Ofcom’s UK digital communications review: BT can keep Openreach (for now…)

On 25 February 2016 Ofcom published its initial conclusions from its strategic review of the UK’s digital communications market. Whilst much of the headline press coverage has focused on BT being able to retain Openreach, provided its governance is reformed, Ofcom’s review goes much wider than the regulation of Openreach and sets the strategic direction for UK telecoms regulation for the next decade.

However, as someone who has seen successive regulators try alternatives including accounting separation, functional separation and now reformed functional separation whilst technology has moved from cellular telephones that could only be said to be mobile if you drove the car carrying them to modern smart-devices what is striking is the persistency of incumbency, and in particular the ‘last mile’ connection. Whilst Ofcom’s proposals go wider than just addressing this bottleneck, the most interventionist regulation is aimed at this problem, which of course tacitly admits that the last strategic review, done just after Ofcom was formed, failed.

The rest of this post explains how Ofcom reached its conclusions.

What is Ofcom trying to achieve?

Legal Duties

Ofcom is of course a statutory body and the Communications Act 2003 sets out Ofcom’s duties, with Ofcom’s primary duties being:

to further the interests of:

(a) …citizens in relation to communications matters; and

(b) …consumers in relevant markets, where appropriate by promoting competition.

Vision

The challenge for Ofcom is understanding how to turn this duty into something that allows it on a day to basis to take decisions, all of which involve trade-offs. This is where the vision comes in, as Ofcom can then test each of its decisions and see whether they help or hinder it achieving its vision. Ofcom explains that in 2016 its ten-year vision is that:

  • everyone in the UK will enjoy fast, reliable broadband services. Most consumers and businesses will move from ‘superfast’ to ‘ultrafast’ broadband, based increasingly on competing networks, and the latest mobile phone technologies will be rolled out across the UK’s geography;

  • the UK will move towards a new fibre future, with widespread availability of competing ‘fibre to the premise’ and cable networks to homes and businesses. As more consumers and businesses enjoy a greater choice of networks, competition will drive both innovation and affordable prices;

  • people who do not have a choice of providers, do not enjoy even a basic level of service (whether through social circumstance or simply due to where they live), or find it hard to take advantage of offers in the market, will be protected through effective, targeted intervention; and

  • the UK will be a world leader in the availability and capability of its digital networks.

Areas of strategic focus

Ofcom then explains that it will organise its work into five main areas to achieve its vision, with a final sixth theme of seeking to reduce regulation being applied across everything that Ofcom does.

The five areas are:

  1. securing a wide availability of services;
  2. promoting investment and competition;
  3. delivering a step-change in quality of service;
  4. strengthening Openreach’s independence; and
  5. empowering and protecting consumers.

Each of these areas are then examined by Ofcom, and its analysis of the issues to be addressed and form the basis for Ofcom’s proposals. In Ofcom’s own words they are:

Securing a wide availability of services

“From a UK-wide perspective, the availability of fixed and mobile services is good. Most consumers can now access high broadband speeds at home and in their place of work, as well as mobile voice and data services while on the move.

However, some areas of the UK do not have access to an acceptable level of service. The starting point for any future communications strategy must be to ensure that everyone shares in the benefits of a modern digital society.

The Government’s plan for a right to decent, affordable broadband is central to our availability strategy. We will prioritise supporting plans for a 10Mbit/s broadband Universal Service Obligation (USO) to ensure that all people and small businesses have access to decent broadband speeds. Over time, we expect that the USO will need to evolve to ensure all consumers and businesses benefit as technologies and services improve.

We will also secure wide availability of services by:

  • enabling further investment in fixed networks, especially the transition from superfast to ultrafast broadband services, through competitive mechanisms wherever possible;
  • exploring options for extending mobile coverage. We will seek to place new coverage obligations on companies who win new spectrum licences. The 700MHz band is particularly well suited to providing such coverage
  • supporting the UK Government’s reform of the Electronic Communications Code; and
  • providing consumers and businesses with accurate, comparable and accessible coverage information across communications services so that they can make better choices about their services.”

Promoting investment and competition

“Our strategic objective in relation to fixed networks is to encourage the large scale deployment of new fibre networks over the next decade, driving the widespread availability of competing ultrafast broadband services.
To deliver this we will:

  • make it easier for competing providers to build their own fibre networks, across as much of the UK as is practicable, by providing them with access to Openreach’s network of underground ducts and telegraph poles;
  • price access to BT’s network in ways that encourage providers to build their own networks while protecting consumers from excessive pricing;
  • deregulate where network based competition is effective; and
  • continue to promote competition based on other forms of access to Openreach’s network, where effective network competition does not arise.

In mobile, there is no change to our existing strategy. We want the UK to continue benefiting from competition between four national network providers, and a range of resellers. We will work to ensure that the necessary wireless spectrum is made available. If we see takeovers or mergers leading to fewer, bigger network operators, and consumers are worse off as a result, this could lead us fundamentally to rethink our approach to competition and investment in mobile services.”

Delivering a step-change in quality of service

“Widely available networks and services alone are not enough. Consumers and businesses also need these networks and services to be reliable and of a high quality. While most consumers report that they are satisfied with telecoms services, their expectations of quality are rising. The sector needs to deliver significantly better quality of service than it does today.

Our concerns include Openreach’s performance, but extend beyond it to all providers. For example, not only are we concerned about the volume of faults on Openreach’s copper network and about how quickly Openreach repairs them; but also about the customer service that retail providers offer when something goes wrong.

For Openreach, we intend to:

  • set more demanding minimum standards, extending them to new areas as necessary; and
  • set wholesale pricing controls that strengthen Openreach’s incentives to make long term investments in service quality.

For the wider sector, we will:

  • drive improvements to service quality by making more information accessible to consumers and businesses; and
  • publish an annual Service Quality Report showing how telecoms companies compare. Well-informed consumers who are able to make informed decisions are better able to hold providers to account for the service quality they deliver.

In addition, we intend to work with industry to improve coordination between providers where this is affecting service quality: for example, to reduce missed appointments and solve consumers’ in-home problems. Finally, we will look to introduce automatic compensation for consumers and small businesses when something does go wrong”

Strengthening Openreach’s independence

“BT has a crucial role to play in ensuring that consumers and businesses enjoy good communications services, given its market position and the continued reliance competitors will have on its network.

However, we are concerned that the current model of functional separation fails to remove sufficiently BT’s ability to discriminate against competitors. Therefore risks to competition remain.

Given the concerns identified, continuing the status quo is not an option. We have decided to reform the relationship between Openreach and BT Group to give the former greater independence and autonomy. Under this new structure, Openreach should have:

  • more independent governance structures and processes, with a responsibility to serve all wholesale customers equally;
  • independent technical and operational capabilities;
  • greater autonomy over its budget, and over its strategic and operational decision making; and
  • an ongoing responsibility to consult with all customers in the same way.

One option that might achieve this is structural separation, but we recognise that this would entail significant disruption. We will therefore consider whether a strengthened model of functional separation could deliver the greater independence and autonomy for Openreach that we believe is necessary. If functional separation cannot be strengthened, we reserve the right to take forward structural separation.

We are now developing detailed proposals, which we will discuss with the European Commission later this year.”

Empowering and protecting consumers

“Even when choices are available, people need practical information and tools to take advantage of what the market can offer. This need becomes increasingly important as communications services increase in diversity and complexity.

To help people make informed choices, we will:

  • publish more detailed information, including on: service quality and customer response; fixed and mobile service availability; and broadband speeds;
  • work to introduce a standard cost comparison measure, such as average monthly cost of the core elements of a service over the contract period, so consumers can more easily compare different products;
  • closely monitor the impact of providers’ adherence to the Advertising Standards Authority’s broadband price advertising rules;
  • work with third parties, such as price-comparison websites, to improve information consumers have to hand before they buy; and
  • identify what more can be done for consumers who are not responsive to this information, for example, through stronger triggers to consider other deals when contracts expire.

We will follow up our work on Openreach network switching with proposals to make mobile switching easier. We will also complete our review of switching triple-play services (i.e., phone line, TV and broadband).

Some consumers will find it difficult to engage effectively with the market regardless of the information available them. We will therefore take more direct action to help protect such consumers, for example, by tracking market prices more closely and intervening directly to provide protections for the most vulnerable.

Finally, we will continue to protect consumers when things go wrong, from issues such as nuisance calls to various forms of fraud.”

 

How much space do you need for structural separation?

I was intrigued to read today’s joint response (from Starhub, M1, MyRepublic, ViewQwest, SuperInternet, Nucleus Connect and the Asia Pacific Carriers’ Coalition) to the Singapore telecoms regulator’s (IDA) public consultation on whether to allow additional ownership consolidation in its national fibre-optic network market.

With the benefit of hindsight, I was pondering how an apparently elegant solution to a regulatory challenge has ended up being so complicated and arguably ineffective. The challenge that Singapore faced was how to regulate the build out of a subsidised national fibre-optic network. The solution they chose was structural separation of the various up-stream and down-stream activities of a national fibre-network.

However, with hindsight I would argue that the chosen solution was over-engineered and was unlikely to work in a market where some of the retail competitors ended up with economic interests in some of the theoretically separate upstream entities. In part, this was because an overly complex solution was imported from another market without sufficient regard to the local market conditions and the practical difficulties of achieving de facto ownership separation in a small and concentrated market such as Singapore. Whilst it is too late for Singapore to rethink its regulatory structure in this space, there are lessons for other jurisdictions considering appropriate regulation of subsidised fibre roll-out.

To explain further, a market failure may occur in situations where, without regulatory intervention, the market will not deliver an optimal outcome for consumers. Broadband networks relying on a common infrastructure but with retail competition (such as Singapore’s national fibre broadband network or NBN) are an example of a potential market failure if the same company both controls the common infrastructure and competes in the down-stream retail market. This failure manifests itself by the company controlling the network favouring its own retail business over its retail competitors (that do not have control of the network). Without equal treatment, competitive intensity decreases and customers get worse service, quality, choice and may pay more. In essence, any vertically integrated company which both controls a  network and competes in a retail market which requires use of that network has both the incentive and the ability to discriminate in favour of itself.

Regulatory invention can take many forms. What was originally intended in Singapore was that the NBN network (OpenNet) would be owned separately from the NBN operating company (Nucleus Connect) and the operators  (Singtel, Starhub, myRepublic, etc) would compete at the retail level. In addition, (this happened during the tender process) the passive assets of Singtel (ducts, etc) used by OpenNet would be operationally separated from Singtel and placed into a trust – the NetLink Trust, which would be managed separately from Singtel.

This would create a four layer structure:

  1. Passive asset owner (Netlink Trust)
  2. Network owner (OpenNet)
  3. Wholesale network operator (Nucleus Connect)
  4. Competitive retail service providers.

This structure theoretically fixes the market failure described above provided that the first three layers are regulated (as they are monopoly providers) and that no participant in the retail market has ownership or control of any of the first three layers.

However, this theoretical situation does not exist in Singapore today and the proposed consolidation proposals arguably exacerbates the existing problems by giving Singtel additional economic interest in the network owner layer as well as the passive assets.

If we come back to the issues I identified above, Singapore’s IDA has imposed various regulatory obligations that seek to constrain the ability of Singtel to effectively influence the conduct of Netlink Trust.

However, whilst Singtel retains economic ownership (even through a trust) it retains the incentive to discriminate. To be clear, this isn’t about companies or trustees seeking to do anything wrong – it is more that they have a duty to maximise shareholder value or act in the interest of relevant beneficiaries and as part of that duty any rationally managed company or trust will seek to maximise the value of its vertical integration or vertical relationship unless constrained otherwise. At the moment Singtel has a 100% ownership interest in the assets held by the Netlink Trust, and the trustees must act in the best interests of their beneficiary. Following the proposed consolidation, OpenNet’s assets will also be 100% owned by Singtel (through the trust). Although there are proposals for divestment of Singtel’s interest in the trust down to a minority interest, the timetable for the planned divestiture has been delayed.

The key question is whether the regulatory constraints on Singtel’s actions are sufficient to constrain its ability to discriminate in favour of its own downstream business. Whilst the IDA consultation sets out a list of current controls (including reference offers and non-discrimination requirements), market experience to date would suggest that there are still material deficiencies in the regulatory regime (evidenced in particular by roll-out problems) that need to be addressed, and the consortium response sets out a long list of proposed additional regulatory conditions.

An interesting contrast is the approach taken in the UK (albeit to address a somewhat different problem – bottleneck control over legacy last mile copper access) to require BT to functionally separate its copper access business into Openreach. Openreach was then made subject to a requirement of equivalence which in practice went much further than the existing Singapore requirement to provide reference offers and non-discrimination (and also goes further than the conditions proposed by the consortium).

In a small market like Singapore, it seems unlikely that ownership will ever be really disentangled, so regardless of whether consolidation is approved or not it will be interesting to see what additional regulatory requirements the IDA will consider imposing on the NetLink Trust.

BT accounts reveal fear of retrospective price adjustments

BT announced its annual results today.

Press comment focused on BT’s profit growth and the reduction in their pension deficit. However, both of those stories are not quite such good news for BT as might be supposed. Profit growth came from BT cutting costs faster than the fall in BT’s revenues – trends which are not exactly going to set the analysts’ models humming when plugged into DCF valuation models. BT’s pension deficit reduction was to a large extent driven by timing – not surprisingly it looks much better now than shortly after the 2008 market crash – and some commentators have suggested that BT has used some rather optimistic inflation assumptions in its deficit valuations modelling.

For me a bigger story was BT’s narrative that revenue growth would come from its (very capital-intensive) roll-out of fibre-optic access and associated services (such as BT Vision). With established competition from Virgin Media, the strong triple-play offering from Sky, potential new entrants such as Fujitsu and continued regulatory scrutiny there would seem to be significant implementation risk around this plan.

However, I always find that the most interesting sections of annual results are buried in the notes to the accounts. In note 11 (risks) BT says this about regulation:

“Communications industry regulation

Some of our activities continue to be subjected to significant price and other regulatory controls which may affect our market share, competitive position, future profitability and cash resources. Many of our wholesale fixed network activities in the UK are subject to significant regulatory controls. The controls regulate, among other things, the prices we can charge for many of our services and the extent to which we have to provide services to other CPs. In recent years the effect of these controls has required us to reduce our prices, although in some recent cases, prices have been allowed to increase in real terms.

Regulatory authorities may increase the severity of the price controls, extend the services to which controls apply or extend the services which we provide to other CPs. These controls may adversely affect our market share, our ability to compete and our future profitability and cash resources. Wholesale customers may also raise disputes with Ofcom, seeking lower prices on wholesale services which are not subject to direct price control.

Impact
In recent years, changes in price controls have required us to reduce our prices and in some instances to make payments in respect of retrospective price adjustments. Additional or more substantial regulatory price reductions could constrain our revenue growth. Regulatory actions may also indirectly affect us. For example, Ofcom has reduced the mobile termination rates that mobile network operators can charge to terminate calls on their network. There will be a stepped reduction in prices over four years starting from April 2011. This regulatory action will have a significant impact on future transit revenues in the UK and Europe.

We may be required to provide new services to wholesale customers on a non-discriminatory basis, increasing our costs and increasing retail competition. Disputes may result either in reduced revenue or increased costs going forward. We may also be required to make retrospective payments to CPs if it is ruled that past charging mechanisms we have applied have overcharged CPs. Appeals may change Ofcom’s decisions, which had originally been concluded in our favour.

Risk mitigation
We continuously monitor and review potential regulatory changes and disputes, and maintain a strategic dialogue with regulators and other key influencers on critical issues.[underlining added].

This is a very interesting statement in the light of BT’s recent loss in the PPC case in the CAT.

Fujitsu announces UK FTTH roll-out to 5 million homes

In today’s connected world a lot of what passes for news is more of a rolling update – a snippet of new information that is not terribly unexpected. However, today’s announcement by Fujitsu that it is planning to deploy a fibre to the home (FTTH) network to over 5 million UK rural homes really is new, in that it was unexpected and market changing.

Until this announcement, received wisdom was that there were only two players in the UK’s next generation broadband infrastructure market – BT Openreach and Virgin Media. Both of these players have been focussing their rollout on the lucrative dense urban areas, and the expectation was that government subsidy to stimulate fibre deployment to the ‘final third’ (the third of the country where deployment is uneconomic without financial assistance) would be taken up by BT Openreach.

The project appears to be well thought through with two large ISPs – Virgin and TalkTalk apparently committed to purchasing the venture’s wholesale outputs. The underlying technology is fibre to the home, based on Cisco technology with initial speeds of 1GB/s, upgradeable to 10GB/s and above.

However, the deployment is predicated on two regulatory assumptions:

  1. Access to BT’s ducts and poles on  fair, reasonable and non-discriminatory terms; and
  2. Access to a significant proportion of the available government subsidy.

Neither of these assumptions can be taken as read. Whilst BT is progressing its passive infrastructure access product, there remain significant problems with its current offer and I understand that industry remains very concerned about the restrictions within BT’s current proposed contract.

So far as the subsidy is concerned, I would expect to see BT Openreach fight very hard to retain the subsidies it would previously have taken for granted. Competition for subsidy is good news for tax payers, provided that Fujitsu’s venture gets over whatever threshold it needs to get off the ground.

Ofcom consults on reductions in LLU and WLR prices

Ofcom today started a consultation on price controls for local loop unbundling and wholesale line rental products provided by Openreach, the functionally separate local access division of BT.

This consultation follows on from Ofcom’s finding in its wholesale local access and wholesale fixed analogue exchange line market reviews that BT held a position in those markets akin to dominance (in EU telecoms regulatory speak – ‘significant market power’). Each of those market reviews imposed various obligations on BT including an obligation to meet reasonable requests for network access, an obligation to publish a reference offer, cost-orientation requirements and a compliance with charge control requirements – the subject matter of today’s consultation. 

In common with other UK telecoms charge controls, the proposal is that the charge controls will take the form of an RPI-X% control (where RPI = retail price index and X is set at a level to ensure that BT’s expected rate of return reaches an ‘acceptable’ level by the end of the charge control period), although somewhat unusually a two year, rather than the more normal four year, period is proposed for the charge control.

The charge control has been structured as:

  • an individual control for metallic path facility (or MPF – the copper wire to the home);
  • an individual control for shared metallic path facility (or SMPF – the high frequency part of the copper wire to the home, used to provide broadband, rather than voice);
  • separate baskets for (i) MPF ancillary services, (ii) SMPF ancillary services; and (iii) co-mingling services;
  • an individual control for wholesale line (WLR) rental;
  • an individual control for WLR new connection; and
  • an individual control for WLR transfer.

Prior charge controls were reviewed by the Competition Commission (see here for LLU and here for WLR), and those determinations have been taken into account in this consultation as well as BT’s revaluation of its duct network. This consultation uses a WACC for BT of 8.6%, although this is subject to another consultation on the appropriate WACC.

Responses are due by 9 June.

BT sets prices for passive access to ducts and poles

Before Christmas, this blog flagged that last-mile fibre access (also know as next generation access, or NGA) was a commercial and regulatory issue that would be high on the agenda over the coming years.  On Friday, BT announced its draft pricing and product proposals for ‘passive access’ to its ducts and poles in the UK.  (In the NGA world passive access is used to describe access to physical infrastructure, whereas active access means access to some form of wholesale service).

BT is careful to position the new draft product proposals as complementary to its existing (active) Generic Ethernet Access products which it ‘expects … will form the basis of most [of BT’s competitors’ offerings]’. However, BT’s competitors may of course have a different view.  In reality, the impact and usage of BT’s new products will depend on their pricing, both in absolute terms as well as relative to active products and the underlying technology used by its competitors.

In terms of pricing, BT is proposing that duct access will start from £0.95 per metre per year, with various additional charges for ancillary services, whilst pole sharing access will be around £21 per pole, per year.   In BT’s view the duct access is around 15% less than international comparables, although I haven’t seen any underlying analysis to support that contention.  Going beneath BT’s headline figures, the list of ancillary services is extensive and it looks like the level of the charges will be material for most purchasers, so the detail is well worth looking at.

So far as the regulatory background is concerned, the position is somewhat complex, with regulators in Europe and the UK both having taken an interest and the waters muddied even further by the interplay between traditional electronic communications regulation of markets in which players hold significant market power and BT’s Enterprise Act undertakings.  Regulation in the UK is of course subject to EU thinking, in particular the Commission’s  recommendation on NGA which takes into account views of the European Regulators’ Group (BEREC) .

The Commission’s recommendation makes clear in outline that the regulatory requirements on BT in relation to ducts and poles  should include:

  1. duct access on an equivalent basis (para 13 of Recommendation);
  2. cost-orientated pricing for access to existing civil engineering infrastructure (para 14);
  3. mandated reference offer (para 15);
  4. requirement to install capacity for other operators when undertaking future civil engineering works (para 16); and
  5. provision of information to a central database (para 17).

Some of this was picked up by Ofcom in its October 2010 Review of the Wholesale Local Access Market, where following a finding that BT had significant market power in the UK (except Hull)  in the market for wholesale local access services (being those based on copper loops, cable networks and optical fibre at a fixed location), it imposed a range of remedies relating to local loop unbundling (LLU), sub-loop unbundling (SLU), virtual unbundled local access (VULA) and physical infrastructure access (PIA) – with the last relating to ducts and poles.

The obligations imposed on BT pursuant to that market review specifically relating to PIA (i.e. ducts and poles) are to:

  1. produce a draft reference offer by mid-January (i.e. the latest announcement) – although this need not support leased line services at this stage;
  2. launch the product by the ‘middle’ of the year (which translated from Ofcom-speak,  I would take to mean that BT need to have something in play by September);
  3. pricing should be cost-orientated (which means argument is likely);
  4. provide network access, to not discriminate unduly, to keep separate accounts and to publish certain information.

Although not referenced in Ofcom’s market review, the various requirements under BT’s undertakings in relation to NGA and equivalence are also relevant (although, Ofcom has expressly decided to not implement a para 13 equivalence requirement), as is Ofcom’s separate consideration of industry-wide mandation of infrastructure sharing.  As can be seen, last week’s announcement is the start of a process that will play out over the rest of this year (and beyond).  Challenge at this stage is unlikely, but the experience of the launch of almost any new product (interconnection in 1984, LLU in 2000) suggests that disputes may well be on the horizon.