered in principle under the terms of Condition 13 of BT's licence. For the future it proposed that from August 1997 IPLCs should be classed as prospectively competitive services with IPLCs on individual routes subject to an RPI+0% safeguard cap. The safeguard cap would be removed as individual routes were determined to be competitive. Following DTI's announcement on international facilities liberalisation, Oftel consulted in July 1996 on its proposals for IPLC charges for the future. In the light of that consultation Oftel now considers that by the time the new network controls start, August 1997, there will have been a significant increase in the alternative provision of IPLCs. Prices at both retail and wholesale levels should have fallen significantly by then and the differential between them should reduce. Oftel wants to encourage competition through the development of alternative infrastructure or the take up of indefeasible rights of use on existing cables. Consistent with its policy on inland private circuits, Oftel therefore proposes that from August 1997 IPLCs should be excluded from the application of Condition 13. All private circuits (inland and international) for all operators will be excluded, thus removing some current anomalies for inland circuits.
Guidelines
1.20 Oftel intends in due course to produce a freestanding document setting out how the new arrangements will work. A first shot at this was included in the June Statement. A further draft is included here at Annex B. Oftel welcomes input from the industry on the issues which need to be covered in these Guidelines.
Dealing with AntiCompetitive Behaviour
1.21 Many of the Director General's detailed determination powers relating to interconnection services and charges will no longer be appropriate in the new framework for setting interconnection charges. Oftel will, however, still be able to determine which interconnection services should reasonably be provided. It will also be able under ordermaking powers to enforce Conditions 13, 17 and 18A (following the making of a determination) to follow up reasoned complaints from other operators that BT's charges are anticompetitive. (Which Condition would be used would depend on the circumstances of the case.) Annex C sets out in some detail the procedures Oftel would use.
1.22 Oftel considers that the proposals in this document will provide the UK telecoms industry with a framework for setting interconnection charges which meets the demands of an increasingly competitive market. They will promote efficient setting of charges and allow the regulator to withdraw from detailed intervention n markets as they become competitive while retaining essential protection against anticompetitive behaviour.