Regulation, competition and prices

The commercial environment in the UK and in the countries in which BT operates or wishes to operate is increasingly competitive and dynamic. However, we remain subject to extensive regulation, particularly in the UK, which can materially affect the way in which we carry out our business. We also use inputs from other regulated operators, largely outside the UK, and the availability and price of these inputs may change from time to time, impacting on our business.

Regulation in the UK

The regulatory structure for UK telecommunications is set out principally in the Telecommunications Act 1984, which gives regulatory authority to the Secretary of State for Trade and Industry and the Director General of Telecommunications who heads the Office of Telecommunications (Oftel). The Secretary of State and the Director General are each required to exercise their functions under the Act in the way which they consider is best calculated to ensure, as far as reasonably practical, that all reasonable demand for telecommunication services, including certain community services, is met, and to secure the ability of licensed telecommunications operators to finance the provision of the services which they are licensed to provide. In addition, they are required, among other things, to promote the interests of consumers, purchasers and other users in the prices, variety and quality of telecommunication services and equipment, and to promote and maintain efficiency and effective competition among UK telecommunications operators.

With limited exceptions, a licence under the Telecommunications Act is required to run a telecommunication system in the UK. The Secretary of State is responsible for issuing licences after consulting the Director General. The regulatory regime will change during 2003 and a new regulator, Ofcom, will take over – see sections ‘‘The BT Licence’’, ‘‘New European Union Directives’’ and ‘‘Communications Bill and Ofcom’’ for further information.

The BT Licence

BT currently operates in the UK under a number of licences, the most important of which is our licence to operate our fixed-line public telecommunications network (the ‘‘Licence’’). Subject to the implementation of the new European Union Directives (see below), the Licence remains in force indefinitely, but the Secretary of State may revoke the Licence on ten years’ notice. The Licence can also be revoked at any time on various grounds, including non-compliance with an enforcement order from the Director General. In September 1999, the Licence was modified to meet the harmonisation requirements of the European Union Licensing Directive.

The Licence contains terms and conditions designed principally to ensure the widespread provision of telecommunication services in the UK, to protect the interests of consumers and to encourage the development of effective competition in telecommunication services and network provision within the UK.

Under the Licence, we have to fulfil reasonable requests for voice telephony, low-speed data and fax transmission services, and provide public call boxes in accordance with published guidelines, throughout nearly all the UK, including rural areas (these being the principal elements of the Universal Service Obligation).

Under the Licence, we must allow other licensed operators to interconnect with our telecommunications systems on cost-oriented, transparent and non-discriminatory terms.

We must comply with a variety of fair trading obligations, such as:

• a prohibition on showing undue discrimination between customers or unfairly favouring any part of our own business as against competitors in relation to matters such as the price, terms and conditions or quality of our main services; and
  
• a prohibition on the unfair cross-subsidy of certain of our activities.

We must publish audited financial statements for the regulated ‘‘businesses’’ and ‘‘activities’’, in order to support the linkage of costs with interconnect prices and with a view to providing demonstrable evidence that we are neither behaving in a discriminatory fashion nor unfairly subsidising our activities. If it appears to the Director General that an unfair cross-subsidy exists between specified parts of our own business, we must take such steps as the Director General may direct to remedy the situation. The regulatory businesses for which separated accounts are currently produced are retail narrowband access, apparatus supply, network, retail systems, mobile, supplemental services and residual services. The Licence also contains provisions enabling the Director General to monitor our activities, including requirements for BT to supply him with information requested.

The Licence contains price control formulae, the overall effect of which requires us to reduce, or restricts the extent to which we can increase, the prices of many of our telephony services to the bulk of the residential market and also the prices for our interconnection services, wholesale line rental services and number portability services. In addition, the Licence contains certain specific restrictions on the terms on which we can trade. In particular, we are required to publish and adhere to standard prices and other terms for providing certain services and, in general, to apply uniformly a published scale of charges for installing residential exchange lines on premises to be served by a single line.

As a result of our international interests, a Licence condition prohibits us from doing anything, by act or omission, that would detract materially from our ability to meet our Licence obligations to provide UK telecommunication services and to do so to any specified standards. BT’s directors are required to submit an annual compliance certificate to the Director General.

The Director General may make modifications to a licence if the licensee does not object or the modification is deregulatory. Alternatively, proposed changes to the Licence may be referred by the Director General to the Competition Commission. In either case, the Telecommunications Act requires public consultation before a licence can be modified. Licences may also be modified in order to implement European Union directives into UK law.

New European Union Directives

The provision of telecommunications networks and services throughout the European Union was liberalised through the implementation of a number of Directives which came into force in January 1998. Following a review initiated by the European Commission in 1999, a new package of Directives for the regulation of electronic communications continuing the EU’s policies of liberalisation and harmonisation was adopted by the EU in April 2002. These Directives must be implemented in all Member States by 25 July 2003. The new framework aims to be technologically neutral. Individual licences will be replaced by a general authorisation applying automatically to all providers of electronic communications networks and services. Member States will no longer be permitted to require undertakings to obtain licences before operating in the sector, though providers of electronic communications networks and services may be required to comply with a limited range of general conditions. Additional obligations, legally separate from the general conditions, will be imposed on individual providers designated by their National Regulatory Authority as having Universal Service Obligations or ‘‘significant market power’’ in specified market sectors. The ‘‘significant market power’’ trigger will be aligned with the competition law concept of dominance, and any obligations imposed on significant market power grounds must be the minimum required to address identified competition problems. The new framework requires the availability of full rights of appeal, including appeal on the merits, against regulatory decisions to a body with appropriate expertise. The new Directives also incorporate mechanisms designed to ensure consistency of regulation across the European Union.

Oftel is currently consulting on the proposed general conditions and Universal Service designations and obligations. Both these aspects of the new framework need to be in place when all existing licences are due to cease to apply on 25 July 2003, the implementation date for the new Directives. Oftel is also consulting on market analyses required to identify whether significant market power exists in specified market areas. However, as existing significant market power obligations can be carried forward until the analyses are completed, this aspect of the framework does not have to be in place by 25 July. Significant market power obligations under the new framework may not, therefore, be implemented until later in 2003 and Oftel has indicated that because the process cannot be completed before 25 July, certain existing licence conditions relating to market areas subject to the analyses will need to be carried over until at least the end of August. BT can, in any event, expect to continue to be regulated in the majority of the markets in which it is currently regulated.

The new general conditions and Universal Service Obligations are not expected to have a major impact on BT, although some beneficial rationalisation of these aspects of the framework is anticipated to result. The introduction of the new definition of significant market power and the requirement for market analyses should lead to the eventual withdrawal of competition-related regulation, relying instead on competition law in specified market sectors which are competitive or which become competitive in the future. In its current market analysis consultation documents, Oftel is proposing the removal or relaxation of such regulation in a number of markets. Similar regulatory reviews are underway in all EU member states which will have an impact on the level of regulation BT, and its suppliers, are subject to in those countries.

The Communications Data Protection Directive, which is not part of the main Electronic Communication Directives, was adopted in June 2002 and must come into force in Member States by 30 October 2003. This Directive may have cost implications for industry.

Communications Bill and Ofcom

The UK Government has completed a review of telecommunications and broadcasting regulation. A new regulatory body has been established, called the Office of Communications (Ofcom), to amalgamate the roles of the five existing regulatory agencies: the Director General of Telecommunications; the Independent Television Commission; the Broadcasting Standards Commission; the Radio Authority and the Radiocommunications Agency. Ofcom is headed by a chairman (Lord Currie) and chief executive (Stephen Carter) and supported by executive and non-executive board members.

The reforms are in two parts. The first comprises the Office of Communications Act passed in March 2002, which enables the board, office and budgets of Ofcom to be established, but does not enable Ofcom to exercise any regulatory functions. The second comprises a Communications Bill. The draft Bill was published in May 2002 and the final Bill is expected to be passed by Parliament by 17 July 2003. It will confer regulatory functions on Ofcom, which will be able to take up those functions when the Bill is brought into force. However, Ofcom is not expected to take up its regulatory functions until later in the year and the Bill provides for a transitional period between the Bill coming into force and the date when Ofcom takes up its formal powers. In this period, the existing regulators will carry out Ofcom’s functions relating to networks and services, and spectrum.

The main changes for providers of electronic communications networks and services will be the possibility of fines being imposed for breach of regulatory obligations, appeals on the merits against regulatory decisions and the creation of a new regulatory regime which will, among other things, implement the requirements of the new EU Directives for general authorisations, instead of individual licences, and basing regulation of dominant players on analyses of relevant markets. Statutory instruments have been made to enable preliminary work to be undertaken to implement the Directives, and, in the event that the Bill is not passed before 25 July 2003, the deadline for implementation, the Government will ensure implementation by means of further statutory instruments which will, for a limited period, duplicate provisions in the Bill.

Competition

The competitive environment

The UK telecommunications market is fully open to entry and highly competitive. As a result, the UK Government and Oftel have indicated their expectation that it will be appropriate to move away from sector-specific (including licence-based) regulation to greater reliance on the Competition Act as individual markets become sufficiently competitive. Furthermore, the new EU Directives – see ‘‘New European Union Directives’’ – prohibit the imposition of competition based, sector-specific economic regulation in any market which is found to be effectively competitive.

In January 2000, Oftel published a strategy statement based on the principle that regulation should go no further than the minimum necessary to protect consumers. The strategy is underpinned by a programme of competition reviews, which are intended to ensure that the regulatory framework responds to changed competitive conditions: where it is found that competition is delivering benefits to consumers in the sectors reviewed, regulation will be reduced or withdrawn as appropriate. These reviews will need to be incorporated into the market reviews mandated by the new EU Directives, which will come into force by 25 July 2003 (see ‘‘New European Union Directives’’).

Although it is some years since the Telecommunications Act abolished the monopoly of the former statutory corporation, British Telecommunications, in the running of telecommunication systems, obligations placed on BT, including pricing regulation and the requirement to provide universal service (discussed below) are generally more onerous than for other licensees.

Competition Act

In addition to telecommunications industry regulation, BT is subject to general competition law.

By virtue of provisions in the Competition Act 1998, UK competition law is in line with European Community law in prohibiting anti-competitive agreements and concerted practices and the abuse of a dominant market position. In the case of telecommunications, the Director General of Telecommunications has concurrent investigatory and enforcement powers with the Office of Fair Trading. They also have significant investigative powers. Breach of the relevant prohibitions could lead to fines of up to 10% of relevant turnover in the UK for each year of infringement (up to a maximum of three years) and/or result in claims for damages in the civil courts. There are also powers to order a company to cease an infringing activity. There is an independent mechanism for appeals to the Competition Appeals Tribunal against decisions under the Competition Act.

Oftel is continuing to investigate the terms and conditions of BT’s telephone rental business under the Competition Act. Also, following the decision of the Competition Appeals Tribunal in the Freeserve case in April 2003, Oftel has undertaken to re-issue a decision on BT Openworld’s broadband activities.

Enterprise Act

The Enterprise Act 2002, which received Royal Assent on 7 November 2002, aims to give more independence to the competition authorities, to reform insolvency and bankruptcy laws and to tackle trading practices that harm consumers.

The provisions of the Act are largely complementary to those of the Competition Act 1998, which will remain in force with some minor amendments – but it also contains new provisions criminalising cartels and allowing for the disqualification, in appropriate cases, of company directors where companies commit breaches of competition law.

Pricing regulation

Fixed network

We are subject to price controls on our fixed network services in the UK at two levels: retail and network. Fixed network competitors are generally not subject to direct price controls, although there are some controls on mobile network operators.

Retail price controls

We are subject to two sets of UK retail price controls, one on certain public-switched telephony call charges and exchange line rentals, and one on certain private circuits. Each price control is based on a formula calculated by reference to the UK Retail Prices Index (RPI) and a factor, X.

For services covered by the controls, the weighted average of base prices cannot increase in each year beginning 1 August by more than the annual change in RPI minus X. The current retail price control for public-switched telephony, applying from August 2002 to July 2006 is RPI minus RPI (i.e. the value of X is RPI and prices cannot increase). It is measured on services used by the lowest 80% of our residential customers classified by bill size. From August 2002 the services covered by the control were extended to include BT’s share of the revenue for calls to all four mobile networks, replacing the previous separate control on BT for calls to Vodafone and O₂. The price control formula and our performance against the formula are set out in the table below.

^a Annual increase in RPI to previous June
^b From 1 August 1997, the RPI formula covers the main switched telephone services provided to the lowest 80% of BT’s residential customers by bill size
^c After permitted carry forward of any unused allowance or shortfall from previous years
^d From 1 August 2002, the RPI formula covers the change in average prices (including residential discount packages)
^e Base and package price changes implemented up to 31 January 2003
^f Regulation allows any unused allowance or excess reduction remaining at the end of the price control year (31 July) to be carried forward

Under the new controls, we have also given an assurance that increases in line rental for business customers will be no more than the annual change in RPI. Under the price controls for private circuits that applied from August 1997 to July 2001, prices for domestic analogue and low-speed digital private circuits could not increase by more than the change in the RPI in any year. The application of the analogue price cap has been extended until July 2005 and the low-speed digital private circuits cap was removed in July 2001.

Review of retail price controls

In July 2002, BT accepted Oftel’s proposals for changes to its licence to introduce new retail price controls of RPI minus RPI (i.e. no price increase) from 1 August 2002 until 31 July 2006. Under the changes:

• BT is required to provide a cost-based wholesale line rental product to other service providers at a regulated price and in a way that does not discriminate between BT’s retail business and service providers. This product (Wholesale Access) has been available from BT since 1 September 2002. Oftel has since issued a further consultation regarding enhancements to this product and BT, Oftel and industry are discussing the proposed requirements.
• for those services covered by the previous control, BT’s prices to the lowest spending 80% of its customers would be pegged at their current level and not allowed to rise with inflation, using an RPI minus RPI price control. The services covered by the control have been extended to include BT’s share of the revenue for calls to all four mobile networks, replacing the previous separate control (RPI minus 7%) on BT for calls to Vodafone and O₂ UK.
• once Oftel is satisfied that the new wholesale line rental product is fully implemented and starting to have an impact in the retail market, the retail price control will be further revised to allow prices to increase at the rate of inflation.
• there are some minor changes to the workings of the Light User Scheme designed specifically for people making fewer calls, including provisions to extend the number of customers potentially qualifying if the standard exchange line rental rises significantly.

Network charge control

We operate under interconnection agreements with most other licensed operators. A new network charge control period began on 1 October 2001 and will last for four years from that date. It requires us to set reasonable charges based on long-run incremental costs for our standard interconnection services. Depending on the degree of competition for these services, charges are cap controlled each year by RPI minus X (where X ranges from 7.5% to 13%) for services Oftel considers unlikely to become competitive in the near future; safeguard cap controlled (i.e. no increases above RPI during any relevant year of the overall control period) for services likely to become competitive; and those services considered fully competitive are not subject to direct charge controls. The network charge controls that ended on 30 September 2001 capped charges for services unlikely to become competitive in the near future at RPI minus 8%. On 12 July 2002, a new condition was included in the Licence. The effect was to set charges for, and bring under regulatory control, BT’s fixed portability services. Number portability allows customers to change the company providing their telephony services without changing their telephone number. Fourteen non-conveyance Portability Standard Services were identified. The charge control runs from 1 August 2002 until 31 July 2006. The charges are controlled by a RPI minus X formula, with X set at 5%. BT must publish a notification to the Director General and other licensed operators if it intends to amend existing charges or to offer new services.

Wholesale Access Charge Control

The charges for the Wholesale Access services agreed by BT in July 2002 are subject to price control. The charges for the line rental (residential and business products), line transfer and new line installations have been determined and are subject to a price control of RPI minus 2% effective from 1 September 2002 for four years. The control applies to the aggregate of all charges (rental, transfer and installation) as well as to line transfers separately. BT is also under an obligation to notify the Director General and service providers if it intends to amend existing charges; the notification is 90 days for determined charges and 28 days for all others.

Non-UK regulation

BT must comply with the regulatory regimes in the countries in which it operates or wishes to operate. The obligations placed on BT and its suppliers continue to be relevant to its business models and have cost implications for its end user services. These rules are generally applied by national regulatory authorities operating under a governmental mandate. The impact of decisions of these bodies can have a material impact on our business models from time to time.

European Union

See ‘‘New European Union Directives’’.

Rest of the world

The vast majority of the markets in which BT operates around the world are regulated, and in the majority of these it has to obtain licences or other authorisations and comply with the conditions of these. The degree to which these markets are liberalised varies widely: while many are fully open to competition, others place restrictions on market entrants, such as the extent to which foreign ownership is permitted, or on the services which may be provided. The extent to which the national incumbent operator is effectively regulated also varies considerably. BT’s ability to compete fully in some countries is therefore constrained.

Other significant changes and issues

Broadband regulation

There has been considerable dialogue with Oftel and the Department of Trade and Industry over the past financial year regarding the introduction of broadband services and how best to deal with the issues arising from rapid roll-out. Much of this activity has centred around the creation of approaches designed to foster increased demand, to reduce the costs of providing broadband facilities, and to encourage creative partnerships with others, both in the public and private sectors, and to bring the benefits of broadband to areas that might not be reached on a purely commercial basis. In addition to the standard licence and competition law obligations, BT ensures that the particular obligations for wholesale service provider products are met. These include the need to treat BT’s retail businesses and service providers equally and the provision of various interconnection points to BT’s broadband network.

Deregulation of inbound services

Inbound services were deregulated in July 2002 as the market for these services is now fully competitive.

BT no longer has a regulatory obligation to supply voice inbound services (e.g. 0800, 0845, 0870, 09XX), to notify and publish prices, or adhere to them. We can therefore choose to offer different prices and service levels to different customers. BT must, of course, still comply with competition law. The result of deregulation has been that prices have been reduced in this market.

Local loop unbundling

The Licence requires the provision of unbundled local loops to other operators to enable them to provide telecommunications services, including broadband ADSL services, to end customers. Local loop unbundling, line sharing and sub-loop unbundling are also required by an EU Regulation. Local loop unbundling services have been phased in over the past few years. In March 2003, BT launched a line sharing service.

Carrier pre-selection

Carrier pre-selection (CPS), required by a condition in the Licence, allows customers to opt for certain classes of call to be carried by an alternative operator, selected in advance, without having to dial additional access codes.

Leased lines

Oftel published a Direction in respect of Partial Private Circuits (PPCs) in December 2002. PPCs are a wholesale variant of certain private circuits at cost-based prices, which interconnecting operators can use to form local tail-parts of end-to-end circuits offered to their retail customers. The Direction resulted from an investigation into the cost base of this relatively new wholesale product group (PPCs were initially launched in August 2001). The Direction resulted in reductions averaging 15% to 20% in PPC charges compared with the initial 2001 PPC charge levels, along with a range of relatively minor amendments to the product specifications. A proportion of the price reductions has been made on a retrospective basis, as the majority of private circuits leased by other operators had already switched to PPC prices and conditions following initial launch. Now that the Oftel investigation has concluded, BT is looking forward to a period of stability as the use of the new product portfolio becomes established.

Universal Service Obligation (USO)

The Communications Bill will implement the Universal Service Directive, one element of the new European Union Directives package (see ‘‘New European Union Directives’’). Oftel consulted in March 2003 on conditions to apply to BT. Some additional obligations are proposed, such as guidelines that refer to a minimum data rate of 28.8 kbit/s which will have adverse cost implications for BT if implemented. Oftel continues to take the view that the USO is not an unfair burden on BT. Oftel is expected to carry out a formal review of the USO next year, looking at the scope and funding of the USO, and is currently consulting on the controls applying to removal and re-siting of payphones.

Flat-rate internet interconnection (FRIACO)

Initially launched in 2000, this group of products is the normal means of providing interconnecting operators with a service to support flat-rate internet access packages via internet service providers to end users. Most FRIACO use involves interconnection at local exchange level, and the period of rapid growth in demand, following the initial FRIACO launch, has now developed into a more stable environment. The charges for both FRIACO services are subject to RPI minus X controls under the Network Charge Control regime and hence have been falling gradually. Oftel is currently consulting on whether there should be a further reduction in the price of one element of the service with effect from December 2001.