‘Drastic remedy’ of functional separation gaining attention in Canada

A new approach to dealing with vertical integration and competition in the Internet services market is catching the attention of industry insiders and even some Canadian politicians. The regulatory approach, called functional separation, has been employed in other jurisdictions for years but Canadian experts remain divided about whether it should—or even could—be adopted here. According to the International Telecommunications Union (ITU), a UN agency guiding information and communications technology standards, functional separation is when a provider establishes operationally separate business entities to divide the control of network elements from the provision of service. The ITU says on its website that the separation can be done without “an actual change in ownership or ultimate control.” Functional separation is also known as “operational separation,” depending on the jurisdiction. The objective is to establish equal terms of network access for both new market entrants and the incumbent retail service provider, “giving the new entrants a fair chance to build their businesses using the incumbent's existing infrastructure,” the ITU says. Shareholders retain ownership of both entities. The model gained some traction in Canada last week when Liberal candidate and former industry critic Marc Garneau said he supports functional separation during a live online discussion. On April 11, the Liberal candidate for Westmount-Ville-Marie, Que. answered questions from OpenMedia.ca’s Steve Anderson and University of Ottawa law professor Michael Geist as part of the party’s digital platform release. When pressed by Anderson, Garneau said a Liberal government would adopt functional separation. Talk of new models is emerging as some critics say the CRTC’s wholesale Internet access policy for small ISPs is broken, particularly following controversy over its decisions on wholesale usage based billing (the commission is now reviewing that policy). But is functional separation necessary in Canada, and would it work? According to a research paper prepared for the ITU’s 2008 Global Symposium for Regulators, called “Breaking up is hard to do: The emergence of functional separation as a regulatory remedy,” the separation of an incumbent’s retail and wholesale divisions blunts both the incentive and the ability of incumbents to discriminate on pricing and quality of service. “This new institutional framework means that discriminatory behaviour will be much more difficult for the incumbent to achieve, and easier for the regulator and competitors to identify, which should deter the behaviour in the first place,” Malcolm Webb, a partner with New Zealand law firm MGF Webb, wrote in the paper. Versions of functional separation have been adopted in the United Kingdom, New Zealand, Italy, Australia and France, among other countries, Webb wrote. A similar approach is accounting separation, which requires separate financial reporting from an incumbent’s wholesale and retail divisions to ensure parity of access pricing between what incumbents and small resellers pay. But a third form, called “structural separation” requires the incumbent to sell off its retail arm completely. In 2005, under threat of being referred to the U.K. Competition Commission, British Telecommunications (BT) reached an agreement with the country’s regulator, Ofcom, to form the basis of what is now its functional separation model. BT established an operationally separate business division called Openreach, whose senior managers were “incentivized solely on the objectives of Openreach, rather than the objectives of BT Group,” Webb wrote. Steve Anderson has been trying to make a case for functional separation. He says the British experiment has yielded greater competition, a more vibrant independent Internet services provider (ISP) market, and lower prices. A 2009 report by the SPC Network—consultants who specialize in telecom strategy and public policy—found the same results. “We’ve some of the highest prices in the industrialized world for some of the slowest speeds. We’re falling behind,” Anderson said in an interview. “So I think what Canadians are saying is we need to do something structurally to fix this problem. Piecemeal’s not going to work. This seems to be working elsewhere. It seems to be where things are going, so that’s why we’re advocating for it.” John Lawford, counsel with consumer advocacy group the Public Interest Advocacy Centre (PIAC), said applying functional separation to Canada would basically mean forcing Bell Canada to sell its wholesale services to division Bell Sympatico at the same price it sells wholesale access services to Telus Corp. or small ISPs. Right now, Bell is only “notionally charging” Sympatico, Lawford said. With the two entities separated and self-dealing banned, Lawford said, Bell would sell services to Sympatico and other ISPs with the same business objectives. “Theoretically, Bell Sympatico, Telus and everybody else would be interested in having low prices,” he said in an interview. “Everybody would expand the network because it’s in the interest of the backbone being faster. And the little guys would just piggyback off it and then it would all be equal access.” Functional separation is intended to encourage ISPs to provide Internet access for its own sake rather than to promote and deliver companies’ own content—a change that Lawford said would reshape the current business model. It’s also why he says it will never happen. “There’s been a lot of investment in buying a whole bunch of content and getting the network ready to jam it down everybody’s throats,” he said. “If the top-end of the network is interested in selling just network capacity, it doesn’t care if it’s going to Netflix, or to little ISPs, or to Bell. Theoretically, they would have products that were fast, cheap, high-volume Internet, on which you could run over-the-top services.” Anderson said in an interview that separating wholesale services from retail could have a significant impact on what he calls behind-the-scenes decisions brokered between the CRTC and the incumbent telcos. He said Bell holds too much power in the determination of its wholesale pricing for independent ISPs, influenced by its retail arm. “Right now, there’s a whole bunch of small ways that Bell makes it difficult for small competitors to compete, because they control the infrastructure and they have the incentive. There isn’t a wall between their retail and wholesale,” he said. Webb’s report doesn’t identify functional separation as the answer for everyone. It’s expensive and time-consuming for the incumbents to put in place, and it probably can’t be reversed once implemented, he wrote. “Functional separation is a drastic remedy, which many believe is appropriate only where other regulatory remedies have proven to be insufficient to deal effectively with discriminatory behaviour.” He also wrote that the approach could impede new investments in assets such as next-generation networks because it would be more difficult for retail and wholesale divisions to communicate about demand signals. ITU spokeswoman Sarah Parkes said the approach can be highly successful in one market but fail in another if certain factors aren’t taken into account. According to the ITU, the European Commission has proposed functional separation “only in exceptional cases, where there has been persistent failure to achieve effective non-discrimination and where there is little or no prospect of network-based competition in the near future.” Bell Canada Enterprises Inc. spokeswoman Jacqueline Michelis said she doesn’t think it’s time for drastic action in Canada. “Canadians are well-served by intense competition between telco and cable Internet services, as well as multiple wholesale third-party ISPs that enjoy mandated access to those networks,” Michelis wrote by email. “The result is that Canadians are leading the world in time spent online, clear evidence of the success of the Canadian model." Mark Goldberg, head of telecom consultancy Mark H. Goldberg & Associates Inc., also said he isn’t convinced that the model applies here. He responded to Garneau’s support for functional separation in a blog post: “Of course, functional separation has never been imposed in a country that has platform competition and it is unclear how it would be implemented or whether it makes any sense in Canada. The telephone companies are not the incumbent service providers for broadband. Cable based services were first. In virtually every geographic market, the phone companies aren’t even the market leader. So, which company would it apply to?” Ryerson University professor Catherine Middleton, the Canada research chair in communications technologies and the information society, said by email that functional separation is typically applied to telephone companies “to separate their wholesale access to the copper loop from their own retail DSL service provision”—but added that she is not aware of any instances of separation for cable wholesale providers. Middleton said focusing on DSL isn’t the answer, pointing to countries such as Australia where the government is working with the private sector to build fibre-to-the-home. “Canadian policy makers need to think about how to ensure that Canadians can access high quality, fibre broadband networks rather than focusing on policies designed to improve access to DSL services,” she said. For their part, Lawford and Anderson said they aren’t sure the politicians are listening. Lawford said adopting functional separation would take “gigantic political will”—the kind that doesn’t exist in Canada. Anderson is more optimistic, given Garneau’s commitment. “If you asked me that a year ago I would have said it would never happen,” he said. “Now I think there’s a decent chance.” mburgess@thewirereport.ca

‘Drastic remedy’ of functional separation gaining attention in Canada

News | April 20, 2011

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