Mike Conradi delves into the new rules affecting co-investment and offers an explanation and a critique
The new European Communications Code (which I wrote about here) will, in its latest draft form, introduce a mechanism allowing investments in fibre networks made by operators with significant market power (SMP), in some circumstances, to be excluded from the normal access rules that are usually imposed by national regulatory authorities (NRAs). This article will discuss this further and look at some possible models that could qualify for the exemption before concluding with some comments critiquing this new approach on the basis of its deviation from the well-respected (and broadly successful) approach that would otherwise have applied.
For the reasons explained below the new rules could even act as a disincentive to new investment over the next two or more years.
The Exemption – Commitments and the ‘cumulative conditions’
The rules on co-investment are to be found at Article 74 of the Code. The latest (through not-necessarily final) draft says that:
‘Undertakings that have been designated as having SMP may offer “commitments” to open the deployment of a new very high capacity network (that consists of optical fibre elements up to the end-user premises or base station) to co-investment.’
The first point to note is that this applies only to optical fibre and would not apply to other technologies (such as satellite) irrespective of their merits. This is a deviation from the normal principles of technology-neutrality that usually govern EU telecoms regulation.
It is also important to note that the investment must be new and must either be for fibre all the way to the user premises (FTTP – ‘fibre to the premises’) or (for mobile networks) to the base station. Other types of fibre investments, such as ‘fibre to the curb’ (FTTC) will not qualify.
The following are the ‘cumulative conditions’ that must be met in respect of the co-investment:
Annex IV adds that the full terms of the co-investment offer must:
Article 76bis of the Code then sets out the procedure for confirming these commitments, including through a public consultation. Where the commitments have been adopted in this way then, provided that at least one co-investor has entered-into a (compliant) co-investment agreement with the SMP operator, the NRA will not impose on the SMP operator any of the other ex ante access obligations in respect of the new infrastructure that would normally apply. This means that the SMP operator will not have to supply wholesale broadband products to other ISPs which use this new infrastructure.
Working within the complex criteria set out above, there are a few high-level models that co-investors (consisting of the SMP operator plus at least one other) could adopt in order to ensure that their new investment will be exempt from access regulations. Here are some ideas for this.
Setting up an SPV
The co-investors could set up an entity (a special purpose vehicle or SPV) that would itself build and own the new infrastructure. The SPV could offer a standard set of wholesale telecoms services like ‘bitstream access’ (on fair, reasonable and non-discriminatory terms) and over this new infrastructure exclusively to its shareholders – refusing to provide services to other operators. It would have to offer the same set of services to all shareholder-customers. Importantly it would have to be possible for new shareholders to join at any time on pre-set terms, without the possibility of existing shareholders vetoing this (unless on a reasonable basis such as their financial capacity). Each time a new investor joined there would be an increase in share capital, or else a sale of some of the current owners’ existing shares to the new joiner. Although all customers would pay the same price for the services received from the SPV irrespective of the quantities purchased, the price for buying a share in the SPV could increase for shareholders joining at a later date (to reflect the reduced risk they would be taking). The financing could be arranged either through the balance-sheets of each shareholder (ie the SPV itself is funded entirely through equity) or else some sort of project finance for the SPV itself would be an option. In either case each of the shareholders would likely need to enter into commitments to purchase a minimum level of services, perhaps at several stages over time.
Joint Build Consortium
Another model would be that each of the co-investors enter into some sort of consortium agreement under which they each agree to build and operate infrastructure to a defined specification in a defined geographic area and then make services using that infrastructure available to other co-investors on pre-set terms. In this case it may not be sufficient for the services to be regular wholesale telecom services such as bitstream access because this may not offer sufficient ‘protection’ to the customers. Instead it may make sense for the infrastructure-developer to sell ‘IRUs’ to co-investor customers, allowing very long-term rights (15 years plus) to specific amounts of capacity, or to individual dark-fibre strands. The arrangement would have to be open to new co-investors to join later, which could mean new joiners who themselves commit to build infrastructure in a new geographical area, but might also include new joiners who do not themselves build any new infrastructure, but who instead commit to sufficient IRU purchases to qualify. The price of IRUs taken at a later date can be greater than for IRUs which are committed-to early on, but should be the same for all co-investors whether or not they are original members of the consortium or later joiners.
SMP Operator as Manager
Another model might be similar to the Joint Build Consortium just discussed, but with only the SMP operator building and owning all new infrastructure in all regions. Other members of the consortium would still ‘own’ IRUs over that infrastructure, and (presumably) would have to commit in advance to pay a material element of the cost of the new infrastructure to be built. The price for an IRU would have to be agreed (and open to all co-investors on a non-discriminatory basis) but – importantly – there is no specific requirement that it be ‘cost-based’ so it could be at any level the parties agree is appropriate.
These new rules on co-investment offer a (very complex) way for new investments to be exempt from the wholesale access rules that would otherwise apply. These are intended to incentivise additional investment in one specific technology (fibre-optics) – and even then only when the new infrastructure constitutes FTTP rather than alternatives like FTTC. When all of the above conditions are met, the SMP operator will be able to refuse to provide access to the new infrastructure, or the services which can be provided over it, to competitors who are not co-investors.
This whole concept is contrary to many of the principles that have made the EU model for telecoms regulation the gold standard of international best practice, much emulated in other parts of the world. Specifically this is not technology-neutral – it very clearly favours one type of technology over others that might have better cost-benefit ratios, and it offers a benefit for incumbents in the form of a derogation from the rules that would otherwise apply, and thus makes it harder for smaller-scale internet service providers to compete.
Because the new rules apply only to new infrastructure this could also, perversely, act as a disincentive to any new investment during the period from now until the new Code has been implemented (which will be two years from when it is finalised).
By contrast, if these new rules were not put in place, then the SMP operator would still be obliged to offer wholesale internet services (such as bitstream access) over any new infrastructure at a regulated price. Note, though, that under the Code the regulated price could already allow a ‘reasonable rate of return on capital […] taking into account any risks specific to a particular new investment network project’ (Article 72.1, para 2 of the Code). The same paragraph also specifically states that in determining whether or not to apply price controls in the first place the NRA should take into account the long-term end-user interest in the deployment of very high capacity networks.
It seems to me that there would have been an option to leave out these new rules on co-investment entirely, leaving national regulators to determine, on the basis of Article 72, either that no access rules at all should apply to certain infrastructure in certain locations, or else that the price for access should be set at such a level as to incentivise the new investment. After all, as BEREC itself acknowledged some years ago (before these new rules were under consideration) in its April 2012, Report on Co-Investment and SMP in NGA Networks (BoR (12)41):
‘In those cases where LRIC [Long-Run Incremental Cost] -based cost-orientation is imposed as an appropriate remedy on the regulated market, an infrastructure rental solution, based on a per-line rental charge (including in terms of investment risk taken by the infrastructure operator, which can still charge the appropriate risk premium) should be equivalent to building its own infrastructure where the operator would obtain the totality of the revenues, and paid the totality of costs for a given area’ (section 1.3.1 page 14, emphasis added)
In other words the LRIC price for regulated access to infrastructure should already reflect the risk taken and offer an appropriate reward to the SMP operator making any new investment. Thus the regulated access price ought anyway to offer appropriate incentives for new investment.
Either of these two options (not imposing access rules at all, or ensuring that the regulated price incentivises new investment) might have required that the NRA make some differentiation – perhaps segmenting markets on the basis of a technical measure like minimum (symmetric) upload speeds – and then allowing, for example a higher regulated access price to apply for services which met the higher technical standard.
This would have been a much less interventionist approach, with less risk of distortion of the market and would have had the significant advantage of allowing investors to come up with whatever structure they wished for their investment rather than being constrained to comply with rules set out above. It would also have avoided the risk, inherent in the co-investment model, of reducing competition by encouraging competitors to co-operate with one another.
Although this new regime may succeed in incentivising new network investment, there might have been a simpler, and easier, way to achieve this with less risk of working against the interests of consumers throughout the EU.
Mike Conradi is a Partner at DLA Piper LLP, with a focus on providing commercial and regulatory advice to businesses in the telecoms sector.