functional separation in european telecoms regulation

Assessing the Role and Long Term Value of Functional Separation

Claudio Boreggi

RegEcon Consulting & Media

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IIR‐ Telecoms Regulation

1° April 2009

Key Questions

Understanding the reasons advocates for functional separation (FS) as a possible remedy in European Telecoms regulation, and its role:

• Which problems should be addressed by FS?• Should FS be seen as an end in itself or as a means to an end?

• Which “key features” should be present in the FS?Which experiences in Europe?Should FS be mandatory?

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List of possible obligations for a wholesale market (according to Access Directive) (*) :

•transparency (Article 9); •non‐discrimination (Article 10); •accounting separation (Article 11), •obligations for access to and use of specific network facilities (Article 12), •price control and cost accounting obligations (Article 13).

In addition, according to Article 8.3 of the Access Directive, “in exceptional circumstances” NRAs may also impose obligations not comprised in this list.

Dealing with SMP: Standard Remedies

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Under the new 2002 framework, the National Regulatory Authorities must impose appropriate remedies (obligations) on the

operators notified as having SMP in a specific market.

(*) Directive 2002/19/EC of 7 March 2002 on access to, and interconnection of, electronic communications networks and associated facilities

Bottleneck facilities and discriminatory behaviour

According to a number of NRAs there is the risk that standard remedies might not be enough to prevent a discriminatory behaviour by a vertically integrated operator, particularly where “bottleneck” facilities are involved, e.g. the “access markets”

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•refusing to provide wholesale access to the bottleneck service;

•raising upstream wholesale prices above internal costs,so implementing a margin squeeze and pushing competitors out of the market

•providing preferential treatment to the SMP Operator’s retail unit in respect of non‐price terms, for example by providing superior service quality levels;

i i fid i l h l l i

Most common risks of competitive problems include:

•misusing confidential wholesale customer information to benefit the retail unit’s marketing activities.

Reasons why some discrimination problems could not always be addressed by “standard remedies” (1/3)

As a matter of fact wholesale services to Competitors often managed/delivered

• on the basis of ad‐hoc wholesale Support Systems implemented after the opening to competition

• with consequent processing performances & costs different than those of the Support Systems used/optimised for retail services

External and Internal KPIs often defined/monitored in different ways, according to the specific (differentiated) production processes

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Such behaviours are not “per se” illegal and cannot always be addressed under Art.10 of AD:

Obligations of non‐discrimination shall ensure, in particular, that the operator applies equivalent conditions in equivalent circumstances to other undertakings providing equivalent services, and provides services and information to others under the same conditions and of the same quality as it provides for its own services, or those of it subsidiaries or partners. (Article 10).

Factual limits of Accounting Separation

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For this reason, the regulatory accounts are sometimes viewed by AltNets as being more useful in theory than in practice and hence as not being of real value in increasing transparency of the system.

• In principle aimed at guaranteeing absence of any (undue) discriminationin terms of cost allocation and price definition

• However Accounting Reports are often made publicly available with significant delays, because:

•CA&AS reports mainly to be based on data to be reconciled with the Statutory Accounts•CA & AS reports complex and often audited by NRAs with months/years of delay


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Lack of skill in NRAs• Accounting Separation limits in timely preventing price discrimination could be greatly softened by the definition of proper Price Tests aimed at avoiding:o Predatory Prices

o Price squeeze situations

• However Price Test definition/implementation implies skilled resources and complex activities so giving incentives to NRAs to find out more straigthforward and simpler (from their point of view) solutions


Reinforcing the “standard remedies” (1/2)

For the above reasons in a number of MS the regulatory obligations on “access markets” have been reinforced in order to better cope with “non‐price discrimination”problems and to reduce “price discrimination” incentives

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• through a shift from “non‐discrimination” obligations to a concepts of “Equality of Treatment” or of “Equivalence”

However NRAs are aware that functional separation is not in the list of possible “remedies” presently included in the EC framework (art. 8.3 of the AD too “weak”)

•in some cases by using additional regulatory tools, such as “voluntary undertakings” by the Operator, with regard to administrative and organizational aspects

administrative/functional separation

Reinforcing the “standard remedies” (2/2)

Under the current review of the European Regulatory Framework (Nov. ‘07), the EC has stated its intent to offer an additional “regulatory tool” to

NRAs in order to achieve sufficiently competition in EU markets. This regulatory tool is Functional Separation.

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•The decision to impose functional separation needs to be considered by the NRAs after a careful analysis and based on the nature of the problem identified, proportionate and justified in the light of the objectives of the Directives.

•Functional Separation should only be implemented when it can be shown that other mechanisms or remedies (Accounting Separation, non‐discrimination, etc.) cannot ensure non‐discriminatory access .

(*) ERG (07) 44

Feedbacks: generally negative by Incumbents, positive by Altnets; mixed by economists; ERG quite cautious:

ERG (07) 44:Functional separation allows for the targeted separation of those enduring bottlenecks which are difficult for rival operators to replicate commercially, but which provide vital inputs to a range of downstream products and services provided by both the vertically‐integrated operator and its competitors.

By creating a separate business unit with business incentives based on the performance of that unit (rather than the performance of the vertically integrated company as a whole), it is more likely that the business unit will deliver the services that its customers want.

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Key elements of Functional Separation (1/4)

Separation of functions:‐ Creation of separate business unit, A, responsible for the production and supply of

products in question‐ Obligation to supply all operators under non‐discrimination conditions (equivalence)‐ Separation of operational support systems‐Separation of the brand (total=different name/partial = A, a division of B)

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Separation of Employees:‐Employees are not permitted to work some of the time for A and some of the time for another department

‐Restrictions on the movement of A's managers to the rest of the group‐Physically separate offices and places of work‐ Pay incentives‐ Code of conduct, notice boards, training

Separation of Information‐Limits to the flow of information between A and the other divisions (firewalls, Chinese

walls)‐Implementation of separate access systems (information specific to the needs of the

employee)‐Separation of information management systems

Note by ERG: Several of the measures mentioned here are mandatory in most member states i.e. accounting separation. Others are optional and can be applied to differing degrees. Finally some components can only be imposed in conjunction with others.

Key elements of Functional Separation (2/4) ERG (07) 44

Full equivalence of input (EoI) means that all wholesale customers, internal and external:

•receive the same inputs •on the same terms •using the same order management systems.

Full EoI and Transparency are then implemented by organisational changes, for example separate business units of the integrated SMP operator.

Other analysts (*) put more in evidence that FS should not be seen as an end in itself but as a means to the specific end of

achieving full “equivalence of inputs”

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(*) Equivalence of Input and Functional Separation: A Framework for Analysis ‐Prepared by Strategy and Policy Consultants Network Ltd for BT Global Services –February 2009

In summary

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Accounting Separation (AS) is a tool for examining whether the incumbent complies with its obligations regarding the pricing non‐discriminatory treatment and price control.

Non Discrimination allows in principle different treatment where that treatment is objectively justifiable

Equivalence means the provision of the same product under the same terms and using the same processes and systems to internal and external customers. It also means treating information, complaints and requests received from internal and external customers equally. Functional Separation means creating a separate upstream business unit which, while integrated in the firm, provides bottleneck products to internal and external customers equivalently.

Although separate functional business entities are created, the overall ownership remains unchanged.

Additional key elements which could be relevant (*) :

• Financial incentives for managers and staff based only on the performance of the upstream division.

• Publication of relevant performance and financial information demonstrating that all downstream customers are treated equivalently;

• An independent, external body to oversee the implementation of functional separation and reports to all stakeholders. Such a body needs to be adequately staffed with qualified employees; and

• A credible set of sanctions that can be employed by the regulator in a timely manner in the event of a breach of the equivalence conditions by the functionally separated firm.

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(*) Equivalence of Input and Functional Separation: A Framework for Analysis ‐Prepared by Strategy and Policy Consultants Network Ltd for BT Global Services –February 2009

Which experiences in Europe?

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• The Administrative and Functional Separation in Italy• The Functional separation in UK• Other cases

Main features of the “administrative separation”:

“Equality of treatment” on service levels, assistance, and technical conditions, based on the comparison of SLA for OLO vs. performance for TI Retail (surveyed every 6 month)

“Transparency and Reporting” and new operational procedures to protect confidential data (Equal Treatment Compliance report, including QoS indicators for services provided to OLOs, submitted to Agcom every 6 months; Annual Report, certified and approved by an independent advisor, submitted to Agcom)

“Organizational measures”: • physical separation of Retail and Wholesale staff• firewalls separating TI Network, TI Retail and TI Wholesale OSS Systems & Procedures (more than 60 systems have been modified and are annually certified to ensure the avoidance of access to OLO’s data by TI’s Retail units)

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The very first case of enforcement of organizational remedies by a European NRA has been the “administrative separation” of Telecom Italia’s fixed activities introduced in 2002

(AGCom Decision 152/02/CONS, on the basis of the Italian law n. 481 dated 14/11/1995)

The Italian model of “administrative separation” (2002)

The Information Systems separation

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Positive outcomes of the “2002 administrative separation” (1/2)

Positive outcomes of the “2002 administrative separation” (2/2)

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Source: Telecom Italia

A further step : the creation of Open Access Division

At the beginning of 2008 TI established the Open Access Division in order to achieve efficiencies in operational/maintenance costs and investments of the access network

According to TI Open Access has been created to better manage the access infrastructures in an autonomous and transparent way, in order to provide wholesale access services both to

• TI’s commercial departments, and to

• the alternative Operators (by means of the “commercial” interface represented by TI’s Wholesale department).

Open Access’s main services include:

• Copper physical link supply between client and local exchange for TI and OLO

• Wholesale Line Rental (WLR) service

• Co‐location service supply in the central exchange spaces

• Optical fibre physical link supply

• Maintenance services on copper and fibre links

• Access to ducts

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Relationship between Open Access and internal/external clients (1/2)

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TI Transport Network

TIRetail

TIRetail

TIWholesale

TIWholesale

Open AccessProduction

of SMPServices


of SMPServices

Open Access:Production of

Telecom’s retail services



OLO network:Production of

retail services of OLO



TIRetail

TIRetail

OLORetail

OLORetail

Finalcustomer

Finalcustomer

Finalcustomer

Finalcustomer

TIRetail

TIRetail

TIWholesale

TI Wholesale

(Access

and Transport services)


of SMPServices

Productionactivitiesrelated to

SMPwholesale

access services



Open Access:Production activitiesrelated to TI’s retail

access services




OLO’s retail access services

TIRetail

TIRetail

OLORetail

OLORetail

Finalcustomer

Finalcustomer

Finalcustomer

Finalcustomer

“ComercialRelationships”

TI Open Access

OLOs

RetailCustomers

Relationship between Open Access and internal/external clients (2/2)

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The provision of the “wholesale‐like” phase of an SMP access service for TI Retail is taken into account when granting and evaluating equivalence of access between TI Retail and OLOs(For instance, to provide a TI’s final customers with a PSTN access line, you need a preliminary wholesale access service (correspondent to the LLU) and additional activities for the configuration of the service in the TI’s node, including the allotment of a telephone number and the service activation)

“wholesale‐like” phase of TI’sRetail access services

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TIRetail

TIRetail

TIWholesale

TIWholesale


of SMPServices


of SMPServices









TIRetail

TIRetail

OLORetail

OLORetail

Finalcustomer

Finalcustomer

Finalcustomer

Finalcustomer

TIRetail

TIRetail

TIWholesale

TI Wholesale

(Access

and Transport services)


of SMPServices

Productionactivitiesrelated to

SMPwholesale

access services



Open Access:Production activitiesrelated to TI’s retail

access services




OLO’s retail access services

TIRetail

TIRetail

OLORetail

OLORetail

Finalcustomer

Finalcustomer

Finalcustomer

Finalcustomer

“ComercialRelationships”

TI Open Access

OLOs

RetailCustomers

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AGCom concerns about fixed access networks (2007‐08)

In May 2007, AGCOM launched a public consultation (Decision n. 208/07/CONS) for the assessment of the competitive scenario concerning the fixed access networkFocus on possible competitive structural problems caused by:‐ TI’s control of the only nation‐wide fixed access network (no CATV networks in Italy)‐ limits of existing regulation, especially in a NGAN perspective

Following the results of the public consultation, with Order n. 626/07/CONS, AGCom started the 2nd round of market analyses on fixed access markets, proposing

… either to consider the possibility, where justified, of imposing more effective “exceptional” separation measures regarding the organization

of TI’s wholesale access service provision, on the basis of Article 8(3)

of the Access Directive

… or to accept voluntary undertakings assumed by Telecom Italia to grant an effective separation of the access network activities from the rest of the company as well as

equivalence of treatment in the provision of wholesale access services to OLOs and its own

commercial divisions

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Law 4/8/06, n. 248 has introduced in the Italian legislation – as a unicum in the European Union – the legal institution of the “undertakings” to be adopted in the context of regulatory proceedings in front of the NRA (AGCOM).

This Italian legislation mimics the corresponding European antitrust legislation (undertakings that can be assumed by firms in the framework of competition proceedings)

With following Decisions AGCom has introduced specific regulations for the implementation of the “undertaking procedure”

Possible submission and approval of undertakings are without prejudice of the provisions stated by the European Regulatory Framework

The legislative “trigger” of the undertakings

TI’s undertakings for a Functional Separation: main steps

On June 19th, 2008 – TI submitted the first preliminary proposal of the Undertakings for a FS

Discussions with Agcom followed

Agcom started a public Consultation

TI submitted a revised version of Undertakings

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December 15th, 2008 – Final Agcom Decision 718/08/CONS: • closing of the AGCom proceeding • approval of 14 Groups of Undertakings, to become legally binding

as of January 1st, 2009)

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Group of Undertakings n. 1

Introducing: (i) a new delivery process of SMP Services; (ii) additional procedures for the handling of co‐location Services; (iii) a new system for the handling of wholesale customersGroup of Undertakings n. 2

Introducing: (i) a new incentives system for the management of Open Access and of the Wholesale Division; (ii) a Code of Conduct and (iii) training programs on the Code of Conduct and the Undertakings for all employees of Open Access and the Wholesale DivisionGroup of Undertakings n. 3

Establishing a performance monitoring system for SMP servicesGroup of Undertakings n. 4

Guaranteeing transparency of the monitoring system Group of Undertakings n. 5

Guaranteeing transparency of the Technical Plans for the Quality of the Fixed Access NetworkGroup of Undertakings n. 6

Guaranteeing transparency of the Technical Plans for the Development of the Fixed Access NetworkGroup of Undertakings n. 8

Including further specifications in Telecom Italia’s regulatory accounting with respect to Open Access and determination of transfer charges

Structure of TI’s approved Undertakings:

Equivalence

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Group of Undertakings n. 1Introducing: (i) a new delivery process of SMP Services; (ii) additional procedures for the handling of co‐location Services; (iii) a new system for the handling of wholesale customers

Structure of TI’s approved Undertakings:Equivalence

• New Single Delivery Process for all the SPM servicesAs under current supply processes, activities concerning the activation, suspension, variation, and migration for all the SMP services do not distinguish between TI Retail and OLO orders. In addition, the new process foresees that the orders will be handled with priority depending on reception time (first come first served) and will be organized in a number of different “queue” on the basis of: i) type of service; ii) level of quality chosen at the order and iii) technical complexity of the related network activities.In case of network resource unavailability, upon request, OLOs’ orders will be held in waiting system based on a “single‐queue” and will be automatically processed when the network resource becomes available.The implementation of the new delivery features will be discussed with OLOs in a consultative technical forum

• New CRM Wholesale SystemThe new system will provide OLOs with new on‐line features, including pre‐sale analysis, advanced tracking features and a data warehouse on dismissed orders. The implementation of the new CRM system will be discussed with OLOs in a consultative technical forum

• New operational procedures for the management of co‐location servicesNew procedures, additional to the current ones, in order to speed up the activities aimed at finding new technical space inside TI switching centres in case of “saturation”

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Introducing: (i) a new delivery process of SMP Services; (ii) additional procedures for the handling of co‐location Services; (iii) a new system for the handling of wholesale customers Group of Undertakings n. 2

Introducing: (i) a new incentives system for the management of Open Access and of the Wholesale Division; (ii) a Code of Conduct and (iii) training programs on the Code of Conduct and the Undertakings for all employees of Open Access and the Wholesale DivisionGroup of Undertakings n. 3

Establishing a performance monitoring system for SMP servicesGroup of Undertakings n. 4

Guaranteeing transparency of the monitoring system Group of Undertakings n. 5

Guaranteeing transparency of the Technical Plans for the Quality of the Fixed Access NetworkGroup of Undertakings n. 6

Guaranteeing transparency of the Technical Plans for the Development of the Fixed Access NetworkGroup of Undertakings n. 8

Including further specifications in Telecom Italia’s regulatory accounting with respect to Open Access and determination of transfer charges

Structure of TI’s approved Undertakings:

Equivalence

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Introducing measures related to Next Generation Access Network

Group of Undertakings n. 6 (as far as NGAN plans are concerned)

Guaranteeing transparency of the Technical Plans for the Development of the Fixed Access Network

Next Generation Access Networks

GovernanceGroup of Undertakings n. 7

Establishing a Supervisory Board in charge of (i) supervising the proper implementation of the Undertakings; (ii) verifying the compliance of the KPI, monitored and reported to AGComaccording to the Groups of Undertakings n. 3 and 4, with the principles of equal treatment and the quality objectives for the fixed network access services


Joining a body, to be created by AGCom, in charge of the resolution of technical and operational disputes on the provision of access services (e.g. the British “OTA”)

Group of Undertakings n. 9 (as far as the NGN Forum is concerned)

Joining the “NGN Italy Committee” that will be created by AGCom with the aim to discuss issues related to the transition towards the new access infrastructures

Management & Compliance oversight

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5 members, of which: >3 designated by AGCom (including the Chairman)>2 designated by TI

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Ban on commercial activities for Open Access network technicians involved in production activities concerning SMP servicesGroup of Undertakings n. 12

Undertaking to report to the Supervisory Board (that will report to AGCom in case of lack of Telecom Italia’s initiatives to remedy to such situations) complaints related to the activation of “unsolicited” services to end‐users, collected by Open Access’s network techniciansGroup of Undertakings n. 13

Undertaking to interrupt the CPS termination procedure as soon as the concerned OLO forwards a so‐called “KO” report due to a modification of the end users decision to move to Telecom Italia (even in case Telecom Italia’s commercial Divisions subsequently ascertains and reports a different desire from that end user). As a consequence, Telecom’s commercial Departments will have to repeat the necessary notifications, observing the relevant notice timeframes.Group of Undertakings n. 14

Undertakings aimed at dealing more efficiently with customers’ complaints and at reducing the number of disputes with consumers, also through the creation of a single TI organizational unit to manage all the compliant proceedings

Consumer Protection

Time schedule and cumulative number of μ‐undertakings to be implemented

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220194187184

177166165164153149

3629 32

0

50

100

150

200

250

gen-09

feb-09

mar-09

apr-0

9

mag-09

giu-09lug-09

ago-0

9se

t-09

ott-09

nov-09

dic-09

gen-10

feb-10

mar-10

apr-1

0

67% of TI’s undertakings to be implemented by April 1st, 2009

Source: Telecom Italia

Which experiences in Europe?

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• The Administrative and Functional Separation in Italy• The Functional Separation in UK• Other cases

The 2004 Strategic ReviewIn 2004 Ofcom conducted its Telecoms Strategic Review (TSR). Ofcom’s conclusion was

that the combination of BT’s upstream market power and vertical integration provided BT with both the ability and the incentive to discriminate against its downstream competitors.It summarised its findings by saying that those who rely on BT to provide access have

experienced twenty years of:•slow product development;•inferior quality wholesale products;•poor transactional processes; and•a general lack of transparency.

According to the Enterprise Act 2002, Ofcom may make a market investigation reference to the Competition Commission where it has reasonable grounds for suspecting that competition is restricted or distorted

Instead of making such a reference Ofcom may accept undertakings from for the purpose of remedying, mitigating or preventing any adverse effect on competition concerned

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Key elements of BT’s Undertakings

BT has offered undertakings in lieu of a reference under the Enterprise Act 2002:

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Provision on an equivalence of inputs (EoI) basisEstablishment of “functionally separate”business unit: OpenreachFocus on key access and backhaul bottlenecksTransparency, information sharing constraints and duty of confidentialityClear functional separation between upstream and downstream divisions: operational separation, systems separation, asset register split and accounting separationIndependent oversight and enforcement (Equality of Access Board ‐EAB) Next Generation Networks to be implemented in an “equivalent”manner

Equivalence of input

Same products & services for BT & othersSame time‐scales, terms & conditions, incl. PriceSame systems & processesSame reliability & performanceSame commercial informationSubject only to:‐• Trivial differences, or • Other differences agreed by OfcomApplies to Openreachp ortfolio plus IPStream

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Openreach‐portfolio

Wholesale Analogue Line Rental–customer access for analogue voice services

Wholesale ISDN2 and ISDN 30 Line Rental–customer access for digital voice services

Local Loop Unbundling (full and shared)–copper pairs

Wholesale Extension Service–Ethernet partial private circuits from customer to first exchange

Backhaul Extension Service–Ethernet partial private circuits from first exchange to POP or second exchange

and facility to co‐locate specified equipment at exchanges–aggregation equipment, video servers, access network termination

Plus specified future access and backhaul services if requested by a CP

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Oversight and monitoring

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Chaired by BT Group non‐exec director, with three independent members plus one senior BT manager

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Positive outcomes of BT’s undertakings

Since the introduction of equivalence and functional separation, the number of broadband connections based on LLU in the UK has grown from just 123,000 to 5,385,000 (Dec 08)

The average advertised speed has increased from a little over 512 kbit/s to 4.6 mbit/s as broadband service providers have invested in ADSL2 and ADSL2+ where they have unbundled exchanges

Source: Equivalence of Input and Functional Separation: A Framework for Analysis ‐Prepared by Strategy and Policy Consultants Network Ltd for BT Global Services –February 2009

FS in other European MS: >Sweden

Strategic agenda 2009:Equal treatment for access to TeliaSonera’s access network

“This area involves using existing tools to make TeliaSonera treat all market players that use the company’s access network in the same way as it treats its own end‐user organisation. One important goal for 2009 is for TeliaSonera not to have competitive advantages, to the extent it does today, in the end‐user market due to a lack of equal treatment at wholesale level.”

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Telia voluntarily formed its network division, Skanova Access, in January 2008 as Sweden's telecoms regulator, PTS, called for ‐ and was granted ‐legal powers to impose functional separation.

“The President of UKE claims that independently of any other remedies, function separation of the incumbent ‐ Telekomunikacja Polska S.A. will be taken into account as a remedy to address actual and potential problems with access to the incumbent's services.

The analyses carried out to date as well as the information available to the President of UKE show that:

• the existing remedies have not been effective and are unlikely to bring about any permanent effect in the form of ensuring effective competition;

• there are substantial non‐transitory problems with competition in the wholesale markets;• there are limited or no prospects for infrastructure‐based competition over a reasonable period of time.• Based on the analysis to date, the President of UKE finds that substantial competition problems resulting

from TP anticompetitive behaviour and abusing the weaknesses of the Polish legal system will be solved as a result of TP separation.”

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“The objective of functional separation is to establish a separate wholesale unit independent of TP and subject to independent supervision(…). Thanks to this remedy the TP retail arm will use TP infrastructure under the same terms and conditions as alternative operators”“Talks with TP about its "Equivalence of Access" plan as an alternative measure to functional separation should be continued.”

FS in other European MS: >Poland

Should FS be mandatory?Present situation

Under the provisions of the current Framework, and in particular in accordance with Article 8(3) of the Access Directive (2002/19/EC), a draft measure for the imposition of functional separation must be submitted to the Commission for agreement. However, the national authority, in proposing such a remedy, has to justify the presence of exceptional circumstances and the remedy has to be based on the nature of the problem identified, be proportionate and justified in the light of Article 8(4) of the Access Directive.

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Review of EU 2003 Regulatory Framework

An explicit provision to ensure that NRAs have the power to introduce functional separation is one of the measures proposed by the Commission as part of the reform of EU telecom rules, adopted on 13 November 2007.

The proposed provisions give national regulators the possibility to apply functional separation to a vertically integrated operator, provided that a number of criteria and conditions are fulfilled, in particular that

it can be demonstrated that the standard regulatory remedies have been insufficient in preventing discrimination, and

only after the impact on investment and on consumer welfare have been carefully analysed.

Thank you

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Claudio BoreggiRegEcon Consulting & Media

[email protected]

functional separation in european telecoms regulation

Business

equivalent services

number of nras

integrated operator

functional separation

different ways

european telecomsregulation

standard remedies

skilled resources