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Ofcom commences second strategic review of UK telecoms market
Pat Treacy and John Townsend

As discussed in a previous cookie jar post, a wave of mergers between telecoms companies is occurring across the EU. These mergers are focused primarily on the EU mobile market, as reflected by the mergers between BT / EE and O2 / 3 in the UK. Separately, a wide-ranging “strategic review” of the digital communications sector has recently been announced by Ofcom, the UK’s telecoms regulator.1 As set out in the strategic review’s Terms of Reference, the process has two phases: an evidence gathering Phase 1, set to conclude by Summer 2015, and a Phase 2 for policy analysis by the end of 2015.2 This strategic review will consider the UK telecoms market in the round (how competition works for consumers in mobile, broadband and land line and business line markets), with a view to recommending regulatory action to strengthen competition over the next decade. The timing is interesting given the current level of disruption and change for the industry across the EU.

The strategic review is the second sector-wide process initiated by Ofcom and comes roughly a decade after the first strategic review, which concluded in September 2005. There are a variety of potential outcomes, including a clean bill of health, or recommended regulatory action. The first review ended with BT offering Ofcom “undertakings in lieu of a market investigation reference”. Such an investigation would have been carried out by the Competition Commission and is an in-depth procedure. The Competition and Markets Authority, formed in 2011, now undertakes these investigations. BT’s undertakings to Ofcom are subject to revision, and have often been amended to reflect agreements between Ofcom and BT about how BT responds to changing market conditions.3

BT’s current undertakings and the creation of BT Openreach

The undertakings offered by BT, the UK’s fixed line incumbent, to Ofcom following the first strategic market review were unique within the EU. The first strategic market review concluded that there were problems with competition in the market, but that these were best dealt with in a flexible and informal way. The undertakings set out the basis for BT’s operations for the following decade. There was a perception that avoiding a market investigation reference of the telecoms market was a favourable outcome for BT. If such an investigation results in a finding of adverse effects on competition, the remedies imposed can be significant. In other sectors (such as airports or cement) remedies imposed included the forced divestment of assets from privatised incumbents (such as sales of Edinburgh, Stansted and Gatwick airports by BAA), and the break-up of longstanding market structures (such as divestment of a cement plant by Lafarge).

It was widely debated in 2005 whether a reference to the Competition Commission would have resulted in BT having to “spin off” its infrastructure section (BT Openreach). Access to telecoms infrastructure is the primary concern of competition law in this sector because there is the risk that privatised fixed line incumbents could exclude access to infrastructure ( or make it unreasonably difficult or expensive) at the expense of competitors. The undertakings accepted by Ofcom bound BT to a unique remedy with respect to infrastructure. BT promised (a) to supply telecoms services on an “equivalence of inputs” basis, meaning that BT Openreach would treat all wholesale customers (including the rest of BT) on the same commercial terms; and (b) to create a functional separation between BT Openreach and the rest of BT, with a separately appointed CEO and management team for Openreach endowed with a degree of managerial discretion on spend, Capex and the like. These two promises were thought to deal adequately with any competition issues caused by not requiring BT to divest its infrastructure business. Crucially, Ofcom allowed BT to preserve its vertically integrated structure. In telecoms regulation, the “last mile” of telecoms infrastructure, the copper “local loop”, and the associated “posts, ducts and wires” are subject to heavy regulation at the EU and UK level to allow competitors to access these on fair terms.

Has the Openreach model of access failed?

While BT provided undertakings to allay Ofcom’s concerns following the market investigation, the entire company (including BT Openreach) remains subject to scrutiny by Ofcom. Ofcom is able to examine whether BT’s unilateral conduct is an abuse of a dominant position in amy telecoms markets where it exercises significant market power. It is difficult to second-guess the possible outcomes of the latest strategic review. Intense litigation occurred following the first strategic review concerning the process of “local loop unbundling” (LLU). Competitors to BT felt that LLU was not offered on sufficiently viable terms, even after litigation to establish the basis of the access. The BT Openreach model itself was criticised severely by competitors, who felt that the emphasis on copper wires held back the UK telecoms market technologically. However, most copper has now been replaced by fibre (or at least fibre “to the cabinet”) and the most competitive parts of the market remain centred geographically on the key areas of business activity within the UK, in London and the Midlands conurbation. Criticism has also recently been directed against BT in the mainstream media (such as the Guardian4) about BT’s decision to enter premium broadcast content with the launch of BT Sport, the innovative offering of bundled premier league football with superfast broadband. This launch is known within the industry as “quad play”, and mirrors developments in France, Germany and elsewhere.

Since the first strategic review, Competition Act enforcement within the telecoms sector has had mixed results. Ofcom’s recent investigations into margin squeeze such as the THUS / Gamma complaint and the TalkTalk complaint resulted in “no grounds for action” decisions. (This is a verdict equivalent perhaps to “not proven” in Scottish criminal law.) It will be interesting if further changes to Competition Act enforcement priorities emerge from the strategic review.

Conclusion

These developments create some uncertainty for the UK telecoms sector. Compared to the position prior to the first telecoms strategic review, where economic growth was coupled with a fairly stable regulatory framework, the disruptive trends of technological convergence in bundled offerings such as “quad play”; mergers between telecoms companies; and renewed market intervention in the form of a whole-scale re-assessment of telecoms regulation under the second strategic review will inevitably cause some disruption. It will be interesting to see what remedies (if any) Ofcom proposes in the strategic review process and how BT and other players react, which will surely determine the development of the UK market for years to come. A clearer picture will probably emerge after Q3 2015, following the results of Ofcom’s Phase 1 and Phase 2 processes.