OFCOM case study 1: Termination Charges Dispute

OFCOM Case Study 1: Termination Charges Dispute

 

OFCOM decision <Appeal to the CAT < Appeal to the Court of Appeals < Appeal to the UKSC

The case concerned a dispute about the termination charges which BT is entitled to charge to mobile network operators for putting calls from the latter’s networks through to BT fixed lines with associated 08 numbers. It raises issues of great importance to the telecommunications industry, to its regulator, and indirectly to millions of consumers.

Background

In principle, the cost of a call is charged to the caller by the originating communications provider to which he subscribes (a “CP”). Out of its charges to the caller, the originating CP must pay charges to the terminating network or to an intermediate carrier if there is one. 08 numbers are known as non-geographic numbers. They are allocated to fixed line subscribers, and automatically translated into the appropriate geographic number in the course of transmission. Where the call originates from another fixed line, an 08 number allows the subscriber to whom that number has been allocated to receive it on the basis that the caller will be charged at a standard, and generally reduced, charge. Calls to 080 numbers are free to fixed line callers except where charges are notified at the beginning of the call. Calls to 0845 numbers are charged to fixed line callers by the originating CP at its standard local call rate. Calls to 0870 numbers are charged to fixed line callers by the originating CP at its standard national call rate except where different charges have been published. In each case, the terminating CP will collect a termination charge from the CP from which it received the call. However, where calls originate from a mobile network operator, that operator will commonly charge the caller for a call to a 080 number, or charge him more than the standard local or national rate for a call to a 0845 or 0870 number.

In 2009, BT notified mobile network operators of a revised scheme of termination charges for 08 numbers. According to the new scheme, mobile network operators (MNOs) would be charged at a rate which varied according to the amount which the originating network charged the caller. The higher the charges, the greater the termination charge. The four MNOs rejected the scheme. The issue was referred to the OFCOM under its statutory dispute resolution powers.

Appeal lies from Ofcom to the Competition Appeal Tribunal, and from them on points of law only to the Court of Appeal. Ofcom decided that BT should not be allowed to introduce the new charging scheme. The Competition Appeal Tribunal overturned that decision and decided that they should. The Court of Appeal restored the original decision of Ofcom.

Ofcom’s determinations

Ofcom issued a final determination dated 5 February 2010 in relation to 080 numbers, and a second final determination dated 10 August 2010 in relation to 0845 and 0870 numbers. Ofcom decided that it would permit the changes to be made only if they were “fair and reasonable”, judged by three governing principles (OFCOM’s analytical framework).

All three principles can be related to objectives set out in Article 8.2 of the Framework Directive.

  • Principle 1 was that mobile network operators should be able to recover their efficient costs of originating calls to the relevant numbers. < OFCOM found this principle to be satisfied.
  • Principle 2 was that the new charges should (i) provide benefits to consumers, and (ii) not entail a material distortion of competition. < Principle 2 was “not sufficiently likely to be met”.

As regards Principle 2(i), which is known as the “welfare test”, Ofcom distinguished between three potential effects on consumers: the “direct effect”, essentially the effect on consumer prices for calls to 08 numbers; the “indirect effect”, which referred to the possibility that revenue gains by BT would feed back to the consumer in the form of lower charges or higher standards of service by service providers who use 08 numbers; and the “mobile tariff package effect” (or “waterbed effect”), by which it meant the potential for mobile network operators deprived of one revenue stream to try to compensate themselves by seeking to raise prices elsewhere. It thought that the direct effect was likely to be positive for consumers, because a tariff based on the originating network’s charge to the caller was likely to lead mobile network operators to reduce their charges to callers, although it could not say by how much. It thought that the indirect effect was also likely to be positive, because over time some of the benefits to BT would be passed on to service providers using the 08 numbers in question, although callers to 08 numbers would not necessarily benefit. Ofcom’s concern was about the mobile tariff package effect. It thought that this was likely to be negative because mobile network operators would probably try to recoup the higher termination charges by raising charges for other services.

  • Principle 3 was that implementation of the new charges should be reasonably practicable < it was not satisfied < Ofcom was overruled by the CAT

Taking the three effects together, Ofcom’s conclusion was as follows:

9.31 Our judgement in respect of Principle 2 is therefore finely balanced. We recognise the possibility that consumers could benefit from NCCNs 985 and 986. However, we also recognise the risk of harm to consumers from NCCNs 985 and 986, particularly in light of our conclusions on the Mobile tariff package effect.

9.32 Given the uncertainty which we have identified as to whether BT’s NCCNs would result in a net benefit or net harm to consumers, and in light of our overriding statutory duties to further the interests of consumers, we consider it is appropriate for us to place greater weight on this potential risk to consumers from NCCNs 985 and 986.”

Turning to the competition test at Principle 2(ii), Ofcom concluded that while there were some concerns on this count, the risk of a material distortion of competition arising from the changes was “relatively low”.

  1. Taking the welfare test and the competition test together, Ofcom concluded that Principle 2 was not satisfied, because BT could not positively demonstrate that the proposed tariff changes would be beneficial to consumers. In summary, what Ofcom decided was that although the direct and the indirect effect of BT’s proposed price changes could be expected to result in lower prices for consumers, BT should not be allowed to make the changes because it was not possible to forecast how far mobile network operators would be able to compensate themselves by increasing other charges.

CAT judgment  [2011] CAT 24

Under section 192 of the Communications Act 2003, an appeal to the CAT is an appeal on the merits. It is a rehearing, and is not limited to judicial review or to points of law. This reflects the requirements of Article 4 of the Framework Directive.

The CAT allowed BT’s appeals. The tribunal agreed with the approach embodied in Ofcom’s three principles, but they had a different starting point. In their view, BT was prima facie entitled to change its charges for three reasons.  The first was that BT had a contractual right to vary its charges, subject to Ofcom’s determination if the dispute resolution procedure was operated. The second was that the introduction of innovative charging structures was itself a mode of competing, and that interference with it would restrict competition. The third was that “price control is an intrusive form of control which elsewhere in the 2003 Act can only be introduced by SMP condition” (para. 442). It was therefore inappropriate for Ofcom to use its dispute resolution powers as a way of controlling the charges of a CP like BT which did not have significant market power in a relevant market. Summarising their view of these points, the CAT said:

“396. The crucial question is what is a regulator to do in the context of such uncertainty? Essentially, the regulator has two choices:

(1) To prevent change unless it can be demonstrated that the change is beneficial- in which case it may well be said that the dead hand of regulation is constraining behaviour which may actually be beneficial to consumers. We stress that our conclusion regarding Principle 2(i) was that the welfare assessment was inconclusive, not that consumers would be harmed.

(2) Alternatively, to allow change despite the uncertainty, even though there is a risk that the change may result in a disbenefit to consumers, recognising that an undue fetter on commercial freedom is itself a disbenefit to consumers.”

It followed that, if Principles 1 and 3 were satisfied (as they were), Ofcom could reject a proposed change in a CP’s termination charges only if the welfare test distinctly showed that they would adversely affect consumer welfare.

  1. The CAT reached substantially the same conclusions about the welfare test as Ofcom did, namely that it was inconclusive. They expressed their conclusion as follows at paragraph 379:

“Fundamentally, the welfare analysis is inconclusive, due to a lack of empirical evidence. Even with the assistance of the simplifying assumptions that we have described, a reliable assessment of elasticity of demand is not possible. Whilst it is possible to conclude that prices for 080, 0845 and 0870 calls will, on balance, fall, it cannot be said how far they will fall, nor what volumes of calls there will be at any given price. Equally, the extent of the Mobile Tariff Package Effect is essentially unknown.”

An inconclusive welfare test could not in the CAT’s view be enough. The CAT’s conclusion on this point is conveniently summarised at paragraphs 447-448 of their judgment:

“447. If, therefore, the test to be applied is whether the NCCNs can be shown to provide benefits to consumers, then that test is not met. However, we do not consider this to be the correct test in the circumstances of the present case, because it places undue importance on Ofcom’s policy preference, at the expense of the two other relevant factors that we have identified as forming a part of Principle 2 (namely Principle 2(ii) [the risk of a distortion to competition arising from restricting CP’s commercial freedom to price] and BT’s private law rights.

  1. We consider that whilst Ofcom’s welfare analysis could override these other factors, it should only do so where it can clearly and distinctly be demonstrated that the introduction of the NCCNs would act as material disbenefit to consumers. In short, given the presence of the two other factors that we have identified, it is not enough for the welfare analysis to be simply inconclusive. The welfare analysis must demonstrate, and demonstrate clearly, that the interests of consumers will be disadvantaged.”

The  Court of Appeal judgment [2012] EWCA Civ 1002

Appeal lies from the CAT to the Court of Appeal on a point of law only. The Court of Appeal (Lloyd, Etherton and Elias L.JJ) overruled the CAT and restored the decision of Ofcom. The leading judgment was given by Lloyd LJ, with whom both the other members of the Court agreed.

Lloyd LJ rejected the CAT’s starting point:

  • In the first place, he held that the tribunal had been wrong to treat BT as having a prima facie right to change its charges, which needed to be displaced. It had no more than a right to do so subject to the determination of Ofcom if the counterparty objected.
  • Secondly, he held that they had been wrong to attach weight to their view that a restraint on BT’s freedom to set its own charges would itself distort competition.
  • Thirdly, he held that the CAT had been wrong to attach weight to the fact that BT, not having significant market power in a relevant market, was not subject to ex ante control of its prices on competition grounds. Having disposed of the three considerations that led the CAT to put the burden of justifying their objection to the new charges on the mobile network operators, Lloyd LJ held that it was for BT to justify its charges as being fair and reasonable. This, he thought, required them to establish positively that consumers would benefit by them, something which the inconclusive outcome of the welfare test made it impossible for them to do.

Lloyd LJ attached considerable importance to the nature of the function which Ofcom is performing when it resolves disputes about charges under an interconnection agreement: “dispute resolution is a form of regulation in its own right, to be applied in accordance with its own terms”. (para.63; See also Article 20 of the Framework Directive). In his view, the terms of the Interconnection Agreement were of little if any relevance because their effect was that any new charges introduced by BT were liable to be overridden by Ofcom in the exercise of its regulatory powers. This led him to regard interconnection charges as an essentially regulatory construct. Much of the rest of his analysis follows from these premises. Because Ofcom’s determination of the dispute was a regulatory function, Lloyd LJ considered that the balancing of the various factors relevant to Principle 2 was a value judgment for it. Since it was not shown to have erred in principle, its decision should be restored.

The Welfare Test

Ofcom rejected the new charges was that the welfare test having been inconclusive, it had not been demonstrated that BT’s new schedule of charges would produce consumer benefits.

Supreme Court  [2014] UKSC 42 found that this was wrong in principle, for substantially the reasons given by the CAT.

BT were contractually entitled to vary their charges unless the proposed variations were inconsistent with the Article 8 objectives, including the objective of ensuring consumer benefit in accordance with Article 8.2(a). Ofcom have not found that they were inconsistent with those objectives. They have found that they would produce direct and indirect consumer benefits of unquantifiable value, and that these benefits might or might not be exceeded by disbenefits arising from the attempts of mobile network operators to increase revenue in other directions. The latter factor was found by the CAT to be “essentially unknown”.

‘43. In my opinion, it is not consistent with either the contract or the scheme of the Directives for Ofcom to reject charges simply because they might have adverse consequences for consumers, in the absence of any reason to think that they would. It is not consistent with the contract because it prevents BT from exercising its discretion to alter its charges in circumstances where there is no reason to suppose, and Ofcom has not found, that the limits of that discretion have been exceeded. It is inconsistent with the scheme of the Directives because it involves applying an extreme form of the precautionary principle to a dynamic and competitive market, in a manner which is at odds with the Directives’ market-oriented and essentially permissive approach. Logically, given the inherent difficulty of forecasting the extent of any direct or indirect effects, and the practical impossibility of forecasting the mobile tariff package effect, it would rule out any increases in termination charges other than those justified by reference to underlying costs. On this point, therefore, I think that the CAT were right and that the Court of Appeal were wrong to overturn them.’

‘44. In its submissions on the appeal, Ofcom submitted that the degree of risk which is acceptable must be related to the gravity of the adverse effect if the risk materialises. It expressed concern that it should not, for example, be inhibited from blocking a price variation which on a balance of probabilities was unlikely to be adverse, but which if things went wrong would be catastrophic. I agree. This would be an example of a case where the existence of the risk was itself adverse to the interests protected by Article 8. But on the facts found by Ofcom and the CAT, we are a long way from that kind of situation in the present case. It is right to add that if and when sufficiently adverse effects were to materialise at some point in the future, Ofcom has power to intervene to address them at that stage.’

Anti-competitive effect of price control

‘45. The Court of Appeal’s second reason for thinking that it was for BT to demonstrate positively that there would be consumer benefits from the proposed changes to their charging structure was that they disagreed with the CAT’s emphasis on the anti-competitive effect of preventing the introduction of innovative charging structures. The Court of Appeal did not suggest that it was economically mistaken. But they considered that too much weight had been attached to it by the CAT. In their view, this was a matter of regulatory policy. Since Ofcom was the regulator and it was exercising a regulatory function in resolving the present dispute, the CAT should not have interfered with their conclusion unless Ofcom erred in principle. The Court of Appeal thought that since the CAT substantially agreed with Ofcom’s conclusion on the welfare test, there was no error of principle.

46. I think that in this respect also, the Court of Appeal was wrong. In the first place, as I have explained, in resolving this particular dispute, Ofcom was not exercising a regulatory function, but resolving a dispute under the unchallenged terms of an existing agreement. But the main problem about the Court of Appeal’s view is a more fundamental one. According to the CAT’s analysis, the effect of not allowing BT to introduce innovative charging structures was itself anticompetitive because innovative pricing structures are an effective mode of competing. This was clearly a relevant consideration, even if it was not a conclusive one: see Article 8.2(b) of the Framework Directive. It was not a consideration taken into account by Ofcom. Since the right to introduce the proposed pricing package brought benefits for competition, the mobile network operators should have to justify their demand that the package should be rejected by pointing to some countervailing detriments to consumers disclosed by the welfare test if it were to be accepted. An inconclusive welfare test could not be enough for this purpose. The CAT was hearing an appeal by way of rehearing on the merits. Their conclusion about the anti-competitive effects of restricting price changes and the weight to be attached to it was a factual judgment which it was perfectly entitled to make. It was, moreover, an economic judgment by an expert tribunal which had received a substantial amount of additional evidence, including economic evidence. Since appeal lay to the Court of Appeal only on points of law, the CAT’s findings on the distortion of competition liable to result from the rejection of the new charging structure were not open to rejection on appeal.

Inappropriateness of restricting prices in the absence of significant market power

  1. These considerations are enough to resolve the present dispute in favour of BT. It is therefore unnecessary to consider the CAT’s third reason for requiring the mobile network operators to show a distinct disbenefit to consumers in order to justify rejecting a proposed change to interconnection charges. This was that the rejection of BT’s proposed charges amounted to imposing price control on an entity such as BT which had not been designated as having significant market power in a relevant market. This, it was argued, was wrong in principle because there was no power under the Directives and the Act to regulate the prices of a firm without such power. BT put this point at the forefront of their submissions. For reasons which were never entirely clear but may have to do with their commercial and regulatory strategies, they were anxious to avoid relying on BT’s rights under the Interconnection Agreements or adopting those parts of the CAT’s reasoning which were based on them, and instead sought to obtain a ruling that the Common Regulatory Framework can never authorise Ofcom to reject a price variation unless it would leave an efficient operator unable to cover its costs.
  2. I will only say that as at present advised I am not convinced by this. It seems to me to be irrelevant to the question on which this appeal turns, namely whether BT must positively demonstrate consumer benefit if they are to justify their proposed charges. Moreover, the fact that BT does not have significant market power in a relevant market does not mean that the promotion of competition, which is included among the Article 8 objectives, is irrelevant to a dispute about charges. It only means that Ofcom may not exercise its regulatory power to control prices. Ofcom has not purported to do this. There is an important difference between (i) exercising a regulatory power to impose price control in order to correct market failure or control the abuse of a dominant economic position, and (ii) deciding whether a particular proposed tariff change advances consumer welfare for the purpose of determining whether there is a right to introduce it.

A hypothetical alternative analysis

  1. It will be apparent that I do not accept the basic conceptual framework within which the Court of Appeal reviewed these questions. It is, however right, in view of the way that the argument went and in the light of suggestions that there should be a reference to the Court of Justice of the European Union, to point out that the result would have been the same even if Lloyd LJ had been right to regard Ofcom’s dispute resolution functions as purely regulatory and the interconnection terms as being unimportant. The whole scheme of the Directives is to leave the arrangements for interconnection to the parties unless there are grounds for regulatory intervention. The permissible grounds of regulatory intervention in the case of a CP without significant market power are that the interconnection terms have been framed or are being operated in a manner which is inconsistent with end-to-end connectivity or conflicts with the Article 8 objectives. If the result of the welfare test and the competition test is that there is no positive reason to believe that the effects will be adverse, there is no justification for regulatory intervention.

Conclusion Supreme Court

In my opinion there was no justification for the Court of Appeal to set aside the careful analysis of the CAT on a matter lying very much within its expertise. I would accordingly allow this appeal. Counsel will be invited to make written submissions on the form of order unless this can be agreed.

 

Leave a Reply

Your email address will not be published. Required fields are marked *