Chapter 3

Assessment of market power

Market power assessment

3.1 Under the new Directives SMP has been newly defined so that it is equivalent to the competition law concept of dominance. Article 14(2) of the Framework Directive provides:

3.2 SMP may be held by only one company in the market (single dominance) or by more than one company (collective dominance). In assessing whether SMP exists, this review takes account of the European Commission and Oftel SMP Guidelines referred to in Chapter 1.

The relationship between the market reviews and Competition Act 1998 and Enterprise Act 2002 investigations

3.3 The economic analysis carried out in this consultation document is for the purposes of determining whether an undertaking or undertakings have SMP in relation to this market review. It is without prejudice to any economic analysis that may be carried out in relation to any investigation or decision pursuant to the Competition Act 1998 or the Enterprise Act 2002.

3.4 The fact that economic analysis carried out for a market review is without prejudice to future competition law investigations and decisions is recognised in Article 15(1) of the Framework Directive which provides that:

3.5 This intention is further evidenced in the European Commission’s SMP guidelines, which state:

• Paragraph 25 "… Article 15(1) of the Framework Directive makes clear that the market to be defined by NRAs for the purpose of ex ante regulation are without prejudice to those defined by NRAs and by the Commission in the exercise of their respective powers under competition law in specific cases." (This is repeated in paragraph 37).
• Paragraph 27: "…Although NRAs and competition authorities, when examining the same issues in the same circumstances and with the same objectives, should in principle reach the same conclusions, it cannot be excluded that, given the differences outlined above, and in particular the broader focus of the NRAs’ assessment, markets defined for the purposes of competition law and markets defined for the purpose of sector-specific regulation may not always be identical".
• Paragraph 28: "…market definitions under the new regulatory framework, even in similar areas, may in some cases, be different from those markets defined by competition authorities."

3.6 In addition, it is up to all operators to ensure that they comply with their legal obligations under all the laws applicable to the carrying out of their businesses. It is incumbent upon all operators to keep abreast of changes in the markets in which they operate, and in their position in such markets, which may result in legal obligations under the Competition Act 1998 or Enterprise Act 2002 applying to their conduct.

Criteria for assessing significant market power

3.7 Oftel proposes that the following criteria are used to assess whether any provider has SMP in wholesale international services markets on any particular route. The groupings of criteria have been devised by the Director, but the criteria themselves are taken from the EU Guidelines.

• firm related criteria:
• economies of scale;
• vertical integration; and
• access to capital markets and financial resources
• customer related criteria:
• countervailing buying power
• market entry related criteria
• ease of market entry
• quantitative information criteria:
• market shares; and
• excess pricing

Discussion of SMP criteria

Firm related criteria

Economies of scale

3.8 The Director considers that the total traffic volume carried by wholesale international services operators over all of their wholesale international services markets is likely to have a significant effect on operators’ costs. Where a provider has either large overall traffic volumes or carries traffic on a large number of wholesale international services markets, it is likely to enjoy significant economies of scale, enabling large-scale operators to operate at low average cost. Sources of such economies of scale in these markets include the cost of cable capacity, which in many cases will be uneconomic for small operators. The ownership of cable landing stations in the UK is similarly restricted to the largest international operators (mainly BT and C&W).

3.9 The Director has received representations from one wholesale international services provider that on certain international services routes suggest that the provision of wholesale international services may in certain cases by characterised by a type of diseconomy of scale. This may be the case (under the accounting rate system), in markets where transmission capacity is limited, and average costs may increase with volumes of outbound traffic, as inbound traffic becomes displaced by outbound traffic to some extent. The Director has been given little evidence to support this, and believes that this situation can only exist in a very small number of markets (e.g. ones where either the accounting rate is such as to discourage a provider from competing for outbound traffic, or where satellite conveyance is required).

3.10 More fundamentally, the Director considers that this situation, which exists due to the accounting rate regime, relates to the opportunity costs involved in the provision of wholesale international services, rather than to any lack of economies of scale.

3.11 In the light of the above arguments, the Director considers that operators carrying large volumes of traffic receive an overall net benefit as a result of overall economies of scale, and he has taken this benefit into account when considering the extent of competition on all wholesale international services routes.

Vertical integration

3.12 The Director believes that the wholesale international services operators that are also active in the retail market are in a stronger position than standalone wholesale operators, since such wholesale operators effectively benefit from economies of scope. This is because a vertically integrated service provider is able to benefit from a guaranteed wholesale revenue stream (from its retail business), together with the ability to manage its wholesale business more efficiently as a result of information and analysis received from its retail business. The Director has taken this factor into account when considering competition on wholesale international services routes.

Access to capital markets

3.13 The major operators in the wholesale international services markets are all relatively well established companies that have access to considerable resources. However, BT's larger overall size and relatively strong balance sheet may give it some advantage when it comes to funding. Significantly, the majority of BT’s competitors have recently faced financial pressures that have, to varying degrees, placed a constraint on their ability to make investments.

Customer related criteria

Absence of or low countervailing buyer power

3.14 The existence of customers with a strong negotiating position, which is exercised to produce a significant impact on competition, will tend to restrict the ability of providers to act independently of their customers.

3.15 Such power is more likely where a customer accounts for a large proportion of the producer’s total output, is well-informed about alternative sources of supply, is able to switch to other suppliers readily at little cost to itself, and where it may even be able to begin producing the relevant product itself.

3.16 As indicated above, the major operators in the wholesale international services markets tend to be one of a relatively small group of well established wholesale operators. Some of these (for example, C&W) are also large originators of traffic so they will therefore have a high level of knowledge of the costs of the services involved. Additionally, certain operators, notably C&W and WorldCom, have the capability to meet much of their wholesale international services requirements using in-house supplies.

3.17 The Director has taken the above factors into account in his assessment of market power. However, the Director considers that countervailing buyer power is unlikely to be of much significance or routes with very low volumes and revenues. In these cases, the costs of establishing alternative sources of supply are likely to be greater relative to the benefits than on routes with large volumes of traffic. For this reason, and in the light of the analysis of route characteristics below, the Director considers that countervailing buyer power is of limited importance in his assessment of market power.

Market entry related criteria

Ease of market entry

3.18 The Director has identified a number of barriers to entry that are relevant to wholesale international services markets. These are discussed in turn below.

Correspondent Agreements

3.19 Wholesale international services operators negotiate a "correspondent" agreement with an operator (or more than one operators) in the destination country for all markets on which they have a direct wholesale route (i.e. via direct conveyance). Such an agreement between a UK provider and an operator in the destination country is usually called a "bilateral agreement". The ability (or otherwise) to negotiate a bilateral agreement on fair and reasonable terms may represent a barrier to entry on certain routes, as is described below.

WTO Membership

3.20 The World Trade Organisation ("WTO") is the global international organisation dealing with the rules of trade between nations. At its heart are the WTO agreements, the legal ground-rules for international commerce and for trade policy.

3.21 The agreements have three main objectives: to help trade flow as freely as possible, to achieve further liberalisation gradually through negotiation, and to set up an impartial means of settling disputes.

3.22 A number of simple, fundamental principles run throughout all the WTO agreements. They are the foundation of the multilateral trading system. They include non-discrimination, freer trade, predictable policies, encouraging competition, and extra provisions for less developed countries.

3.23 By 1 January 2002 the WTO had 144 members.

3.24 WTO agreements deal with a variety of different goods and services. The Fourth Protocol of General Agreement on Trade and Services ("GATTS")("the Fourth Protocol") sets out a "basic telecommunications agreement". The basic telecommunications agreement sets up reference offers and WTO members offer a degree of commitment to those reference offers.

3.25 The reference offers require that, within a specified time-period, signatories have:

• a privatised incumbent operator;
• an independent regulator;
• a developed telecommunications legal framework (including obligations such as accounting separation and non-discrimination); and
• liberalised national and international markets.

3.26 Of the 144 members of the WTO, 100 members have given commitments in relation to telecommunications services under the Fourth Protocol. Once commitments have been made, a country has a maximum of five years to implement those commitments.

Destination liberalisation

3.27 The extent to which the need for a correspondent agreement will provide a barrier to entry depends on the degree to which the market in the destination country has liberalised the provision of international facilities. This is because non-liberalised markets do not provide a level playing field that ensures that new operators have the opportunity to enter the market.

3.28 This is because in non-liberalised markets:

• there may be only one operator in the destination countries which is able or allowed to terminate inbound international traffic;
• the incumbent operator in the destination country may have an exclusive or preferential agreement with one (or a very limited number of) UK operator(s); or
• the destination country may prohibit certain alternative methods of carriage which, in a liberalised market, would allow a provider to send international traffic to the destination country and aide competition (such as refile and international bypass via VoIP).

3.29 The Director has taken the following factors into account whilst assessing the extent to which destination telecommunications markets are liberalised for the purposes of this market review:

• WTO membership and commitments under the Fourth Protocol; and
• other evidence available to the Director as to the status of destination markets, including studies of competitive conditions in foreign jurisdictions

Competing operators

3.30 As discussed above, the need for a wholesale provider to negotiate a correspondent or bilateral agreement with an operator in the destination country acts as a barrier to entry and may have a significant impact on competition. Without such an agreement, wholesale providers must either rely on a competing UK provider to convey their traffic via its bilateral agreement or may be able to carry its traffic via an alternative conveyance method. In either case, such conveyance methods may not be as cost-effective as it having its own bilateral agreement.

3.31 Where a single UK provider has a correspondent agreement in a particular market, the Director believes that special consideration must be given to the reasons for the lack of competition on that route and the effect (if any) of that lack of competition.

3.32 As discussed in paragraph 2.71 above, the Director accepts that in certain circumstances wholesale international traffic may be conveyed by methods other than via direct conveyance over bilateral routes (such methods are described in paragraphs 1.64 – 1.77 above). However as stated, the Director has not received sufficient evidence that would enable him to quantify this traffic. He believes that the work required, by the operators and Oftel, to obtain such evidence would not be proportionate to any benefit to consumers that would result from the collection of such data.

3.33 Accordingly where a route is subject to asymmetric international accounting rates or significantly imbalanced inbound traffic flows, or where historical market share figures, or traffic and price volatility suggests the operation of hubbing on that route, the Director has taken this into consideration whilst reviewing that market and the effect that hubbing may have as a price constraint on operators and the effect it has (if any) on competition in that market. The Director has given hubbing particular consideration on routes where a single UK provider is offering international services or where his determination regarding the existence of competition is marginal.

Quantitative information

3.34 The Director has been supplied with a large volume of quantitative data relating to the markets for wholesale international services by both BT and other operators. In particular, he has analysed the following:

• market share data on a route by route basis; and
• trends in BT’s charges on a route by route basis

3.35 However the data supplied has not been of consistent quality. In practice, the Director’s analysis has principally focused on barriers to entry. This is because of the importance of these in markets for wholesale international services, and of the ready availability of information relating to these on a route by route basis. Market share data, to the extent that it has been available on a route by route basis, has been used to supplement information on barriers to entry and to improve the Director’s understanding of conditions in non-liberalised markets.

Initial conclusions on significant market power

3.36 The Director’s most recent previous review of international markets was conducted in November 2001. That review determined that competition in wholesale international services markets had been increasing. This was due in part to an increasing number of wholesale international services markets being liberalised at the far end, notably due to market liberalisation in an increasing number of countries. A number of markets were therefore added to the group of markets on which the Director believed that competition was effective. Following the relaxation of regulation, the Director observed that BT’s charges had not increased significantly in these markets.

3.37 The Director continues to be conscious of a need to ensure that that regulation is proportionate and that no more controls are put in place than are necessary due to the absence of competition. Such controls may inhibit the ability of wholesale providers to compete fully in the markets for the provision of wholesale international services, since, for example, the fact that other operators can act as price followers may dampen competition in such a case.

3.38 The Director’s current review suggests that the level of competition in a number of markets continues to increase. He is satisfied that, in many cases, the availability of alternative methods of carriage, notably refile, ISVR and VoIP, has allowed the wholesale international services markets to liberalised destinations to become increasingly competitive. Accordingly, having reviewed market conditions in all of the wholesale international services markets, the Director considers that wholesale international services to liberalised routes are effectively competitive and should not be subject to regulatory controls.

3.39 In those markets where the destination country has yet to liberalise its telecommunications market, the Director’s initial view is that, as described in paragraph 3.28 substantial barriers to entry at the wholesale level are likely to persist. In such cases he has therefore assessed competitive conditions on each route according to other indicators of the level competition. However, in all markets where the destination country has been liberalised, the Director has determined that the availability of alternative routings (most notably hubbing, and also others such as ISR) mean that barriers to entry are at such a low level that those markets are effectively competitive.

3.40 In non-liberalised markets in which only a single wholesale international services provider has negotiated a correspondent agreement with an operator in the destination country of any route, it appears clear to the Director that the likelihood of competition at the wholesale level being effective is low. In such markets, the operator that has negotiated the agreement will be in a position to price irrespective of the actions of competing operators. Accordingly the Director considers those operators to be in a position of dominance within the wholesale international services market.

3.41 In those markets in which no UK international provider has negotiated a correspondent agreement, the Director considers that BT is in a position of dominance. This is because BT’s legacy position as a vertically integrated monopolist means that it has existing relationships with a large number of operators in other countries. The Director considers that these factors mean that BT is in a far stronger position to negotiate arrangements for the conveyance of its traffic in these markets than other wholesale international services providers.

3.42 In those non-liberalised markets in which two or more wholesale operators have correspondent agreements, but where the destination telecommunications market is not liberalised, the Director has considered market share and pricing data supplied to him by wholesale international services providers. In those markets in which a single provider enjoys a very high market share, the Director considers that this implies market power on the part of that provider. In those markets on which market shares are moderately high, and on which wholesale price levels have been static or increasing in the past two years, the Director has similarly inferred that a position of market power is enjoyed by the relevant provider. In remaining markets, the Director proposes to determine that competition is effective.

3.43 Relying on the methodology set out above, the Director’s initial conclusion is that of the 242 wholesale international services markets that have been considered under this market review, he now considers 117 of these to be competitive and 125 are not competitive and have a provider which is dominant in that market.

3.44 Despite the relatively large number of markets which continue to be considered as not competitive under the Director’s proposal, these routes constitute a very small proportion of the total wholesale international services traffic. This proposal would result in more than 95% of the total wholesale international service traffic being within markets which the Director considers competitive.

3.45 Accordingly the Director proposes that :

• BT plc has SMP in 121 of those markets; and
• Cable and Wireless plc has SMP in 4 of those markets.

3.46 In each of the markets where the Director proposes that BT or C&W has SMP, then, as set out in the table below, he believes that BT or C&W enjoys a position of economic strength that affords it the power to behave, to an appreciable extent, independently of competitors, customers, and, ultimately, consumers. Such positions have been identified by reference to the criteria discussed above and listed in the table below.

Assessment of SMP against relevant criteria

3.47 The Director has considered the relevant criteria set out above in relation to each of the wholesale international service markets. A summary of his initial findings in relation to each of those markets is set out below together with indicators of some of the criteria considered.

3.48 Those factors that are relevant to all wholesale international services markets, such as firm related and customer related criteria, have been considered in relation to each operator and applied across all markets. The Director’s assessment, based on market specific factors, i.e. market entry related criteria (WTO membership/destination liberalisation, number of operators) and quantitative information (market shares, price trends) have been set in the table below.

3.49 Due to the commercial confidentiality of providers that have submitted data for the purposes of this review, the Director is unable to include quantitative data that has been used to in his SMP analysis.

Table 1 – Route analysis

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Chapter 4

Options for wholesale international services remedies

Introduction

4.1 In Chapter 3, the Director has proposed that BT and C&W have SMP in certain wholesale international services markets (i.e. that they are dominant providers). This chapter therefore considers the remedies that are appropriate to those markets.

4.2 Clause 83(1) of the Communications Bill provides that where the Director has made a determination that a person is dominant in the market reviewed, he shall set such SMP conditions as he considers appropriate and as are authorised in the Bill. This implements Article 8 of the Access Directive.

4.3 The SMP conditions relevant to this review which may be set are detailed in Clause 83 of the Bill and Articles 9 to13 of the Access Directive: They are:

a. the provision of network access:
b. no undue discrimination;
c. transparency;
d. cost accounting and accounting separation;
e. charging, including, in particular, charge controls.

What are the options for regulation?

4.4 Clause 83(1) of the Communications Bill says that where SMP is found, Ofcom "shall...set conditions...as they consider appropriate". This implements Article 8 of the Access Directive. The European Commission’s guidelines on market analysis and SMP state that this means that Ofcom (or Oftel in the interim period) must impose one or more SMP conditions on a dominant provider.

4.5 The Director has set out his intention to consider the appropriateness of SMP conditions in his regulatory option appraisal guidelines. The Director also notes Recital 27 of the Framework Directive that provides that sectoral regulation should only be imposed where effective competition does not exist and where competition law remedies are not sufficient to address the problem. The Director has considered this Recital as part of his assessment as to the appropriateness of SMP conditions – i.e.: a situation whereby no regulation was imposed and whether it would be sufficient to rely on competition law alone.

Aims of regulation

4.6 If the Director reaches the conclusion that BT and C&W have SMP in the wholesale international services markets referred to in Chapter 3, in reference to Clause 4 of the Communications Bill, the aims of regulation considered would be, amongst other things, to promote competition in this market and to prevent market power in these markets being used to distort competition in downstream retail international services markets.

What are the options for regulation?

4.7 The Director has considered four different options for regulation in wholesale international services markets, varying from no specific sectoral regulation at all to a similar level of regulation to that which is currently in place in relation to wholesale international services markets which are currently designated prospectively competitive.

4.8 It is important to stress that these remedies would only apply in relation to particular wholesale international services markets in which a provider or providers have been determined to have SMP in a specified market. Accordingly it follows that a particular provider may be determined to have SMP in one or more of the wholesale international services markets but not have SMP in all of the markets and that overall more than one provider may be determined to have SMP within the group of 244 wholesale international services markets.

4.9 The five options for wholesale international services remedies are set out in the following table:

4.10 The following tables summarises each of these remedies:

4.11 Any SMP conditions to be imposed must comply with the provisions of clauses 41 to 46 and 74 to 85 of the Communications Bill as applicable. The Director must also bear in mind the duties set out in clause 4 of the Communications Bill.

4.12 In particular, each SMP condition must pass the test set out in clause 43 of the Communications Bill, namely that each condition must be:

a. objectively justifiable in relation to the networks, services or facilities to which it relates;
b. not such as to discriminate unduly against particular persons or a particular description of persons;
c. proportionate to what the condition is intended to achieve; and
d. in relation to what it is intended to achieve, transparent.

Each of the possible options for regulation, set out in paragraph 4.10 above, are discussed below.

Option 1 – No sectoral regulation

4.13 Without any sectoral regulation in relation to the wholesale international services market, the Director would rely on his relevant powers in order address any failures of competition.

Benefits and advantages

4.14 Having no sectoral regulation theoretically reduces the regulatory burden on both dominant providers and on Oftel. Having no requirement to provide network access additionally removes a small regulatory and commercial burden on the dominant providers.

Costs and disadvantages

4.15 The absence of a requirement to provide network access means that the dominant provider could refuse reasonable requests for access or provide access on unreasonable terms. In order to compete fairly at the retail level, retail providers must be able to wholesale inputs in order to convey traffic to all countries. The inability of retail providers to offer retail services to all countries or the ability of retail providers to offer retail services but relying on unreasonable terms and/or unreasonable charges, would be a significant impact on the retail international services market. Additionally a vertically integrated wholesale provider would be better placed to exploit its position in the wholesale market in order to distort the retail market.

4.16 The absence of a requirement not to unduly discriminate again gives a vertically integrated provider the ability to distort the retail market by offering different terms, conditions and prices to its retail competitors in wholesale markets where it is the dominant provider. Such behaviour would lead to a reduction of retail competition on retail routes which correspond to the wholesale markets where there is dominance.

4.17 The absence of a requirement to publish a reference offer or the publication of charges increases the possibility of disputes and that lack of transparency, both in relation to the wholesale provider’s retail business and other retail providers is likely to lead to an increased number of complaints being made to Oftel against dominant providers.

4.18 In principle, it might be possible to address some of these issues under general competition law, but in the Director’s view this is likely to be less certain and less effective than a sectoral approach. Even if the Director were not under an obligation to impose one or more SMP conditional, the Director would not be inclined towards option 1. Taking into account the various costs and disadvantages of this option, this option may lead to greater uncertainty and a greater regulatory burden as well as disadvantaging end-users due to increased competition complaints.

Option 2 – Network access, non-discrimination and reference offer

4.19 The draft conditions relating to this option are: Conditions KA1, KA2 and KA3 in relation to BT and Conditions KB1, KB2, and KB3 in relation to C&W, as set out in Annex A.

4.20 The proposed condition to provide network access on fair and reasonable terms would require dominant providers to satisfy all reasonable requests for network access on fair, reasonable and timely terms. The respective draft conditions are set out in conditions KA1 and KB1 in Annex A.

4.21 The proposed non-discrimination condition sets out that there should be no undue discrimination. The Director has considered how he might treat undue discrimination in his Statement Imposing access obligations under the new EU Directives September 2002 ("the Access Guidelines"). This Statement notes that any obligation with respect to undue discrimination does not mean that there should not be any differences in treatment between undertakings, rather that any differences should be objectively justifiable, for example, that there are differences in underlying costs of supplying different undertakings. It does however, also note that there is a rebuttable presumption that a vertically integrated dominant provider discriminating in favour of its own retail business would have a material adverse effect on competition (paragraph 3.9 of the Access Guidelines). The respective draft conditions are set out in conditions KA2 and KB2 in Annex A.

4.22 The proposed reference offer condition would require the dominant provider to publish a Reference Offer (RO) which includes, amongst other things:

• a clear description of the network access to be provided;

• terms and conditions including charges, technical information and ordering and provisioning procedures; and

• service level details.

4.23 Details of what should be published in the Reference Offer are set out in the draft Condition KA3 and KB3 in Annex A.

Benefits and advantages

4.24 The requirement to provide network access on fair and reasonable terms ensures that retail providers are able to offer calls in the corresponding downstream retail market.

4.25 In the absence of such a requirement the dominant provider may refuse reasonable requests for access or provide access on unreasonable terms. As it is difficult or impossible for retail providers to obtain a wholesale input in relation to these markets from another wholesale provider, those retail providers would be unable to offer a retail product on these retail routes. If retail providers are unable to offer an overall retail product on all retail routes, it is likely that there would be a significant impact on the retail international services markets.

4.26 The benefit of the requirement not to unduly discriminate is that competing providers purchasing network access are placed in an equivalent position to the dominant provider's own retail businesses, for example BT Retail, and would therefore be better able to compete with them. Both proposed dominant providers are vertically integrated and in the absence of such a condition, the dominant providers may have an incentive to provide network access on terms and conditions that discriminate in favour of their own businesses, in a way that would have a material adverse effect on competition. In particular, dominant providers may have incentives to charge competing providers more for network access to increase the costs of competing providers and give their own retail businesses unfair competitive advantages. Dominant providers might also provide services on different terms and conditions which would disadvantage their retail competitors and hence consumers.

4.27 A requirement on dominant providers to publish a reference offer has two main benefits: to assist transparency for the checking of potential anti-competitive behaviour and to give visibility to the terms and conditions on which other providers are able to purchase network access. This helps to ensure stability in markets and without it, incentives to invest might be undermined and market entry made less likely.

4.28 The publishing of a RO will potentially allow for speedier negotiations, avoid possible disputes and give confidence to those purchasing network access services that they are being provided such access on transparent and non-discriminatory terms. Without such a published offer, market entry might be deterred to the detriment of the long-term development of competition and hence consumers.

4.29 This option seems unlikely to place a significant regulatory burden on dominant providers. However in relation to BT, this option will be less of a regulatory burden than under the existing regulatory regime.

4.30 In principle, it might be possible to address some of these issues under general competition law. However, as under option 1 the Director considers that this would be more uncertain and less effective than a sectoral approach. This would be less beneficial to the promotion of competition and the interests of end-users.

Costs and disadvantages

4.31 Publication of charges has some disadvantages, particularly in markets where there is some competition as it can act as a disincentive to compete. Competitors can merely observe the published charges of the dominant provider and relate their charges to those of the dominant provider. However, the Director does not consider this disadvantage to be major given that there is little or no competition in these markets.

Option 3 – Option 2 plus prior charge publication

4.32 This option is identical to option 2 with the addition of a requirement to notify charges.

4.33 The draft conditions relating to this option are: Conditions KA1, KA2, KA3 and KA4 in relation to BT and Conditions KB1, KB2, KB3 and KB4 in relation to C&W, as set out in Annex A.

4.34 The proposed charge notification condition requires the dominant provider to publish any changes to its charges for the provision of network access 28 days in advance. The Director's view is that a notification period of 28 days is appropriate where a particular market is not effectively competitive. The respective draft conditions are set out in conditions KA4 and KB4 in Annex A.

Benefits and advantages

4.35 Publication of charges at the wholesale level gives advanced warning of charge changes to competing providers purchasing network access. This is important to ensure that competing providers have sufficient time to plan for such changes, as they are likely to want to restructure retail prices in response to changes in wholesale charges. This helps to ensure stability in markets and without it, incentives to invest might be undermined and market entry made less likely.

4.36 Wholesale international services markets that the Director has proposed in Chapter 3 as not being effectively competitive have low traffic volumes. Although there is the possibility that a new entrant wholesale provider may appear, the Director sees no evidence that this is likely on any short to medium term time scale. For the time being, retail providers are therefore compelled to obtain wholesale inputs for those markets from the dominant provider. Accordingly retail providers which are reliant on a dominant provider for a wholesale input to their retail product require advance notification of charge changes so as to be able to price their retail product and to compete effectively in the retail market, thus increasing competition and benefiting consumers.

4.37 This option seems unlikely to place a major regulatory burden on dominant providers although the Director recognises that there will be some constraint on their freedom to change prices.

Costs and disadvantages

4.38 As stated above publication of charges has some disadvantages, particularly in markets where there is some competition as it can act as a disincentive to competition. Competitors can merely observe the published charges of the dominant provider and relate their charges to those of the dominant provider. Advance notification of charge changes can increase the anti-competitive effect of charge publication, because competitors have more warning of changes in the dominant provider’s charges and therefore have longer to match their own charges to those of the dominant provider. However in markets where there is currently very little evidence of competition and little likelihood of significant market entry, these disadvantages are not likely to be pronounced.

Option 4 – Option 2 plus safeguard charge cap

4.39 This option is identical to option 2 with the addition of a safeguard charge cap requirement.

4.40 The draft conditions relating to this option are: Conditions KA1, KA2 and KA3 in relation to BT and Conditions KB1, KB2 and KB3 in relation to C&W, as set out in Annex A. Draft conditions relating to the safeguard charge cap have not been set out in this consultation document.

4.41 A safeguard charge cap condition would prohibit a dominant provider from increasing its charges each year for its network costs for services within each wholesale international services market by an amount which is greater than the change in the Retail Prices Index for the preceding year. For the avoidance of doubt, "network costs" referred to above are the provider’s costs minus the outpayment paid to the operator in the destination country.

Benefits and advantages

4.42 A safeguard charge cap would ensure that, where there is little competition for a particular service, the dominant provider cannot increase the charges by an amount which is greater than an amount which relates to the change in general price levels in the economy. Therefore a safeguard charge cap protects against excessive charging.

Costs and disadvantages

4.43 A relatively small proportion of the total traffic on all wholesale international services markets would be subject to the charge cap. The Director considers that the regulatory cost of compliance with the charge cap would be proportionately high in comparison to the benefits to retail providers and, in turn, consumers.

4.44 Accordingly the Director’s initial view is that in relation to wholesale international services a safeguard charge cap would impose a disproportionate regulatory burden on dominant providers. As discussed below, the Director considers that the combination of charge publication, plus the capacity of the Director to intervene if evidence of excessive pricing emerges, should be sufficient protection for customers of dominant providers and end-users.

Option 5 – Option 4 plus prior charge publication

4.45 This option is identical to option 4 with the addition of a requirement to notify charges.

4.46 The draft conditions relating to this option are: Conditions KA1, KA2, KA3 and KA4 in relation to BT and Conditions KB1, KB2, KB3 and KB4 in relation to C&W, as set out in Annex A. Draft conditions relating to the safeguard charge cap have not been set out in this consultation document.

4.47 A charge notification condition together with a safeguard charge cap condition would require a dominant provider to publish its charges 28 days prior to any change in those charges and any such change would have to be within the safeguard charge cap (as set out in paragraph 4.41 above).

Benefits and advantages

4.48 A charge notification condition and safeguard charge cap would give a slight benefit to a purchaser of network access as it would again ensure that retail service providers which rely on this wholesale input can react to a change in wholesale charges as explained above.

Costs and disadvantages

4.49 As stated in paragraph 4.43 above, the Director’s initial view is that in relation to wholesale international services a safeguard charge cap imposes a disproportionate regulatory burden on dominant providers and on Oftel in ensuring that providers comply with the charge cap. An additional prior charge notification condition would further increase this regulatory burden, though not by a significant amount. Consistent with the Director’s initial view on a safeguard charge cap, he believes that this option would place a disproportionate regulatory burden on dominant providers.

Other options for regulation

4.50 BT has suggested that one option for regulation would be to allow dominant providers to set and publish a maximum charge for each non-competitive wholesale international services market. Such markets would not be subject to a no undue discrimination obligation and dominant providers would be entitled to negotiate charges with other providers (presumably including their own retail business) which are below that maximum charge.

4.51 A dominant provider would still be subject to prohibitions under competition law powers were there to be any attempt to distort competition.

4.52 The Director considers that such regulation could allow a dominant provider to discriminate in favour of its retail business. Without a sectoral prohibition on undue discrimination, it could be more difficult to ensure that discrimination did not have a potential material adverse effect on competition.

4.53 Whilst the Director accepts that he would be able to rely on his relevant powers in order to control distortions of the retail market as a result, he believes that such regulations would make it extremely difficult to readily observe evidence of a breach of competition law and that the scope for an abuse of this arrangement is too great.

Initial conclusions

4.54 The Director's initial conclusion is that Option 3 is the preferred option for regulation if he concludes that a provider has SMP in any of the wholesale international services markets. Although this option imposes some regulatory costs on dominant providers, the limited retail traffic in these markets and consequently the limited demand for network access in the corresponding wholesale markets, suggests that there may be limited scope for competition to develop at the network level in the short term. Further, the likely impact at the retail level of a retail provider being unable to offer a comprehensive range of international routes to its customers means that a dominant provider could abuse its dominance in the corresponding wholesale markets. Hence the Director considers that the proposed requirement on the respective dominant provider to meet reasonable requests for access is a proportionate response to address the problem of lack of competition in the wholesale markets proposed in Chapter 3. In order to ensure retail competition on these routes is possible, the Director considers that it is important that competing retail providers can obtain network access so as to offer a full service retail product on terms that are reasonable and enable them to compete in the retail market.

4.55 The Director considers that Option 3 meets the tests set out in Clause 43(2) of the Communications Bill.

4.56 The Director considers that the proposed condition to provide network access (conditions KA1 and KB1) is objectively justifiable as it ensures that retail providers can offer a full service retail product to their customers on routes where there is limited or no competition in the corresponding wholesale market. It is proportionate, since it does not require a dominant provider to provide access if a request for access is not reasonable. The Director has set out how he might assess whether demands for access are reasonable in his Statement Imposing access obligations under the new EU Directives (the "Access Guidelines"). The Director has identified the requirement for network access and the draft conditions are considered to address this requirement. Accordingly the proposed obligation therefore meets the requirement of transparency set out in the Communications Bill. In addition, the Director has taken into account the factors set out in Clause 83. In particular, the requirement to only meet reasonable requests for access ensures that the requested access is feasible to provide. The proposed condition is non-discriminatory because it is imposed equally on all dominant providers.

4.57 The Director considers that the proposed condition not to unduly discriminate (conditions KA2 and KB2) is objectively justifiable, in that it provides safeguards to ensure that competitors, and hence consumers, are not disadvantaged by a dominant provider discriminating in favour of its own retail business or other retail providers. It is proportionate in that discrimination is only considered undue if it has a material adverse effect on competition. Discrimination may be objectively justified under certain circumstances. The requirement for the proposed condition is transparent as is the precise nature of the condition and the intention of the condition is clear from the proposed text of the condition and this consultation document. The proposed condition itself is non-discriminatory because it is imposed equally on all proposed dominant providers.

4.58 In relation to BT, the Director considers that the proposed condition to publish a reference offer (condition KA3) is objectively justifiable in so far as it provides information to prospective market entrants in order to encourage competition in markets that are not effectively competitive. It is proportionate, in that it is intended to replicate conditions in competitive markets and does not impose regulation in addition to what might be expected in a competitive market. The requirement for the proposed condition is transparent as is the precise nature of the condition, and the intention of the condition is clear from the proposed text of the condition and this consultation document. It is non-discriminatory because it is imposed on all proposed dominant providers.

4.59 In relation to C&W, the Director considers that the proposed condition to publish a reference offer (condition KB3) is objectively justifiable in so far as it provides information to prospective market entrants in order to encourage competition in markets that are not effectively competitive. It is proportionate to the extent that it is intended to replicate conditions in competitive markets and does not impose regulation in addition to what might be expected in a competitive market. However the Director is conscious that the regulatory cost of producing a maintaining a reference offer for wholesale international services is essentially a fixed cost regardless of the number of individual markets in which a dominant provider is determined to be dominant. Whereas the Director’s initial view is that it is proportionate for BT to produce a reference offer in relation to the 121 markets for which it has SMP, the Director’s initial view is that it would not be proportionate for C&W to be subject to the same obligation. The Director wishes to ensure balance between non-discrimination and proportionality in the obligations he imposes. Accordingly the Director proposes to impose the condition to publish a reference offer (condition KB3) on C&W but shall issue a direction that for the time-being C&W shall not be obliged to comply with that condition. If the Director considers that the disapplication of this condition is distorting competition, the Director shall revoke this direction. Therefore, despite being disapplied for the time-being in relation to C&W, this condition is non-discriminatory as it is imposed on all proposed dominant providers.

4.60 The Director considers that the proposed condition to publish charges (conditions KA4 and KB4) is objectively justifiable, in that the benefits of charge publication and notification outweigh the disadvantages. It is proportionate, as it does not require publication of any details that would not be available in a normal commercial contract and is unlikely to impose a great burden on dominant providers. The requirement for the proposed condition is transparent as is the precise nature of the condition, and the intention of the condition is clear from the proposed text of the condition and this consultation document. It is non-discriminatory because it is imposed equally on all proposed dominant providers.

4.61 Overall, the Director considers that Option 3 enables him to meet his duties as set out in Clause 4 of the Communications Bill. In particular it aims to promote competition and ensure a level playing field in the market for international services at the retail level.

4.62 The Director's initial view is that to impose no sectoral regulation on the wholesale international services market, as considered in option 1, would present a considerable risk of distortion in the retail international services market. Retail providers might be prevented from offering a comprehensive retail service to its customers which enabled such customers to access all retail routes at a reasonable price. In such circumstances, there is a very real risk that a vertically integrated provider would be able to exploit its dominance in the wholesale market and distort the retail market. Accordingly the Director does not consider this option to be appropriate.

4.63 The Director's initial view is that the additional safeguard charge cap condition included in option 4 would not currently be proportionate in relation to wholesale international services. The Director proposes to continue to monitor charging in wholesale international services markets. If his decision to not impose a safeguard charge cap leads to dominant providers excessively charging, he will review the relevant market(s) and will consider the introduction of the safeguard charge cap, or action using other powers (for example, the Competition Act).

4.64 The Director's initial view is that option 5, which imposes greater regulatory controls than option 4 also would not currently be proportionate in relation to wholesale international services for the same reasons as those set out in paragraph 4.63.

4.65 The Director's initial view is that option 2, access, non-discrimination and reference offer obligations only, would not be sufficient for a number of reasons. The markets in which the Director’s initial view is that there is a dominant provider are unlikely to be subject to realistic competition in the short term and therefore retail providers will be heavily reliant on dominant providers for wholesale input. The prior charge notification obligation in option 3 does raise the possibility of charge following which can distort competition. However, the Director considers that the possible detrimental effect from the lack of transparency is greater than the negative effect from charge following. He further considers that in relation to the markets for which he proposes there are dominant providers, competitive pressures are weak and market conditions are not currently conducive to competition, and that there is very little competition in those markets. Therefore the Director considers the negative effects of charge following are less than the potential risks of retail market distortion. Finally as charges for wholesale input to the downstream retail product will directly affect the price which the retail provider can charge for that retail product, a prior charge notification obligation ensures that the retail provider has sufficient time to reflect any increased costs in its retail prices.

4.66 As explained in paragraph 4.57, the Director believes that dominant providers should be prevented from discriminating against competitors of its downstream retail business in terms of the charges for wholesale international services, the terms and conditions on which it is made available, and the quality of service. For the purpose of ensuring that such dominant providers do not discriminate against its retail business’s competitors in terms of price, the Director believes that it is necessary for dominant operators to separately account for their wholesale international and retail international businesses. These accounts will need to show that the vertically integrated retail business pays the same amount for wholesale services as other providers.

4.67 Chapter 5 sets out the Director’s powers to impose accounting separation obligations. The Director intends to publish a separate consultation document in which he will establish all of the accounting requirements that he proposes to impose under the new regime.

Chapter 5

Accounting separation

5.1 This chapter covers financial reporting obligations that may be imposed on dominant providers (the Director proposes that this would be BT and C&W) to ensure that a number of the proposed obligations set out in Chapter 4 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. Specifically, this chapter covers the imposition of obligations for accounting separation.

5.2 The Director is of the view that it is necessary to impose accounting separation obligations on BT for the markets covered in this review. The sub-section below outlines why the accounting separation obligations are required.

5.3 However, the processes of 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 an accounting separation 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 players in the market regarding regulatory financial information requirements.

5.4 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 accounting separation, and also, although not relevant for this review, cost accounting systems. 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. This 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.

Accounting separation

5.5 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.

5.6 In paragraph 4.57, the Director is proposing that BT and C&W should have obligations to not unduly discriminate in the provision of wholesale international 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.

5.7 Given the importance of this issue in ensuring an effectively competitive marketplace in the UK, the Director believes that it is necessary that BT should be obliged to have an accounting separation obligation. This obligation will enable the Director to monitor whether BT is unduly discriminating against or between other providers or not, by making visible the wholesale prices and internal transfer prices of its services. Therefore, the accounting separation obligation for BT will apply to the 123 wholesale international service markets listed in Part 1 of Annex A to this consultation document.

5.8 The Director proposes not to impose an accounting separation obligation on C&W. This is because whereas the Director’s initial view indicates that BT has SMP in 123 wholesale international services markets, his initial indicates that C&W has SMP in only four wholesale international markets. Therefore, while the imposition of an accounting separation obligation to monitor BT’s 123 markets is considered to be proportionate, the Director does not believe that it would be proportionate to impose an accounting separation obligation on C&W for only four markets.

5.9 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 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. Also, by supporting the obligation of non-discrimination, the accounting separation obligation will support effective and sustainable competition, which in turn will benefit customers of communications providers and therefore also citizens of the European Union.

5.10 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 (as described in paragraph 4.57) the imposition of an accounting separation obligation is objectively justifiable. That is, in order to ensure that the obligations to not unduly discriminate are 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 is the only provider of wholesale international services that has SMP in a significant number of wholesale international markets, i.e. 123 markets, compared to the provider with the second largest number of SMP markets, i.e. C&W’s four markets.

5.11 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.

5.12 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.

5.13 In order to ensure that the wholesale international services were not being provided on a basis that was unduly discriminatory, it would be necessary to make visible the wholesale prices and internal transfer prices of the services within each market. It is likely that there would only be two services within each market, i.e. PSTN and ISDN. Additionally, to ensure the appropriate level of outpayment is passed through to third parties and BT's retail activities on an equivalent basis it will be necessary for outpayments to be identified separately. However, the consultation document on financial reporting will go into these issues of granularity in more detail and provided justification for the level of granularity in each market.

Chapter 6

Associated international facilities

6.1 There are a number of associated international facilities that are required for the inland conveyance of traffic by wholesale international services providers in order to provide wholesale international services (and ultimately in order to provide network access to retail providers). These facilities will depend on whether the traffic is being carried via satellite or via submarine cable.

Satellite conveyance

6.2 Where traffic is carried via a satellite routing, the inland conveyance of that traffic to the relevant satellite is relatively simple.

6.3 International traffic is handed over to the wholesale provider at its DISC. The wholesale provider will carry the traffic to its satellite uplink and convey the traffic via its satellite facilities.

Satellite uplinks

6.4 A satellite uplink is the earth station that transmits traffic to the orbiting satellite. Satellite uplinks are general relatively small, moderately expensive and can be located virtually anywhere (in these circumstances generally co-located with the wholesale provider’s DISC).

6.5 The Director does not consider that the network access to satellite uplink facilities would act as a barrier to entry in relation to the provision of wholesale international services.

6.6 The Director has not considered whether there is a market for satellite uplink facilities for wholesale international services. If he received a complaint from a provider regarding access to satellite uplink facilities, he would identify and analyse the relevant market(s) and, if necessary, regulate the market(s) under his relevant powers.

Submarine conveyance

6.7 Where traffic is carried via a submarine routing, the inland conveyance of that traffic to the relevant submarine cable is more complex.

6.8 International traffic is handed over to the wholesale provider at its DISC. The wholesale provider will carry the traffic via international backhaul facilities to the relevant cable landing station, the traffic will then be carried via the submarine cable from that landing station.

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International backhaul

6.9 International backhaul is a high capacity inland circuit that is required by wholesale providers to link a cable landing station to an operator’s existing national network. Prior to December 1996, only CWC and BT supplied backhaul services in the UK.

6.10 Presently any provider with a PTO licence can use elements of their existing network to provide backhaul. Additionally many providers have networks that pass within relatively short distances of cable landing stations. This has resulted in increasing competition in the provision of backhaul services and a distinct market for this service has developed.

6.11 There are now numerous providers of international backhaul services in the UK in competition with BT and C&W (including WorldCom, Energis, ntl, Telia and Surf Telecoms).

6.12 The increased competition in the supply of backhaul services has resulted in significant price reductions. The evidence available to Oftel shows that BT prices its backhaul services keenly and there is no evidence that operators experience any difficulties in obtaining backhaul services.

6.13 The Director does not consider that network access to international backhaul acts as a barrier to entry in relation to the provision of wholesale international services.

6.14 The Director has not reviewed the markets for international backhaul as part of this market review. If he received a complaint from a provider regarding network access to international backhaul, he would expect to identify and analyse the relevant markets and, if necessary, regulate those markets under his relevant powers.

Cable landing stations

6.15 Cable landing stations are the point at which international submarine cables come onshore and terminate. Simply, they are buildings which contain the onshore end of the submarine fibre optic cable, house the necessary equipment to interconnect and pass traffic to and from the submarine cable, and are the point where the submarine cable is connected to the international backhaul circuit.

6.16 Almost all UK cable landing stations are owned by either BT or C&W, the remainder are owned by WorldCom, Global Crossing, Eurotunnel and Farland.

6.17 There is the potential for the owner of a cable landing station to deny access to cable landing stations and thereby prevent competition from new entrants. However presently BT is obliged to meet reasonable requests for cable landing station access on cost-orientated and non-discriminatory terms. C&W is obliged to connect certain providers to its cable landing stations. Additionally agreements between the owners of cable landing stations and the submarine cables will generally oblige the cable landing station owner to provider access to those persons who contract for capacity on the submarine cable.

6.18 The Director is not aware of any provider that has experienced any material difficulty in obtaining network access to cable landing stations. Accordingly, the Director does not consider that the access to cable landing stations acts as a barrier to entry in relation to the provision of wholesale international services.

6.19 The Director has not considered which markets exist in relation to cable landing stations (whether all cable landing stations form one market or whether each is a separate market) nor has the Director reviewed the market or markets for cable landing stations, as part of this market review. If he received a complaint from a provider regarding network access to cable landing stations, he would identify and analyse the relevant markets and, if necessary, regulate those markets under his relevant powers.

Chapter 7

Consultation

7.1 The purpose of this consultation is to seek views on the Director’s assessment of the level of competition in the wholesale international service markets in the UK, and his proposals for regulation to be applied in those markets. The Director will consider all relevant comments before making the final Notification.

7.2 In addition to comments respondents may wish to make on the Director’s proposals, the Director would like respondents’ views on the specific questions raised.

7.3 The Director is publishing the draft Conditions together with this explanatory document so that interested parties may have a reasonable opportunity to make representations. Having considered any such representations, the Director will, if appropriate, adopt Directions as appropriate, and will explain his reasons for making them.

7.4 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.

7.5 Where possible, comments should be made in writing and sent by e-mail to alexander.shepherd@oftel.gov.uk. However, copies may also be posted or faxed to the address below. If any stakeholders are unable to respond in one of these ways, they should discuss alternatives with:

Alexander Shepherd
Oftel
50 Ludgate Hill
London
EC4M 7JJ

tel: 020 7634 8721
fax: 020 7634 8847

Further copies of this document

7.6 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.

Publication of representations made by stakeholders

7.7 On this occasion, the Director is not inviting stakeholders to comment on the representations made by others. However, in the interests of transparency, all representations will be published, except where respondents indicate that a response, or part of it, is confidential. Respondents are therefore asked to separate out any confidential material into a confidential annex which is clearly identified as containing confidential material. Oftel will take steps to protect the confidentiality of all such material from the moment that it is received at Oftel’s offices. In the interests of transparency, respondents should avoid applying confidential markings wherever possible.

7.8 Non-confidential representations can be viewed on Oftel’s website in the Publications section under Responses to Oftel consultations. They can also be viewed at Oftel’s Research and Information Unit. Appointments must be made in advance by telephoning 020 7634 8761 or by sending an e-mail to infocent@oftel.gov.uk.

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