On 26 May, regulators across Europe will boast a powerful new weapon in their arsenal against market dominant incumbent operators. It is a power that, although designed only to combat serious market failures where all other options have been exhausted,…
On 26 May, regulators across Europe will boast a powerful new weapon in their arsenal against market dominant incumbent operators. It is a power that, although designed only to combat serious market failures where all other options have been exhausted, is perhaps already having an effect on the telecoms sector.
Under the European Commission’s [2002/19/EC] ‘Access Directive’, amended in December 2009, national regulatory authorities (NRAs) will soon have the ability to require telcos with significant market power to implement Functional Separation. That is, the separation of a telco’s division for selling network access products from its retail and other units, through internal reorganisation rather than through a sale.
It requires that the network division of the vertically integrated operator – normally the incumbent – provide wholesale services to its own separate retail division under the same conditions as are provided to unrelated retail providers. This goes beyond just price, since it requires that the competing retail providers receive the same service levels and even use the same operational systems for functions such as provisioning.
Such a measure has already been used to great effect in the UK, where in January 2006 the incumbent operator BT announced the launch of its separate network access arm Openreach, having been obliged to do so by NRA Ofcom.
Openreach manages the country’s telecoms infrastructure, treating the rest of BT, which includes end-consumer focused units BT Retail, BT Wholesale and BT Global Services, on an equal basis to other operators. The equal basis is aptly described in the UK model as “equivalence of inputs”.
It is widely seen as a success in reducing the incentives for BT to discriminate against downstream retail competitors in granting access to its network, and thus encouraging competition in telecoms, internet service provision and so on.
However, Functional Separation is not a one-size-fits-all remedy, says Tom Levine, head of Allen & Overy’s telecoms practice, who points out that under European Law it is permitted only as a “remedy of last resort”.
The 2009 amendment to the Access Directive, at Article 13a, states that NRAs may only impose Functional Separation where they conclude that other, less intrusive regulatory measures have failed to achieve effective competition, and that there are important and persisting market failures.
According to Levine, the combination of these conditions in the Directive constitutes a high hurdle to any NRA considering imposing such a separation. This is because the NRA must establish not only that the other remedies have failed but also that they will continue to fail because of structural factors.
He added that this is fertile ground for an incumbent to mount a legal challenge to Functional Separation, no doubt partly as a result of lobbying by some incumbents during the long negotiations over the 2009 amendments.
Despite this, some industry spectators argue that its mere possibility has already influenced Europe’s regulatory landscape, as well as the relationship between regulators and incumbents.
From around the time the additional regulatory powers were being outlined in 2009, incumbent operators in Italy, Sweden and Poland have all been making moves towards voluntary Functional Separation.
Although perhaps still far away from regulators’ preferred model in the UK, incumbents in these countries have been making increasing efforts to replicate BT and its Openreach.
“The spectre of enforced Functional Separation already seems to be giving regulators leverage over the networks of incumbents,” said Michael Grenfell, a partner for antitrust, competition and regulation at Norton Rose.
Grenfell pointed to developments in Ireland, where local regulator ComReg has recently been commended by the European Commission over plans to introduce key performance indicators (KPIs) for network access.
ComReg’s plan to implement such KPIs is being made as part of efforts to enforce its non-discrimination obligations more effectively. Naturally, the move could also help identify where enforcement has been ineffective, requiring tougher measures such as Functional Separation.
On 21 March, the Commission wrote to the Irish regulator, welcoming its KPI proposal as a way to enhance its ability to monitor non-discrimination obligations “In this respect, the Commission shares ComReg’s view that the greater transparency around compliance by Eircom with its non-discrimination obligations could have a beneficial effect on competition in the relevant markets, as it not only provides the national regulator with a tool to detect potential noncompliance quickly but also as it is designed to increase the confidence both of Eircom’s competitors in the wholesale input and of consumers in the retail products offered by alternative operators,” the Commission stated in the open letter.
Lawyers have highlighted how these remarks are significant for the Commission, which usually only comments on draft regulation notified by NRAs to criticise areas that do not coincide with its guidelines.
As such, the Commission appears to be encouraging other regulators to follow suit to improve their own market conditions.
A spokesman for the Commission’s Digital Agenda told TelecomFinance that, although it has no concrete information as to whether, or how far, countries are being influenced by measures that will come into force at the end of May, it is at the very least a conversation starter.
“It cannot be denied that the threat of enforced Functional Separation might motivate some incumbents to be more co-operative and to work more closely with their national regulators to ensure non-discriminatory access to the networks of operators with significant market power, thereby improving the competitive conditions in the relevant markets within the existing framework of remedies,” he said in an email.
“If this kind of cooperation leads rapidly and effectively to a more competitive landscape (without the need to formally impose functional separation), for example, by way of a well functioning non-discrimination obligation, the Commission would, of course, welcome such a development.” Ovum analyst Matthew Howett agreed that the addition to regulators’ toolkits will help address market issues across Europe, whether it is used or not.
Howett said: “The threat of Functional Separation being used is a very powerful one. Incumbents will want to avoid it, and it could be enough to fix some of the problems in markets.” However, he added that the success of BT’s split in the UK would perhaps be more of a driver for incumbents to come around to the idea of separating their own businesses.
To this end, a secondary amendment to the Access Directive, at Article 13b, makes it easier for incumbents to accomplish Functional Separation on a voluntary basis through added legal clarity.
Even still, Howett warned of the “phenomenal” costs involved in carrying out the separation, including “headaches” such as devising new billing systems.
Levine also suggested that, faced with the considerable cost of implementing Functional Separation, incumbents would be motivated to challenge a threat from an NRA to impose it, and may feel that the legal conditions for its introduction are so strict that the threat is not so credible.
Andrew McMillan, a partner within the TMT sector group at Simmons & Simmons, also took a more skeptical view of benefits that will be brought about by NRA’s new regulatory power.
“The threat of Functional Separation will only be effective if the incumbent believes that it may actually be implemented,” said McMillan.
“Recent history suggests that European regulators outside the UK may continue to take a softer approach than Ofcom did with BT and this may in turn undermine its effectiveness as a potential remedy.” McMillan added that even within the UK, Functional Separation had not in itself addressed some of the key issues.
He highlighted that no matter how far financial and accounting separation is pushed, if network access and retail businesses remain within the same group, budget (and thus material capex) will be approved at the group level rather than at the level of the network business. This, he says, will inevitably impact upon the perceived independence of the network access business.
