Improved broadband competition through functional separation - PTS-ER-2007:18

14/06/2007

The National Post and Telecom Agency's (PTS) conclusion from this report is that there are structural competition problems that have existed in the market for a long time. Neither the sector-specific regulation nor general competition law has been able to remedy these problems. A new regulatory tool that provides the authority with powers to impose requirements for the vertical separation of a dominant stakeholder should be created in order to rectify this situation. A new tool, together with the current powers to impose obligations on operators with significant market power, would reduce persistent competition problems in the electronic communications market.

The solution is proportionate and tested
A vertical separation can be implemented in mainly two different ways; structural separation and functional separation. The authority considers that a structural separation as well as a functional separation will solve the current problems of competition in the market. PTS draws the conclusion that it is impossible to impose structural separation as a special obligation under the current EC regulation. PTS also draws the conclusion that it is possible to impose functional separation as a special obligation under the current EC regulation, provided that existing obligations are insufficient.

PTS has identified a number of positive qualities for functional separation. This solution is proportionate. It rectifies the problems of equality of access that need to be resolved, which makes it inappropriate to apply a more intrusive measure. Functional separation has also been tested and shown to function in the United Kingdom. Several other countries are introducing or are about to introduce the functional separation of telecom operators.

The separation should as a minimum include regulated products for broadband access
Supported by an obligation decision; PTS considers that it should be possible to create a functionally separate unit that comprises, as a minimum, the market for LLU and ancillary assets. These assets include the rollout of fibre to connection cabinets (FTTC). Bitstream and associated assets should also be covered by a separate unit.

The dominant operator should consider organising itself voluntarily so that other parts of the physical layer in the local loop are also covered by the separate unit, as such a model would probably be more efficient and practical for use by a vertically integrated operator than a model that excludes certain unregulated assets from the entirety that the local loop constitutes.

Organisational measures improve separation
As a rule, the functionally separate unit should be its own legal entity in the form of a limited company.

It should be possible to impose requirements as regards the composition of the board, its quorum and its independence from the dominant operator.

Requirements should also be imposed regarding the independence of the managing director in relation to the dominant operator.

An audit committee should be established to, in contact with the company's auditors, exercise supervision of its routines and processes for accounting, and also internal controls relating to compliance with the obligation. It should also be possible to impose requirements on reporting with the aim of following up the obligations imposed in relation to the actual outcome and key figures set. This report should be submitted to PTS. An auditor should also conduct a special annual review of the accounts of the operation and thereafter submit, by means of a special certificate, an opinion on the matter of compliance with the obligation.

There may also be cause to impose requirements on the separate unit's equity, solvency and liquidity in order to prevent abnormally high group contributions, profit distributions and other value transfers from the separate unit.

Rules of conduct should also be imposed in the event of functional separation by establishing 'Chinese walls' between the separate unit and other parts of the operator's organisation. The areas that should be covered are the rules on the exchange of information, employment conditions and incentive programmes. All of the IT systems that refer to the functionally separate unit should also be partitioned off from other parts of the operator's organisation.

The proposed implementation is predictable and creates stability
The opportunity to impose functional separation as an obligation will be a new tool in PTS's ongoing work to promote competition. Consequently, it is possible that such an obligation could be imposed on an operator after a market analysis of relevant markets and a decision regarding stakeholders with significant market power. PTS's proposed solution thus harmonises with the overall EC legal rules. Implementation of functional separation should be viewed as a long-term measure, even if adaptations may be made depending on changing circumstances in the market. The proposal to incorporate functional separation among the other possible obligations thereby creates stability and predictability in the market.

A renewed market analysis could possibly commence during the autumn of 2007 and any decisions on obligations may be made during the spring of 2008, subject to the precondition that the proposed statutory amendment enters into force on 1 January 2008.

Voluntary commitments can replace certain obligations
PTS also proposes that powers be introduced into the Electronic Communications Act (LEK) enabling PTS to accept voluntary commitments from an operator. The rules for voluntary commitments contained in LEK should also be based on the rules contained in general competition law to accept voluntary commitments, both within EC law and the Competition Act. The commitment to introduce functional separation should aim to expedite the introduction of regulation of the LLU market and its closely related markets.

The proposal yields positive consequences for operators and end users
PTS's impact analysis has led to the assessment that the potential gains that the model entails exceed any costs that might arise.

The costs that arise derive mainly from the transaction costs arising for the regulated operator in conjunction with the implementation and formation of the functionally separate unit. There are also potential costs in the form of loss of efficiency as a consequence of it no longer being possible to fully realise the synergies found in the original vertical structure.

On the income side, there is the value of greater transparency and predictability for market stakeholders. The value of all operators being treated equally in the event of local loop unbundling is mainly manifested through improved terms of competition for the operators, which results in product development, improved service and downward price pressure for the benefit of consumers. Greater transparency also contributes to reducing the number of potential disputes and legal conflicts, which releases resources, not only from the operators and PTS, but also from the legal system.