BT Group plc
Regulatory teach-in
15 June 2012
Agenda and introductions
Regulatory framework in the UK
Regulatory remedies and impact on BT
Regulatory reporting and accounts
Current regulatory activity
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Regulatory framework in the UK
Mark Shurmer, Group Director,
Regulatory Affairs
UK regulatory framework history
 1981 British Telecom split off from the Post Office
 1984 Telecommunications Act and BT privatised
Oftel created
 1998 First set of EU Directives in force
Competition Act gives Oftel competition authority powers
 2003 Oftel replaced by converged communications regulator Ofcom
Second set of EU Directives in force – includes market review framework
Communications Act
 2005 BT Undertakings and the creation of Openreach
 2011 EU Directives refreshed
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UK regulatory framework today
EU Directives
• Establish EU-wide “Common
Regulatory Framework”
• Specify market review process for
imposing remedies, including
frequency
• National regulators must consult EU
on remedies, including charge
controls, to ensure consistency
BT’s Undertakings
• Offered by BT in lieu of reference
under the Enterprise Act
• Creation of Openreach, Equivalence
of Inputs (EOI), Equality of Access
Board
• Vast majority of Undertakings
delivered
UK Communications Act
• Gives Ofcom legal powers and
implements the EU Directives
• Review ongoing – White Paper
expected early 2013
“Horizontal” UK legislation
• Competition law
• Consumer protection legislation
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UK regulatory framework BT’s objectives
Clarity in the framework and rule set
Ability to make fair and reasonable return on investment
Level playing field relative to competitors
Less friction in the system – break out of cycle of litigation
Evolution to a truly converged framework
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UK regulatory framework market review process
•
Principle is to ensure regulation is only implemented where competition is not effective
•
Focus is on “access bottlenecks” to facilitate market entry further downstream
•
Key access markets (set out in EC Recommendation) must be reviewed every three
years to assess where regulation is still required
Step 1: Market definition
Regulators define relevant markets, having regard to Recommendation and following
competition law approach (e.g. are mobile calls a constraint on provision of fixed calls?)
Step 2: SMP assessment
Regulators assess whether any CP has Significant Market Power (SMP) - “position of
economic power affording an undertaking the power to behave to an appreciable extent
independent of competitors, customers and ultimately consumers”
Step 3: Impose remedies
Regulators assess what ex ante remedies are appropriate to impose on any CP found to
have SMP
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UK regulatory framework upcoming market reviews
2012-13
2013-14
Business Connectivity
- Ethernet, Partial Private Circuits
Wholesale Local Access
- LLU (MPF/SMPF), GEA
Wholesale Broadband Access
- WBC, IPStream
Wholesale Fixed Narrowband Access
- WLR, ISDN2
Wholesale Narrowband Calls
- CPS, Indirect Access
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High
Severity of
constraint
Low
UK regulatory framework SMP remedies
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Supply
- Must supply services in market to others
on reasonable request
Non-discrimination
- Must not show undue discrimination
against others/in favour of own activities
- EOI is a stronger form
Accounting
separation
- Must publish financial statements to
enable transparency
Cost orientation
- Must ensure prices are reasonably
derived from costs of provision
Charge control
- Must ensure prices change by no more
than RPI-X% each year
UK regulatory framework enforcement powers
 Dispute resolution:
– Under the framework, CPs can refer commercial disputes about network access to
Ofcom for resolution
– Pricing disputes can relate to past periods, giving rise to retrospective repayments
 Compliance investigations:
– Triggered by complaints or by proactive Ofcom reviews
– Enforcement powers analogous with Competition Law
– CPs affected by any non-compliance could subsequently seek damages
 Competition Act:
– Ofcom has concurrent powers with the Office of Fair Trading („OFT‟) in the electronic
communications sector under the Competition Act and EU competition law
– Ofcom may investigate suspected infringements of the prohibitions of anti-competitive
agreements and abuse of a dominant position
– Where an infringement is found, Ofcom may give directions they consider appropriate
to bring the infringement to an end
– Fines of up to 10% of group worldwide turnover may be imposed
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UK regulatory framework appeal process
 All Ofcom decisions can be appealed on the merits to the Competition Appeals
Tribunal:
– Market definitions, SMP findings, choice of remedies, including setting of charge controls
– Dispute resolution determinations
 Ofcom decisions stand pending outcome of appeal
 CAT will refer “specified price control matters” to the Competition Commission
(CC):
– CC will consider evidence and issue Determination back to the CAT answering the
specific questions asked of it
 CAT Judgment can order Ofcom to implement different outcome or to reconsider
the issues addressing identified errors in analysis
 CAT Judgments can also be challenged by affected parties (including Ofcom) to:
– The Court of Appeal on judicial review grounds; or
– The High Court on judicial review
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Regulatory remedies and impact on BT
James Tickel, Head of Operational Regulation
& Economics, Regulatory Affairs
Remedies imposition of charge controls
 Charge Controls in the UK now generally last three years to align with market
review frequency
 Controls require defined prices in the SMP market to move by no more than “RPIX%” in each year
 The setting of the control is essentially a forecasting exercise. The value of X is
set so that by the end of the control period, BT is forecast to recover relevant costs
of provision, including a fair return.
 It is prices rather than actual returns earned that are controlled. As such, BT has
incentives to keep costs beneath levels forecast by Ofcom.
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Remedies operation of charge controls
Current unit price
RPI-X glide path
“Target” unit price
Unit
price/cost
ROCE
Operating costs
Depreciation
Year x
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Base year
actual unit
costs
Year x+3
Final year
forecast
efficient unit
costs
Remedies operation of charge controls
Current unit price
….or possible
“step” followed by
RPI-X glide path
“Target” unit price
Unit
price/cost
ROCE
Operating costs
Depreciation
Year x
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Base year
actual unit
costs
Year x+3
Final year
forecast
efficient unit
costs
Remedies charge controls “relevant costs”
 Ofcom needs to identify the annual operating costs that will be incurred in providing the
relevant service(s) and the value of the assets required to provide the relevant
service(s)
 To this end, base year costs tend to be assessed by reference to BT‟s Current Cost
Accounting Fully Allocated Costs (“CCA FAC”) for the relevant service(s) as reported in
our Regulatory Financial Statements (see below)
 However, Ofcom makes some adjustments to BT‟s published costs in defining the
costs it views as “relevant” to be recovered through regulated charges – e.g. it can
decide that for policy reasons certain reported costs should not be recovered through
the allowed regulated charges
 Key factors behind Ofcom‟s forecasting final year costs:
– How will volumes change over the period?
– How will unit costs change with volumes?
– What efficiency savings is BT expected to make?
– What is BT‟s estimated cost of capital?
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Remedies charge controls RAV
The “RAV adjustment”
 Prior to 1997, regulated prices were set on basis of Historic Cost
Accounting (HCA) asset valuations
 Ofcom considers that BT would receive a windfall gain if prices today
were now set on a CCA basis for any in-life assets originally in place
prior to 1997 (mainly duct assets with some copper)
 Ofcom therefore adjusts the CCA values of the RAV in our RFS to use
HCA values for those pre-1997 assets
 We disagree with Ofcom‟s adjustment and have appealed its use in the
latest WLR/LLU charge control
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Remedies charge controls: WACC
Estimate of Weighted Average Cost of Capital (“WACC”)
 Ofcom use the Capital Asset Pricing Model (CAPM) to calculate the rate
by reference to both general and BT-specific financial market information
 Ofcom has recently set the WACC for Openreach (copper products) at
8.8% and rest of BT at 9.7%. This was reduced from WACC used in
setting 2009 controls due to changes in financial market parameters,
including falls in the risk free rate
 Sensitivity to WACC: round 1/3 of the relevant costs for setting WLR and
MPF rental prices is made up by the allowed WACC
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Remedies cost orientation
 Imposed as “Basis of Charges” remedy requiring that prices in the SMP market are
“reasonably derived” from the costs of provision including “reasonable” mark up for
recovery of common costs and “reasonable” return
 As such remedy is not “prescriptive” about the level of the charge (unlike a charge
control)
 Disagreement with Ofcom on its interpretation: focus seems to be exclusively on
individual prices being between reported “floors” and “ceilings” with no account being
taken of other factors – such as how costs are recovered across related services
 Driver of number of recent high value retrospective disputes:
 2009 PPC trunk circuits decision
 2012 Ethernet/high bandwidth draft decisions
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Remedies cost orientation: floors and ceilings
 As noted, charge controls tend to be set to by reference to FAC (Fully Allocated Cost):
-
Cost of providing a service including a specific allocation of fixed and common
costs shared across different BT services
 “Floors” for cost orientation are based on “DLRIC” (Distributed Long Run Incremental Cost):
-
LRIC for a service is calculated by taking its FAC and stripping out the fixed and
common cost (FCC). DLRIC includes an attribution of any FCCs shared between
services within defined “increments” within BT‟s business, but not with services outside
the increment
 “Ceilings” for cost orientation based on “DSAC” (Distributed Stand Alone Cost)
-
DSACs are calculated from the LRIC for a service plus an allocation of all FCCs
shared with all other BT services across only those services within the defined
increment
 DLRICs and DSACs then reported in BT‟s Regulatory Financial Statements
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Remedies cost orientation: floors and ceilings
Pricing too high
Cost Ceiling
“DSAC”
“FAC”
Pricing
flexibility
Cost Floor
“DLRIC”
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Pricing too low
Effect on BT where does BT have SMP?
Line of Business
BT Retail,
BT Global
Services
Retail
Leased
lines
BT Wholesale
Broadband
Market 1
and 2
PPCs
Call
origination
termination
Passives
WLR
Openreach
LLU
ISDN30
ISDN2
Market Review
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WLR,
ISDN30
Ethernet
<=1G
GEA
WLA,
WBA
BCMR/LLCC
Narrowband
Calls
Effect on BT where is BT charge controlled?
Line of Business
BT Retail,
BT Global
Services
BT Wholesale
Openreach
Broadband
Market 1
WLR
LLU
PPCs
Call
origination
termination
Ethernet
<=1G
ISDN30
Market Review
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WLR,
ISDN30
WLA,
WBA
BCMR/LLCC
Narrowband
Calls
Regulatory reporting
Michael Rickard, Group
Regulatory Finance
Regulatory reporting summary
 Regulatory reporting obligations are determined by EU Directives and by
Ofcom:
– The Annual Ofcom reporting consultation process amends (and generally
increases) reporting requirements
– The content is also impacted by market reviews and other changes
 Required to show
– Cost orientation, Non-discrimination, Market level returns by each market and more
 Accounts are prepared on CCA basis
– Accounts also use different (Ofcom) terms e.g. AISBO for Ethernet
 Extremely detailed
– Over 2000 pages of information (but mostly reference tables)
– Useful information is in Section 7 and 8 (Access and Wholesale markets) and
section 10 (Openreach report)
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Regulatory reporting Current Cost Accounting (CCA)
 Reflect assets at „current‟ value to the business
– Should reflect „economic cost‟ and is „forward looking‟
– Ofcom requirement
 Key assets affected by CCA
– Duct and copper
 CCA adjustments flow through P&L as:
– Supplementary depreciation (ongoing return)
– Holding gain / loss (one-off impact)
– Other CCA adjustments (one-off impact – methodology changes etc.)
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Regulatory reporting regulatory accounts
 Ofcom statement (front of statement before page 1)
 Section 1 – Introduction (Pages 3 to 8)
 Section 2 – Statement of Responsibility (Pages 9 and 10)
 Section 3 – Audit Report (Pages 11 to 14)
 Section 4 – Basis of Preparation (Pages 15 to 19)
 Section 5 – Summary of Financial Performance (Pages 20 and 21)
 Section 6 – Attribution of Current Costs and MCE (Pages 22 to 28)
 Sections 7 & 8 – Review of Access and Wholesale Markets (Pages
29 to 82)
 Section 9 – Reconciliation to BT Group‟s statutory accounts
(Pages 83 to 87)
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 Section 10 – Openreach statements – to comply with
Undertakings (Pages 87 to 94)
 Appendices (Pages 95 to 124)
 Glossary of terms
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Regulatory reporting overview of RFS
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Current regulatory activity
Mark Shurmer, Group Director,
Regulatory Affairs
Current regulatory activity
Market reviews and charge controls
– Business Connectivity Market Review: consultation imminent
– Leased Lines Charge Control : consultation expected end-June
– Wholesale Narrowband Market Review: responses due to Ofcom call for inputs at end June
– Wholesale Local Access/Broadband Access Market Review: preparation starting soon, call
for inputs expected early 2013
Appeals and disputes
– WACC appeal: CC determination now published; CAT Judgment later
– Pensions appeal: CC determination now published; CAT Judgment later
– WLR/LLU charge control appeal (includes BT challenge of RAV adjustment): expected to
conclude May 2013
– Ethernet £145m /high bandwidth disputes: decision from Ofcom expected in next 2-3
months
Other key activity
– Regulatory reporting and cost orientation: consultation expected before end June
– Wholesale Calls Competition Act case: Ofcom investigation ongoing
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BT Group plc
Q&A
Remedies operation of charge controls
Current unit price
RPI-X glide path
“Target” unit price
Unit
price/cost
ROCE
Operating costs
Depreciation
Year x
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Base year
actual unit
costs
Year x+3
Final year
forecast
efficient unit
costs