4.1 This chapter explains how the new interconnection charge arrangements will work. It sets out the principles Oftel will follow to deal with a range of issues that arise from the new arrangements. The more detailed application of these principles is set out in the Guidelines on the Operation of the Network Charge Controls. A revised draft of these Guidelines is included at Annex B.
4.2 The following key issues are discussed in this chapter:
4.3 Chapter 2 sets out for each interconnect service how initial charges will be set and within what restraints BT will be free, subsequently, to set charges. BT's freedom will vary according to the degree of restraint exerted by market forces. Oftel will consider charges against a number of principles in order to ensure that BT does not use its freedom in an anticompetitive manner.
4.4 Oftel wishes therefore to be sure that all sides of the industry understand the basis on which it will assess if charges are being set at levels damaging to competition. Oftel intends to do this through a test of floors and ceilings. The floors and ceilings will be set in terms of Oftel's definition of the incremental and standalone costs of conveyance. How this will work is:
4.5 In the earlier consultative documents, Oftel proposed that BT should be required to obtain Oftel's prior consent for charges outside the relevant floors and ceilings. This proposal reflected the premise that, in principle, charges below the incremental cost of conveyance could be presumed to be anticompetitive and charges above the standalone costs could be assumed to be excessive. But it also implied that it would be possible for charges outside the range not to be anticompetitive and for charges within the range to be found anticompetitive.
4.6 On further consideration, Oftel has concluded that using floors and ceilings to make firm decisions about charges - and to define where the burden of proof should lie - is unlikely to be helpful. Oftel proposes that in the first instance it will be down to BT to decide for itself whether a proposed charge is not anticompetitive (and complies with its licence). When BT announces a change in interconnection charges operators will have to consider whether in their judgement the charges are in any way anticompetitive. Where they see cause for concern, OLOs should make representation to BT. If they are unconvinced by BT's response and BT declines to change, the OLO will have to decide whether to make a formal approach to Oftel to open an investigation. In appropriate cases, Oftel will require BT to produce the information necessary to test whether the charge is or is not anticompetitive. BT will be rquired to have and to make available sound information to a sufficient level of detail for Oftel to judge whether the charge is compliant with the licence. Oftel proposes to introduce a modification to C13 to ensure that BT is required to maintain and provide appropriately disaggregated financial information.
4.7 Oftel proposes that there will thus be no formal requirement for BT to seek Oftel's prior consent to any changes. BT will itself have to make a judgement about the level of charges it intends to set and how it would justify them if challenged. It will have to publish details of underlying component costs and routing factors when it makes changes to charges. The analysis of the relationship between the proposed charge and the floors and ceilings will be a very important element in any assessments made by Oftel: particularly as a first stage in the assessment. However, this relationship will not be the sole determinant: Oftel will take into consideration all other relevant factors in making its final decision in any particular case whether a charge is anticompetitive. Oftel recognises the absence of prior consent is an important change from the earlier proposals and seeks operators' views on the new approach. There will, however, be no change in the analysis Oftel will undertake of complaints about charges.
Special Cases: Extended Notice
4.8 Whilst generally there will be no requirement for BT to seek Oftel's prior agreement to a change in interconnect charges, there are two special cases where Oftel believes that the risks of anticompetitive behaviour are sufficiently strong that some further degree of protection should be available. These are: changes that would introduce enduse charging and changes that decouple the interconnect time gradient from the retail time gradient.
4.9 For changes in charges that would have the effect of introducing enduse charging, Oftel had proposed in the earlier consultation that there should be a presumption against such charges, coupled with provision for BT to make a case and for Oftel to give consent. On consideration, Oftel believes that the proposed process of formal prior consent would be too restrictive. Oftel is nevertheless concerned that such cases should be given the fullest discussion and the maximum opportunity for both BT and OLOs to make their views known. Oftel proposes that BT, having satisfied itself that proposed changes would be reasonable, could proceed to give notice of such charges (28 days or 90 days as appropriate). However, if an operator raised a complaint and/or if Oftel itself felt further investigation was needed then the introduction of the new charges would be subject to 'extended notice'. Oftel would start an investigation and the relevant period of notice would start only when the investigation had been completed.
4.10 The basis of Oftel's concern on any BT proposals to decouple the interconnect and retail time gradients is set out in paragraphs 4.28-35.
4.11 Oftel believes that the process of extended notice described above should safeguard OLOs against anticompetitive effects whilst allowing public discussion of the issues. Oftel seeks operators' views on this principle of extended notice and its application to interconnect charging proposals that have the effect of introducing enduse charging or of decoupling time gradients.
4.12 Under the provisions of Condition 24F BT is required to notify Oftel when it proposes a change in certain controlled retail prices. For all such price changes BT is required to produce a Price Change Notice (PCN) which lists all the elements of the existing price (including profit) and in particular what is the rate applied to each of the network components within the service; it also shows the new price similarl broken down. BT has to have the Director General's prior consent for price changes when it is proposing to reduce the price paid for the service to below fully allocated costs (and in consequence may be reducing the amount applied to one or more of the network components used in the service to below that chargeable to other operators). These are called Type A price changes. All others are Type B.
4.13 The prime object of this provision is to preserve the principle of nondiscrimination in interconnect charges. The PCN shows if BT is attributing all or part of a retail price reduction to a reduction in the amounts attributed to network components. It enables Oftel to verify the accuracy of BT's explanation of how the reduction in retail price is attributed to the elements of retail and network cost used in providing the service. Where the reduction is attributed to network components - and is allowed by Oftel - then the equivalent reduction has to be made in all other interconnection services where the component concerned is used. The Condition also includes provision for the Director General to consent to a BT request that the equivalent reduction should be restricted in application.
4.14 C24F thus also currently acts to ensure that BT cannot reduce a transfer charge for a network component below the determined level without the Director General's permission (when part of a retail price change). The onus is on BT to demonstrate to Oftel that a Type A charge is justified. The Condition also provides that BT is not allowed to publish notice of Type A proposals under Condition 16 until the consent has been obtained - and cannot destabilise either the wholesale or retail markets by implementing them until it has clearance.
4.15 Oftel has considered whether, in the light of the change from a system of determined interconnect charges, there should be some relaxation of the prior consents required by C24F. It has concluded that it cannot yet remove the protection provided by this Condition. BT still has the potential through pricing in retail and interconnect markets to squeeze OLOs' margins unfairly at the time it changes its retail tariffs. C24F is designed to prevent this and thus provides a protection that is likely to continue to be needed.
4.16 Oftel intends therefore to make only changes to C24F necessary to bring it in line with the new basis of costing for interconnect charges. The distinction between Type A and Type B will be that Type A changes will be those that result in new prices which fail fully to cover the combination of Retail fully allocated costs and the transfer charges relating to interconnect components at that time. PCNs will remain an essential element of the support information BT is required to supply when making proposals for retail price changes.
4.17 Where DG gives his consent, Oftel will expect the full PCN to be made available - just as it is now.
4.18 The modified C24F will continue to require that a reduction in transfer charges to BT Retail will be matched by equivalent reductions in the same components when used in other services. It will also preserve the possibility for BT to apply for, and the Director General to consent to, limits on this extension of the reductions.
Oftel would welcome comments on this proposal to maintain the powers of prior consent provided by C24F.
4.19 For services included in the incremental cost model, Oftel will estimate the floors on the basis of the hybrid incremental costs of conveyance broken down into components. The floors will reflect BT's relevant incurred costs.
4.20 Ceilings will be estimated as the stand alone cost of conveyance (ie the incremental costs plus all common costs between access and conveyance) broken down into component costs. Contrary to the position fo the floors, the cost levels will not be BT's incurred costs, but those of an 'efficient operator'.
4.21 This is a deliberate asymmetry. The floor is set on the basis that, to avoid anticompetitive charges, the yardstick should be the cost that BT has actually incurred. The ceiling, on the other hand, is intended to prevent excessive charging: it would not generally be appropriate for BT to be able to raise charges, in the absence of competitive pressure, to cover any remaining inefficiencies. Hence, BT should not be permitted, generally, to raise charges above the standalone costs of an efficient operator. Greater detail on this and on the working of the Oftel approach to estimating floors and ceilings is set out in the Guidelines. (See Annex B para B.28 and B.29.)
4.22 It is intended that the operation of the price cap X factor of the RPI-X formula will require BT to improve the efficiency of its Network operations to the level of an efficient operator by the end of the control period. This will require a progressive reduction in the efficiency gap between BT's incurred costs and efficient operator costs, in addition to the yearonyear cost reductions that an efficient operator would achieve. Thus the efficiency gap between BT's incurred costs and the efficient level of costs on which the ceiling will be based should shrink through the period.
4.23 Oftel intends to publish indicative figures for the key interconnect inland conveyance services in May 1997. Oftel will publish revised figures in 1999. This will show the trends in these costs and allow operators to check against their own calculations as to where floors and ceilings lie.
4.24 Oftel does not, however, intend to publish any further reviews of floors and ceilings during the control period. Oftel believes it is important that the market should be as free as possible of such regulatory overhang. Oftel believes also that it is for operators, if they think there is cause for complaint, to make their own judgements on what constitutes anticompetitive behaviour. Floors and ceiling have a useful role to play in these assessments but are not the sole, or the determining, criteria. Evidence of anticompetitive effects would be an important part of the investigation process.
4.25 Floors and ceilings will apply at the level of charges for interconnection services, since these are what interconnecting operators purchase from BT, not individual network components. Indicative values for floors and ceilings for the main inland conveyance services for 1994/95 are shown in Table 4.1 - these draw upon NERA's advice to Oftel on the hybrid incremental cost figures (see Chapter 3 and the forthcoming NERA report for details of the derivation of hybrid figures). The figures are indicative because work is in progress to examine the nature, source and relevance of the common costs and hence the ceilings.
4.26 The floors and ceilings for interconnection services shown in Table 4.1 are derived by applying routing factors to component cost floors and ceilings. The floors represent the incremental cost of inland conveyance, broken down into component costs. The ceilings represent the standalone costs of conveyance. Tables 4.2 and 4.3 set out the component cost floors and ceilings that underlie the interconnection service floors and ceilings in Table 4.1.
Table 4.1 Indicative interconnection floors and ceilings for 1994/95
Floor Ceiling % difference
Interconnection service
Local exchange segment 0.404 0.735 82%
Local-tandem conveyance 0.234 0.328 40%
Intertandem conveyance 0.446 0.667 49%
Note: The figures for ceilings are stated before the efficient operator adjustment.
4.27 There may be some (exceptional) circumstances where there may be a clash between the floors and ceilings or between the floors and ceilings and the value of Xs. These are covered in the Guidelines (see Annex B paras B.32-B.34).
4.28 The rationale for the use of BT's retail tariff gradient (RTG) relates to peak load pricing. Peak load pricing gives the economically efficient structure of retail prices by timeofday. Capacity can be utilised more efficiently if demand is spread more evenly over the day, which is encouraged by higher prices at times of peak demand and lower prices at times of offpeak demand. When network interconnect charges are set on a pence per minute basis it is desirable for them to differ by time of day. If instead there were a uniform price throughout the day, the interconnect charge signals faced by interconnecting operators would encourage them to set retail prices that are lower than BT's prices at peak times and higher than BT's at offpeak times, so that the timeofday profile of demand would be made more "peaky", the opposite of the desired outcome. In other words, an interconnect regime without a time gradient would encourage inefficient use of the network with too much demand at peak times, leaving capacity underutilised at offpeak times.
[Peak load pricing may be defined as: A method of pricing for goods and services which are not storable and for which demand varies by time period. For the facilities in question, the level of capacity to be provided is determined by equating the marginal cost of provision with the total willingness to pay for the facilities (at all times of the day taken together). Prices for individual time periods are then set so as to use the capacity provided as fully as possible at all times, subject to every price covering at least the marginal operating costs.]
Table 4.2 Indicative component floors and ceilings for 1994/95 (£m)
Table 4.3 Indicative component floors and ceilings for 1994/95 (in pence per minute)
Floor Ceiling
Local switch 0.275 0.584
Tandem switch 0.084 0.084
Junction transmission: link 0.083 0.083
Junction transmission: length 0.0082 0.0133
Trunk transmission: link 0.079 0.079
Trunk transmission: length 0.0016 0.0029
Note: The figures for ceilings are stated before the efficient operator adjustment.
4.29 For a pence per minute regime the optimal structure of interconnect charges by time of day would be given by the solution to the peak load pricing problem. But this would require a very large amount of information about costs and demand. In determinations of interconnect charges by Oftel, BT's RTG has therefore been used as a proxy for peak load pricing, on the assumption that BT in setting its retail price structure will take account of peak load pricing considerations. However, the current proposals represent a move away from determinations by Oftel to charges set by BT, taking account of market conditions. In theory, allowing BT some flexibility to set the network tariff gradient (NTG) differently from the RTG could lead to a more efficient outcome than requiring that the two be the same, because BT should possess (or be able to obtain) the necessary information about costs and demand.
4.30 There are two reasons why there might be an increase in economic efficiency. First, it would allow the retail tariff gradient to be set optimally by BT in relation to the time of day profile and demand elasticities of BT Retail's traffic and allow the NTG to be set optimally by BT in relation to the potentially different time of day profile and demand elasticities of BT Network's traffic. Second, since different interconnection services might have different time of day profiles and demand elasticities, it could be optimal for the NTG to differ between interconnection services.
4.31 However, allowing BT the freedom to decouple the gradients would be appropriate only if BT can be provided with appropriate incentives and constraints. The caveat is extremely important. There would appear to be a very real danger of BT using the flexibility to set the NTG in an anticompetitive manner, by selectively squeezing margins for particular services. This would not be so much of a problem if Oftel could be fully confident of detecting such anticompetitive behaviour and taking the appropriate action under the Fair Trading Condition (FTC) or other licence conditions. The difficulty with applying the FTC is not so much in identifying the possible effect on a competitor, but in assessing the validity of BT's efficiency justification for its action, since this is likely to depend upon very detailed information and judgements about traffic profiles and particular elasticity values.
4.32 On the one hand, the recognition that there are potential efficiency gains if the NTG is not always required to e equal to the RTG suggests the desirability for BT to have the potential to decouple the NTG from the RTG. But, on the other hand, the recognition that anticompetitive behaviour could be very difficult for Oftel to detect, suggests that it would be appropriate in some cases for changes to be delayed until Oftel has had a full opportunity to examine them.
4.33 However, not all services need be treated in the same way. For competitive services there is a strong argument that BT should be given the flexibility to set the NTG differently from the RTG (and differently from the NTG for other interconnection services), subject only to the FTC and other licence conditions. Since Oftel is not proposing to control the level of charges for competitive services, then logically BT should also be allowed the broad freedom to set the structure of charges by time of day.
4.34 Oftel proposes that for competitive services BT should have the flexibility to set interconnection charges by time of day, subject to other licence conditions, and to the general requirement that BT be able to produce the justification and information required to the right timescale.
4.35 Oftel proposes that for services in baskets and under safeguard caps, there should continue to be an expectation that the network charges tariff gradient should be coupled to that of the retail prices. If BT wishes to decouple them it will need first to satisfy itself that its proposals are not anticompetitive. BT's proposals should then be subject to the extended notice process - the period of notice before the introduction of the decoupled charge should be extended to 90 or 28 days as appropriate after the completion of Oftel's investigation of the proposals, as outlined in Paragraph 4.9 above.
4.36 To set the initial charges for the services in the network baskets Oftel proposes to use the most uptodate audited routing factor information available at the time, which will be for the first six months of 1996/97. Routing factors change through time because of the modernisation of the network or, in the case of junction and trunk length, because of movements in the distance travelled by the average call minute through BT's transmission network. When BT decides to change the initial set of charges, and for each subsequent change in charges, it will need to announce the new charges for interconnection services and the underlying rates for the components and parts. The routing factors that should be used to link the component rates to the interconnection service charge should be the latest available audited routing factors. This does not, however, mean that BT will be required to change charges every time that a new set of audited routing factors becomes available or vice versa.
4.37 Oftel will continue to require BT to produce Regulatory Accounts (Financial Statements) set up under the Interconnection and Accounting Separation system. But some changes will be needed. The information from the Financial Statements, and the Detailed Attribution Methodology which underlies it, provides a structured basis from which to analyse BT's incurred costs. Of BT's total Operating Expenditure approximately 70-75% would be little changed in the CCA Accounts from the HCA Account figures. The basic accounting information derived through the attribution system into the HCA and CCA Accounts - together with routing factors and volumes - provide essential input data for BT's topdown model.
4.38 At present, BT is not required to produce CCA Accounts for the half year (although they will in fact be produced for the interim 1996/7 Accounts exceptionally); the full year CCA Accounts are produced for a more restricted range of businesses/activities than for the HCA Acconts; and the CCA Accounts are required to be produced to a lesser standard of audit than the HCA Accounts (although again exceptionally Oftel has asked for the interim 1996/7 CCA Accounts to be produced to a higher standard).
4.39 Oftel believes that, for the purposes of demonstrating the basis of its charges when these are challenged, BT should have available information that is as up to date and as disaggregated as reasonably possible. With the move to incremental costs, an increasing burden will be placed on the CCA Accounts as the important source of information underlying BT's charges. Oftel therefore considers that BT should have available both yearly and half yearly CCA Accounts with the same disaggregation down to businesses and activities currently provided for in the HCA Accounts. Moreover, given the importance of these Accounts in providing justification of charges, Oftel proposes to require as stringent an audit report on these Accounts as is achievable under current audit practice. Oftel will be discussing this objective further with BT and its Auditors. Oftel would welcome views from the industry on the need for fully disaggregated halfyearly CCA Accounts.
4.40 Under the new control arrangements, the HCA and CCA Accounts provide the basis of information fed into the top down model to derive the hybrid incremental cost figures. These model outputs are an essential element in monitoring BT charges to establish how they relate to floors and ceilings. Oftel therefore believes that it will be important for greater transparency - and for other operators' confidence in the fairness of the charges they pay - that BT should run the topdown model, and the adjustments required to produce the hybrid outputs, at least once every year, most suitably so that the results are available at the same time as the annual audited CCA Accounts. Oftel believes that BT may itself wish to ensure that it has more uptodate information when setting new charges, to enable it to meet challenges or answer investigations. Oftel also believes that these model outputs need to be subject to as stringent an audit requirement as is practicable.
4.41 Key elements in the present system of accounting documentation supporting the current interconnection charges arrangements are the Statements of Costs. These are part of the Financial Statements and therefore audited to the same standards as the rest of the Accounts. They are matrices of costs of components and usage (routing) factors which allow the charges for a service to be verified and to ensure that the same component is charged by BT Network at the same rate to operators and to BT Retail. Under the new incremental cost basis for interconnect charges, there will still be a need for this sort of matrix derived from the HCA and CCA Accounts which can tie back to BT's books of accounts.
4.42 Oftel is considering whether it would be appropriate to require BT to publish similar sets of matrices for floors and ceilings, including the routing factors, derived from the hybrid outputs of the topdown model. Oftel would welcome industry's views on this.
4.43 As part of its dereglatory approach in the new interconnection arrangements, Oftel intends to reduce the range of issues where operators or BT may invoke the Director General's powers of determination to resolve disputes. Oftel intends to rely, as far as possible, on operators reaching commercial agreements between themselves.
4.44 Oftel has therefore sought to reduce the number of determination powers to the minimum. The result is that only two principal powers of determination which specifically relate to interconnect will remain: determining that a service should reasonably be provided; and whether a service is competitive (or has ceased to be competitive). Oftel will rely on ordermaking and other remaining determination powers to deal with any anticompetitive charging or unreasonable terms of agreement. This is discussed further in Annex C.
4.45 In earlier consultation documents, Oftel set out the grounds for its conclusion that the present process through which other operators typically agree with BT that there should be reciprocity of the charging between them should continue to apply (so that they receive from BT charges for carrying BT's calls which mirror those which BT charges them). There has been extensive discussion within the industry on the application of this principle. Oftel's view is that, as laid out in the June Statement, the payments from BT would be based on the point in BT's network through which the call is routed. On this basis calls routed via a DLE would attract the local exchange segment charge; calls routed via a DMSU would attract the single tandem segment (that is: the combination of the local exchange segment and the local-tandem conveyance charge).
4.46 Oftel's proposal provides - on the assumption of balanced traffic across points of interconnect - a neutral impact on other operators' costs. It is therefore neutral in terms of its net effect on OLO revenues. An advantage of this approach is that it does not cut across OLOs' own analysis of the best way of developing their networks in terms of topology, architecture or technology. OLOs are thus encouraged to seek further efficiencies that will reduce the cost of their own customers' calls over their own systems.
4.47 An alternative to reciprocity of charging could result in each operator's charging BT according to its own costs. This in turn could mean that BT might conclude it should reflect these different costs in different retail prices. This would be confusing, potentially impracticable and unwelcome to customers.
4.48 Practicality is the essential argument in favour of the Oftel proposals on reciprocity - the same charge in each direction based on BT's costs and based (in terms of the level of the charge) by reference to the position in BT's hierarchy of the BT exchange from which the call is routed. This arrangement can be easily understood and easily applied. It gives results which are broadly neutral in their effects on operators' development of their own networks without confusing investment signals. It sets the charges in relation to BT services which are controlled by the RPI-X baskets, so that costs reduce steadily across the industry. Oftel does not propose to change its views on reciprocity. In the light of this, Oftel now hopes that the industry can sort out how this approach would be implemented.
4.49 Under the current BT licence, the charges raised by other operators for delivery of BT's calls may be determined under Condition 13.5B. This mirrors in part the provisions that apply to BT's charges - reflecting the current regime, therefore, of FACbased determined charges. Other operators have made representations to Oftel that it is inappropriate for the Conditions under which their charges to BT are set to be incorporated in BT's licence, particularly when their own licences already include the necessary provisions albeit in less specific detail). Oftel has therefore proposed in the earlier consultation documents that Condition 13.5B should be deleted - and a new provision incorporated in the licence modifications (now as C13.5(h) and C13.6 in Annex A) which will make it clear that OLOs' charges to BT will be governed by the terms of the other operator's licences.
4.50 If no further changes are made, this would mean that - in default of agreement on reciprocity - any fall back determinations made by the Director General of OLO's charges to BT would be made on an FAC basis. This would be out of step with the basis of BT's charges to other operators. Whilst Oftel firmly believes that reciprocity is the right principle - and expects other operators to reach agreements with BT on this basis - Oftel has concluded that it would not be right for it to rely on this. Oftel therefore proposes to modify all the other operators' licences so that, in default of agreement on reciprocity, other operators' charges to BT may be based on incremental costing principles. There would of course continue to be a fall back provision for the Director General to determine that there was an obligation to provide the interconnect service.
4.51 Oftel's original intention had been to assemble sufficient information in time to run the models and establish the appropriate values of Xs in good time so that the licence modifications (assuming BT agrees to them) could be implemented at least 90 days before August 1997. The intention was to give BT the opportunity to exercise freedom to set charges as from 1 August 1997.
4.52 In the event the timetable for the production of the 1995/6 and Interim 1996/7 incremental cost information and its translation, with audit verification, through into Oftel's financial model has required a longer timetable. It is not now expected that the modifications will be signed into effect until midJuly 1997. Oftel has therefore concluded that it should set the initial charges as at 1 August 1997 for the conveyance services controlled through the baskets and for interconnect specific services. The charges for other services will remain those that have been set by Oftel in the interim determination for 1997/8 (which will have been running from 1 April 1997). It will be open to BT to change any of these charges after the licence modifications come into effect as long as they give the appropriate periods of notice - 28 days for competitive and prospectively competitive services, 90 days for others.
4.53 How Oftel will monitor compliance with the charge controls is set out in the Guidelines (paragraphs B.11-B.14).