A Direction issued by the Director General of Telecommunications

Contents

Direction

Explanatory Memorandum

Chapter 1 Summary

Chapter 2 Background

Chapter 3 History of the dispute

Chapter 4 Responses to the draft direction

Chapter 5 The Director’s decision and reasons

Annex A Credit terms comparison

DIRECTION UNDER REGULATION 6(6) OF THE TELECOMMUNICATIONS INTERCONNECTION REGULATIONS 1997 RELATING TO A DISPUTE BETWEEN VODAFONE LTD AND BOTH NTL LTD AND MCI WORLDCOM LTD OVER VODAFONE LTD’S CREDIT VETTING CLAUSE

Whereas:

(A) The Secretary of State granted to Vodafone Ltd ("Vodafone") on 9 December 1993 a licence under section 7 of the Telecommunications Act 1984 ("the Act") for the running of telecommunications systems specified in that licence ("the Vodafone Licence");

(B) The Secretary of State has granted to ntl Ltd ("ntl") on 23 June 2000, a licence under section 7 of the Act for the running of telecommunications systems specified in that licence;

(C) The Secretary of State has granted to granted to MFS Communications Limited on 24 September 1993 and to WorldCom International Inc. on 31 March 1994 licences under Section 7 of the Act for the running of telecommunications systems as specified in those licences

(D) Both MFS Communication Limited and Worldcom International Inc. are now part of MCI Worldcom Ltd ("MCI"); 

(E) ntl entered into an agreement for interconnection with Vodafone on 11 December 2002, and MCI entered into an agreement for interconnection with Vodafone on 10 December 2002 (each a "New Agreement" and together the "New Agreements");

(F) Both ntl and MCI have stated that although they entered into the New Agreements they disputed certain aspects of Clause 4 of the New Agreement (the "Credit Vetting Clause"), and therefore signed the New Agreements under protest;

(G) On 20 December 2002, in accordance with the provisions of Regulation 6(6) of the Telecommunications (Interconnection) Regulations 1997 ("the Regulations"), ntl referred a dispute relating to the Credit Vetting Clause to the Director General of Telecommunications ("the Director") for determination;

(H) On 31 March 2003, in accordance with the provisions of Regulation 6(6) of the Regulations, MCI referred a dispute relating to the Credit Vetting Clause to the Director for determination;

(I) Regulation 6(6) of the Regulations provides that where there is a dispute concerning interconnection between organisations, the Director shall, at the request of either party, take steps to resolve the dispute within six months of the date of the request. The direction which the Director makes to resolve the dispute must represent a fair balance between the legitimate interests of the parties, and must be notified to the parties in accordance with Regulation 8(3). The parties are entitled to a full statement of the reasons on which the direction is based;

(J) The Director has considered inter alia, the information provided by the parties and the matters set out in Regulation 6(8) of the Regulations. The principal points are summarised in the explanatory memorandum which accompanies, and is published with, this direction;

(K) The Regulations place upon the Director the general responsibility to encourage and secure adequate interconnection in the interests of all users;

(L) The Director issued a draft of this direction and the explanatory memorandum which contained the Director’s reasons on 5 June 2003 and responses were invited by 19 June 2003;

(M) Non-confidential comments were received from the respondents as detailed and discussed in Chapter 4 of the explanatory memorandum which accompanies and is published with this direction. The Director in making this direction has taken these comments into account;

THEREFORE:

Pursuant to Regulation 6(6) of the Regulations, and having considered, inter alia, the views of the parties and those matters set out in Regulation 6(8) of the Regulations, the Director makes the following direction to resolve the dispute between Vodafone and both ntl and MCI:

1. Vodafone shall, as soon as reasonably practicable, amend the New Agreements as necessary so as to clearly incorporate the following principles:

(a) where Vodafone carries out an internal credit check in respect of any other operator with a view to determining whether or not that other operator constitutes a credit risk, that other operator’s payment history will be taken into account by Vodafone; and

(b) where Vodafone intends to require any other operator to provide a financial security in accordance with the terms of the New Agreement, both Vodafone and that other operator shall make all reasonable endeavours to agree a form of security which is proportionate in the circumstances and represents a fair balance between the legitimate interests of the parties.

2. Except as otherwise defined in this Direction, words or expressions used shall have the same meaning as in the Act, the Vodafone licence or the New Agreements as appropriate.

3. This direction shall take effect on the day it is published.

HEATHER JULIE CLAYTON

DIRECTOR OF INVESTIGATIONS

A person authorised under Paragraph 8 of Schedule 1 to the Telecommunications Act 1984

16 July 2003

Chapter 1

Summary

1.1 The Director General of Telecommunications ('the Director') has issued a Direction in accordance with the provisions of Regulation 6(6) of the Telecommunications (Interconnection) Regulations 1997 ('the Regulations') for the resolution of a dispute between Vodafone Ltd ('Vodafone') and both ntl Ltd ('ntl') and MCI WorldCom Ltd ('MCI').

1.2 The dispute concerns clause 4 (‘the Credit Vetting Clause’) of Vodafone’s revised interconnect agreement (‘New Agreement’). The Director has been asked to consider the following three issues in order to resolve this dispute:

(i) is it reasonable for Vodafone to carry out Credit Checks on all Operators that it interconnects with (‘Operators’);

(ii) should the requirement to provide a form of financial security be instigated and withdrawn solely as a result of payment history, or is it reasonable for Vodafone to use credit vetting agency reports to identify when an Operator is a financial risk; and

(iii) should an Operator have a contractual right to make more frequent/rapid payments, pursuant to receipt of an invoice, instead of providing a payment in advance or a bank guarantee, in the event that the Operator is deemed a credit risk;

1.3 Following this referral, the Director sought the views of the parties to the dispute (http://www.oftel.gov.uk/publications/licensing/2003/credvet0603.htm) and considered submissions made by Vodafone, ntl, MCI and also other operators. The Director issued a draft direction in respect of this dispute on 5 June 2003 to the industry as a whole for consultation.

1.4 The details of the submissions made in response to the draft direction, together with the Director’s reasons for making his decision, are set out in Chapters 4 and 5.

1.5 In summary, the Director considers that credit vetting is reasonable in principle, and that the imposition of an appropriate credit vetting policy, which prevents bad debt from occurring in the first place, is more efficient than taking steps only after the bad debt has been incurred. However, a balance needs to be struck between protecting the legitimate commercial interests of the SMP operator and ensuring that action to protect those interests does not harm competition. The Director considers that creditworthiness can be taken into account in determining what constitutes reasonable terms and conditions for interconnection but it is of vital importance that SMP operators do not seek to impose financial security requirements that are either unnecessary or disproportionate to the risk that has been identified.

1.6 Against this background, the Director recognises that both payment history and credit vetting agency reports are relevant in assessing whether an operator constitutes a financial risk. However, SMP operators must take into account, and, if appropriate, act upon, all relevant information when assessing whether an operator constitutes a credit risk. It is not reasonable for an SMP operator to rely solely on one source of information if that information source is contradicted by other valid sources of information. The parties must have scope to negotiate the relevance of available information. Furthermore, if agreement is not reached after an appropriate period of time, dispute resolution provisions should be invoked. These dispute resolution procedures should allow a suitably qualified third party to assess the reasonableness of any request for a financial security by an SMP operator, and, if appropriate, the level of the financial security that has been requested in any particular instance based on a considered weighing of information available.

1.7 The Director has determined the following in respect of the three determination requests that he has been asked to address in resolving these disputes:

(i) the Director does not consider it unreasonable for Vodafone to credit vet all Operators. The Director considers that the universal application of credit checks to all Operators does not provide cause for concern, providing that credit vetting is not applied in a manner which distorts competition; 

(ii) the Director considers that the use of third party reports to assess an Operator's creditworthiness is a reasonable method and does not, in itself, give Vodafone the opportunity to act anti-competitively. Therefore, the Director is not requiring Vodafone to instigate and withdraw financial security obligations solely on the basis of late payment. However, the Director has concluded that Vodafone should amend the New Agreement to make it clear that recent payment history is an additional objective criteria which should be taken into account by Vodafone when carrying out its own internal credit checks; 

(iii) the Director does not propose to require Vodafone to offer Operators, in all cases, more frequent and/or rapid payment, pursuant to receipt of an invoice, instead of providing a payment in advance or bank guarantee. Different financial security obligations have different impacts on Vodafone’s credit risk and an Operator’s cash flow, and requiring Vodafone to offer more frequent and/or rapid payments pursuant to receipt of invoice may not in all cases represent a fair balance between the interests of the parties. However, Vodafone is required to amend its financial security clause to make it clear that the parties have scope to agree a form of financial security and that both parties must reasonably endeavour to agree a form of security that may be proportionate to the operator and the case in hand.

1.8 Vodafone is required to implement the requirements arising out of these requests, which are set out in the direction which this Explanatory Memorandum accompanies. Following the draft direction, certain changes have been made to these requirements to provide greater clarity. However, the Director considers that the requirements set out in the final direction do not materially differ from the requirements as set out in the draft direction.

1.9 The Director intends to issue a continuation notice to carry over the obligations imposed under this Direction for the period from 25 July 2003 until such time as the new obligations proposed in the Review of Mobile Wholesale Voice Termination Markets come into force. For further information on Oftel's proposals with respect to continuation notices, see the document ‘Consultation on continuing licence conditions after 25 July 2003’, which can be found at http://www.oftel.gov.uk/publications/licensing/2003/cont0703.htm.

Chapter 2

Background

2.1 As a result of having been designated with Significant Market Power ('SMP') under the Telecommunications (Interconnection) Regulations (which implement EC Interconnection Directive (97/33/EC) in the UK), Vodafone is obliged to meet all reasonable requests for interconnection from Operators seeking access to its network by virtue of Condition 45 of its licence. Condition 45 also requires Vodafone to secure that such interconnection is offered on reasonable terms and conditions.

2.2 Operators interconnecting with Vodafone may purchase interconnection services from Vodafone in accordance with the terms that are set out in Vodafone’s interconnection agreement. The interconnection requested in this case relates to services that originate on ntl’s and MCI’s network and terminate on Vodafone’s network. As of the date of this direction, 13 Operators directly interconnect with Vodafone.

2.3 Vodafone has stated that during the early part of 2001, it recognised that the financial standing of a number of operators was deteriorating and that this trend was likely to continue for the foreseeable future. As a result, at the end of November 2001 Vodafone sought to introduce the New Agreement containing the Credit Vetting Clause. Vodafone has stated that the aim of this clause was to limit its financial exposure resulting both from financially unsound new operators entering the market and existing operators becoming insolvent. Vodafone served 12 months notice for Operators to terminate their existing agreements.

2.4 Oftel has issued a draft direction (http://www.oftel.gov.uk/publications/licensing/2002/credit1102.htm#2) (‘the BT credit vetting draft direction’) and a direction (http://www.oftel.gov.uk/publications/licensing/2003/credit0203.htm) (‘the BT credit vetting direction’) in respect of credit vetting measures that BT sought to introduce into its Standard Interconnect Agreement. Interested parties should consult these documents in order to familiarise themselves with relevant background to this area.

Chapter 3

History of the Dispute

ntl

3.1 ntl provided the Director with a summary of negotiations regarding direct interconnection with Vodafone. ntl stated that negotiations began on this matter in 1998 and have proved unsuccessful as far as it is concerned.

3.2 Following Vodafone’s signalled introduction of the New Agreement, ntl and Vodafone had discussions regarding the Credit Vetting Clause. During this time revisions were made to the New Agreement.

3.3 ntl signed the version of Vodafone’s interconnection agreement which did not contain the credit vetting clause (‘Old Agreement’) on 31 October 2001. ntl’s Old Agreement expired on 8 December 2002. ntl has stated that in order to ensure continuity of service from Vodafone, ntl signed the New Agreement. ntl provided the Director with a copy of this agreement (The agreement considered by the Director for the purposes of resolving this dispute is the agreement provided by ntl in its referral of 20 December 2002.). Negotiations continued between the parties regarding the New Agreement.

3.4 ntl referred this dispute to the Director on 20 December 2002. ntl stated that the Credit Vetting Clause is unreasonable in three respects:

3.5 Subsequent to this matter being referred, the Director had discussions with both ntl and Vodafone. Further to these discussions, ntl and Vodafone confirmed that they would be entering into commercial negotiations regarding the determination requests set out above at 3.4.2 & 3.4.3. Therefore these requests were removed from the scope of the matters under investigation.

MCI

3.6 MCI signed Vodafone’s Old Agreement on 22 June 1995.

3.7 MCI has stated that negotiations began with Vodafone regarding the New Agreement in April 2002. During this time revisions were made to the New Agreement.

3.8 Vodafone and MCI continued negotiations regarding the Credit Vetting Clause. On 10 December 2002, Vodafone and MCI agreed to execute the New Agreement (The agreement considered by the Director for the purposes of resolving this dispute is the interconnect agreement between Vodafone and MCI Worldcom of 10 December 2002). However, MCI stated that it considered the credit vetting clause was unreasonable.

3.9 MCI stated that throughout these negotiations Vodafone refused to concede ground on the core issue that concerned MCI, which was the lack of objectivity of the Credit Vetting Clause.

3.10 On 31 March 2003 MCI submitted a determination request to the Director regarding Vodafone’s Credit Vetting Clause. MCI requested a determination that:

3.11 As the issues submitted by MCI were closely related to request that had been previously submitted by ntl, MCI’s determination request has been handled in parallel with the existing ntl dispute.

Chapter 4

Responses to the draft direction

4.1 Responses to the draft direction are set out below. Certain respondents wished their comments to remain anonymous and are therefore not identified by name.

Vodafone

4.2 Vodafone stated general support for the Director’s conclusions, which it considered were in the best interests of the industry at large.

4.3 However, Vodafone stated that it had several concerns with paragraph 5.41 of the draft direction, which required that Vodafone should amend its Agreement so that it is clear that parties use reasonable endeavours to agree a form of financial security that is appropriate in the circumstances, and which represents a fair balance between the legitimate interests of the parties. Paragraph 5.41 stated that negotiation, backed up by an effective dispute resolution procedure, should enable a proportionate and reasonable security to be agreed in any particular instance.

4.4 Vodafone stated that the Director’s position in 5.41 of the draft direction goes beyond the Director’s position on BT’s credit vetting policy. Vodafone stated that BT’s credit vetting clause proposes a number of possible types of security and also provides the option, rather than the obligation, of agreeing an alternative form of security. Vodafone stated that if it is contractually required to use its reasonable endeavours to agree an alternative security and no agreement is reached, Vodafone will be forced in each case to refer the matter to an expert to set an arbitrary type of security.

4.5 Vodafone considered that there is a strong probability that credit risk parties will use negotiation obligations proposed by the Director in paragraph 5.41 to delay the establishment of the form of financial security. Vodafone stated that such parties deemed to be a credit risk will reject the security options stated in the credit vetting clause and propose an unreasonable measure. Vodafone stated that this would increase Vodafone’s risk and introduce additional cost as result of potential third party involvement.

4.6 Vodafone argued it has taken steps to be explicit about the forms of security that can be provided and these securities are more extensive that those specified by BT.

4.7 Vodafone stated that it has shown itself willing to agree alternative forms of security that are reasonable and appropriate in the circumstances. Vodafone stated that it should be able to continue to apply its discretion in negotiating the form of security.

MCI

4.8 MCI welcomed many of the principles set out in the draft direction, but stated that Vodafone’s ability to impose obligations should be limited to the same extent as would be the case in a competitive market. MCI stated that Vodafone can only enforce its credit vetting terms because of its position of dominance. MCI stated that as Vodafone’s ability to impose such obligations in interconnection arrangements is so much greater than an operator that does not possess SMP, Oftel should take ex ante steps to ensure that the terms imposed are reasonable. MCI referred to Oftel’s access guidelines on the interpretation of ‘fair and reasonable’, (meaning terms that would be provided in a competitive market, and are sensible and practical) in support of its agreement that the credit vetting clause is unreasonable. MCI considered that the draft direction erroneously concludes that since Vodafone has a mix of security arrangements in place, Vodafone’s credit vetting requirements are not reducing competition.

4.9 MCI argued that the draft direction overlooks the fact that reduction of competition by foreclosure of competitors is not the only way in which a dominant position can be abused, as the imposition of contractual conditions that would not be sustainable in a competitive market (exploitative abuses) are also relevant. MCI argued that regulatory intervention is required to ensure that Vodafone’s ability to abuse its dominant position is limited. Furthermore, MCI stated that the draft direction should consider the impact that financial security obligation have on the margin for calls to Vodafone’s network.

4.101 MCI argued that Vodafone’s reliance on credit vetting reports leaves the credit vetting process open to abuse in the future. MCI stated that the clause should be unambiguous as to the criteria that Vodafone must apply, otherwise operators will be forced to dispute the decision after the fact, which would be unfair, inefficient and unworkable. MCI argued that Oftel should set out the criteria that Vodafone would be expected to apply when evaluating credit risk in the direction.

4.11 MCI considered that the sole use of agency reports is not appropriate. MCI stated that a UK subsidiary of a parent company based outside the US may be thinly capitalised and as a result may have a poor report. MCI believed this unfair. MCI stated that errors of fact can be corrected, but there are limitations in how far the report can be changed. MCI argued that reports should be considered in context of overall commercial relationship between the parties. In addition, it was stated that late payment should be key indicator of credit risk and Oftel should make it clear that this should be given appropriate weight. MCI concluded that if an operator’s payment record is good the dominant operator should bear the burden of demonstrating serious risk of default.

4.12 MCI considered that suddenly becoming insolvent after a history of paying its bills on time is not a realistic prospect for a larger, established operator.

4.13 MCI considered that under the draft direction operators have little predictability of the type of security to be requested. MCI stated that operators will have to rely on dispute resolution and that Vodafone could also unfairly discriminate against operators.

4.14 MCI argued that if an operator has a good payment history there should be a rebuttable presumption that financial security is not required. MCI stated that Vodafone should be required to specify substantial risk of default, by:; (1) specifying aspects of report that have been relied upon; and; (2) considering any additional information provided by an operator. MCI stated that Oftel should set this process out in the final direction.

4.15 MCI stated that the risk of a 'laissez-faire' approach to the issue of credit vetting is multiplied because other mobile operators and incumbent operators can be expected to follow Vodafone's lead, not just in the UK but also across Europe. MCI considered that this will lead to operators going out of business.

ntl, on behalf of the Operator’s Group (OG)

4.16 ntl stated that it considered Oftel has fundamentally misunderstood the key issue within this dispute, that the ability of SMP operators to increase costs by requiring financial security provisions should be controlled by ex ante regulation. ntl further stated that there are no reasons why BT and Vodafone’s credit vetting policy should differ. It stated that Vodafone currently has carte blanche to insist on the most onerous financial security obligation. ntl stated that credit vetting terms should mirror those that would exist in a competitive market.

4.17 ntl considered that the impact of the clause on the development of sustainable competition was not properly considered in the draft direction. ntl stated that the clause will discourage any to any connectivity as direct interconnection will be reduced. ntl considered that any to any connectivity does not arise naturally out of the actions of market participants in this case as it is not in the interests of networks with significant numbers of customers to interconnect with networks with less customers. ntl stated there are competition benefits and positive network externalities that arise out any to any connectivity which Oftel should model. ntl stated that Oftel should consider whether: (a) Vodafone would act in the same way if it did not have SMP; and (b) the benefits of any to any connectivity.

4.18 ntl stated that certain OG members have signed up to Vodafone’s clause, but this should not be taken as evidence that the terms of that clause are acceptable. ntl stated that relying on a single credit report is not an acceptable means of objectively measuring credit risk. It argued that the time and effort needed to change an adverse credit report is an additional unreasonable cost for an operator to bear.

4.19 ntl stated that Oftel needs to urgently consider the impact of BT credit vetting all interconnecting operators, because of the implications of the decision in this case. ntl argued that no justification for the difference in the approaches adopted by BT and Vodafone had been given. ntl stated that if no justification for this difference could be identified, such a difference was unsustainable.

4.20 ntl stated that the draft direction should go further in requiring that Vodafone pursue alternatives to the financial security measures set out in the clause. It stated that Vodafone should be required to offer more frequent payment coupled with measures to allow rapid intervention, such as immediate suspension of contract. ntl stated that it is unreasonable for Vodafone to mitigate all of its financial risk.

4.21 ntl echoed the point made by MCI in paragraph 4.14 regarding the incorporation of a rebuttable presumption test within the credit vetting clause.

Operator A

4.22 Operator A stated that Vodafone should not be able to impose a financial security obligation based on reports where no failure to pay has occurred.

4.23 Operator A stated that agency reports present a historic rather than actual picture of a particular company. Operator A considered that it is appropriate to use these reports for considering whether or not to interconnect with a new operator. However, Operator A stated that it is perverse to rely on such reports when previous payment history information is available.

4.24 Operator A stated that direct interconnection will be adversely affected if the draft direction is confirmed. This could lead to less efficient interconnection arrangements and higher prices for consumers.

4.25 Operator A argued that the terms of the credit vetting clause are indicative of Vodafone’s SMP status giving it scope for leverage in any negotiation with an operator. It stated that Oftel should refer to terms found in standard interconnect contracts as a reference for reasonable terms and conditions.

4.26 Operator A stated that the triggering by Vodafone of financial security obligations will in may cases require stock market disclosure. This may have a further negative impact on the operator in question. 

T-Mobile

4.27 T-Mobile stated that Vodafone should not be able to require financial security where an operator has a good payment history. It argued Oftel should specify the weight that payment history has in considering whether it is necessary to require a financial security.

4.28 T-Mobile stated that Oftel should require that no financial security can be requested where payment history has been good over the last 12 months. If Oftel does not do this, T-Mobile stated that there should be a presumption that no financial security can be imposed where there has been a clear payment history unless Vodafone can demonstrate that there are objective reasons why it is proportionate in the circumstances.

Operator B

4.29 Operator B stated that it had also experienced difficulties in negotiating direct interconnection with Vodafone.

4.30 Operator B stated that the credit vetting clause should be deleted in its entirety, as it is being used to raise barriers to the interconnection market. However, Operator B stated that if the clause is to be included it should be modified. In particular, Operator B stated that the ‘reasonable endeavours’ obligation does not give an interconnecting operator sufficient protection, as if Vodafone does not agree an appropriate form of security with the operator, the operator will still be required to provide one of the forms of security in the Financial Security Notice within a very tight timeframe. Operator B also stated that Vodafone may suspend service if the operator does not meet these timescales.

European Competitive Telecommunications Association (ECTA)

4.31 ECTA stated that the analysis in Annex A of the draft direction does not reflect the reality of the situation, as pan European operators will be asked to place deposits in other countries as a result of the draft direction. ECTA stated that such ‘non price discrimination’ is becoming more prevalent.

4.32 ECTA stated that where a perfect payment record in the past 6 months has been demonstrated, there should be a burden of proof on the requesting operator to demonstrate that the financial security is appropriate. The dispute resolution procedure would then judge whether this condition has been met.

Chapter 5

The Director’s decision and reasons

5.1 As set out in Chapter 2, Vodafone is required to meet all reasonable requests for access to its network due to its SMP designation under the Telecommunications (Interconnection) Regulations 1997 (which implement EC Interconnection Directive (97/33/EC) in the UK). It is the Director’s opinion that creditworthiness is a factor that can be taken into account in determining what constitutes reasonable terms and conditions for interconnection.

5.2 The draft direction set out the Director’s view in respect of the three determination requests that he had been asked to consider. These requests are as follows:

(i) Is it reasonable for Vodafone to carry out Credit Checks on all Operators?

(ii) Should the requirement to provide a form of financial security be instigated and withdrawn solely as a result of payment history, or is it reasonable for Vodafone to use credit vetting agency reports to identify when an Operator is a financial risk?

(iii) Should an Operator have a contractual right to make more frequent/rapid payments, pursuant to receipt of an invoice, instead of providing a payment in advance or a bank guarantee, in the event that the Operator is deemed a credit risk?

5.3 In the draft direction, the Director set out the preliminary view that it is reasonable for Vodafone to carry out credit checks on all Ooperators. He also set out the view that a requirement for financial security can be instigated and withdrawn on the basis of credit vetting agency reports. However, the draft direction proposed that Vodafone’s credit vetting clause should be amended to ensure it is clear that late payment is taken into account when Vodafone carries out an internal credit check on an operator. Finally, although the draft direction stated that Vodafone did not have to provide Operators with the option of making more frequent/rapid payments, pursuant to receipt of an invoice, instead of providing a payment in advance or bank guarantee, it did state that Vodafone’s contract should make it clear that the parties have scope to reasonably endeavour to reach agreement on a form of financial security that may be appropriate in the circumstances, and which represents a fair balance between the interests of the parties.

5.4 All but one of the respondents to the draft direction did not dispute that it is reasonable in principle for Vodafone to have a credit vetting policy. However, a number of responses argued that the terms of Vodafone’s policy are unreasonable and could enable Vodafone to distort competition. Set out below are the Director's considerations on issues raised in response to the draft direction. These are set out in the context of each of the original determination requests that he was asked to consider. It should be noted that unless this Explanatory Memorandum indicates otherwise the Director’s position remains as set out in the Explanatory Memorandum which accompanied the draft direction.

5.5 Interested parties should also note that responses to the draft direction which fall outside of the scope of the initial three determination requests referred to the Director have not been addressed in the formal direction as they do not form part of the original dispute. However, where appropriate and directly relevant to the issues covered by this final direction, the Director has expressed his current view in relation to the points raised.

(i) Is it reasonable for Vodafone to carry out Credit Checks on all Operators?

5.6 Under BT’s credit vetting policy, BT only credit vets new operators. Under its own policy, Vodafone credit vets all operators that it interconnects with. ntl stated in response to the draft direction that the Director should outline a justification for the discriminatory approach between BT’s and Vodafone’s policy. It further stated that the Director needs to urgently consider the impact of BT credit vetting all interconnect parties.

5.7 As explained in the draft direction, the Director has not previously concluded that only credit vetting New Operators on an automatic basis is a proportionate response to the risk posed by insolvency. In the draft direction the Director stated that universal application of credit vetting does not provide cause for concern, providing that the practical application of credit vetting does not give operators the ability to act anti-competitively. This remains the Director’s position on this matter. The Director considers that any competitive distortions are likely to arise from the impact of the terms found in a credit vetting policy, for example those that enable an operator to require a security that is unreasonable or disproportionate to the perceived risk. The Director considers that any such allegations should be referred to an appropriate party for dispute resolution in the first instance. In addition, any allegations of alleged anti-competitive behaviour in this regard may, of course, be subject to further investigation by the Director.

(ii) Should the requirement to provide a form of financial security be instigated and withdrawn solely as a result of payment history, or is it reasonable for Vodafone to use credit vetting agency reports to identify when an Operator is a financial risk?

5.8 The following arguments were made in response to the draft direction:

• payment history should be given greater weight when Vodafone is carrying out a Credit Check;
• it is not realistic to state that a larger, established company will choose to pay one vendor as a priority so that an increasing danger of insolvency does not manifest itself until it is too late;
• agency reports are not an adequate indicator of whether an operator constitutes a credit risk as: (a) they may not be relevant in certain circumstances; and (b) there are limitations on how inaccuracies in a report can be corrected;
• Vodafone’s terms could not be imposed in a competitive market, and will have a detrimental impact on competition; and
• Vodafone’s terms will have a detrimental impact on any to any routing, and will trigger credit vetting by incumbent operators in other member states.

Payment history should be given greater weight when Vodafone is carrying out a Credit Check

5.9 Although the majority of respondents to the draft direction considered that credit vetting should only be triggered in the event of late payment, it was argued that if the Director considers it reasonable for all operators to be credit vetted, there should be a rebuttable presumption that security is not required when an operator has a good payment history with Vodafone. It was argued that if Vodafone is requesting a form of financial security on the basis of a credit vetting agency report, Vodafone should be required to specify the aspects of the report that have been relied upon, and consider any additional information provided by the operator. Respondents to the draft direction considered that the clause as drafted provided Vodafone with too much discretion as to the method by which an operator is considered a credit risk, and that late payment is the only purely objective method of triggering a requirement for financial security.

5.10 The Director believes it would not be appropriate for him to specify precisely how much weight should be given to late payment in considering whether an operator constitutes a credit risk. The weight to be attributed to payment history may differ according to the case at hand. It is not possible for the Director to specify in all cases how much weight should be attributed to payment history, or outline the relationship between payment history and a credit vetting agency report in determining to what extent an operator constitutes a financial risk. The Director considers that both payment history and a credit vetting agency report are appropriate sources of information to be considered when identifying whether an operator is a credit risk. An appropriate balance will need to be struck between them on a case-by-case basis.

5.11 The Director is therefore of the opinion that the approach set out in the draft direction provides the appropriate means for ensuring that Vodafone’s credit vetting terms are reasonably applied.

5.12 If the parties fail to agree on the relevance of late payment, or if an interconnecting operator considers that any request for financial security is unreasonable or disproportionate to the perceived risk that operator should have access to appropriate third party dispute resolution measures. A relevant third party should then be able to determine on the appropriate relationship between the application of the operator’s credit vetting report, and any other information that has been provided by the operator. This information may include late payment information and/or a critique of the agency report. The drafting of these dispute resolution provisions is currently being negotiated between ntl and Vodafone and therefore is not considered further by the Director at this time. However, the Director’s view is that an adequate dispute resolution procedure should allow an appropriate third party to take a view on whether the level of security that has been requested in a particular instance represents a fair assessment of the credit risk that an operator might pose.

5.13 The Director has considered Vodafone’s argument that it is not appropriate for a third party to have the ability to ‘re-make’ a decision that has been taken in this regard but considers that his stated approach is necessary to ensure fair application of credit vetting measures. The Director has also considered Vodafone’s argument that referral to third parties in this manner will enable operators to delay the imposition of a financial security and expose Vodafone to undue risk. The Director considers that it is incumbent upon the parties to agree timescales for resolution which adequately represents their interests in this regard.

It is not realistic to state that a large company will choose to pay one vendor as a priority so that an increasing danger of insolvency does not manifest itself until it is too late

5.14 MCI did not agree with Vodafone's argument that it is possible for an operator to pay all its bills on time and then suddenly become insolvent. MCI stated that while this may be possible in the case of a small company that is heavily dependent on a single vendor, it is not realistic in the case of interconnected parties, which will have many more large vendors, all of which would demand priority treatment.

5.15 The Director is of the opinion that an operator may seek to ensure it pays the invoices of certain of its key suppliers on time, even if it is experiencing cash flow difficulties. It is not necessarily the case that all 'large vendors' will be treated the same by the operator. Payment on time (despite financial distress) is most likely in respect of the most critical suppliers, and where there are negative financial consequences associated with failure to pay on time. In particular, operators in financial distress will seek to continue to trade, requiring them to ensure the continuation of supply from their principal suppliers which they achieve through the continuation of timely payments.

5.16 As a result, it is possible that the deterioration of an operator’s financial position may be quite advanced before this manifests itself in late payments to certain suppliers. From this point, further deterioration may be very rapid, providing little opportunity for a supplier to take action to protect itself.

5.17 However, it should be noted that the Director recognises that although neither payment history or agency reports are perfect barometers of financial distress, both can be appropriate in assessing whether an operator constitutes a credit risk.

Agency reports are not an adequate indicator of whether an operator constitutes a credit risk as; (a) they may not be relevant in certain circumstances and; (b) there are limitations on how much can be corrected

5.18 A number of representations made in response to the draft direction stated that credit vetting agency reports do not provide an appropriate means of identifying whether or not an operator is a financial risk. Furthermore, it was put to the Director that although errors of fact can be corrected, there are limitations in how far the report can be changed. It was also stated that reliance on such reports leaves the process of credit vetting open to abuse in the future. It was put to the Director that reliance on a single report is not an acceptable means of assessing credit risk. For example, it was stated that a UK subsidiary of a parent company based outside the UK may be thinly capitalised, and as a result may have a poor report.

5.19 As set out in the draft direction, it has been established that an interconnecting operator can engage directly with the agency in question if it considers that information in a report is inaccurate or misrepresents its financial position. Furthermore, the Director has received evidence that Vodafone has migrated operators to standard payment terms following a change in the rating provided by a credit vetting agency.

5.20 The Director considers that the use of reports generated by external credit vetting agencies is one, but by no means the only, legitimate method of assessing the creditworthiness of an Operator. Such reports aim to provide objective and non-biased data on the financial viability of an Operator, and are prepared by a party which is independent and for whom a reputation of independence is critical for the continuing success of their business. As set out in the draft direction, the Director would expect organisations to liase with such agencies on an ongoing basis in order to ensure that credit ratings in respect of an operator are accurate.

5.21 The Director would also expect that an operator with evidence that contradicts or supersedes information found in an agency report would put forward that information to the operator requesting financial security. Vodafone is contractually required to consider such additional information under the current versions of the New Agreements, and the Director would expect this to continue. If an operator has sought to rely on one agency report as justification for financial security in spite of convincing information to the contrary, the Director would expect that the affected operator would seek recourse to appropriate dispute resolution procedures.

5.22 Finally, whilst it is true that a parent company may legitimately choose to ensure that a subsidiary is 'thinly capitalised', the existence of a parent company does not in itself provide any assurance over the credit worthiness of the subsidiary. A parent company is under no obligation to support a subsidiary that becomes subject to financial distress. It may, if it chooses, allow the subsidiary to enter a formal insolvency process. Although cross-guarantees may exist between a parent company and subsidiary, it may be difficult to establish the degree of protection they provide to creditors and prove timely or costly in the event that recoveries are sought under these guarantees, particularly where the company providing the guarantee is itself thinly capitalised or in distress. It is therefore true that a thinly capitalised subsidiary may be no more financially secure than a similar company without a parent.

Vodafone’s terms could not be imposed in a competitive market, and will have a detrimental impact on competition

5.23 It was put to the Director that Vodafone could not impose its credit vetting terms in a competitive market. Operator A provided the Director with information on the terms included in interconnect agreements between it and other operators without an SMP designation. Operator A’s terms did not seek to credit vet all interconnecting parties. Operator A argued that these terms should be viewed as terms appropriate to a competitive market. Operator A stated that Vodafone would not be able to enforce the more onerous terms in its own credit vetting clause if it did not hold a position of SMP in the relevant market, as interconnecting operators could purchase services from an alternative operator.

5.24 Furthermore, an Operator stated to the Director that Vodafone does not seek to credit vet operators in retail markets, where it does not possess SMP. The operator requested that details of this scenario remain confidential, but provided the Director with information on the contract in question. It was argued that in such scenarios Vodafone faces a degree of competition which prevents it from imposing financial security obligations in the way that it has done in the interconnect agreement.

5.25 In addition, MCI argued that Vodafone’s credit vetting clause effectively increases the price of call termination on Vodafone’s network. MCI alleged that by credit vetting all operators Vodafone is engaging in exploitative practices which would not be sustainable in a competitive market. MCI stated that there is an abuse where a dominant operator leverages its market power in order to impose prices or other contractual conditions that would not be sustainable in a competitive market, and provided the Director with details of case law which it considered supports its argument in this regard. MCI stated that Oftel should require revisions to be made to the credit vetting clause in order that Vodafone’s ability to abuse its position in this respect is appropriately limited.

5.26 The Director recognises that where one party to a transaction holds a position of SMP in a relevant market, it can be appropriate for ex-ante regulation to be imposed. In this case, the form of regulation that has been imposed is the requirement on Vodafone to meet all reasonable requests for interconnection. In a competitive market Vodafone would not be under the obligation to interconnect with all requesting parties but would be free to decline a request if it considered an operator a credit risk. The fact that Vodafone is obliged to interconnect justifies the application of reasonable credit vetting terms. The key point to be considered is whether Vodafone is acting unreasonably by seeking to credit vet all interconnecting operators. As has been set out, the Director does not consider that this is the case.

5.27 The Director recognises that the difficulty in analysing the argument regarding credit vetting in competitive markets is that in competitive markets there is no obligation to interconnect. Hence, it may be the case that credit vetting terms or conditions would not be as prevalent in markets where operators do not possess a position of SMP, as operators may choose not to directly interconnect. Conversely, credit vetting terms are more likely where a firm is forced to interconnect, as they are potentially being exposed to costs that they might not be exposed to in a competitive market.

5.28 However, in response to the representations that had been made by the operator in this regard, the Director asked Vodafone to confirm whether it credit vets retail customers (It should be noted that as the Operator requested that details of its retail contract where it had not been credit vetted by Vodafone remain confidential, the Director was not able to request responses from Vodafone in respect of this particular contract.). Vodafone stated that it credit vets consumers at the time of purchase, and that pre-payment was introduced in order to address poor creditworthiness. Furthermore, Vodafone stated it credit vets all directly connected corporate customers, and that credit agency reports are used to establish whether a customer is a credit risk. Vodafone also stated that where a customer is a credit risk, Vodafone may refuse to do business with that customer or seek revised payment terms to minimise Vodafone’s financial exposure. Vodafone provided the Director with details of instances where Vodafone has sought to mitigate the credit risk that may be posed by retail corporate customers. The Director considers that the evidence Vodafone produced points to consistent treatment by Vodafone of corporate retail customers and interconnecting operators. The Director also notes that the value of the particular retail contract referred to by the Operator (see footnote 7) is significantly less then the value of payments made by that operator under Vodafone’s interconnect agreement.

5.29 It has also been put to the Director that the impact of costs arising out of a requirement to provide a financial security will further diminish the margin made on calls terminated on Vodafone’s network. It has been argued that a margin analysis is more appropriate than analysis of impact on cash flow when considering the effect that Vodafone’s credit vetting terms have on an operator. The Director considers that if an operator is judged to be a credit risk and is asked to provide a form of security, there will inevitably be an increase in its cost base, which may diminish margins in certain parts of its business. However, such costs are an unavoidable result of that operator being designated a credit risk. That is, an operator may legitimately have to bear increased costs as a result of being designated a credit risk.

5.30 Finally, Oftel is familiar with the caselaw referred to in MCI's representations regarding Vodafone’s alleged exploitative practices. However, it is important to view this case in its correct context. The Director has handled this case as a dispute under Interconnection Regulations, not as a complaint under the Competition Act 1998. The Director's duty in relation to this dispute is to make a direction for its resolution which represents a fair balance between the legitimate interests of the parties (as set out in Regulation 6(6)), taking into account, amongst other things, the criteria listed at Regulation 6(8). These criteria include:

• regulatory obligations or constraints imposed on any parties;
• the relative market positions of the parties; and
• the promotion of competition.

5.31 The Director, in the light of these criteria, has considered the fact that Vodafone has been designated as having SMP in accordance with the Interconnection Directive Regulations in the markets for the provision of public mobile telephone networks and public mobile telephone services. As a result of that designation, Vodafone is required to comply with condition 45 of its licence. Condition 45 requires Vodafone to provide interconnection services to other Annex 2 operators on reasonable request and on reasonable terms and conditions. Given this regulatory environment, it is crucial, in the Director's opinion, that he assess whether the terms and conditions proposed to be imposed by Vodafone in respect of credit vetting are fair and reasonable. The Director’s assessment of whether this is the case is set out in this document.

5.32 This is not to suggest that the Director is ignoring the broader competitive environment nor the promotion of competition: as demonstrated in this document, the analysis by the Director as to the reasonableness of any terms and conditions proposed by Vodafone includes an analysis of whether these terms or conditions allow Vodafone to act anti-competitively. The requirements set out in this direction are being made in order to ensure that the credit vetting clause does not provide Vodafone with unreasonable discretion, taking into account Vodafone’s market position.

Vodafone’s terms will have a detrimental impact on any to any routing, and will trigger credit vetting by incumbent operators in other member states

5.33 ntl, on behalf of the OG, encouraged the Director to further consider the impact that the credit vetting clause will have on interconnection between operators. ntl referred to the desirability of the ‘any to any’ principle of interconnection.

5.34 If an operator constitutes a credit risk, it may be appropriate for that operator to place a form of financial security with any operator providing interconnection. ntl appears to be suggesting that if Vodafone imposes an unfair costs on an operator, that operator will cease to directly interconnect with Vodafone and send traffic via another route. The Director considers that providing the level of financial security requested is proportionate to the risk involved (which is related to the value of traffic carried) there should be no distortion of incentives for efficient interconnection between operators. The Director has set out in this determination the measures he considers necessary for ensuring that any financial security demanded is proportionate.

5.35 It has also been put to the Director that if the draft direction is upheld, other European incumbent operators will implement credit vetting policies similar to that of Vodafone’s, which will have a serious impact on pan-European operators. The Director is aware that European operators have sought to introduce credit vetting policies and has investigated the practice of other NRAs in relation to this activity. However, the Director believes allegations that credit vetting policies are applied in a way likely to have an adverse impact on competition can be appropriately dealt with by the relevant National Regulatory Authorities acting individually in the light of their own market conditions and the individual case investigated.

(iii) Should an Operator have a contractual right to make more frequent/rapid payments, pursuant to receipt of an invoice, instead of providing a payment in advance or a bank guarantee, in the event that the Operator is deemed a credit risk?

5.36 The following responses were received in respect of this determination request:

• it is not appropriate for Vodafone to be contractually required to reasonably endeavour to agree a form of security with an operator as this goes beyond what the Director required in the BT credit vetting dispute reasonable endeavours requirement; and
• Vodafone’s contract provides it with too much discretion regarding the suspension of an operator’s service who is deemed to be a credit risk.

It is not appropriate for Vodafone to be contractually required to reasonably endeavour to agree a form of security with an operator as this goes beyond what the Director required in the BT credit vetting direction

5.37 Vodafone has stated that the Director is applying an inconsistent approach by requiring that Vodafone make it clear contractually that the parties have scope to reasonably endeavour to reach agreement on a form of security appropriate in the circumstances. Vodafone argued that BT was not contractually required to implement such a measure as a result of the BT credit vetting direction. Vodafone’s is concerned that if no agreement is reached with an Operator it will be forced, in each case, to refer the matter to an expert to set an arbitrary type of security.

5.38 With regard to the consistency of this measure with the BT credit vetting direction, the Director considers that the current dispute differs from the dispute about BT’s credit vetting clause in a material respect. In the dispute relating to BT’s credit vetting policy, the Director was not required to determine on when a particular type of security should be offered. The Director has now been asked to determine that Vodafone be required in all cases to offer an operator a particular form of financial security (more frequent/rapid payments) in advance of offering other forms of security. Furthermore, it has also been argued that Vodafone will seek to impose a form of security that has the most significant impact on an operator’s cashflow. In considering these points, it has been necessary to reach a formal position on the manner by which Vodafone should offer different types of security and the impact of these different forms of security. As a result of this more detailed analysis, it is relevant and appropriate for the ‘reasonable endeavours’ requirement to be included as a contractual term. The Director notes that this is significantly less intrusive than the alternative option of Oftel specifying the form of security itself.

5.39 Vodafone has also argued that it if it is required to use reasonable endeavours to agree a form of security it will be forced to refer the matter to an expert if no agreement is reached. As part of negotiations that are continuing in respect of the credit vetting clause Vodafone has included a provision which allows the parties to reasonably endeavour to agree an alternative form of security. In the event that the parties are unable to agree, Vodafone has proposed that the parties revert back to the standard list of securities. Therefore, under Vodafone’s proposed drafting an operator will be required to select one of the securities set out in the credit vetting clause if no agreement can be reached.

5.40 The Director recognises that it may be appropriate for a reasonable time limit to be set on the period when the parties may negotiate an appropriate form of security. The Director also expects both parties to use reasonable endeavours to agree a proportionate financial security, as set out in the direction. However, an operator should not be required to place a form of security if no agreement is reached. The Director considers that if no agreement can be reached within a reasonable time period, the dispute resolution procedures can be invoked in order that a third party can determine what type of financial security is reasonable and proportionate in the circumstances. The Director notes, however, that negotiation as to the scope and procedure for a dispute resolution mechanism is ongoing, and therefore does not propose to make formal directions in respect of the issue at this time.

5.41 The Director has noted Vodafone’s argument that such a requirement could unnecessarily protract the credit vetting process, leaving Vodafone exposed. As set out in paragraph 5.13, the Director considers that his stated approach is necessary to ensure fair application of the credit vetting measures, and that it is incumbent upon the parties to agree timescales for resolution which adequately represents their interests in this regard.

Vodafone’s contract provides it with too much discretion regarding the suspension of an operator’s service who is deemed to be a credit risk

5.42 It was put to the Director that Vodafone can, at any time, oblige an interconnecting party to provide such financial security as Vodafone may in its discretion determine and if such security is not provided as required Vodafone can suspend or terminate the agreement. The relevant provision relating to suspension of service can be found in clause 19.4 of the interconnect agreements between the parties to this dispute. Clause 19.4 states that

"In the event that an Event of Default has occurred and that Vodafone has issued a Financial Security Notice and the Operator has not provided the financial security by the due date specified in Clause 4, Vodafone may, by written notice immediately suspend the provision of the Interconnection Service and Call Conveyance Service".

5.43 The Director considers that an operator should have the option of agreeing a form of financial security with Vodafone prior to the issue of a financial security notice. If no agreement has been reached within a particular time period, the matter should be referred to an appropriate third party for resolution. Therefore, an operator should not have to pay a financial security until it has been agreed, or, if necessary, an appropriate third party has had the opportunity to determine on whether a proposed form and level of security is reasonable or not. It is incumbent upon the parties to agree timescales that effectively represent their best interests in this regard. For the avoidance of doubt, an operator should not be faced with the threat of disconnection until negotiations over any financial security have taken place and, if necessary, the dispute resolution procedures have been invoked.

Conclusion

5.44 The Director’s final position in respect of these disputes is as follows:

(i) the Director does not consider it unreasonable for Vodafone to credit vet all Operators. The Director considers that the universal application of credit checks to all Operators does not provide cause for concern, providing that credit vetting is not applied in a manner which distorts competition;

(ii) the Director considers that the use of third party reports to assess an Operator's creditworthiness is a reasonable method and does not, in itself, give Vodafone the opportunity to act anti-competitively. Therefore, the Director is not requiring Vodafone to instigate and withdraw financial security obligations solely on the basis of late payment. However, the Director has concluded that Vodafone should amend the New Agreement to make it clear that recent payment history is an additional objective criteria which should be taken into account by Vodafone when carrying out its own internal credit checks; and

(iii) the Director does not propose to require Vodafone to offer Operators, in all cases, more frequent and/or rapid payment, pursuant to receipt of an invoice, instead of providing a payment in advance or bank guarantee. Different financial security obligations have different impacts on Vodafone’s credit risk and an Operator’s cash flow, and requiring Vodafone to offer more frequent and/or rapid payments pursuant to receipt of invoice may not in all cases represent a fair balance between the interests of the parties. However, Vodafone is required to amend its financial security clause to make it clear that the parties have scope to agree a form of financial security and that Vodafone must reasonably endeavour to agree a form of security that may be appropriate to the operator and the case in hand.

  Annex A

Credit terms comparison

Basic assumptions

• X provides mobile termination services to Y
• Y also provides equivalent value telecommunications services to X
• Financial security arrangements are imposed by X on Y
• The services are provided evenly over each month
• Under normal circumstances X and Y are required to pay each other 30 days after receipt
• Invoices are received three days after the end of each month for services received in that month
• Measuring to the middle of the month of service (MOS), each operator therefore receives 48 days credit
• Where payment is missed, a breach notice is issued in 3 days, and service is suspended 30 days later.
• Impact of each scenario is assessed against normal payment terms as a benchmark.
• Monthly termination costs £1,000,000
• Annual discount rate 13.500%
• Monthly discount rate 1.061%

*Under assumptions no exposure. Exposure could however result if Y ceased or scaled back services.

**Monthly cost to Y of a reduction of one day in X’s exposure as a result of the financial security arrangements