In an increasingly competitive, multi-provider environment, theinterconnection and interoperability of telecommunications networksand services has emerged as a priority issue. Telephone users must be assured that whatever network operator or service provider supplies them with telecommunications service, they will be able to connect with any other telephone user in their own, or in other countries. Interconnection terms should be designed to serve the public policy objective of ensuring seamless communication among all telecommunication users.

A fair and efficient interconnection regime is of critical importance in promoting competition and entry into telecommunications markets. The key role of interconnection terms has recently been emphasized by telecommunications regulators in the United States and the United Kingdom:

"The interconnection obligation plays a vital role in promoting competition by ensuring that a requesting carrier can on reasonable rates, terms and conditions transmit telecommunications traffic between its network and the incumbent's network in a reliable efficient manner."

"The terms and conditions on which operators can interconnect with [each other] are of vital importance to the further development of a competitive telecommunications market in the U.K.--and to Oftel's policy objective of obtaining the best possible deal for the end user in terms of quality, choice and value for money."

Issues of interconnection arise whenever one or more network operators requires access to and use of the facilities and services of another network operator for the origination, termination or transit of its own telecommunications services. Interconnection arrangements may involve competing firms (e.g., such as between competing local service operators, or between a long distance operator and a vertically-integrated long-distance and local telephone company) or non-competing firms (e.g., such as between a long-distance and a local operator, between two regional companies, or between a domestic long distance operator and an international network operator).

In the case of these types of interconnection arrangements, issues may arise concerning abuse of dominant market position. For example, because various network operators (e.g., cellular, value-added service, private line, satellite, long distance, Internet service providers, etc.) require interconnection to the public switched telephone network ("PSTN") in order to deliver their traffic to end-customers, the PSTN operator may attempt to exercise its market power by setting interconnection charges at levels that exceed the associated costs. The inequality of bargaining power between a monopoly or dominant telephone company and a competing start-up operator often makes it difficult to reach negotiated interconnection arrangements. In some cases, the new competitor must capitulate at the bargaining table and accept unsatisfactory terms of interconnection as the only means of staying in business. In such instances, regulatory intervention, mediation or impartial arbitration are required in order to ensure that the commercial and technical aspects of interconnection are fair and reasonable.

Although there is no single interconnection model, a number of principles are widely accepted to be fundamental to the establishment of a fair and reasonable interconnection regime. As an initial matter of principle, there should be no a priori restrictions on network interconnection. Accordingly, regulatory authorities must ensure that incumbent telephone companies do not refuse interconnection to other network operators or restrict it unreasonably.

Efficient competition is most likely to be achieved if interconnection arrangements are characterized by the following principles:

The right to non-discriminatory access. Interconnection should be provided wherever technically and economically feasible. In order to ensure that fair and efficient interconnection arrangements are established between the incumbent and new operators, interconnection should be equal in type, quality and price to that provided by the incumbent telephone company to its own operations that are competitive with the new operator.

Adherence to established, non-proprietary technical standards. Different networks have unique interfaces and standards. To ensure full network connectivity and interoperability so that all customers may communicate with each other, non-proprietary, open standards must be adopted. The interoperability of networks also requires that advanced notice of network planning programs and changes to network architecture or configuration be provided by all interconnected network operators.

The implementation of cost-oriented interconnection charges.

While there may be general agreement among network operators that these broad principles provide an appropriate basis for an interconnection regime, the nature of interconnection arrangements is such that many implementation issues generally arise.

Controversies regarding network interconnection focus primarily on implementation related matters (e.g., points of interconnection, extent of network unbundling, calculation of network access costs, appropriateness of mark-ups, and generally the ability to provide customers with equal access and service features). For example, although parties may agree that the rates terms and conditions for interconnection should be publicly tariffed, non-discriminatory and cost-oriented, disagreements often arise regarding the interpretation and application of these principles.

Consider also the general principle of non-discriminatory access. Does this principle obligate the incumbent telephone company to provide competitors with network access at the company's switching centres (i.e., collocation)? Similarly, does adherence to the principle that non-proprietary technical standards should be adopted require network operators to provide advance notification of every change to their network architecture or configuration, or is this notification requirement only applicable to "significant" network changes? In addition, what constitutes an appropriate advance notification period (e.g., one month, six months, two years)?

Finally, and most significantly, how should the general principle of "cost-oriented" interconnection charges be implemented? Pursuant to what economic and/or accounting principles should such charges be calculated? Should interconnection charges be calculated to include long run incremental costs, embedded costs, replacement costs or opportunity costs? Should interconnection charges include a mark-up to recover a firm's fixed and common costs? Is there a need to include a further additional amount for the recovery of any local access deficit incurred by a telephone company as a result of its universal service obligation? If so, what is the appropriate basis for calculating and recovering any demonstrated access deficits?

The fair and efficient resolution of these implementation issues is usually the single greatest challenge facing telecommunications regulators in establishing an appropriate and workable interconnection regime. The balance of this paper examines the implications of these issues for the seamless interconnection of networks and for the development of efficient competition. The various options available to regulators in considering and resolving these implementation issues are addressed as are the appropriate criteria for establishing a fair and economical interconnection regime.

Payments between network operators for the origination or termination of calls are a crucial determinant of competitive outcomes. As illustrated by the chart below, interconnection payments represent a major item of expenditure, oftentimes the single largest expenditure, for telecommunications network operators.

AT&T (U.S.A.) - 26%

Optus (Australia) - 28%

Clear Communications (New Zealand) - 40%

Source: An International Comparison of Interconnect Prices, Ovum Research, 1995.

It is clear that interconnection charges represent a significant explicit expense to network operators seeking interconnection to the PSTN. Conversely, interconnection charges represent a significant revenue source for network operators providing interconnection to other carriers. Accordingly, it is understandable that the setting of interconnection fees is often a highly contentious exercise. For the same reasons, incumbent telephone companies have a natural incentive to exercise their market power in the pricing of interconnection charges. Again, the result is that telecommunications regulators are often called upon to intervene in interconnection disputes and to establish appropriate rates, terms and conditions for interconnection.

Recent technological advances (i.e., fibre optic transmission, microprocessing, broadband wireless) coupled with consumer demand for high quality, affordable and widely available communications services place increasing pressure on governments and regulators to open up telecommunications markets to competition. Many countries have responded to these pressures by allowing competition in many non-basic telecommunications markets, including cellular telephony, value-added and information services, as well as private networks. Other countries have gone one step further and opened up basic telecommunications markets (long distance, international and local) to competition. In both cases, the licensing of new competitive service providers requires that appropriate interconnection arrangements be established between service providers and network operators.

In the United Kingdom, where a duopoly policy has recently been superseded by a multi-operator competition policy which supports increased competition between cable companies and telephone companies for the supply of local telecommunications services, Oftel has articulated four fundamental criteria to be met in interconnection arrangements in order to promote efficient competition:

1. Interconnection arrangements should be transparent in the sense that charges should be published and operators should understand how charges relate to costs. Sufficient information about the methodology by which interconnection rates have been established should be made publicly available.
2. Interconnection charges should be efficient and sustainable. Interconnection rates should be set at a level such that no over or under recovery of the incumbent operator's costs would generally result. Interconnection charges need to include an element for the recovery of the access-deficit, although the Director General may waive access deficit contributions in certain circumstances.
3. Interconnection arrangements should not be unduly discriminatory either between competing operators or between the incumbent operator and other operators. Operators should face similar charges and terms of service for the use of the network to those the incumbent operator applies to itself for equivalent services.
4. Sufficient information should be available to give operators confidence in the interconnection arrangements reached.

In its June 1993 policy statement on interconnection, Oftel stated that these four general interconnection principles should apply to interconnection arrangements over the next four to five years as a competitive market becomes more fully established.

More recently, the Commission of the European Communities, in its Green Paper on the liberalization of telecommunications infrastructure and cable television networks, identified the following principles for interconnection charges:

1. Interconnection charges should be a matter for commercial agreement between the parties involved, subject to supervision and if necessary timely intervention by the National Regulatory Authority, and subject to the competition rules.
2. Interconnection charges should encourage efficient and sustainable market entry. Charges should be based on underlying costs of an efficient operator.
3. The cost of inefficiencies should not be passed on to interconnecting operators. Charges should promote efficiency gains by the incumbent operator. It should not threaten the financial ability of any operator to fulfil its licence obligations.
4. Charges should be transparent, non-discriminatory and sufficiently unbundled. Published interconnect tariffs are the best mechanism for ensuring this.
5. Charges related to recovering losses due to tariff imbalances should be identified separately. It is anticipated that these charge elements will quickly decline as tariffs are progressively rebalanced in Europe. Until then, they may be recouped through charges on interconnecting operators.
6. Any residual charges related to the provision of uneconomic universal service obligations should also be separately identified. Such charges relate to the cost of serving uneconomic customers, or to providing services such as emergency services.

More generally, the European Commission proposed that the conditions for interconnection should be based on the established principles of open network provision; i.e., conditions on access and use should:

• be based on objective criteria;
• be transparent and published in an appropriate manner;
• guarantee equality of access and must be non-discriminatory;
• comply with essential requirements (interoperability of services,protection of data, network integrity, network security, etc.)

While the Green Paper proposes that a negotiating framework be established for network interconnection such that all parties have the right to enter into commercial and technical agreements, the Paper recognizes that regulatory authorities should have a responsibility to prevent any abuse of unequal negotiating power, and "for ensuring the provision of adequate information, cost-oriented pricing structures, and for issues of unbundling, collocation, end-to-end quality, network integrity and security, etc."

Most other governments and regulators that have been called upon to establish an interconnection regime for the telecommunications sector have also advocated the implementation of transparent, non-discriminatory, cost-oriented interconnection charges. For example, the Telecommunications Act of Sweden requires all licensees carrying out telephone services to allow any other licensed or registered operators to interconnect on non-discriminatory terms. The charges for interconnection are to be fair and reasonable and cost-oriented. Such costs may, to a reasonable extent, include the relevant operator's costs for special obligations under its licence (i.e.,to provide universal service) although, in order to promote competition, the Swedish Parliament has decided that the incumbent operator, Telia, will not be entitled to include such costs in its calculation for the period 1993-1996.

In the United States and Canada, a system of tariffed interconnection (or "access" charges) has been established to permit long distance carriers to interconnect to the local network. Local exchange carriers ("LECs"), which are the monopolistic or dominant public telephone network operators, must file tariffs stating the rates, terms and conditions for provision of network access services, and setting forth the rates for a variety of unbundled services and service elements (e.g., end-office switching, access tandem switching, transport, billing, directory assistance, operator services, etc.). In the United States, the LECs' interconnection charges are subject to price cap regulation, such that annual changes in interconnection rates are constrained by a price index established for these services.

Regulators in both the United States and Canada are currently working on establishing an interconnection regime that will facilitate competition in the provision of local telecommunications services. The recently enacted U.S. Telecommunications Act of 1996 outlines the key principles that will govern local network interconnection and imposes upon incumbent LECs several interconnection-related obligations. In particular, the Act requires the incumbent telephone companies to: