295 32844 privatesector P U B L I C P O L I C Y F O R T H E NUMBER NOTE 2005 Interconnection Disputes JUNE Michel Kerf, Isabel Neto, Antitrust or Sector Regulation and the Case of New Zealand and Damien Géradin Full liberalization of telecommunications markets provides scope Michel Kerf for relying largely on general antitrust rules and institutions for (mkerf@worldbank.org) is an infrastructure policy economic regulation. But at least for a time after liberalization, adviser in the World sector-specific rules and institutions are likely to be needed in Bank's East Asia and Pacific Region and a some areas, including interconnection. This Note draws lessons visiting professor at the PRESIDENCY from the experience of New Zealand. After fully liberalizing its University of Liège. telecommunications market in the late 1980s, the country relied VICE Isabel Neto is a telecommunications primarily on antitrust instruments to regulate interconnection until specialist. Damien Géradin 2001, when it introduced a new regime putting heavier emphasis on is a professor at the University of Liège and at sector-specific regulation. DEVELOPMENT the College of Europe, Bruges. In telecommunications, interconnection agree- ments. Primary responsibility for a range of SECTOR ments allow one operator to use the networks of technical issues--including interconnection-- This is the second of three Notes evaluating how best other operators, including their physical infra- lay with the operators themselves. Any inter- to balance antitrust and structure and software systems. Thanks to these connection disputes that might arise were to be PRIVATE sector-specific approaches interconnection agreements, each operator can resolved through antitrust rules applied by in regulating give users of its own network access to the users antitrust authorities. telecommunications. or services of other networks. One of the key A first case, between Telecom (the incum- The first assesses which regulatory objectives in telecommunications is bent) and Clear (a competitor), involved the GROUP deals more quickly and to ensure that operators conclude such agree- long distance market. Clear needed intercon- effectively with key ments under equitable conditions. When dis- nection to the local loop, monopolized at the BANK regulatory issues. The putes about the conditions of interconnection time by Telecom, so that it could compete in the third discusses how the arise, are antitrust or sector-specific rules and national and international long distance mar- balance between the two institutions a better choice for resolving those ket. Clear's negotiating position was somewhat affects competition. disputes fairly? strengthened by the government's unwilling- WORLD In New Zealand the regulatory model for ness to approve Telecom's privatization until an telecommunications adopted at the end of the interconnection agreement had been reached. THE 1980s made limited use of sector-specific instru- From Clear's point of view, the final agreement, I N T E R C O N N E C T I O N D I S P U T E S A N T I T R U S T O R S E C T O R R E G U L A T I O N A N D T H E C A S E O F N E W Z E A L A N D concluded in March 1991, was an improvement ponent pricing rule (ECPR) should be used to over the standard interconnection terms previ- determine the interconnection price, while Clear ously offered by Telecom.1 Telecom's standard countered that the ECPR was contrary to antitrust offer stated that its competitors would be law (box 1). The High Court recognized that the charged an interconnection price equivalent to ECPR would enable Telecom to recover its the price paid by Telecom's business users and monopoly profits as well as its economic costs. It the customers of the new operators would have indicated, however, that the rule would compen- to dial a three- or four-digit access code. By con- sate Telecom for having to meet universal service trast, in the 1991 agreement interconnection objectives while still enabling Clear to enter the 2 charges were 6 percent lower than standard market if it were more efficient than Telecom. business rates, and Telecom agreed to eliminate The court concluded that application of the rule the access code once Clear's share of the long would not reveal an anticompetitive purpose and distance market exceeded 9 percent. would therefore not violate antitrust law. The In 1993, however, Clear argued that Telecom court did not impose any specific interconnec- had been late in providing noncode access after tion price on the parties, however, urging them the 9 percent threshold had been reached and instead to resume negotiations and resolve their that Telecom had charged an unreasonable differences within the framework it provided. price for granting that access. The dispute was Clear appealed the decision. The Court of resolved through arbitration. Clear obtained Appeal overturned the High Court's ruling, satisfaction on both counts, but only after a pro- concluding that use of the ECPR would amount tracted hearing that lasted 13 weeks and to obligating a new entrant to indemnify the involved many expert witnesses. monopolist for any loss of profits. This, it A second case related to the mobile market. judged, would put the new entrant at a compet- BellSouth started negotiations on GSM intercon- itive disadvantage, and in those conditions an nection with Telecom in February 1992 and anticompetitive purpose could be assumed. The reached an agreement with Telecom by mid- court ruled that the interconnection price 1993. The agreement proved less advantageous should be based on the incremental costs than the one Clear had secured earlier. For exam- involved in providing interconnection services ple, BellSouth had to pay slightly more than the plus a reasonable return on capital. It refused to standard charge for business users. Other provi- set a specific interconnection price, however, sions of the agreement were later dropped arguing that it was not a price fixing authority. because they were obviously anticompetitive. Telecom then contested the judgment of the A third case, which proved extremely con- Court of Appeal before the Privy Council in troversial, related to local loop interconnection Britain, the highest court in New Zealand's judi- and kept Clear and Telecom at loggerheads cial system. The Privy Council rejected the deci- from 1991 to 1995. Clear, already operating in sion of the Court of Appeal and ruled, as the the long distance market, also wanted to provide High Court had, that use of the ECPR would not local telephone services in competition with violate antitrust law. The Privy Council judged Telecom. The two companies failed to reach an that, in applying the ECPR, Telecom would not agreement on the conditions of Clear's access to be using its dominant position, since it would be Telecom's local network, and Clear brought an acting just as firms in competitive markets do in action against Telecom before the High Court. seeking to recover the opportunity costs of pro- Some issues were easily resolved. The judges viding services to competitors. The Privy unanimously pronounced that Telecom's Council left the parties with the task of trying attempts to impose an access code on Clear's cus- once again to agree on a specific price that tomers and to force Clear to pay the same inter- would conform to its judgment. connection price as Telecom's large end users After arduous negotiations and government with their own switches were anticompetitive. pressure, Telecom and Clear finally reached an Other issues proved much more difficult to agreement in March 1996 with interconnection resolve. Telecom argued that the efficient com- prices below ECPR levels. interconnection prices on long distance or Main approaches to interconnection mobile competitors so as to gain a competitive Box pricing advantage over them. It also was the case when 1 Historical cost-based pricing: Includes costs the incumbent faced competition in the local that are specifically attributable to the provision of market from operators that appeared too weak to interconnection services plus a share of the com- respond to unfavorable interconnection condi- mon costs (generally evaluated through historical tions by competing vigorously for market share.2 accounting). So, for example, when government pressure Long-run incremental cost (LRIC) pricing: subsided in the long distance interconnection Includes the incremental costs incurred in the long 3 case, Telecom--which held a monopolistic posi- run that result from the provision of interconnection tion in the local market and competed with Clear and that would be incurred by an incumbent using in the long distance market--reneged on its the most efficient current technology to provide the agreement with Clear. Clear finally obtained sat- interconnection. isfaction, but only after difficult arbitration. In a Efficient component pricing rule (ECPR): similar situation in the mobile market Telecom Includes the actual costs of providing interconnec- tion plus the opportunity cost of (or profit forgone used its dominant position to force BellSouth to in) providing interconnection. accept unfavorable interconnection conditions. Peering arrangements (or bill and keep): The local loop interconnection case provides yet Implies that parties provide each other with free another example. Clear's ability to compete for access to their networks. The formula may closely market share in local services was apparently reflect costs when traffic flows from one opera- insufficient to persuade Telecom to offer an tor's network to that of the other are roughly in acceptable interconnection price. balance. This last case also revealed the inability of judges, operating under an antitrust regime, to determine what constituted an equitable inter- Some lessons of experience connection price. The three courts that exam- Antitrust regulation appears well suited to ined the case disagreed with one another and addressing some clearly anticompetitive inter- ultimately failed to impose a specific price on connection issues. It worked well in the local the parties. In addition, their reasoning interconnection case, for example, where the appeared to be flawed in some instances. For outcome prevented Telecom from imposing an example, the Privy Council's conclusion that, in access code on Clear's customers and forcing applying the ECPR, Telecom would not be using Clear to pay the same interconnection price as its dominant position--because it would be act- Telecom's large end users. ing just like firms do in competitive markets-- Antitrust regulation has also been adequate ignores the fact that Telecom had much greater in some cases where the government put pres- opportunity costs and a much greater ability to sure on operators to reach an agreement. Clear force its rivals to cover those costs than firms was able to extract a relatively favorable inter- operating in competitive markets. connection agreement from Telecom in 1991, In 2000 a ministerial inquiry concluded that enabling competition in the long distance mar- the policy of relying heavily on general competi- ket, thanks in part to the government's refusal tion law had fallen short of expectations and to approve Telecom's privatization until agree- pointed to a number of changes needed, partic- ment was reached. ularly relating to interconnection. A law adopted Antitrust regulation has tended to work in 2001 to introduce these changes required that poorly, however, when specific interconnection interconnection prices be based in most cases on conditions had to be imposed, in the absence of the long-run incremental cost (LRIC) of provid- government pressure, on operators that lacked ing interconnection. It also established a spe- incentives to agree. This was the case when the cialized telecommunications unit, headed by a incumbent held a monopolistic position in the newly appointed telecommunications commis- local market and could use it to impose high sioner, within the antitrust authority. I N T E R C O N N E C T I O N D I S P U T E S A N T I T R U S T O R S E C T O R R E G U L A T I O N A N D T H E C A S E O F N E W Z E A L A N D Broadly speaking, these reforms yielded the Telecom to conclude peering arrangements desired results. After having fought so bitterly in with Clear and TelstraSaturn than the fact that the first half of the 1990s to impose the ECPR on Telecom now faces strong competitors in the Clear, Telecom accepted the terms of a peering local market and thus has incentives to offer arrangement that give Clear free access to its them favorable interconnection terms. viewpoint local network in exchange for free access to As enough experience is gained in setting Clear's own local network as long as certain con- interconnection prices under a sector-specific ditions are met (such as roughly balanced traf- regime, an antitrust-based system may become is an open forum to fic flows between the two networks). increasingly appropriate for resolving such pric- encourage dissemination of ing issues. With interconnection agreements in public policy innovations for The way forward place, antitrust authorities would have bench- private sector­led and New Zealand undoubtedly benefited from adopt- marks, or precedents, to set interconnection market-based solutions for ing sector-specific rules and establishing special- prices themselves. And once antitrust authorities development. The views ized regulatory capacity to tackle difficult are seen as credible and predictable regulators, published are those of the interconnection pricing issues. But sector-specific operators are more likely to reach agreements authors and should not be instruments may not be needed forever. Mobile on their own. attributed to the World phone service is progressively substituting for Bank or any other affiliated fixed service; cable television networks are deliv- organizations. Nor do any of ering telephone service and broadband Internet; the conclusions represent WiMax and other emerging wireless technologies Notes official policy of the World are being commercially tested as a means to 1. Telecom was commercialized in 1987 and privat- Bank or of its Executive deliver a mix of voice, data, and video products; ized in 1991. Directors or the countries and power lines are being tested as a way to pro- 2. When interconnection prices are high, it is much they represent. vide broadband access. As local operators grow in cheaper for an operator to convey a call entirely over its number, the incumbent will find it more and own network than to have to use the network of another To order additional copies more difficult to impose high interconnection operator. High interconnection prices therefore give contact Suzanne Smith, prices on competitors in the long distance and operators a strong incentive to maximize the number of managing editor, mobile markets, since these competitors will be Room F 4K-206, calls originating and ending within their own network-- able to choose to negotiate interconnection with The World Bank, that is, to compete fiercely for market share. 1818 H Street, NW, other local operators. And as new local operators Washington, DC 20433. gain strength, they will be able to compete more Reference fiercely for market share with the incumbent, Géradin, Damien, and Michel Kerf. 2003. Controlling Telephone: reducing its incentive to try to impose high prices Market Power in Telecommunications: Antitrust vs. Sector- 001 202 458 7281 for local network interconnection. Specific Regulation. New York: Oxford University Press. Fax: Today, with local incumbents tending to 001 202 522 3480 remain dominant in the local market, sector- Email: specific tools are likely to continue to be needed ssmith7@worldbank.org to set interconnection prices in most cases. But there are signs that the situation is starting to Produced by Grammarians, change. As noted, Telecom recently concluded Inc. a peering arrangement with Clear, one of its main competitors in the local market; it also Printed on recycled paper concluded a similar agreement with another competitor, TelstraSaturn. These agreements differ from the LRIC methodology, which regu- latory authorities now have to apply when par- ties are unable to come to an agreement. So it appears that the existence of the fallback LRIC regime was less instrumental in persuading T h i s N o t e i s a v a i l a b l e o n l i n e : h t t p : / / r r u . w o r l d b a n k . o r g / P u b l i c P o l i c y J o u r n a l