It looks like the ILECs are not quite ready to swallow the proposed new rules for business data services (BDS). As you may remember, on October 7th the FCC released a “fact sheet” of its proposed regulations for special access and Ethernet services. The new rules are scheduled to be adopted at the Commission’s November meeting and take effect in 2017. The essence of the proposal is that ILEC DS1 and DS3 special access circuits will be regulated using price caps regardless of the level of competition in a market. Other providers of time-division multiplexed (TDM) special access services would not be have their prices regulated. Ethernet services, regardless of provider, would also not be price regulated. Parties unhappy with Ethernet rates would be able to appeal to the Commission through a bulked-up complaint process. Our summary of the “fact sheet” can be found here.

Since the proposed rules were released, not surprisingly, ILECs have claimed the rules would unfairly target them and make little economic sense. Some of their claims are valid. Let’s review their major complaints.

Rules don’t account for existing competition – No doubt the most obvious flaw in the proposed rules is the fact that price cap regulation would apply in all markets, even when ILECs face obvious DS1 or DS3 and/or Ethernet competition. 

In the Commission’s earlier proposal in this proceeding, price regulation depended on the number of competitors in a market. In competitive markets the Commission had proposed to stay out and let the free market rule. Clearly the Commission realized that conducting market tests to determine which markets were actually competitive was administratively impossible.  Moreover, the industry could not even agree on the number of competitors necessary in a market to classify it as competitive. Unfortunately, with its new proposal which treats all markets alike, the Commission has eliminated common sense from its regulations. It has also opened the door to an obvious ILEC court appeal based on the notion that the Commission’s decision is arbitrary and capricious.  While in a declining special access market we originally speculated that the ILECs would forego any appeals,  we are not so sure now, especially when the up-front rate cut required may be larger than originally thought and the productivity factor (x-factor) utilized to annually decrease rates would apparently not be based on current data (see below).

Larger up-front rate cuts than expected - The new rules require the ILECs to make an up-front 11 percent reduction to their existing DS1 and DS3 rates over three years. But as CenturyLink points out in an October 28, 2016 letter to the FCC, this decrease may actually be larger than 11 percent in areas in which ILECs have gained Phase II pricing flexibility:

CenturyLink understands that, in areas in which an ILEC enjoys “Phase II” pricing flexibility and applies contract-based charges that exceed the tariffed rates, rates will first be reduced to the relevant “current” tariffed rate and then will be subject to the reset and annual reductions. To take a simplified example, if an ILEC sells carriage on just two circuits – one for $100 in a price-cap jurisdiction and another for $120 in a “Phase II” jurisdiction – then the contemplated reset (leaving aside the annual X-factor) would bring prices for both circuits to $89.  This would reflect an 11% reduction to the $100 rate but an almost 26% reduction to the $120 rate, amounting to a total revenue reduction of $42, or 19%. In short, because the proposal under consideration contemplates that above-tariff contract charges would be reduced to the tariff rates before the 11% reduction takes effect, the total cuts will necessarily be greater than 11% – and perhaps significantly greater – with serious consequences for ILECs’ ability to recover costs and continue to invest in rural broadband infrastructure going forward (Docket 16-143, CenturyLink October 28, 2016 ex parte letter at pp. 1-2).

Of course one could argue that since ILECs were able to charge higher prices in so-called competitive markets with pricing flexibility then in less competitive areas using their general tariff rates, means that pricing flexibility was a clear flop. It also bolsters the Commission’s claim that regulation is needed in all markets since none are actually competitive. Nevertheless, this larger up-front price decrease has really angered ILECs.

Required up-front and annual productivity factor decreases not based on current data - CenturyLink claims that the Commission would in appropriately use the Bureau of Labor Statistics (“BLS”) KLEMS data as a starting point, and then apply an adjustment factor based on a comparison of those data to X-factors computed by the Commission during the 1990s. KLEMs are short for K-capital, L-labor, E-energy, M-materials, and S-purchased services.  According to CenturyLink there is no justification for using data from different sources and from the 1990’s to develop a productivity factor and an up-front decrease for today.

The feelings of the ILECs for the proposed rules can be summed up in a piece from AT&T’s Policy Blog on October 7, 2016. The carrier wrote the following:

“This proposal is little more than a wealth transfer to companies that have chosen not to invest in last mile fiber infrastructure. It will result in less fiber investment and contribute to mounting job losses at a time when our country needs just the opposite.

Like its privacy and set-top box counterparts (which may or may not also be voted upon in three weeks), the special access proceeding seems designed to pick winners and losers rather than being an even-handed analysis based on facts and sound economics.

While the Commission has correctly determined (for the time being) not to re-regulate the Ethernet market, there is no evidence in the record to support the Commission’s proposal to re-regulate all legacy TDM-based service without regard to the number of competitors operating in a markets. To reach such a preposterous conclusion, the Commission had to ignore facts and virtually all of the economic analysis submitted by its own ‘independent’ economist as well as all of the other economists who provided analysis in this proceeding.

The Commission is scheduled to adopt the new BDS rules on November 17th.

By Andy Regitsky, CCMI