On October 7, 2016 the FCC circulated a draft order establishing new regulations for the business data services (BDS) market including ILEC special access and Ethernet services. At the same time, the agency released a summary of the plan which we discuss below. The proposed regulations may be adopted at the Commission’s October 27, 2016 meeting or, more likely in November. The rules are based on the Commission’s finding that ILECs continue to have market power in DS1 and DS3 services but face more competition in packet-based services where they face new entrants such as cable companies.  Here are the regulations the Commission is recommending:

ILEC price cap regulation works by setting maximum revenues for services such as DS1 and DS3. This maximum amount is adjusted downward annually using the formula of Gross Domestic Product – Price Index (GDP-PI) less inflation. The forced decrease (called the X-Factor) is designed to adjust prices to account for the efficiency gains made each year by the telecommunications industry that otherwise would not be reflected in lower rates. 

Price cap decreases have been on hold for years since the CALLS Plan which essentially froze rates in place in 2004. The proposed order seeks to make up for those lost years and restore “fairness” to DS1 and DS3 rates through four specific requirements:

1. DS1 and DS3 price caps will be adjusted downward through a one-time downward adjustment of 11 percent phased in over 3 years, beginning in July 2017 (specifically, 3 percent in year one, 4 percent in year two, and 4 percent in year three).

2. In addition to the one-time adjustment, rates will be adjusted downward annually using an X-Factor of 3 percent offset by inflation, beginning in July 2017.

3. Phase I pricing flexibility rules will apply to all price cap ILECs. These rules allow individual contracts for DS1 and DS3service at rates that may be below the price cap filed in tariffs at the FCC. As a result, price cap carriers which until now lacked the ability to decrease their prices below the cap on an individualized basis obtain that flexibility for the first time. And customers of providers who sold DS1 and DS3 services at essentially whatever price they felt fit to charge using Phase II pricing flexibility will have protection from arbitrarily high prices.

4. The Commission will require fair terms and conditions for DS1 and DS3 services based on the findings in its May 2, 2016 Tariff Investigation Order. This means forbidding new “all-or-nothing” tariff plans that force users to make all of their purchases under one plan rather than split them among more tailored and cost-effective options, and forbidding excessive penalties for early termination or failure to purchase a set minimum amount of capacity.

Packet Services such as Ethernet will be lightly regulated

1. The Commission reaffirms that packet-based BDS is largely a “telecommunications service,” as are TDM-based services. This means that Ethernet providers are common carriers and must offer reasonable and nondiscriminatory terms under Title II of the Act. 

2. There will be no ex ante pricing regulation. Thus, no price cap, benchmarking, or other forms of pricing regulation will apply.

3. There will be a robust complaint process. Pricing and other disputes will be resolved through the FCC’s complaint process. Complaints will be expedited by guidance and requirements that include the following:
   
   
   1. Wholesale rates are presumptively unreasonable if they exceed retail rates for like services. Also applies to TDM.
   2. The FCC expects to apply greater scrutiny when there is evidence of rates that are materially higher than those charged by the same provider for the same circuit in nearby buildings with competition
   3. The FCC also expects to apply greater scrutiny when there is evidence of rates for low-bandwidth Ethernet service that are materially higher than rates for the nearest-bandwidth TDM rates
   4. Rates of new entrants and parties with smaller market shares are unlikely to be questioned
   5. Staff-supervised mediation is required prior to the filing of a complaint, which will expedite adjudication
   6. Providers are required to furnish specific rate information during adjudication
   7. Requirements for the unreasonable terms and conditions banned for TDM providers (see above) will be applied as a yardstick for adjudication
   8. Non-disclosure agreements barring disclosure of information related to the provision of BDS to the FCC are prohibited. Also applies to TDM.

The proposed order would also include a Second Further Notice of Proposed Rulemaking which will seek industry comments on how best to collect accurate data on market developments and what administrable means can be developed, if necessary, to deal with any concerns that may emerge with respect to pricing for packet-based BDS.

The order would level the playing field for all packet-based and circuit-based BDS providers delivering speeds in excess of DS3 by granting uniform forbearance to certain portions of Title II, including dominant carrier and tariffing requirements. In other words, all BDS services above DS3 speeds could be provided through the use of individual customer contracts.

It is important to note that the draft order differs from the Commission’s original proposal in several key areas:

1. The Commission originally proposed a competitive test which would classify certain markets (i.e., census blocks) as non-competitive. Only those markets would have been subject to price regulation. Now, apparently there will be price caps on DS1 and DS3 services in all markets.

2. In the original plan, new entrants in non-competitive markets such as cable companies would have had their Ethernet service prices benchmarked to the corresponding ILEC TDM service. Now, these packet-based services will not be price regulated (other than prices must be just and reasonable under Title II).

3. Both the one-time percentage decrease and the annual X-Factor decrease are less than expected. In addition, the one-time decrease is spaced over three years rather than all at once.

The result of these changes is two-fold. First, the new regulations will be easier to implement and administer, since market tests and ongoing market classifications will not be necessary.

Second, the new proposals are much less likely to be appealed by BDS providers. With their Ethernet offerings no longer threatened by price regulation, cable companies can rest easy, especially knowing some of their ILEC competitors will still be subject to regulation. ILECs, while certainly unhappy with the renewal of forced price cap reductions, will be somewhat mollified by the lower and drawn out one-time and X-Factor decreases than expected. Moreover, with their revenues from TDM DS1 and DS3 decreases rapidly declining, they are likely to feel a court appeal is not worth the costs and resources. Thus, it is likely, that come July 2017, the new BDS regulations will take effect.

By Andy Regitsky, CCMI