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Openreach | Ofcom Strategic Review Of Digital Communications

18th August 2016  by Gareth

As part of its Strategic Review of Digital Communications (SRDC), Ofcom has announced proposals to ‘legally separate’ Openreach, the division of BT that operates the UK’s national network, within the BT Group. The regulator believes the successful implementation of this plan will counter restrictions created by the current governance of Openreach.

Published by Ofcom on 26 July, the plan forms part of a wider strategy to help make the UK a world-leading digital economy, although its main focus is on proposals to strengthen Openreach’s independence.

In the wake of Ofcom’s Strategic Review of Digital Communications, published in February 2016, many industry stakeholders, including some of the UK’s largest carriers, had called for the full ‘structural separation’ of Openreach from the BT Group. In the SRDC, Ofcom itself had even gone so far as to describe structural separation as “the cleanest and most clear-cut long-term solution.”

However, in order to deliver meaningful reform of Openreach in a way that is robust and swift, Ofcom has chosen instead to ‘legally separate’ Openreach. The BT Group will retain ownership of Openreach but, Openreach will now be a completely separate subsidiary, operating with its own board of directors and corporate structure.

The ‘legal separation’ proposal could be interpreted as pragmatism on Ofcom’s part. A ‘structural separation’ would almost certainly face a legal challenge and, even if BT were to concede, there would be other complex legal and logistical issues that would need to be resolved, inevitably slowing down implementation.

The core proposals made by Ofcom are:

Openreach as a distinct company
Openreach should be separately incorporated, becoming a company in its own right. It would have its own purpose, set out in its Articles of Association, and its own governance arrangements including a board of directors.

Openreach’s purpose and directors’ duties
The new Articles of Association should make clear that one of the company’s purposes is to act in the interests of all downstream customers equally, and that the Openreach directors must act accordingly.

The Openreach Board
This would have a majority of non-executive directors, including the Chair. These would be appointed and removed by BT. Crucially, these non-executive directors would not be affiliated in any way to BT Group, and Ofcom must be consulted on, and approve, each appointment and removal.

The Openreach Executive
The Openreach Chief Executive would be appointed by, and accountable to, the Openreach Board. The Chief Executive would be responsible for other executive appointments. There must be no direct lines of reporting from Openreach executives to BT Group executives or functions, except where this is specifically agreed with Ofcom.

Greater consultation with customers on investment plans
Openreach would be obliged to consult formally with all downstream customers on large-scale investments. There would be a new ‘confidential’ phase where customers can discuss ideas – for example, joint ventures with Openreach – without this information being disclosed to BT Group.

Greater independent financial control within an agreed budget
BT Group would set a ‘financial envelope’ (a set spending capacity). Within this envelope, Openreach would have delegated authority to develop and manage its own strategic and annual operating plans. Openreach would also be able to make recommendations to the BT Group Board for increased spending.

Openreach employees
Ofcom’s strong preference is that people who work for Openreach would be employees of the new company, rather than employees of BT Group. This would prevent any real or perceived conflict of interest, and allow Openreach to develop its own distinct organisational culture. Ofcom recognises that these employee arrangements would present some issues, particularly in relation to pensions, but believes these can be appropriately addressed.

Openreach assets
Ofcom’s starting position is that Openreach should own those assets it already controls, namely the underlying infrastructure (such as underground ducts and telegraph poles) associated with the current Openreach network. Ofcom recognises, however, that some asset transfers may trigger material costs, including those related to pensions. In those circumstances, it is open to proposals that would mitigate such costs by means of agreements between Openreach and BT.

Increased resources and capability to support effective governance of Openreach
Openreach would have greater resources, giving it the technical and commercial capability to develop strategy and manage its operational delivery without relying on BT Group.

Openreach to have its own brand, independent of BT
Openreach would have its own brand, not affiliated with BT Group, to help embed the organisational culture of an independent company enabled by the other changes set out above.

Regulatory compliance ensured by the Openreach Board
The new model would no longer require the Equivalence of Access Board (EAB), which is the current mechanism for ensuring compliance. Its responsibilities would instead become a duty of the Openreach Board, discharged by a sub-committee of non-executive members.

Although these plans have been met with scepticism by some, it seems for the most part that industry stakeholders are ready to work with Ofcom to deliver the plans for reform it has proposed. However, several areas of concern have already been identified. These include:

Articles of Association and Purpose – These must ensure a clear separation of Openreach’s interests and objectives and priorities from those of BT Group.

Appointment of the Board – Ofcom envisages that the board would be appointed by BT but must be approved by Ofcom. Stakeholders believe it would be helpful if some terms of reference on both the profile of individual candidates and the shape of the board is agreed in advance to ensure that the board composition represents all parts of industry (smaller CPs and business customers etc).

Financial Control – Ofcom envisages BT Group setting a “financial envelope” within which Openreach would have delegated authority – this does not address what an appropriate level of profit and contribution to BT Group would be. NB: in the year ended March 2014 Openreach made an operating profit of over £1 billion on revenue of £5 billion.

Openreach Employees – Ofcom expresses a “strong preference” that these should be employed by Openreach rather than BT Group which many believe should be non-negotiable. The review also needs to address stopping the current free movement of key personnel moving between Openreach and other parts of BT Group.

Use of BT facilities – Openreach should be free to use its own or external resources for research and development, systems development etc. This currently potentially inflates costs of development meaning that industry requirements are often rejected on grounds of cost.

Statements of Requirement – New acceptance criteria for evaluating industry Systems of Requirements (currently criteria include that development should be beneficial to Openreach).

Incentivising Performance – new arrangements should offer clear incentives to improve over current levels of performance.

In summary, nothing worth having can be achieved without some effort. The proposals put forward, however, are not out of the ordinary. Corporate restructuring of this kind happens every day in large business institutions as they try to better serve their customers. The hope is that these propositions can be implemented swiftly delivering a step change in the effectiveness of Openreach.

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