WhoPaystheTerminatingOperator

30 May 2002

Sally Trebble




Who pays the transit operator? The fashion for examining the accounting practices of telecoms operators has spread to asking the courts to rule on cascade accounting and direct accounting. Until now an almost invisible issue, the choice is in fact central to cash flow.

Interconnection revenues, from transit or termination services, are a significant source of income for network operators, in several cases amounting to up to 25 – 30 per cent of the operator’s total income. Given that the costs of billing and collecting interconnection payments have been modest and that solvent operators generally make reliable payers, interconnection revenues have traditionally made a stable oasis in the business plan.

However, this may be about to change. SMP operators are under relentless pressure from national regulatory authorities (“NRA”) to reduce interconnection charges to the costs of an efficient operator in the interests of competition, and so call termination is not the comfortable revenue stream it once was. This is particularly true of mobile termination rates whose levels are being investigated by the European Commission as well as by several NRAs. The pricing of fixed call termination rates was a long running dispute in the UK which led to acceptance of the principle of reciprocity between all operators, based on BT's costs. In France, the ART has recently been asked by alternative operators to rule in the opposite direction and reject reciprocity. The argument rumbles on.

In a different direction, disputes about practices for collection of termination fees are becoming more common and increasingly complicated as operators look for ways of reducing their exposure to risk of bad debt. In relation to this, Bird & Bird’s Stockholm office has recently been advising the Swedish Post and Telecom Agency on the application of cascade and direct accounting principles to transit calls in Sweden.

Interconnection and transit

The most basic form of interconnection involves two networks that have a physical and logical connection. In such a case, the operator of the network where the call terminates is entitled to a termination fee from the operator of the network where the call originates.

Transit services are required where the originating operator and the terminating operator do not interconnect directly with each other and so cannot hand over calls for termination according to the terms of an interconnection agreement between them. Transit calls originate on operator A’s network, are carried through operator B’s network (the transit operator) to finally terminate on operator C’s network (i.e. reach a customer of that network). In this case operator C is entitled to a termination fee. However, the question is: in the absence of any agreement dealing with the matter who, A or B, shall pay the termination fee to C?

Accounting principles

There are two available accounting standards for transit calls: direct accounting and cascade accounting.

Direct accounting is where the originating operator (A) pays the termination fee directly to the terminating operator (C) without the involvement of the transit operator. (In addition to the termination fee the origination operator normally pays a (lesser) amount to the transit operator in payment for the transit services.)

Cascade accounting is where the transit operator (B) pays the termination fee to the terminating operator (C). (The transit operator in its turn has to recover the fee from the originating operator. Thus each operator invoices the previous and the charges “cascade” from one operator to the next.)

If the operators involved cannot agree on which accounting principle shall apply they may turn to the NRA for mediation and guidance and a possible decision in the matter. In such cases the NRA has a choice to make about which of the above accounting standards is most appropriate.

Cascade accounting in Sweden – a matter for the courts

Cascade accounting and direct accounting have been specifically contentious in Sweden which in part is because Telia, unlike former incumbents in other EU Member States, wished to adopt direct accounting principles, something now considered unacceptable by the Swedish NRA.

In one current case Telia and the competing Swedish operator Tele2 have not been able to reach an agreement on how transit calls should be charged and they have referred the matter to the Swedish Post and Telecom Agency. The dispute concerns Telia’s rights and liabilities as a transit operator (i.e. operator B in the description above) and Tele2’s rights as an operator where calls terminate (i.e. operator C above). Tele2 claims that cascade accounting should be applied in such way that Telia shall pay to Tele2 termination fees regardless of Telia having received any payment from the originating operators. Telia, however, is not as a transit operator willing to pay any termination fee to Tele2. Furthermore, Telia claims that even if cascade accounting shall apply – which it objects to – Telia shall not be liable to pay any fees to Tele2 unless Telia has received corresponding fees plus a compensation for its transit services from the originating operators.

The Swedish Post and Telecom Agency decided in August 2000 that cascade accounting should be applied between Telia and Tele2 and that Telia should pay termination fees to Tele2 regardless of Telia having received any payment from the originating operators. The decision was appealed by Telia to the Administrative Court of Stockholm.

Meanwhile, Tele2 initiated a civil case against Telia asking for the equivalent of approximately EURO 50 million in outstanding termination fees. Telia in its turn has asked for corresponding payment from the originating operators but Telia’s claims for such payment have in several cases been unsuccessful. According to Telia this puts them in a unreasonable position where they have to act as a bank assuming huge credit risks without any compensation.

On 7th March 2002 the Administrative Court of Stockholm presented its decision. The Court rejected Telia’s appeal. Thus cascade accounting shall be applied in accordance with Post and Telecom Agency’s decision of August 2000. The Court did not find any explicit support for its decision in the relevant telecom legislation. Instead it turned to the general aim of the Swedish Telecommunications Act, which is to ensure that private individuals, legal entities and public authorities shall have access to efficient telecommunications at the lowest possible cost to the national economy. A clear advantage with cascade accounting is that new entrants to a market only need a single interconnect agreement with one major operator in order to have their calls delivered around the world, as opposed to a system of direct accounting which requires a vast number of interconnection agreements to be operational on a larger scale.

The Court also commented on the credit risks Telia will have to bear. It stated that if a system were introduced where Telia did not have to compensate Tele2 unless Telia had received corresponding payment from the origination operators, then Telia would loose its incentive to claim payment from the originating operators, since no pay from the originating operators would mean that Telia did not have to pay Tele2. Instead Telia has to see to it that it is compensated for the credit risks while negotiating new interconnection agreements.

The Courts decision of 7th March 2002 has been appealed by Telia and the civil case between Telia and Tele2 is resting until the appealed administrative case has been finally settled.

EU and ITU guidance

The Directive 97/33/EC on Interconnection in telecommunications imposes an obligation upon operators to negotiate interconnection agreements with each other. However, the Directive does not state which accounting principles shall apply if the operators fail to reach such agreements. Neither has the EU provided any other specific guidance on the matter. The same goes for the International Telecommunications Union.

UK

In the UK, the issue does not seem to have been the subject of any regulatory decision or complaint because BT, the original, ubiquitous transit operator, has adopted the principle of cascade accounting, following normal contract law principles of receiving payment under an interconnection contract from the originating operator and making payment through a separate interconnection agreement to the terminating operator. The principle of reciprocity may have facilitated this practice, since the termination payments made by BT have always been set by reference to its own costs allowing BT a measure of control when agreeing to provide transit to originating operators.

Conclusion

Based on the situation in Sweden it seems quite clear that cascade accounting brings several advantages to smaller operators and new entrants since with cascade accounting an originating operator only needs an agreement with the first operator in the chain and not with anyone else involved in delivering the call. This reduces administration costs and makes it possible to become operational much faster. Furthermore, with cascade accounting the transit operator is paid a fee to complete the call, not a transit fee. This works as an incentive for the transit operator to find the least cost route for terminating the call and thus improve its interconnection margin.

There are also obvious risks with a cascade accounting system. The transit operator not only has to invoice the originating operator but also has to pay the termination fee to the terminating operator. This involves, as Telia has pointed out, a credit risk for which the transit operators will require compensation (i.e. in the end higher prices for the consumers).

As a result of the general confusion on which accounting principles shall apply in Sweden originating operators have refused to pay the transit operator (Telia) in circumstances where they have not come to an agreement with the terminating operator (Tele2) on the price to pay. In spite of the fact that the transit operator is not getting paid, it still has to transit the calls due to regulatory obligations. This could have the effect of distorting competition, since some operators are getting calls delivered without paying for them. In many jurisdictions, operators whose interconnection charges are regulated are permitted to make an allowance for bad debt. Thus in Sweden, the current situation could have the effect of raising interconnection charges across the board.

No matter which principle one favours, the most important thing is to set aside the uncertainty presently at hand. Most Swedish operators have experience of handling both accounting principles and the market is likely to adapt quickly. What the market cannot adapt to is long periods of uncertainty.

Questions about the Swedish dispute? Contact hampus.vallien@twobirds.com. Any other enquiries about interconnection should be emailed to clb@twobirds.com.