In 2017, the UK telecoms regulator, Ofcom, set out proposals to achieve the optimum balance between protecting consumer interests and facilitating the delivery of ultrafast, full-fibre networks.
The most significant proposal in its review of the Wholesale Local Access (WLA) market was a move to impose a charge control on BT Group’s fibre-to-the-cabinet (FTTC) access product after more than 10 years of pricing flexibility.
BT called on Oxera to assess whether Ofcom’s price control proposal was consistent with the regulator’s ‘fair bet principle’, which requires giving investors the opportunity to earn returns equal to the cost of capital in expected terms.
Where there are significant downside risks, the fair bet principle requires giving investors the ability to earn returns in excess of the cost of capital when the investment is successful.
The key question was: ‘how can we quantify these additional required returns?’
BT tasked us with assessing the magnitude of the downside risks and providing a quantification of the fair bet uplift above the weighted average cost of capital (WACC).
The work involved empirical and conceptual analysis. The conceptual analysis involved developing a framework to implement the fair bet principle, building on core ideas from corporate finance theory and economic regulation. The empirical analysis applied this framework using BT Group’s FTTC business plans and other evidence from the time the investment decision was taken.
The empirical analysis was complemented with two further workstreams—an assessment of papers and models determining unregulated returns, and a benchmarking exercise of the spreads/premia above the WACC for regulated and unregulated assets.
Building a new framework for all
• Ofcom accepted our review and critique of its approach to FTTC regulation. In fact, Ofcom later referred to this as ‘the Oxera framework’ and used it to stress test its own conclusions during the WLA market review.
• We assisted BT in presenting its case to Ofcom for upfront clarity and certainty of the parameters under which the fair bet will play out. The case was supported by the fact that early knowledge is value-enhancing and reduces uncertainty, which can be a blocker to investment and innovation.
• Our analysis found that if greater certainty was provided, Ofcom itself would benefit from having greater access to BT’s investment plans. This would make it easier for Ofcom to later assess the risks that existed at the time of the investment decision, while also allowing it to experiment with the design of regulatory incentive models—driving innovation.
Oxera continues to work with BT Group in its ongoing discussions with Ofcom regarding the appropriate regulatory framework for its future investment in fibre-to-the-premises (FTTP) networks.