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Chapter 6Options and proposals for remedies for other fixed network providersIntroduction 6.1 This chapter assesses options for regulatory remedies in the markets for wholesale fixed geographic call termination on other fixed network providers’ networks. This chapter is broken down into three distinct sections, each of which considers different interrelationships. The first section considers the provision of fixed geographic call termination services by other fixed network providers (excluding Kingston) to BT. The second considers the provision of services from fixed network providers (other than BT and Kingston) to other fixed network providers (excluding BT), and to mobile providers. The third considers the provision of services by Kingston. Competitive conditions may differ across each of these sets of relationships. It is therefore appropriate to consider the approach to remedies in relation to each of these in turn. 6.2 As explained in Chapter 4, the Director’s initial view is that all fixed geographic network providers have SMP in the provision of their own network fixed geographic call termination services to all originating network providers. However, the preliminary conclusions set out in this chapter are relevant only if the Director finds, after consultation, that all fixed network providers do indeed have SMP in the provision of their own network fixed geographic call termination services. The Director will reach his final conclusions in the light of responses to this consultation document. 6.3 Clause 83(1) of the Communications Bill provides that where Ofcom (or the Director in the interim period) has made a determination that a person is dominant in the market reviewed, it shall set such SMP conditions as it considers appropriate and as are authorised in the Bill. This implements Article 8 of the Access Directive. 6.4 Paragraphs 21 and 114 of the European Commission’s Guidelines on market analysis and SMP state that this means that Oftel must impose one or more SMP conditions on a dominant provider. Furthermore, the European Commission states that the imposition of no SMP conditions on a dominant provider would be inconsistent with the new regime. Thus, Ofcom (or the Director in the interim period) is under an obligation to impose at least one appropriate SMP condition on all fixed network providers. 6.5 The Communications Bill (clauses 41-46 and 74-85) sets out what obligations the Director can impose if he finds that any undertaking has SMP. Those obligations relevant to this review are:
6.6 Oftel has set out its intention to consider the appropriateness of SMP conditions in its regulatory option appraisal guidelines. For this, please see www.oftel.gov.uk/publications/about_oftel/2002/roa0602.htm. Oftel also notes Recital 27 of the Framework Directive which provides that ex-ante regulation should only be imposed where there is not effective competition and where competition law remedies are not sufficient to address the problem. In order to provide a full analysis, Oftel has therefore considered the option of no ex-ante regulation, and whether it would be sufficient to rely on competition law alone. Aims of regulation and conditions that may be imposed 6.7 Clause 4 of the Communications Bill sets out the Community requirements for regulation. The Director in considering whether to propose any conditions has considered all of these requirements. In particular, the Director has considered the requirement to promote competition and to secure efficient and sustainable competition. Therefore, the Director has particularly considered whether conditions are required to prevent SMP in this market being used to distort competition in downstream markets. 6.8 Any SMP conditions to be imposed must comply with the various tests set out in the Communications Bill. The Director must also bear in mind the duties set out in clause 4 of the Communications Bill. In particular, each SMP condition must pass the test set out in clause 43 of the Communications Bill, namely that each condition must be:
6.9 It is the Director’s initial view that the proposals made in this chapter satisfy the relevant requirements specified in the Communications Bill. Fixed network providers (other than Kingston) providing fixed geographic call termination to BT: options and proposals for remedies What are the options for regulation? 6.10 For other fixed network providers, Oftel has considered three regulatory options. Each of these options is considered on the basis that Oftel’s preferred regulatory approach for BT (Option C, see chapter 5) has been implemented and that BT is required to buy other network providers’ call termination services. This latter point will be discussed in the forthcoming consultation document entitled End-to-end-connectivity. The options that have been considered are:
No ex-ante regulation
To provide fixed geographic call termination on fair and reasonable terms;
To provide fixed geographic call termination on fair and reasonable terms; not to unduly discriminate in the provision of this service; to secure transparency through price publication; a requirement to set cost-oriented prices; price controls; and requirements for separate accounting and appropriate cost-accounting systems. The Director's initial view is that Option B satisfies the duties and tests set out in the Communications Bill. Option A No ex-ante regulation 6.11 As an effectively competitive market will produce a more efficient outcome than a regulated market, the promotion of competition is central to Oftel’s goal of securing the best deal for the consumer in terms of quality, choice and value for money. 6.12 Where markets are effectively competitive, ex-post competition law is sufficient to deal with any competition abuses that may arise. However, ex-post general competition law powers are unlikely to be a sufficient response to dominance where it is firmly established in markets such as those found in telecommunications. Key reasons for this include, first, the fact, that ex-post powers allow competition authorities to respond to the abuse of dominance rather than dominance per se. Ex-ante powers by contrast can be utilised to reduce the level of market power in a market and thereby encourage effective competition to be established. 6.13 Telecommunications markets are also often characterised by features that can complicate the assessment of behaviour under ex-post powers. A good example is the existence of significant common costs and economies of scope and scale. This may complicate the assessment of pricing behaviour, for example, since it may be difficult to establish that prices in any one market are excessive until the extent of common cost recovery in other markets has been considered. The complexities that would be involved in dealing with ex-post regulation could result in uncertainty and this would result in additional costs for providers in the relevant markets. This is likely to impair fair and effective competition, and thereby disadvantage consumers. 6.14 However, in some circumstances use of some ex-ante measures can themselves limit or hinder the development of competition. In such cases, Oftel would remove regulation if it were hampering competition. 6.15 In relation to the provision of fixed geographic call termination by fixed network providers to BT, Oftel does not believe that it can rely on ex-post measures. Each fixed network provider has SMP in the provision of fixed geographic call termination services over their own network and, in the absence of ex-ante regulation, there is a risk that this dominance could be leveraged to distort competition in other markets. In this case, network providers could increase BT’s costs. 6.16 In the forthcoming consultation document that will be entitled End-to-end connectivity Oftel will propose that BT must purchase fixed geographic call termination services from other network providers. However, in the absence of any ex-ante obligations, other network providers will not be obliged to supply fixed geographic call termination services. Oftel does not consider that it would be appropriate to rely on general competition law as a means of ensuring supply, as this would increase risk and uncertainty for the industry. As well as this, it is not technically feasible to terminate a call over another network provider’s network. SMP in these markets is therefore persistent. 6.17 The Director’s initial view therefore is that, even if he did not have to impose at least one obligation, as a result of a finding of SMP, it would not be appropriate to do without ex-ante regulation. This is because, in the absence of an obligation to supply on reasonable terms, other network providers could choose to decline to provide this service to BT or provide it at excessive prices. There would also be an asymmetry in the provision of fixed geographic call termination, as BT would be required to supply its services to other network providers, but they would not have to provide their service to it. This would not be consistent with the promotion of fair and effective competition, or in the interests of end-users. The Director therefore rejects Option A. Option B To provide fixed geographic call termination on fair and reasonable terms 6.18 An obligation on other network providers to provide fixed geographic call termination to BT on fair and reasonable terms would ensure that services were provided, and this occurred on terms that were ‘fair and reasonable’. However, in the absence of any other regulatory rules on other network providers, BT might have a strong incentive to dispute any terms that were offered to it that it believed were not fair and reasonable. Such disputes could create uncertainty and additional costs for the industry, as well as engaging significant regulatory resource in resolution. 6.19 It is important to recognise that, in the absence of regulation, there would be incentives for other network providers to set termination charges for BT that were in excess of costs. At the retail level, as a result of the termination externality, this would place BT at a disadvantage and benefit other network providers’ retail activities. 6.20 The Director’s initial view is that an appropriate response to the termination externality and the risk of monopolistic pricing would be to ensure that the charges set by other fixed network providers for termination services were set on a reciprocal basis and based on BT’s costs. The Director cannot fetter his discretion as to how he would resolve any disputes brought if the obligations on network providers were limited to the obligation to provide fixed geographic call termination on fair and reasonable terms. But the Director’s present view is that a reciprocal charging arrangement would fall within the scope of ‘fair and reasonable’ terms. The present arrangements for charging for termination are based on reciprocal terms. The continuation of these arrangements should help to ensure that the number of disputes between providers is kept to a minimum. The issue of what terms might be considered reasonable is discussed further in paragraphs 6.43 to 6.49. Option C To provide fixed geographic call termination on fair and reasonable terms; not to unduly discriminate in the provision of this service; to secure transparency through price publication; a requirement to set cost-oriented prices; price controls; and requirements for separate accounting and appropriate cost-accounting systems. 6.21 This option would extend to other fixed network providers the obligations proposed for BT, as described in chapter 5. 6.22 For this option, other fixed network providers’ fixed geographic call termination services would be subject to charge controls. Oftel would therefore need to know each network provider’s costs and be able to monitor compliance with the control. To ensure that network providers were not unduly discriminating in the provision of their fixed geographic call termination services, they would also be required to produce accounting information showing how much their retail activities were charged for fixed geographic call termination. 6.23 At the network level, as all other network providers’ charges for fixed geographic call termination would be cost-oriented and they would not be permitted to unduly discriminate in the provision of such access, this option would prevent them from exploiting their SMP when providing fixed geographic call termination to BT. In addition, the price controls on all fixed network providers would provide incentives to remove costs that were inefficiently incurred. Each network provider would be permitted to earn a reasonable return on its investment. 6.24 However, as price controls could be set only once each fixed network provider produced detailed financial data and their relative efficiency was assessed, the imposition of the full range of available regulatory remedies under the Communications Bill would place an additional burden on each regulated company and on the regulator. The requirement to publish a reference offer and regulatory accounts would also result in additional regulatory costs. The likely regulatory costs of this option would proportionately be greatest for the smallest fixed network provider. 6.25 The Director considers that there are other disadvantages of this option and these relate to the termination externality. One drawback would be that fixed network providers with the highest costs would both increase the other network providers’ end-to-end costs and face fewer competitive disadvantages in retail markets. There would therefore be a perverse incentive to inflate termination costs. It is likely to be difficult to counter this behaviour through regulatory scrutiny of cost models, given the number and complexity of these models, and the opportunities for exercising discretion in the allocation of costs. 6.26 The Director also considers that it is unnecessary to prohibit undue discrimination by these providers given that their small share of retail calls markets should ensure that any discrimination would not have a material adverse effect on competition. 6.27 At the retail level, retail customers would benefit to the extent that charges for fixed geographic call termination would be based on increasingly efficiently incurred costs. However, as the calling party pays, the retail customer connected to the more efficient or lowest cost network would pay more for fixed geographic call termination on the less efficient provider’s network and vice versa. 6.28 As Oftel would need to find out the relative efficiency of each provider, it would need a large increase in resources to carry out efficiency studies and thereafter set price controls. Comparisons of Options A, B and C 6.29 Oftel has considered three different options for levels of regulation of other fixed network providers when they provide their fixed geographic call termination services to BT. Of these, the Director has already discounted Option A, as this would not address fixed network providers’ SMP in the provision of these services. 6.30 Of the two options that would address other network providers’ SMP, Option B would involve less regulation. It would also have the advantage of allowing other network providers to maintain the commercial arrangements under which charges for termination services are set on a reciprocal basis and based on BT’s charges. In addition, it would also not allow network providers with higher costs to benefit from the fact that the ‘calling party pays’. On the other hand, Option C would involve more regulation and would allow network providers with higher costs to benefit from the fact that the ‘calling party pays’. 6.31 The Director’s initial view is that Option B would be the most appropriate response to other fixed network providers’ SMP in the provision of fixed geographic call termination services to BT. The Director considers that this option would meet clause 43(2) of the Communications Bill. It would be proportionate, because it would represent the minimum regulatory obligation consistent with the existence of SMP. It would not discriminate unduly, because it would reflect the circumstances of other fixed network providers, as distinct from BT and Kingston, and their lesser ability to leverage into other retail and wholesale markets. It would be objectively justifiable, given the benefits in greater certainty that it would provide to the industry and thereby to consumers. It would be transparent in relation to the effect it is intended to achieve given the explanation in this document. In terms of clause 83(4), amongst other things, the Director believes his proposals would help to secure effective competition in the long term. Question 8 Do you agree that Option B is the most proportionate and appropriate response to other network providers' SMP in the provision of their own network fixed geographic call termination when supplying such services to BT? (This proposed obligation is reflected in Condition BC1 included at Schedule 3 to Annex A). Question 9 Do you consider
that it is desirable for these providers' charges for call termination
to continue to be based on BT's costs and on reciprocity? Fixed network providers (other than Kingston) providing fixed geographic call termination to other fixed network providers (excluding BT), and to mobile providers: options and proposals for remedies What are the options for regulation? 6.32 For other fixed network providers when providing fixed geographic call termination services to each other, to Kingston, and to mobile providers Oftel has considered two regulatory options. In considering the regulatory options, it is necessary to consider whether any of these network providers could distort competition in downstream retail local and national calls markets by leveraging their call termination SMP into those markets. The size of BT’s fixed access network far exceeds all other network providers even when their customer bases are combined. It can therefore be surmised that other fixed network providers’ call termination market sizes are relatively small. Therefore any attempts to favour their own retail activities by leveraging their relatively small call termination SMP would be unlikely to adversely affect competition in retail calls markets. In addition, as these network providers do not compete with Kingston in the retail calls market or with mobile network providers in the mobile calls market, they cannot leverage their SMP into those markets. 6.33 For these reasons, the Director does not believe that he needs to prevent other fixed network providers from discriminating in favour of themselves, as it is unlikely that such discrimination would be undue or have an adverse effect on retail competition. 6.34 This is why the following analysis looks at two regulatory remedies only for dealings with interactions between other fixed network providers when providing fixed geographic call termination providers to each other, to Kingston, and to mobile network providers. These are:
No ex-ante regulation
To provide fixed geographic call termination on fair and reasonable terms Option AA No ex-ante regulation 6.35 As explained in chapter 4, the Director’s initial view is that each fixed network provider providing fixed geographic call termination services has SMP in the provision of these services. SMP exists in relation to the provision of all such services by a fixed network provider, whether the originating provider is BT, a mobile network provider, or another non-BT fixed network provider. This reflects the fact that there are no demand or supply side substitutes to the termination of a call to a particular end-user or the network to which that end-user is connected. Moreover, in the Director’s view, countervailing buyer power is unlikely in general to eliminate SMP in the provision of these services, even between different non-BT fixed network providers. In general, larger non-BT fixed network providers are likely to have countervailing buyer power when negotiating with smaller providers. But the existence and consequences of exercising buyer power cannot be predicted reliably, particularly as changes occur frequently in the financial strength and market share of different network providers. 6.36 It is the Director’s initial view that, in light of the analysis, it would not be appropriate to impose no ex-ante rules in relation to the provision of fixed geographic call termination services between different non-BT network providers. The consequences of this would be unpredictable, but could include increases in pricing above the competitive level, as well as additional uncertainty for the industry. The effects would be likely to be more severe for smaller network providers and new entrants to the industry. 6.37 The Director therefore rejects Option AA. Option BB To provide fixed geographic call termination on fair and reasonable terms 6.38 As in all markets in which persistent SMP exists, in the absence of regulation other fixed network providers would have incentives to maximise their call termination profitability. In this case, any network provider that set excessive termination charges to other providers could affect the ability of the other company to compete in its relevant retail market. As explained, the Director proposes to designate BT as a provider with SMP in the local and national calls markets. Therefore any other providers who had to pay call termination charges in excess of those that BT had to pay would have to absorb those costs, as they could not set prices above the competitive level. A loss might therefore be made on such calls and this could affect retail competition in relevant calls markets. This may deter entry or encourage exit by firms who may in the longer-term become significant players (e.g. new indirect access entrants). 6.39 Oftel therefore believes that it is necessary impose an obligation on other PECNs to provide fixed geographic call termination to each other and to do so on fair and reasonable terms. This is discussed further in paragraphs 6.43 to 6.49. 6.40 The Director considers that this option would meet the tests set out in clause 43(2) of the Communications Bill. It would be objectively justifiable, as it would ensure that non-BT network providers wishing to purchase fixed geographic call termination services could do so, and could do so on fair and reasonable terms. It would not be unduly discriminatory, because it would reflect the differing circumstances of fixed PECNs other than BT, compared to BT itself. It would impose significantly fewer regulatory obligations on the former, reflecting their reduced ability to leverage market power into retail calls markets. It would be proportionate, because it would impose the minimum regulatory obligations needed to protect the position of competing providers and thereby end-users. It would be transparent as to what it intended to achieve, given the explanation in this document. In terms of clause 83(4), the requirement to provide access would, amongst other things, help to secure effective competition in the long term and the proposed condition is included at Schedule 3 to Annex A. 6.41 In terms of clause 4(3)(a) of the Communications Bill, this option should promote competition in the provision of electronic communications networks and services, as all network providers would be able to access each other’s fixed geographic call termination on reasonable terms. This should also maximise the benefits of end-users. In terms of clause 83(4), the requirement to provide access would, amongst other things, help to secure effective competition in the long term. Comparison of Options AA and BB 6.42 Of the two options considered for the interactions between other network providers to each other, to Kingston, and to mobile network providers, Option BB is the only option that includes regulatory obligations and, of the two options considered, is the only viable option. That aside, the Director believes that, in the absence of an obligation to provide call termination services on reasonable terms, he would be failing to promote competition or guarantee interoperability and this would be detrimental to end-users. The Director’s provisional view on the terms on which fixed geographic call termination should be made available 6.43 Proposed Condition BC1 requires other fixed network providers to set their charges for fixed geographic call termination on a ‘fair and reasonable’ basis only. However, as the proposed obligation to offer fair and reasonable terms is not prescriptive, the Director believes that it would be helpful if he gave some general guidance on the terms that he might consider fair and reasonable. Nonetheless, this guidance does not fetter the Director’s (or Ofcom’s) discretion to reach a different conclusion given the circumstances of the dispute. 6.44 The Director has considered two theoretical cases under which different charges (and terms and conditions) might be set:
6.45 In considering the reasonableness of any charges, terms and conditions, the Director (or Ofcom) would need to consider the extent to which any fixed network provider might be able to act anti-competitively by raising competitors’ costs. The BT reciprocity agreement 6.46 For other fixed network providers, supplying services to each other, to Kingston and to mobile network providers, it is the Director’s provisional view that charges for fixed geographic call termination that were set on the basis of BT’s costs would be reasonable. The Director has taken this view for the following reasons. 6.47 Firstly, at the network level, charges for call termination (between other fixed network providers) that were based on BT’s costs would lead to fair competition between the two providers, as neither would be able to raise the other’s costs and thus deter entry or encourage exit. Secondly, as BT’s charges for call termination would be based on its increasingly efficiently incurred costs, other network providers’ charges would be as well. At the retail level, the effect of this would be likely to maximise end-users’ benefits. Reciprocally agreed charges 6.48 It is the Director’s provisional view that charges for fixed geographic call termination that were set on a reciprocally agreed basis would be reasonable only if those charges that were agreed were lower than BT’s. However, as the Director cannot fetter his discretion in advance in any case, he would consider any proposals on their relative merits before reaching his final conclusions. 6.49 If network providers agreed to set reciprocal charges for call termination that were higher than BT’s, the Director believes that such charges would not be reasonable, as this could increase end-users’ prices. That said, the extent to which other fixed network providers could agree to set higher charges for bilateral call termination would be limited, as both network providers would need to compete with BT in local and national calls markets and could not therefore set retail prices above the competitive level. Question 10 Do you agree that Option BB is the most proportionate and appropriate response to other fixed network providers' SMP in the provision of their own network fixed geographic call termination services when supplying such services to each other? Question 11 Do you agree that the requirement to offer fixed geographic call termination services on fair and reasonable terms, conditions and charges addresses SMP in these markets? (This proposed obligation is reflected in Condition BC1 included at Schedule 3 to Annex A.) Question 12 Do you agree
that charges for call termination services provided by other network
providers should either be based on BT's costs or on costs that are
lower than BT's? Options and proposals for remedies for Kingston Aims of regulation and conditions that may be imposed 6.50 Clause 4 of the Communications Bill sets out the Community requirements for regulation. The Director in considering whether to propose any conditions has considered all of these requirements. In particular, the Director has considered the requirement to promote competition and to secure efficient and sustainable competition. Therefore, the Director has particularly considered whether conditions are required to prevent SMP in this market being used to distort competition in downstream markets. 6.51 As explained in paragraph 6.7, the aims of any regulation proposed in this chapter is to, amongst other things, promote competition and to prevent SMP from being used to distort competition in retail markets. In Kingston’s case, as explained in chapter 4, the Director’s initial proposal is to identify Kingston as having SMP in the provision of fixed geographic call termination services. In addition, the Director has proposed in the consultation document entitled Review of Fixed Narrowband Retail Markets that Kingston has SMP in relevant retail calls markets. In the absence of regulation, Kingston could distort retail competition in the Hull area, as well as exploit its SMP in fixed geographic call termination. What are the options for regulation? 6.52 Oftel has considered three options for regulation of Kingston in the provision of its fixed geographic call termination services. In considering the appropriateness of these options, it is necessary to consider whether Kingston could distort competition in downstream markets as a result of the provisional SMP findings. In addition, as Kingston’s services are predominantly confined to the Hull area, it is also necessary to consider whether Kingston could take advantage of the termination externality. 6.53 The three options that Oftel has considered for different levels of regulation on Kingston in this market are:
No ex-ante regulation;
To provide fixed geographic call termination on fair and reasonable terms; not to unduly discriminate in the provision of this service; to secure transparency through price publication; a requirement to set cost-oriented prices; and requirements for separate accounting and appropriate cost-accounting systems
As option Y plus price controls 6.54 The Director's initial view is that Option Y is his preferred option for regulation. Option X No ex-ante regulation 6.55 The Director considers that Kingston has persistent SMP in the provision of its fixed geographic call termination services. In the absence of an obligation to supply this service on suitable terms, Kingston could choose to maximise its profitability. This would not be consistent with the promotion of fair and effective competition, or in the interests of end-users. The Director therefore rejects Option X. Option Y To provide fixed geographic call termination on fair and reasonable terms; not to unduly discriminate in the provision of this service; to secure transparency through price publication; a requirement to set cost-oriented prices; and requirements for separate accounting and appropriate cost-accounting systems 6.56 In the absence of a direct constraint on pricing, network providers might choose to set excessive prices for call termination to increase their revenues and competitors’ costs. A requirement not to unduly discriminate may exert some downward pressure on charges, to the extent that the SMP provider’s retail arm may seek lower charges and the wholesale arm would be required to charge the same to all other providers. However, the SMP provider may still have incentives to set its charges at an excessive level to maximise its overall profitability. Higher wholesale charges are likely to mean that competing or potentially competing providers will need to have higher retail prices and may be less able to compete in the retail market. In the long-term this could result in market exit. 6.57 For these reasons, the Director’s initial view is that it is necessary to require Kingston to provide fixed geographic call termination services on fair and reasonable terms, conditions and charges and that such charges should be based on forward looking long-run incremental costs. Option Z To provide fixed geographic call termination on fair and reasonable terms; not to unduly discriminate in the provision of this service; to secure transparency through price publication; a requirement to set prices on the basis of forward looking long-run incremental costs; requirements for separate accounting and appropriate cost-accounting systems; and price controls 6.58 This option is as Option Y, plus an obligation on Kingston under which its charges would be subject to price controls. 6.59 The comparisons between Options X, Y and Z are considered in the following paragraphs. Comparisons between Options X, Y and Z 6.60 Oftel has considered three different options for levels of regulation on Kingston in the provision of its fixed geographic call termination services. Of these, the Director has already discounted Option X, as this would not address Kingston’s SMP in the provision of fixed geographic call termination. 6.61 The combination of obligations included within Option Y would ensure that Kingston had to provide fixed geographic call termination services on fair, reasonable, transparent, and cost-oriented terms, and would be unable to discriminate unduly between wholesale customers. Option Y would therefore address many of the problems associated with markets in which there was a firm with persistent SMP. This option would allow other network providers to compete with Kingston in downstream markets on a fair and even basis and should help to promote competition in the Hull area. In addition, for calls that originated outside the Hull area and were bound for it, the charges for termination would reflect those that Kingston charges itself. 6.62 However, Option Y would not prevent Kingston from setting call termination charges that were based on inefficiently incurred costs. Option Z would do this. The difference between Options Y and Z is the imposition of charge controls in the latter and not in the former. Nonetheless, the Director believes that there are strong reasons for opting for Option Y rather than Option Z. 6.63 Firstly, Kingston’s services are in the main confined to the Hull area and it does not therefore generally directly compete in other markets. Therefore, whereas other network providers that directly compete with each other in retail markets would benefit from the ‘termination network externality’ Kingston would not. Kingston’s charges for fixed geographic call termination would not therefore distort competition via the externality and it does not therefore currently possess the strategic incentive to allow inefficiency in the provision of its fixed geographic call termination services. [ This is not to say that Kingston's network costs are currently necessarily being efficiently incurred. Oftel has commissioned NERA (National Economic Research Associates) to undertake a comparative efficiency study of Kingston's network costs the results of which may inform the process of deriving a price control should this be necessary ] 6.64 Secondly, as a relatively small SMP network provider, Oftel believes that in the absence of further evidence of actual concerns about Kingston’s termination charges, the imposition of a price control, as proposed in Option Z, could at this stage constitute a disproportionate regulatory burden on it. As explained, Kingston’s fixed geographic call termination monopoly is comparatively extremely small when compared to, for instance, BT’s fixed geographic call termination monopoly. 6.65 For these reasons, the Director’s initial view is that Option Y is appropriate in the circumstances. He believes his proposals for regulating Kingston are justifiable and in accordance with the Communications Bill and pass the tests set out in clause 43(2) of the Communications Bill under which it is explained that SMP conditions can be imposed only once or if those tests are met. The Director believes his proposals are objectively justifiable, as they reflect Kingston’s SMP in the provision of fixed geographic call termination services and its SMP in relevant retail calls markets. It is non-discriminatory in that it reflects Kingston’s comparatively small monopoly (compared to BT’s), as the Director has not proposed to immediately set price controls. For the same reason, it is proportionate. It is transparent, in that its intentions are set out in this consultation document. However, this relies on Kingston setting reasonable charges for fixed geographic call termination. 6.66 In terms of clause 4(3)(a) of the Communications Bill, the aims of this option are to promote competition in the provision of electronic communications networks and services in the Hull area and this should maximise the benefits of end-users (clause 4(8)(b)). However, as explained, Kingston’s charges for call termination need to reflect its efficiently incurred costs. Question 13 Do you agree
that Option Y is the most appropriate regulatory response to Kingston's
SMP in the provision of its own network fixed geographic call termination
services? Detail of the proposed remedies for Kingston A requirement to provide network access (proposed Condition BB1) 6.67 Oftel proposes that Kingston should provide network access to any other PECN that reasonably requests such access. Oftel also believes that fixed geographic call termination should be provided on fair and reasonable terms, conditions and charges and on such terms, conditions and charges as the Director may from time to time direct. These obligations are reflected in proposed Condition BB1 included at Schedule 2 to Annex A of this consultation document. 6.68 The Director considers that the proposed condition meets the tests set out in the Communications Bill. The Director in proposing this condition has considered all the Community requirements set out in Clause 4 and in particular the requirement to promote competition and to secure efficient and sustainable competition. 6.69 Clause 43 requires conditions to be justifiable, non-discriminatory, proportionate and transparent. The proposed condition is objectively justifiable, in that it relates to the need to ensure that competition develops to the benefit of consumers. It does not discriminate, in that it is imposed on Kingston and, as explained in chapter 6 and earlier in chapter 5, all other fixed network providers that terminate fixed geographic calls. It is proportionate, in that Kingston is the only network provider that can terminate calls in the Hull area. It is transparent in that it is clear in its intention to ensure that Kingston provides access to its network. In terms of clause 83(4), the requirement to provide access would, amongst other things, help to secure effective competition in the Hull area in the long term. A requirement not to unduly discriminate (proposed Condition BB2) 6.70 The Director believes that Kingston should be prevented from unduly discriminating in the provision of fixed geographic call termination. The Director considers that Kingston would be unduly discriminating if such discrimination were ‘undue’, i.e. there was no objective justification for the discrimination. This is reflected in proposed Condition BB2. 6.71 An obligation of non-discrimination might have disadvantages if it prevented discrimination that was economically efficient or justified. However, the proposed condition provides that there should be no undue discrimination. Oftel has considered how it might treat undue discrimination in its statement Imposing access obligations under the new EU Directives, September 2002. This statement notes that any obligation with respect to undue discrimination has the objective of preventing behaviour that has a material adverse effect on competition. This does not mean that there should not be any differences in treatment between undertakings, rather that any differences should be objectively justifiable, for example, by differences in underlying costs of supplying different undertakings. The statement also notes that in the Director’s view there is a rebuttable presumption that a vertically integrated SMP provider discriminating in favour of its own retail activities or between its own different activities would have a material adverse effect on competition. This view would also apply to discrimination in relation to the underlying components of services provided to competing providers if it would have a material adverse effect on competition. 6.72 The Director considers that the proposed condition meets the tests set out in the Communications Bill. The Director in proposing this condition has considered all the Community requirements set out in Clause 4 and in particular the requirement to promote competition and to secure efficient and sustainable competition. 6.73 Clause 43 requires conditions to be justifiable, non-discriminatory, proportionate and transparent. The Director considers that this proposed condition is objectively justifiable, in that it provides safeguards to ensure that competitors, and hence consumers, are not disadvantaged by Kingston discriminating in favour of its retail business or between its own different activities. It does not discriminate, in that it is imposed on Kingston and, as explained in chapter 5, BT, as no other network providers have SMP in both their own network market for fixed geographic call termination and relevant retail calls markets. It is proportionate in that discrimination is only prohibited if it is ‘undue’ and meant that Kingston could distort competition the Hull area. Finally, it is transparent in that it is clear in its intention to ensure that Kingston does not unduly discriminate. In addition, Oftel has given guidance as to how it might treat undue discrimination in its Access Guidelines and the condition and explanation is set out in this consultation document. Basis of charges (proposed Condition BB3) 6.74 As explained in chapter 5, Oftel believes that in many communications market ex-ante regulation should require charges to be set on the basis of LRIC plus an appropriate mark-up for costs which are common across products. Charges should also allow for an appropriate return on capital. For the same reason as those set out in chapter 5, Oftel believes that Kingston’s charges for its fixed geographic call termination services should be based on its LRIC and allow for an appropriate mark-up for the recovery of common costs. This is therefore reflected in proposed Condition BB3. 6.75 The Director considers that the proposed conditions meet the tests set out in the Communications Bill. The Director has considered all the Community requirements set out in clause 4 including, in particular, the requirement to promote competition and to secure efficient and sustainable competition . The Director believes proposals meet these requirements, as, under his proposals, Kingston would be permitted to earn a reasonable return on its investment. 6.76 Clause 43 requires conditions to be justifiable, non-discriminatory, proportionate and transparent. The Director considers that the proposed conditions are an objectively justifiable and proportionate response to the extent of competition in the markets analysed, as they enable competitors to purchase services at charges that will enable them to develop competitive retail services to the benefit of consumers, whilst at the same time allowing Kingston a rate of return commensurate with that which it would expect in competitive markets. They are non-discriminatory in that the Director proposes to impose a charging basis condition on Kingston and BT and that the charging basis for both is the same. Other fixed network providers are not dominant in the provision of fixed geographic call termination services and in relevant retail call markets. Finally, they are transparent as to the effect that it is intended to achieve given the explanation in this document. 6.77 The Director considers that the tests in Clause 84 have been met. As noted above, there is a risk that, in situations where SMP is persistent, pricing will be distorted and not at competitive levels. The proposed conditions are necessary in order to provide benefits to end users by enabling competing providers to buy wholesale services at levels that might be expected in a competitive market. 6.78 The extent of investment of the dominant operator has been taken into account as set out in Clause 84(2) and the proposed conditions provide for a mark-up for an appropriate return on capital employed. Requirement to publish a reference offer (proposed Condition BB4) 6.79 A requirement on communications providers with SMP to publish a reference offer (RO) has two main purposes: (a) to assist transparency for the monitoring of potential anti-competitive behaviour (if charges have to be published); and (b) to give visibility to the terms and conditions on which other providers can purchase services. A RO helps to ensure stability in markets and maintains incentives to invest that might otherwise be undermined and thus discourage market entry. 6.80 In addition, the publication of a RO would potentially enable negotiations to be completed more quickly, help to avoid possible disputes, and give confidence to those purchasing wholesale access services that those services are being provided on non-discriminatory terms. In the absence of a published RO, market entry might be deterred to the detriment of the long-term development of competition and consumers. 6.81 The published RO must set out such matters as:
and dispute resolution procedures;
6.82 In addition, Kingston must include in the published RO, the amount charged to their own retail activities (transfer charge) and the underlying components from which the amount is derived, for the equivalent service that it provides to competing providers. 6.83 The Director considers that the proposed condition meets the tests set out in the Communications Bill. The Director has considered all the Community requirements set out in clause 4 and in particular the requirement to promote competition and to secure efficient and sustainable competition. 6.84 The Director considers that the proposed condition meets the tests set out in clause 43 of the Communications Bill. It is objectively justifiable in that it requires that terms and conditions should be published in order to encourage competition and provide stability in markets. It is proportionate, in that only information that is necessary to ensure that that there is no material adverse effect on competition is required to be provided. It does not discriminate in that it is applied to Kingston and, as explained in chapter 5, BT. Finally, it is transparent in that it is clear in its intention to ensure that Kingston provides details of its terms and conditions and this consultation document has set out what the condition is intended to achieve. Requirements to notify prices (proposed Condition BB5) 6.85 Oftel believes that Kingston should be required to give notice before it is permitted to change any charge for fixed geographic call termination services. This is reflected in Condition BB5. 6.86 Oftel has considered how much notice Kingston should be required to give before changing charges for fixed geographic call termination services and, as a result, believes that the present notification period remains appropriate. 6.87 Oftel therefore proposes that Kingston should be required to give 90 days’ notice of price changes in markets in which SMP is persistent. This therefore applies to fixed geographic call termination. 6.88 The Director considers that the proposed conditions meet the tests set out in the Communications Bill. The Director has considered all the Community requirements set out in Clause 4 and in particular the requirement to promote competition and to secure efficient and sustainable competition. 6.89 The Director considers that, in accordance with the tests set out in Clause 43 of the Communications Bill, the proposed conditions are objectively justifiable, non-discriminatory, proportionate, and transparent. They are objectively justifiable, in that the benefits of publication and notification of charges outweigh any possible disadvantages. They are proportionate, in that the period of notice is no more than that which other PECNs would need to change retail prices in response to a change in wholesale charges. Finally, they are transparent in that they are clear in their intention to ensure that Kingston provides notification of charge changes. Accounting separation and cost accounting obligations 6.90 Oftel considers that Kingston should be prevented from unduly discriminating in its supply of fixed geographic call termination services. For the purpose of ensuring that Kingston does not discriminate unduly against competitors in terms of price, Oftel considers that it is necessary for Kingston to account separately for its network and retail activities. These accounts will need to show the transfer charges within Kingston for fixed geographic call termination services, alongside payments by other providers for fixed geographic call termination services. 6.91 Oftel has explained further in chapter 7 the basis for implementing the proposed accounting separation obligations. Oftel proposes to set out in more detail what SMP PECNs should be required to do in terms of accounting requirements for their various activities, and the basis on which they should be published, in the forthcoming consultation document entitled Financial reporting obligations in SMP markets. Question 14 Do you have any
comments on the justification or detail of the proposed remedies for
Kingston?
Chapter 7Accounting separation and cost accounting7.1 This chapter covers financial reporting obligations that may be imposed on dominant providers to ensure that other proposed obligations are met. In particular, obligations of cost orientation, price controls and non-discrimination can require the imposition of financial reporting regimes to monitor dominant providers’ compliance with these obligations. In particular, this chapter covers the imposition of obligations for cost accounting systems and accounting separation. 7.2 The Director is of the view that it is appropriate to impose cost accounting and accounting separation obligations in the markets covered in this review. The two sub-sections below outline why these financial reporting obligations are required. 7.3 However, the processes of cost accounting and accounting separation are complex, covering issues such as cost attribution methodologies, accounting standards, audit, transparency, disaggregation, reconciliation and publication of information. These practical processes are distinct from the questions of principle, such as the level of regulation in the market, the remedies to be applied, etc. For example, the decision on whether to impose a cost accounting obligation and the level of information required is made on the basis of the findings of the market review. However, the practical processes must be consistent across all markets susceptible to regulation to ensure that there is certainty both for the Director, the dominant providers, and other persons in the market regarding regulatory financial information requirements. 7.4 Therefore, the Director will be carrying out a separate consultation – Financial reporting in SMP markets: A consultation on accounting separation and cost accounting systems – on the nature of the obligations necessary for implementing the processes of cost accounting systems and accounting separation. The scope of this consultation will be to address the issues of how the requirements for cost accounting and accounting separation will be implemented. It will also address the level of granularity required for such obligations to be imposed in a proportionate and appropriate manner. That consultation will contain the draft cost accounting and accounting separation obligations. The Director intends to carry out this consultation towards the end of the market review process so that the requirements of the accounting separation condition and the cost accounting condition can reflect the findings of the individual reviews. Cost accounting systems 7.5 Under clauses 83(9) to 83(11) and 84 of the Communications Bill, appropriate cost accounting obligations may be imposed on dominant providers in respect of the provision of network access, the use of the relevant network and the availability of relevant facilities. Cost accounting rules may be made in relation to price controls, the recovery of costs and cost orientation. 7.6 The Director is proposing that charges for fixed geographic call termination in certain markets should be cost-oriented on the basis of LRIC and allowing for an appropriate mark-up for the recovery of common costs. As explained in that section, this is to ensure that the charges of dominant providers are constrained to enable competitors purchasing such services to compete with the dominant providers in downstream markets. In particular, paragraph 5.56 describes why LRIC and allowing for an appropriate mark-up for the recovery of common costs is a justifiable and proportionate response to the extent of competition in the markets analysed. 7.7 In addition, the Director is proposing charge controls for BT. As explained in those sections, such charge controls are necessary to ensure that competition develops to the benefit of consumers and to encourage network efficiency. In particular, chapter 5 describes why the charge control is a justifiable and appropriate response to the extent of competition in the provision of fixed geographic call termination, and why the level of the charge control is proportionate, respectively. It should be noted that the Director is not presently proposing a charge control on the wholesale services offered by Kingston. 7.8 Given the imposition of LRIC and allowing for an appropriate mark-up for the recovery of common costs, and a charge control for BT, the Director is proposing that BT and Kingston should each maintain a cost accounting system, that demonstrates that the obligations of cost orientation and – in the case of BT – charge control are being met. This will enable the Director to monitor compliance with those obligations. 7.9 The cost accounting obligations for BT will apply to the provision of fixed geographic call termination for which BT must demonstrate that its charges are set on the basis of its LRIC and an appropriate mark-up to allow for the recovery of common costs. BT’s cost accounting is also necessary to monitor its charge control obligations. 7.10 The cost accounting obligations for Kingston will apply to the provision of fixed geographic call termination for which Kingston must demonstrate that its charges are set on the basis of its LRIC and an appropriate mark-up to allow for the recovery of common costs. 7.11 In order to demonstrate cost orientation of a service or product, it is necessary for the dominant provider to establish cost accounting systems that capture, identify, value and attribute relevant costs to its services and products in accordance with agreed regulatory accounting principles, such as cost causality. A key part of this process is the stage which identifies those parts of the underlying activities or elements that directly support or are consumed by those services or products. These elements are referred to as network components. As these components are frequently used to provide more than one product or service, it is also necessary to determine how much of each component is used for each service or product that should be cost-oriented. The service/product costing methodology applies the utilisation of these components (which are characterised by common usage measures) to the appropriate service product. For example, the call termination local exchange segment service uses four distinguishable underlying cost components – the local exchange concentrator, the local exchange processor, remote to local transmission and remote to local length – which all require analysis in the cost accounting system. Therefore, for each of these components, it would be necessary to produce a financial statement, that sets out costs and volumes that demonstrate that this information has been properly prepared, in addition to the financial statement for the call termination local exchange segment service. 7.12 Clause 4 of the Communications Bill sets out the Community requirements for regulation. The Director has considered all of the criteria in Clause 4 of the Communications Bill. In particular, the imposition of a cost accounting obligation would specifically be justifiable and proportionate to promote competition in relation to the provision of electronic communications networks and electronic communications services; to contribute to the development of the European internal market; to promote the interests of citizens of the European Union; and to ensure efficient and sustainable competition in the markets for electronic communications networks and electronic communications services and the maximum benefit for the persons who are customers of communications providers. This is because the imposition of a cost accounting obligation will ensure that obligations designed to curb potentially damaging market power can be effectively monitored and enforced. 7.13 In addition, the Director has considered the tests laid out in Clause 84 of the Communications Bill. From the market analysis, it appears to the Director that there is a relevant risk of adverse effects arising from price distortion. In particular, the market analysis has shown that BT and Kingston might fix and maintain some or all of their prices at an excessively high level, or impose a price squeeze so as to have adverse consequences for end-users. In the light of this analysis, and taking into account the level of investment of the dominant providers, the Director is of the view that a cost accounting obligation is appropriate for the purposes of promoting efficiency, promoting sustainable competition, and conferring the greatest possible benefits on the end-users of public electronic communications services. 7.14 Clause 43 of the Communications Bill requires conditions to be objectively justifiable, non-discriminatory, proportionate and transparent. The Director believes that given the importance of cost orientation and price controls in these markets, the imposition of a cost accounting obligation is objectively justifiable. That is, in order to ensure that the obligations of cost orientation and price control are met and the benefits are realised it is essential that the Director is able to monitor the obligations via a cost accounting obligation. Furthermore, the cost accounting obligation does not discriminate between network providers of the same class. That is, BT and Kingston are the only dominant providers in the provision of both fixed geographic call termination services on their own network and the provision of retail calls in the relevant geographic areas. 7.15 The proportionality and transparency of the obligation will be dealt with in more detail in the separate consultation document on financial reporting. In this document, the Director will propose the amount of information required and the processes needed to ensure that the information is fit for purpose, relevant and reliable. The Director will ensure that the cost accounting obligation imposed is both proportionate and transparent. Accounting separation 7.16 Under clauses 83(7) and 83(8) of the Communications Bill, appropriate accounting separation obligations may be imposed on the dominant provider in respect of the provision of network access, the use of the relevant network and the availability of relevant facilities. That is to say, the dominant provider may be required to maintain a separation for accounting purposes between such different matters relating to network access or the availability of relevant facilities. 7.17 The Director is proposing that dominant providers should have an obligation to not unduly discriminate in the provision of fixed geographic call termination services. This is because where a dominant provider is vertically integrated it has an incentive to provide wholesale services on terms and conditions that discriminate in favour of its own retail activities in such a way that may have a material effect on competition. 7.18 Therefore, given the importance of this issue in ensuring an effectively competitive marketplace in the UK, the Director believes that it is necessary that BT and Kingston should be obliged to have accounting separation obligations. These obligations will enable the Director to monitor whether they are unduly discriminating against or between other providers or not, by making visible the wholesale prices and internal transfer prices of their services and products. 7.19 Clause 4 of the Communications Bill sets out the Community requirements for regulation. The Director has considered all of the criteria in Clause 4 of the Communications Bill. In particular, the imposition of an accounting separation obligation would specifically be justifiable and proportionate to promote competition in relation to the provision of electronic communications networks and electronic communications services; to contribute to the development of the European internal market; to promote the interests of citizens of the European Union; and to ensure efficient and sustainable competition in the markets for electronic communications networks and electronic communications services and the maximum benefit for the persons who are customers of communications providers. This is because the imposition of an accounting separation obligation will ensure that obligations designed to curb potentially damaging market power can be effectively monitored and enforced. 7.20 Clause 43 of the Communications Bill requires conditions to be objectively justifiable, non-discriminatory, proportionate and transparent. The Director believes that given the importance of non-discrimination in these markets, the imposition of an accounting separation obligation is objectively justifiable. That is, in order to ensure that the obligation to not unduly discriminate is met and the benefits are realised it is essential that the Director is able to monitor the obligations via an accounting separation obligation. Furthermore, the accounting separation obligation does not discriminate between operators of the same class. That is, BT and Kingston are the only providers with SMP in the provision of both fixed geographic call termination services on their own network and the provision of retail calls in the relevant geographic areas. They are therefore the only providers with proposed obligations to not unduly discriminate in their relevant markets. 7.21 The proportionality and transparency of the obligation will be dealt with in more detail in the separate consultation on financial reporting. In this document, the Director will propose the amount of information required and the processes needed to ensure that the information is reliable. The Director will ensure that in imposing an accounting separation obligation it is both proportionate and transparent. 7.22 As non-discrimination must be capable of being implemented, where appropriate, on a service or product basis it is not sufficient for monitoring to be carried out only at the market level, as this would not enable the Director to identify whether products and services are being provided on a non-discriminatory basis. 7.23 In order to ensure that fixed geographic call termination services were not being provided on a basis that was not unduly discriminatory, it would be necessary to make visible the wholesale prices and internal transfer prices of the services at both the service and component level. The consultation document on financial reporting will go into these issues of granularity in more detail and provide justification for the level of granularity in each market.
Consultation details8.1 The Director seeks the views of interested parties on the analysis and proposals contained in this consultation document. The Director will then publish a statement setting out his conclusions. 8.2 With reference to regulation 6(6) of the Regulations, a consultation period of six weeks has been permitted for Representations. Representations must arrive at Oftel no later than close of business on 30 May 2003. Representations received after this time will not be taken into account, and no extensions of the deadline will be permitted. 8.3 Where possible, comments should be made in writing and sent by e-mail to mike.galvin@oftel.gov.uk. However, copies may also be posted or faxed to the address below. If any stakeholders are unable to supply their comments in one of these ways, please use the contact details below to discuss alternatives. Mike Galvin Tel: 020 7634 8869Fax: 020 7634 8847 8.4 Confidential responses should not be sent via the Internet. Responses will be published on Oftel's website in the Publications section under Responses to Oftel consultations except where respondents indicate that the response, or part of it, is confidential. Appointments to view written comments in Oftel's Research and Information Unit must be made in advance (see contact details below). Respondents are therefore asked to separate out any confidential material into a clearly marked annex. In the interests of transparency, respondents are requested to avoid confidential markings wherever possible. 8.5 On this occasion, the Director is not inviting stakeholders to comment on the representations made by others. Further copies of this document 8.6 This document can be viewed on Oftel’s website, www.oftel.gov.uk. Paper copies and more accessible formats such as large print, Braille, disc and audio cassette can be made available on request. Please contact Oftel’s Research and Information Unit by telephoning 020 7634 8761 or by sending an e-mail to infocent@oftel.gov.uk. E-mail notifications 8.7 Oftel has a free e-mail based mailing list to help people stay informed about the work that Oftel is doing. Each time an Oftel document is published and placed on Oftel’s website at www.oftel.gov.uk, subscribers to the list receive an e-mail alert. To register, please go to the What’s New section of the website and access the electronic form.
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