Fixed access market reviews: Approach to setting LLU and WLR Charge Controls

1.1 This consultation sets out Ofcom's proposals for new charge controls for Local Loop Unbundling (LLU) and Wholesale Line Rental (WLR) services. The current charge controls expire on 31 March 2014. We are proposing that new charge controls will enter into force on 1 April 2014 and cover the period to 31 March 2017 (the Market Review Period).

1.2 In our Fixed access market reviews: wholesale local access, wholesale fixed analogue exchange lines, ISDN2 and ISDN30 Consultation (FAMR Consultation), which was published on 3 July 2013, we are consulting on our view that in each of the Wholesale Local Access (WLA) and Wholesale Fixed Analogue Exchange Line (WFAEL) markets, in the UK excluding the Hull Area, BT (Openreach) has Significant Market Power (SMP) and that charge controls are necessary as a remedy to address Openreach's ability to fix or maintain prices at an excessively high level for services in the respective markets. This consultation forms part of our review of these markets and sets out our specific charge control proposals, including the nature, form and duration of the proposed controls.

1.3 In forming the proposals set out in this consultation, we have taken account of stakeholder responses to the 2012 FAMR Call for Inputs (CFI). We have also considered and had regard to, where relevant, the Competition Commission's Determination of 27 March 2013 (the Determination) following appeals brought against the current LLU and WLR charge controls.

Structure of the proposed charge controls

LLU

1.4 We propose to set individual charge controls for Metallic Path Facility (MPF) rental, Shared MPF (SMPF) rental, and certain key migration services. As with the current charge controls, we propose setting separate basket controls for a defined set of MPF and SMPF ancillary services.

1.5 We are proposing to align all migration charges involving jumpering to a volume-weighted average of their incremental costs. Additionally, we propose to introduce separate charge controls for MPF and SMPF Bulk Migrations. We also propose to set a charge control over a basket of ancillary services used for both MPF and SMPF, which we refer to as the Co-Mingling basket.

1.6 We are proposing to use CPI as the relevant index for these controls, rather than RPI which has historically been used.

1.7 We propose that the separate baskets for MPF and SMPF ancillary services are subject to CPI-X% controls respectively. This approach of setting controls on baskets of services relative to an inflation index is the same as for the controls set in the previous statement for these services. However, this time we propose to use the same X for these two baskets because costs move together.

1.8 Based on the policy proposals and financial modelling explained in this consultation, the ranges, and base case proposed for any future LLU charge controls are set out in Table 1.1. below.

WLR

1.9 For WLR, we are proposing to set charge controls for the Analogue WLR rental service (WLR Rental) and also the charges for WLR New Connection and WLR Transfer.

1.10 We also propose impose a charge control on WLR Conversion and to align the price of WLR Conversion with the price of LLU migration services involving jumpering. WLR Conversion was previously subject to a Basis of Charges obligation, not a charge control. In addition, we propose to introduce a discounted price for WLR Conversion where it is provided in combination with SMPF New Provide when simultaneously transferring a customer from MPF to WLR+SMPF.

1.11 Based on the policy proposals and financial modelling explained in this consultation, the new charge controls that we propose for WLR services are set out in Table 1.2. below.

Table 1.1: Proposed LLU charge controls 2014-17

Table 1.2: Proposed WLR charge controls 2014-17

Approach to setting the proposed charge controls

1.12 Based on the policy proposals and financial modelling explained in this consultation, we propose that the controls set out in Tables 1.1 and 1.2 involve:

1.12.1 Form of control: charge controls, indexed by inflation, designed to align current charges to forecast efficient costs.
1.12.2 Inflation: We propose to use the Consumer Prices Index (CPI) to index these charge controls, rather than the Retail Prices Index (RPI).
1.12.3 Efficiency: We propose to use an efficiency range of 4% to 6% (net of the costs of achieving this efficiency). Within this, we propose to use a base case net efficiency rate of 5%.
1.12.4 Weighted average cost of capital: an estimate of the pre-tax nominal WACC for the copper access network of 8.8%. This is consistent with the WACC estimated for the 2013 BCMR Statement, although we have undertaken sensitivity analysis based on range for the pre-tax nominal WACC of 7.8% to 9.8%.
1.12.5 Technology change: An anchor pricing approach will be used to set charges, based on the efficient ongoing costs of providing services over a copper network, ensuring all incremental fibre costs are excluded.
1.12.6 Common costs: Common costs will be recovered equally from MPF and WLR lines, with SMPF making no contribution to common cost recovery. This is to enable both the difference in charges between MPF and WLR and the difference between MPF and WLR+SMPF to be equal to the respective differences in long run incremental costs (LRICs).
1.12.7 Price adjustments: Pricing adjustments will no longer be made in respect of the cost of Test Access Matrices (TAMs) or for line length.
1.12.8 Directories: The charge control on WLR should no longer include a contribution to the cost of providing directories (i.e. the BT Phone Book).
1.12.9 Glide path: With the exception of the directory related costs for WLR, we propose to use glide paths to bring charges into line with projected costs by the end of the control period, rather than one-off price changes at the start of the period. The proposed glide paths will also move the difference in charges between MPF and WLR and between MPF and WLR+SMPF to be equal to the difference in LRICs by the end of the charge control.

1.13 Under the base case of our proposed controls, WLR and SMPF rental charges will continue to fall and MPF rental charges will remain broadly flat in real terms. While we forecast that line volumes will increase only marginally, efficiency gains are projected to continue meaning that average unit costs for WLR and SMPF rentals are falling. For the base case,MPF rental, unit costs are broadly flat because this downward pressure from efficiency gains is broadly off-set by an adjustment in the relative prices of MPF and WLR/WLR+SMPF. Specifically, we propose to set MPF, WLR and SMPF charges such that the difference between MPF and WLR/WLR+SMPF is equal to the difference in long-run incremental costs (LRIC). This reduces the difference between MPF and WLR/WLR+SMPF charges. In doing so, we will be removing the TAMs pricing adjustment so that costs which had been allocated from MPF to SMPF now remain in the MPF cost stack. We also propose to remove costs associated with paper telephone directories from the WLR cost stack.

Disclosure of financial and volume forecast models

1.14 Our modelling approach, together with the associated outputs, is explained in Section 6 and Annex 13. The previous approach to modelling involved cost-forecasting (CF) and cost allocation (CA) models based on BT's Oak model. As proposed in the CFI, we have undertaken a different modelling approach to the cost modelling for these controls based on the costs of BT's network components (based on its Regulatory Financial Statement (RFS)) and AVEs/CVEs (a top-down model). Our financial model consists of information from BT's RFS as well as information confidential to BT which we obtained using our statutory powers.

1.15 We have also prepared a volume forecast model, using publicly available Government information and industry data and BT data from its RFS and confidential data from BT and other Communications Providers (CPs) gathered using our statutory powers. Our approach to volume forecasting is explained further at Annexes 8 and 9.

1.16 We are proposing disclosure of our models as early as possible in the week commencing 15 July 2013 by publishing:

• the RAV model;
• a version of the cost model which includes non-confidential input data and formulae; and
• a version of the volume forecast model which includes non-confidential input data and formulae,

these will be available here: http://stakeholders.ofcom.org.uk/consultations/llu-wlr-cc-13.

1.17 In developing our proposals on model disclosure, we have had regard to our obligations under the Communications Act 2003 (the Act) and our Framework for Disclosure of Charge Control Models.

Broadband line testing costs

1.18 We propose to recover all Test Access Matrices (TAMs) costs from MPF and all evoTAMs (evolutionary Test Access Matrices) costs from SMPF. However, the TAMs costs allocated to MPF in the 2011/12 RFS are considerably higher than in the 2010/11 RFS and compared to our modelling in the March 2012 Statement. Since we have been unable in advance of our consultation to fully understand the reasons for this, for the purposes of this consultation, we have made a simple adjustment to equalise the broadband line testing costs for MPF and SMPF. We will continue to investigate the costs of broadband line testing and, if appropriate, seek stakeholders' views on the appropriate allocation of costs. This is discussed further in Section 6.

Quality of Service

1.19 As part of our review of the fixed access markets we have also been undertaking an examination of matters relating to the quality of service delivered by Openreach in the supply of its regulated wholesale fixed access services. In the FAMR Consultation we have proposed a number of remedies relevant to quality of service, including a set of minimum standards against which Openreach will be required to deliver key provisioning and fault repair obligations.

1.20 The ranges set out above in Tables 1.1 and 1.2 for the proposed LLU and WLR charge controls do not incorporate any additional costs that may be associated with quality of service obligations. As noted in the FAMR Consultation, we propose to consult later in 2013 on the relationship between service quality and resource costs and any impact that this may have on the level of the charge controls for LLU and WLR services. Section 5 covers this in more detail.

Fault rates

1.21 In Section 5 below, we note our ongoing work to understand the likely situation in 2016/17 with respect to the relative incidence of early-life and in-life faults and whether there is likely to be any enduring difference between the incidence of faults on MPF lines as opposed to WLR and WLR+SMPF lines.

1.22 For the purposes of this consultation, we have assumed that the total level of faults will remain at the 2011/12 level and the mix of faults will remain at the 2011/12 level.

1.23 In the mean time, we will continue the substantive analysis to seek to understand the relative fault rates between the different services, MPF, WLR and SMPF, and why early life failures seem to have risen so much.

1.24 Once we have completed this analysis, we intend to publish the results for consultation in the autumn. If the results of this analysis indicate that the levels of the charge controls will fall outside the ranges consulted upon here, we will also conduct a further focussed consultation on the new ranges.

Next steps

1.25 We invite comments, from interested parties, on the proposals in this document. The consultation period runs for just under 11 weeks, to 25 September 2013. We are consulting for a period of just under 11 weeks rather than 12 weeks to enable this consultation to run coterminous with the FAMR. Please see Annex 1 for details on how to respond. Following consideration of responses to the consultation we would expect to publish our Statement in early 2014.

Responses

Responder name	Type
Adaptive_Spectrum_and_Signal_Alignment_Inc.pdf (PDF File, 650.2 KB)	Organisation
BT_Group.pdf (PDF File, 2.0 MB)	Organisation
EE.pdf (PDF File, 568.5 KB)	Organisation
EE_-_Annex_A.pdf (PDF File, 317.9 KB)	Organisation
EE__Additional_Evidence_to_Ofcom_on_directories.pdf (PDF File, 89.5 KB)	Organisation

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