The commercial environment in the UK and in the countries in which BT operates 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, such as networks and services from other regulated operators, largely outside the UK, and the availability and price of these inputs may change from time to time, which in turn affects our business.

Regulation in the UK

It is our policy to be fully compliant with the regulatory framework in which we operate. During the 2005 financial year, we continued to strengthen our compliance activities and, in addition, we have worked closely with compliance professionals in the telecommunications and other regulated industries in the UK to establish best practice. We have been in contact with European telecommunications companies with the intention of sharing ideas and best practice and bringing improvements to the UK market. Our compliance policy remains focused on ensuring that we continue to meet the obligations imposed by, or under, the UK’s Communications Act 2003 (the Communications Act) and the Competition Act 1998 (the Competition Act) while competing fairly and vigorously within the rules. We publish an annual compliance report which can be found in our social and environment report at http://www.btplc.com/Societyandenvironment/index.htm

Ofcom

The UK regulatory environment changed materially in July 2003, when the Communications Act came into force, bringing in a new regulator, the Office of Communications (Ofcom), and a new regulatory framework for electronic communications networks and services.
     Ofcom was set up as a result of the increasing convergence between telecommunications, broadcasting and radio, to provide a single, seamless approach to regulation across the whole converging marketplace. It amalgamated the roles of five former regulatory agencies: the Director General of Telecommunications (Oftel), the Independent Television Commission, the Broadcasting Standards Commission, the Radio Authority and the Radiocommunications Agency.
     Ofcom is headed by a board consisting of a chairman, executive and non-executive members. Currently, the chairman is Lord Currie and the chief executive is Stephen Carter.
     Ofcom has a wide range of general and specific duties laid down in the Communications Act. Below is a summary of those duties and functions of particular relevance to BT’s activities:

	the principal duty to further the interests of citizens in relation to communications matters and, secondly, to further the interests of consumers, where appropriate, by promoting competition. In doing so, Ofcom must secure, among other things, the availability of a wide range of electronic communications services in the UK;
	the duty to have regard to the principles under which its regulatory activities should be transparent, accountable, proportionate, consistent and appropriately targeted;
	the duty to review regulatory burdens on a regular basis and ensure that they do not involve the imposition or maintenance of unnecessary burdens; and
	the functions of setting conditions of entitlement (see Regulatory conditions), and enforcing those conditions (see Enforcement). Ofcom’s decisions are subject to appeal on the merits (see Appeals).

     In carrying out its duties, Ofcom must consider promoting competition and the use of effective self-regulation, encouraging investment and innovation, and encouraging the availability and use of high-speed data services (including broadband).

Regulatory conditions

Under the new framework, based on 2003 EU Directives, providers may no longer be required to obtain licences before offering telecommunications services. Individual licences, such as that granted to BT in 1984, no longer exist. Instead, there is a general authorisation for the provision of electronic communications networks and services.
     Regulation is applied through separate sets of conditions made by Ofcom, of which some apply to all relevant communications providers. Others are imposed individually on particular providers which, following a review of the relevant markets, are found to have ‘Significant Market Power’ (SMP) or are designated as ‘Universal Service Providers’. Other general obligations are set out in the Communications Act. The general and specific obligations that form BT’s regulatory environment are described below.

Conditions applying to all providers of electronic communications networks or services

General conditions

The foundation of the new regulatory framework is the set of general obligations referred to in the Communications Act as ‘General Conditions’. These apply to all providers of electronic communications networks or services, including ‘systemless’ service providers and internet service providers. These conditions are mainly concerned with consumer protection, but also address matters such as general access and interconnection obligations, standards, emergency planning and numbering. In addition, a separate condition has been set regulating the provision of premium rate services.

Electronic Communications Code conditions

The Electronic Communications Code deals with powers to carry out streetworks and similar activities for the purposes of providing networks and its application is subject to conditions made by the Secretary of State for Trade and Industry.

Other general obligations

Other obligations corresponding to former licence conditions under the old framework now apply directly through provisions of the Communications Act. These are:

	the payment of administrative charges (broadly the equivalent of licence fees under the old framework); and
	the provision of information to Ofcom when required to do so.

Conditions applying to BT only

Universal Service Obligation conditions

BT has been designated as the supplier of Universal Service for the UK excluding the Hull area, where Kingston Communications is the designated provider. The services covered by the Universal Service Obligation (USO) are defined in an Order issued by the Secretary of State for Trade and Industry. Our basic obligation is to provide a single narrowband connection to the fixed telephone network, but additional USO conditions relate to issues such as schemes for consumers with special social needs and the provision of payphone services.
     Ofcom is currently reviewing the USO. The review is focused on delivering the current Universal Service arrangements and is being carried out alongside Ofcom’s Strategic Review of Telecommunications (see Other significant changes and issues – Strategic Review of Telecommunications) which looks at longer-term Universal Service issues.

Significant Market Power conditions

The Communications Act, implementing the EU Directives on which the regulatory framework is based, requires Ofcom to define and analyse markets (‘market review’) and to determine whether any communications provider has SMP, which is aligned with the competition law concept of dominance. Economic regulation can only be imposed following a market review and finding of SMP.
     In markets where Ofcom finds that a provider has SMP, it must impose appropriate additional obligations in the form of SMP conditions as specified in the Communications Act. These may include obligations to meet reasonable requests to supply certain services to other communications providers, not to unduly discriminate, and to notify price changes. In some cases, additional obligations relating to, for example, price control and regulatory accounting have also been imposed.
     The market reviews relevant to fixed telecommunications that Oftel and Ofcom have conducted are listed below. For each review, the markets in which BT has been determined to have SMP are shown. All references to UK markets, except wholesale trunk segments and broadband conveyance, exclude the Hull area.

	Fixed narrowband retail markets in the UK: residential analogue lines, residential ISDN2 lines, business analogue lines, business ISDN2 lines, ISDN 30 lines, residential local calls, residential national calls, residential calls to mobile, residential operator assistance calls, residential international direct-dialled calls, business local calls, business national calls, business calls to mobile, business operator assistance calls.
	Fixed narrowband wholesale markets in the UK: residential analogue lines, residential ISDN2 lines, business analogue lines, business ISDN2 lines, ISDN 30 lines, call origination, local-tandem conveyance and transit, inter-tandem conveyance and transit, single transit.
	Fixed geographic call termination markets in the UK: fixed geographic call termination provided by BT and other members of the BT group of companies.
	Wholesale international services markets: wholesale international services on 108 country routes.
	Wholesale unmetered narrowband internet termination markets: BT was not found to have SMP in any market considered in this market review.
	Retail leased lines, symmetric broadband origination and trunk segments markets: retail traditional interface leased lines at speeds up to and including 8Mbit/s; wholesale traditional interface symmetric broadband origination at speeds up to and including 8Mbit/s; wholesale traditional interface symmetric broadband origination at speeds above 8Mbit/s and up to and including 155Mbit/s; wholesale alternative interface symmetric broadband origination at all bandwidths. Wholesale trunk segments at all bandwidths.
	Wholesale broadband access markets in the UK: asymmetric broadband origination; broadband conveyance.
	Wholesale local access markets in the UK: wholesale local access services.

     The Communications Act allows Ofcom to review markets for end-user apparatus and impose conditions on any provider designated with SMP. The conditions which may be imposed are limited to conditions relating to accounting separation, cost accounting, and price control for hardwired telephone rental charges. Ofcom has decided that BT’s price controls in respect of rental of hardwired telephone apparatus, brought forward from the old regulatory regime, should be removed and replaced by written undertakings rather than by SMP apparatus conditions.
     The Act obliges Ofcom to carry out further analyses of markets which have been reviewed at such intervals as it considers appropriate. In the Phase 2 consultation document in the Strategic Review of Telecommunications, Ofcom has made proposals for a number of market reviews over the coming years. Ofcom is currently carrying out a review of the Number Translation Services (NTS) Call Termination market.

Enforcement

The Communications Act sets out the enforcement process to be followed in relation to breaches of conditions. Where a breach is not remedied following preliminary notification by Ofcom, Ofcom may take legally enforceable enforcement action and/or impose a penalty of up to 10% of relevant turnover. In addition, a person who suffers loss or damage as a result of a breach may, with Ofcom’s consent, sue for damages, and, in the case of serious and repeated contraventions, Ofcom may restrict or suspend the provider’s entitlement to provide electronic communications networks or services.
     The Communications Act contains similar enforcement procedures (though with much smaller penalties) for matters such as non-compliance with a request for information or non-payment of an administrative charge.

Appeals

One of the main features of the new regulatory framework is that full appeals on the merits are now available against regulatory decisions. Consequently, appeals can be made against matters such as:

	the making of SMP, SMP apparatus and USO determinations/designations;
	the setting, modification and revocation of conditions;
	enforcement actions, including the imposition of a penalty.

     Any person affected by a decision may appeal to the Competition Appeals Tribunal. However, the Tribunal must refer any matters in any appeal relating to price controls on to the Competition Commission for determination.
     In November 2003, Ofcom issued a notification finding that BT was acting in contravention of the General Conditions by using customer-specific information acquired from other communications providers in connection with the provision of Carrier Pre-Selection (CPS). In May 2004, Ofcom issued a second notification finding that BT was similarly contravening the General Conditions in relation to Wholesale Line Rental (WLR). BT appealed both notifications, and the Tribunal adjourned the WLR appeal pending the outcome of the CPS appeal.
     In December 2004, the Tribunal dismissed BT’s CPS appeal and upheld that notification (although this was subject to a clarification of the definition of ‘marketing activity’ as set out in the notification). Subsequently, Ofcom withdrew the contested WLR notification, indicating that it would issue a new notification in light of the CPS decision. The Tribunal has suspended the WLR appeal pending the new notification, which is expected shortly.

Competition

The competitive environment

The UK telecommunications market is fully open and highly competitive.
     Although it is some years since the Telecommunications Act 1984 abolished the monopoly of the former statutory corporation, British Telecommunications, obligations placed on BT, including pricing regulation, network access, non-discrimination, the provision of universal service and cost accounting/accounting separation, are generally more onerous than for other providers of electronic communications networks and services.

Competition and the UK economy

The growth of mobile over the past decade has been a major factor in shaping the UK’s telecommunications landscape. Mobile now accounts for approximately 30% of total UK voice minutes. BT’s market share of the total UK voice market, including mobile, is estimated to have fallen by about 4% in the 2005 financial year to approximately 40%.
     BT’s share of the residential fixed-voice market, as measured by the volume of fixed-to-fixed voice minutes, declined to an estimated 64% for the 2005 financial year, compared with an estimated 70% and 74% for the 2004 and 2003 financial years, respectively. CPS has been one of the contributors to the loss of share in the fixed-voice market. We estimate that BT had 42% of the market for business fixed-voice calls in the 2005 financial year, compared with an estimated 44% and 47% in the 2004 and 2003 financial years, respectively.
     Estimated market shares are based on our actual minutes, market data provided by Ofcom and an extrapolation of the historical market trends.
     We also estimate that BT supplied approximately 79% of exchange lines in the UK at the end of the 2005 financial year, compared with 82% and 83% in the 2004 and 2003 financial years, respectively.
     The growth in cable operators’ networks in the UK has historically had an adverse effect on BT’s share of the residential market. Current and future wholesale line rental arrangements will allow BT’s fixed-line customers to move PSTN lines to other operators which are expected to be the source of more competition in the future.
     Since 2000, we have been required to provide other operators with the use of the lines connecting BT’s local exchanges to our customers and to other operators to install equipment in our exchanges (see Local Loop Unbundling).

Competition Law

In addition to telecommunications industry regulation, BT is subject to general competition law including the Competition Act in the UK and the competition law provisions of the EC Treaty.
     UK and European Union competition law both prohibit anti-competitive agreements, concerted practices and the abuse of a dominant market position. In the application of UK and EU competition law to electronic communications, Ofcom has concurrent investigatory and enforcement powers with the Office of Fair Trading (OFT). The EC has jurisdiction to apply the EU rules. Breach of the relevant prohibitions in the UK or EU rules could lead to fines of up to 10% of worldwide turnover in a company’s previous financial year and/or result in claims for damages in national courts. A company may also be ordered to cease an infringing activity. There is an independent mechanism for appeals to the Competition Appeal Tribunal against decisions taken by Ofcom or the OFT and to the European Court of First Instance against EC decisions.
     In July 2005, the Tribunal is due to hear Wanadoo’s appeal against Ofcom’s November 2003 finding that BT had not infringed the prohibition on abuse of a dominant position in relation to the pricing of BT Openworld’s consumer broadband products. Separately, in August 2004, Ofcom claimed that BT had abused a dominant position in relation to its pricing of consumer broadband products. BT has responded, arguing that its pricing does not amount to an abuse of dominance. Ofcom has indicated that it will issue either a new statement of objections or a decision of non-infringement in relation to this case, in June 2005.

Enterprise Act

The Enterprise Act 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 key provisions of the Enterprise Act, including the new cartel offence and the section on director disqualification, entered into force on 20 June 2003. It is now a criminal offence, punishable by imprisonment or a fine, or both, to engage in cartel activity. In addition, where companies infringe UK or EU competition law, company directors can be disqualified from being concerned in the management of a company for a maximum period of 15 years. The Enterprise Act also gives the OFT power to make a market investigation reference to the UK’s Competition Commission where the OFT has reasonable grounds for suspecting that any feature of a market prevents, restricts or distorts competition in the supply or acquisition of goods or services in the UK. Once the OFT exercises its power to make such a reference, the Competition Commission is required to decide whether any feature of the market prevents, restricts or distorts competition (‘adverse effect’) and, if so, to take action to remedy the adverse effects. Market investigations are intended to address competition issues in markets as a whole and not merely the behaviour of individual players. In relation to electronic communications markets, Ofcom has concurrent powers with the OFT to make a market investigation reference.

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 (ie 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.
     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. For all retail analogue private circuits and 8Mbit/s digital private circuits, BT has also given an assurance to adhere to a RPI+0% price cap from 30 June 2003 until 30 June 2006.
     As part of the review of price controls in 2002, BT was 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 unduly discriminate between BT’s retail business and service providers. This product, Wholesale Access, has been available from BT since 1 September 2002. Further consultation by Ofcom resulted in an enhanced wholesale access product being available from 29 March 2004. When Ofcom notifies BT that it is satisfied in relation to the introduction and provision of Wholesale Access, it may direct that the retail price control be adjusted to RPI+0%.
     

Price Control (RPI-X)		Years commencing 1 August
			2000			2001			2002			2003			2004
% RPI movement for the relevant perioda			3.32			1.93			1.03			2.89			3.03
X on price control formulaa,b			4.50			4.50			1.03			2.89			3.03
% required change in base pricesc,d			(1.09	)		(2.45	)		0			0			0
% change in base prices overall			(1.20	)		(2.50	)		(0.22	)		(0.19	)		0.46	e

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

Full year forecast based on price changes implemented up to January 2005 for residential customers. There is an unused allowance of 0.41% carried forward from the previous year which would allow prices to rise by this amount in 2005. Further price changes during this year could eliminate the current variance but if not, the amount may be carried forward.

 

Network Charge Control

We operate under interconnection agreements with most other operators. Our charges for a range of interconnect services are controlled by Ofcom, under the Network Charge Control (NCC) regime. The current NCC period began on 1 October 2001 and will last until 30 September 2005. The controls are designed to ensure that our charges are reasonably derived from costs, plus an appropriate return on capital employed. 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 Ofcom considers unlikely to become competitive in the near future and safeguard cap-controlled (ie no increases above RPI during any relevant year of the overall control period) for services likely to become competitive. Those services considered fully competitive are not subject to direct charge controls.
     The main network price caps are listed below:

Basket			X Factor in RPI – X formula			Duration
Call termination			10			30 Sept 2005
Call origination			10			30 Sept 2005
Tandem layer			13			30 Sept 2005
Safeguard cap			0			30 Sept 2005
Interconnect specific			8.25			30 Sept 2005
Local exchange FRIACO			7.5			30 Sept 2005

BT must publish a notification to Ofcom and other operators if we intend to amend existing charges or to offer new services. Notice periods range from 28 to 90 days for regulated services, depending on the degree to which they are judged to be competitive.
     In 2004, Ofcom began a review of the NCC, to determine the controls to apply from 1 October 2005. On 23 March 2005, Ofcom issued a consultation document (‘Review of BT’s Network Charge Controls’) proposing a further four-year NCC regime, with a review of BT’s market power in two specific markets (deregulation being proposed for one of these markets). Ofcom is also proposing some re-definitions of basket services, and consulting on a range of values of X for these services (reflecting the fact that some of the relevant factors in setting X are yet to be resolved). We will respond to Ofcom’s proposals by 1 June; Ofcom is expected to publish a statement by the end of July 2005.
     The various services and proposed ranges of X within Ofcom’s 23 March consultation document are listed below:

Basket			X Factor in RPI – X formula
Call termination			2.25 to 6.25
Call origination			0.5 to 4.5
Single transit			11 to 14
Local-tandem conveyance			0 (safeguard)
Interconnection circuits			1.5 to 5.5
Product management, policy and planning			2.5 to 6.5
Local exchange FRIACO			7.5 to 11.25
Single tandem FRIACO			8.5 to 12.25
Inter-tandem conveyance / transit			No control (propose to de-regulate)

 

Number portability

The number portability 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%. This control is not contained in an SMP condition, but in a non-binding undertaking given by BT to Ofcom. Under the new regime, General Condition 18 requires all providers to offer number portability, among other things, on reasonable terms and for charges to be cost-orientated.

Wholesale access charge control

The charges for wholesale access services (both analogue and digital) are also subject to price control. The charges for the line rental (residential and business products), line transfer and new line installations have been set by Ofcom 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. We are also under an obligation to notify Ofcom and service providers if we intend to amend existing charges or introduce new charges. Notice periods range from 28 to 90 days, depending on the specific service.
     On 28 November 2003, Oftel published its statement on the fixed narrowband wholesale exchange line market. This statement contained new obligations on BT to provide Wholesale Business ISDN2 Line Rental with cost-oriented prices and to provide residential ISDN2 and ISDN30. We launched the required products but the price level was referred to Ofcom as a dispute by Energis on 25 October 2004. On 2 February 2005, Ofcom determined that BT’s price was set at too high a level and that BT must refund Energis an amount for each line rented during the period from 23 November 2003 to 30 September 2004.
     Additionally, during the year a small-scale consultation was carried out which aligned the price control formulae for Wholesale Access, NCC and PPC (Partial Private Circuits) but this did not affect the Wholesale Access control in a material way.

Partial Private Circuit Charge Control

PPCs are leased lines that BT sells to other network operators. On 1 October 2004, Ofcom introduced a PPC charge control to replace the annual determinations previously carried out by Oftel. The control arises from regulation established in the Leased Lines Market Review (LLMR) and deals with PPC terminating segments (the ‘access’ part of the leased line network).
     The control is a four year RPI-X type control with three separate baskets:

Low Bandwidth Basket (RPI-4%);

High Bandwidth Basket (RPI-6.5%); and

Equipment Basket (RPI-8.9%).

     Charges prior to the control were maintained as starting charges and BT is required to make price reductions each year which comply with the controls. However, control formulae are constructed to allow BT some discretion in the timing of the price changes and the ability to meet the control by re- balancing different elements of the PPC charges.
     PPCs are also subject to obligations to notify operators and Ofcom if we intend to revise charges or other contractual conditions. The notification periods range from same day to 90 calendar days depending on the nature of the change.

Non-UK regulation

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

European Union

The degree to which the European Directives have been implemented varies by country. The general move towards the new regime continues in the original EU15 member states before enlargement, although in some of these countries, the implementation of the directives is progressing slowly. In most, but not all, of these EU15 member states, the primary legislation that will enable the introduction of the new regulatory regime is going through, or has been through, the legislative process. The processes of identification of operators with SMP and the subsequent setting of regulatory obligations on those operators are mostly in progress. The EU10 accession member states are in the early stages of implementing these directives.
     BT will not have universal service obligations outside the UK, although in certain member states we may be required to contribute towards an industry fund to pay for the cost of meeting universal service obligations in those countries. Any findings that BT has SMP in any non-UK market are not expected to have a material impact. We are lobbying the European Commission and other EU bodies with responsibility for electronic communications for consistent and timely implementation of the new directives and associated regulation.
     The availability of cost-oriented access products from regulated incumbents remains an important element of our strategy around the world and we continue to press these incumbents, their national regulatory authorities and at the EU level for such access. Availability varies by country.
     The European Commission is formally investigating the way the UK Government has set BT’s property rates and those paid by Kingston Communications. The Commission is examining whether the Government has complied with EC Treaty rules on state aid in assessing BT’s rates. BT’s rates were set by the Valuation Office after lengthy discussions based on well established principles in a transparent process. In BT’s view, any allegation of state aid is groundless and BT is confident that the Government will demonstrate the fairness of the UK ratings system. A finding against the UK Government could result in BT having to repay any state aid it may be determined to have received.

Rest of the world

The vast majority of the markets in which we operate around the world are regulated, and in the majority of these we have to obtain licences or other authorisations and comply with applicable conditions. 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 restrictions 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

Strategic Review of Telecommunications

Ofcom is carrying out a Strategic Review of the UK telecommunications sector (the ‘Strategic Review’). The first consultation document was published in April 2004 and the second in November 2004. The Strategic Review is comprehensive and wide ranging. It aims to assess the options for enhancing value and choice in the UK telecommunications sector while having regard to investment and innovation.
     The first consultation document focused on five fundamental issues: the key attributes of a well-functioning telecoms market for citizen-consumers; the achievement of sustainable competition; the possibility of a significant reduction in regulation; incentivising efficient and timely investment in next-generation networks; and the relevance of the issue of structural or operational separation of BT.
     The second consultation set out three options for the outcome of the Strategic Review. These were as follows:

	Option 1 – full deregulation, with reliance on competition law to address competition concerns;
	Option 2 – a market investigation reference to the Competition Commission under the Enterprise Act to determine whether any feature of the market prevents or distorts competition in the supply of communications services. One possible result of such an investigation could be enforced separation of BT; and
	Option 3 – delivery by BT to its competitors of ‘real equality of access’ to its networks, with the onus on BT to bring forward prompt and clear proposals.

     Option 3, which was supported by most of the respondents to Ofcom’s Phase 2 consultation, would entail introducing more effective regulation focused on enduring economic bottlenecks. Ofcom also proposed that when BT had delivered equality of access in these areas, it would withdraw many additional layers of regulation from wholesale and retail markets. In our response to the Phase 2 consultation, BT put forward proposals for a package of measures which could form the basis for a new regulatory settlement. Under these proposals, we would:

	make significant organisational changes that demonstrated our commitment to transparency and exemplary governance, including the creation within BT of a new Access Services Division based on the assets and people associated with the access network, from the customer’s premises to the main distribution frame in the local exchange;
	create an Equality of Access Board to monitor the performance of the Access Services Division and to oversee delivery of equality of access by BT;
	introduce equality of access in a phased and effective manner;
	ensure that BT’s Wholesale Access product is demonstrably fit for purpose with effective operational performance and an increased margin enabling rapid consumer take-up;
	keep Local Loop Unbundling (LLU) at the heart of BT’s wholesale broadband portfolio, building on the work already done on industrialising LLU operations and taking forward our previous commitment to cut the price of fully unbundled loops;
	make sure the rest of BT’s broadband products keep pace so that all service providers have a wide choice of offerings to suit their business models;
	agree on the enduring economic bottlenecks (assets that are not replicable in the medium term) and work to ensure that regulation is focused around them; and
	set out the ground rules that underpin the development of BT’s 21st Century Network.

     Equally, as part of this package, BT would need Ofcom to:

	commit to rapid, significant and ongoing deregulation in certain key markets;
	create a stable investment environment, with the Strategic Review and the associated studies concluded successfully, so that investors are able to invest with certainty; and
	enable BT to compete on a level playing field with other operators in the market.

Cost of copper

Ofcom issued two consultation documents, in late 2004 and early 2005, concerning the valuation of the local access network assets, with the intention of issuing a statement in summer 2005. The review considered the valuation of the copper local access circuits and the duct through which these circuits pass. Ofcom considers the local access network to be a ‘bottleneck’ (meaning that other fixed line telecommunications operators wishing to serve the majority of UK customers need to use BT’s local access network to do so), and wishes to ensure customers continue to be charged fair prices for the use of these assets. The regulator considered alternative ways of valuing these assets, and Ofcom anticipated that it would conclude that the assets should be revalued at a lower level. Such an outcome would result in lower wholesale charges for the use of local access network assets.

Cost of capital

During its review of the PPC price control, Ofcom concluded that it should amend the allowed rate of return it should use, based on an updated calculation of BT’s overall cost of capital. The September 2004 statement used an allowed rate of return of 13.0% (on a pre-tax, nominal basis), specifically for PPC prices, compared with the 13.5% rate that the regulator had previously allowed in other price controls. In January 2005, Ofcom issued a consultation document that examined various aspects of risk and reward, including aspects of the allowed return that should be used by Ofcom in setting regulated prices. The consultation proposed to review the calculation of BT’s overall cost of capital, and also considered whether to allow different rates of return for different parts of BT. The regulator proposed to reduce BT’s overall cost of capital, from the general current rate of 13.5%, and also suggested that the local access network was less risky than the rest of BT, and BT should therefore be allowed a lower rate of return in regulated prices. Such an outcome would result in lower wholesale charges for local access network services.

Radio base station backhaul circuits and wholesale extension services

During the 2005 financial year, we also launched two new products in line with regulations contained in the Leased Lines Market Review:

	RBS (radio base station backhaul circuits) – these are circuits provided by BT to enable a mobile communications provider to connect a radio base station to its mobile switching centre; and
	WES (wholesale extension services) – these are circuits provided over fibre, typically using Ethernet technology, to enable a telecoms operator to connect a customer site to its own switching site.

     Neither product is currently part of a price control but Ofcom has imposed various regulatory conditions on the products, including notification and cost orientation obligations.

Local Loop Unbundling

Local Loop Unbundling (LLU) enables operators to connect directly to the consumer via BT’s copper local loops and then add their own equipment to offer broadband and other services. There are two types of unbundled line:

	a fully unbundled line gives operators the exclusive use of the copper line; and
	a shared access line only gives operators the use of the high-frequency channel used for broadband and will also be used by the customer’s fixed-line voice provider.

     During the 2005 financial year, Ofcom extensively reviewed LLU regulation as it believed that development of the LLU market, allowing operators to target infrastructure investment and develop scale in the creation of high-speed data services, would be critical in ensuring a fully competitive and innovative telecoms market for the long term. However, while LLU does offer the potential for downstream service and price competition in broadband, it also requires substantial facilities and network investment by competitors.
     Ofcom’s latest approach to regulating LLU focused on process and price:

	in July 2004 Ofcom appointed the independent Telecoms Adjudicator to handle process issues; and
	Ofcom completed its review of LLU prices in December 2004 as part of the wholesale local access market review.

     On 16 December 2004, Ofcom announced final charges for most connection and rental prices for LLU services. The charge reductions follow consultations published on 13 May 2004 and 26 August 2004, and the price ceilings came into effect from 1 January 2005. Ofcom has published a full list of price ceilings at: www.ofcom.org.uk/media/news/2004/12/nr_20041216

Funds for liabilities

Under conditions relating to the Electronic Communications Code, an electronic communications provider with apparatus on or in the public highway is required to make financial provision to cover any damage suffered by highway or other relevant authorities, resulting from works carried out by the communications provider, and for the removal of its network, if necessary, in the event of the liquidation or bankruptcy of the company.
     The conditions require the company to provide Ofcom annually with a certificate that, in the company board’s opinion, the company has fulfilled its obligations to ensure the availability of the required funds. This has been done by BT.