Recent international experience indicates that some of the more
important issues of interconnection cannot be left entirely to
negotiations between the players. For example, in the United
Kingdom, interconnection agreements used to be a matter for
commercial negotiation between parties. After several years of
unsatisfactory results and concerns about the inequality of bargaining
power between British Telecom and competing operators, Oftel
changed its interconnection policy in 1993. The initial regime of
individually negotiated interconnection charges has been superseded
by a tariff regime characterized by standard published interconnection
charges.

A more recent example of the potential difficulties of relying
exclusively on negotiated interconnection agreements is that of
Mexico. In preparation for the liberalization of Mexico's long distance
market in January 1997, Telmex and its new competitors entered into
negotiations to establish interconnection charges. After six months of
negotiations, the parties failed to reach agreement and asked the
government to mediate and set the interconnection charges. The fee
structure approved by the Ministry of Communications and Transport
will require Mexico's new competitive long distance companies to pay
Telmex an average of 5.32 cents per minute for domestic and
international long distance service in 1997. The rate will fall to an
average of 4.69 cents in 1998 and be capped at 3.15 cents between
1999 and 2001. The interconnection fee set by the Ministry is above
the 2 cents demanded by Telmex's competitors and only a third of the
15 cents that Telmex sought.

In Canada, the federal telecommunications regulator, the
Canadian-Radio television and Telecommunications Commission
("CRTC"), initially encouraged the incumbent telephone companies
and new long distance competitors to attempt negotiated solutions
wherever possible. After two years of experience, the CRTC
concluded that "this approach has not been fully successful and that,
in many cases, the Commission's involvement has been required to
resolve disputes" (see Note 6). In addition, the CRTC expressed the
view that leaving the development of local network interconnection
and service unbundling issues to negotiation would likely not be very
effective. The CRTC therefore established a regulatory process to
consider the various proposals for local network interconnection and
to set the terms and conditions for collocation and service unbundling.

In its recent study on international interconnect prices, Ovum
Research concluded that regulatory oversight or intervention of
interconnection arrangements is often necessary in order to ensure
that the terms of interconnection are fair and reasonable. As
explained in the study:

"[T]he most important factor influencing the level of
interconnect prices appears to be the procedural
framework for setting interconnection charges. In those
countries, like the USA, Australia and the UK, where
interconnect rates have involved determinations by the
regulator at various times, prices tend to be lower. In New
Zealand, where there is no regulator and Telecom New
Zealand is able to exercise its market power without
regulatory constraint, prices are highest". (see Note 7)

In order to ensure seamless interconnection and interoperability of
different networks and equipment, non-proprietary technical
specifications must be adopted. Interconnection specifications should
be developed by industry through an open process. The resulting
technical specifications should be published in a tariff or in other
generally available documents.

Where the incumbent carrier intends to introduce changes to the
technical specifications of its network that are likely to affect the
functioning of interconnected networks, the dominant carrier should be
required to notify interconnecting carriers in sufficient time (no less
than six months in advance) for these carriers to take appropriate
action.

In order to promote equitable and efficient competition, new entrants
should be provided with equal access to the local network of the
dominant carrier and with Common Channel Signalling 7 ("CCS7")
interconnection. The provision of equal access is technically feasible,
although it often requires technical upgrades to the dominant carrier's
network. The additional costs associated with upgrading the
incumbent's local network to accommodate equal access (often
referred to as "start-up" costs) must be apportioned somehow
between the incumbent and the new entrants. In some jurisdictions,
including Canada, the larger share of these costs is borne by the
incumbent, in order to facilitate entry.

Interconnection should generally be provided wherever it is technically
and economically feasible. The fewer the number of interconnection
points, the more difficult it will be for competitors to provide an
efficient, competitively-priced service. Conversely, the greater the
number of suitable interconnection points, the easier and more
efficient it will be for competing carriers to provide service.

In the United States, the Federal Communications Commission has
tentatively concluded that incumbent LECs should provide
interconnection to requesting carriers at any point where the LEC
currently provides, or has provided in the past, interconnection to
other carriers, including the LEC's affiliates.

Incumbent carriers should also allow competitors to collocate
equipment at the local carrier's switch to minimize costs and
maximize technical efficiency and interconnection quality. Physical
collocation allows competitors to locate their own transmission
equipment in a segregated portion of the local carrier's central office,
whereas under virtual collocation, the local carrier owns all equipment
in its central office but connects to the competing carrier at a place
outside, but near, its central office. Where collocation is provided, the
local carrier's main distribution frame or digital cross-connect
provides an appropriate point of interconnection.

Unbundling fosters competition by ensuring that new entrants wishing
to interconnect and compete with the incumbent local carrier can
purchase access to those network elements that they do not possess,
without paying for elements that they do not require. The ability to
purchase unbundled network elements at reasonable cost-based
rates, allows competitors to enter the market quickly and
cost-effectively, building their own facilities only where it is efficient to do so.

In determining which network service elements should be subject to
mandatory unbundling, as opposed to voluntary or negotiated
unbundling agreements, regulators may need to assess whether
certain network services or facilities represent "essential" or
"bottleneck" inputs for competitors. Regulators may also need to
consider whether the failure to mandate the unbundling of certain
network elements will impair the ability of interconnecting carriers to
provide the services they seek to offer.

In general, an "essential facility" can be defined as a facility or service
that is:

1. Monopoly supplied or exhibits some degree of monopoly
   control;
   
2. Required by competitors in order to compete; and,
   
3. cannot be practically, economically or technically duplicated by
   competitors.
   

1. Local loops;
   
2. Local and access tandem switching;
   
3. Databases and signalling systems; and,
   
4. Transport facilities.
   

There are various approaches for establishing "cost-oriented"
interconnection charges. For example, "cost-oriented" may be
defined as including incremental costs, embedded costs,
replacement costs or opportunity costs. The challenge facing
regulators (where, in fact, regulatory intervention is required to set
interconnection charges) is to establish rates that are efficient and
sustainable.

From an economic perspective, the pricing of interconnection service
should be based on the forward-looking incremental costs of
supplying the service (see Note 8). While pricing based on long run
incremental costs may be a theoretical ideal, it poses significant
practical and administrative problems, including the requirement for
the incumbent carrier to have an established method of determining
its incremental costs of providing service.9

In regulated industries, setting rates equal to incremental costs is
seldom possible. Significant fixed and common costs as well as
historic (sunk) costs means that the average cost of service is likely to
exceed the long run incremental cost of service. If rates were set to
incremental costs, some portion of the firm's total cost would not be
recovered. In order to account for this, regulators may need to
consider whether mark-ups in excess of incremental costs are
necessary to properly recover the firm's total forward-looking costs,
including its joint and common costs. Establishing economically
efficient mark-ups requires the regulator to develop methods for
quantifying and allocating common costs and other overheads to
various services10.

Where interconnection is provided on a reciprocal basis (i.e., two
local operators exchanging traffic), mutual compensation
arrangements need to be established. In circumstances where the
volume of traffic exchanged between two carriers is roughly
equivalent, it may be economically efficient for interconnecting
carriers to terminate each other's traffic without explicit compensation.
This approach, referred to as "in-kind" compensation or "bill and
keep"11, is similar to the arrangement developed by Internet service
providers who terminate traffic on each other's nodes.

The major advantage of the "bill and keep" approach is its simplicity.
It is administratively simple to establish and maintain, since no billing
systems or records are require and it avoids the need for carriers and
regulators to engage in detailed costing exercises to determine the
appropriate price for interconnection. The "bill and keep" approach
allows carriers to focus on the technical aspects of efficient
interconnection without concerns over costly measurement or
accounting procedures.

Finally, the issue of interconnection charges raises the question of
whether it is appropriate to include an additional element (i.e.,
surcharge) for the recovery of local access deficits. An incumbent
operator with a universal service obligation is normally assumed to
incur an access deficit by virtue of its obligation to provide service in
uneconomic areas, or to price certain services (i.e., local loop) below
cost. In many jurisdictions, entrants are required to pay a
"contribution" to the incumbent to compensate it for these social
costs. In some countries (e.g., the U.K. and Sweden), however,
access deficit contribution waivers have been extended to new
competitors in order to encourage the development of competition.

Conceptually, interconnection charges and "contribution" charges are
separate issues. Although there may be sound economic and public
policy reasons for establishing both types of charges, it is desirable
that interconnection and universal service costs be separately
calculated, administered and recovered.

Interconnection is at the core of the regulator's mission. Although the
terms of interconnection should generally be left to negotiations
between the carriers involved, viable interconnection may not be
achieved solely through commercial negotiations. Regulators should
be prepared to act quickly and effectively to decide the terms of
interconnection if the parties fail to reach agreement in direct
negotiations.

In order to assure effective competition, regulators may need to
establish the parameters for interconnection agreements in advance.
For example, detailed interconnection terms could be built into the
initial license. In other instances, regulators may be called upon to
oversee, arbitrate or resolve interconnection disputes. In these
circumstances, regulators need to have established clear rules and
principles for interconnection so that the "rules of the game" are easily
understood by all parties.

1. In the Matter of Implementation of the Local Competition
   Provisions in the Telecommunications Act of 1996, Notice of
   Proposed Rulemaking, CC Docket No. 96-98, April 19, 1996,
   paragraph 49.
   
   
2. Interconnection and Accounting Separation, Oftel consultative
   document, June 1993.
   
   
3. As an example, after six months of negotiations, Telmex and its
   new long distance competitors were unable to agree on a
   mutually acceptable level of interconnection charges. The
   parties asked the Mexican Ministry of Communications and
   Transport to intervene and establish appropriate interconnection
   charges. The interconnection charges established by the
   Ministry are slightly above the rate per minute sought by
   Telmex's competitors and only a third of the charge sought by
   Telmex.
   
   
4. Interconnection and Accounting Separation, Oftel, June 1993.
   
5. 
   Green Paper on the Liberalisation of Telecommunications
   Infrastructure and Cable Television Networks, Part II,
   Commission of the European Communities, January 1995.
   
6. 
   Review of Regulatory Footwork, Telecom Decision CRTC
   94-19, September 1994.
   
7. 
   An International Comparison of Interconnect Prices, Ovum
   Research, 1995.
   
8. 
   Incremental costs represent the additional costs a firm will incur
   to expand service in the future.
   
9. 
   In the absence of verifiable cost data, interconnection charges
   might be established by reference to "benchmark" cost data
   from other countries in comparable circumstances. This
   approach approximates the incumbent's cost of providing
   interconnection service while avoiding the need to engage in
   detailed costing exercises.
   
10. 
    Methods of allocating common costs may including (I) allocating
    costs in proportion to the revenue generated by each service; (II)
    allocating costs in proportion to the direct costs of each service,
    or (III) allocating costs in proportion to the price elasticity of
    demand.
    
11. 
    This arrangement is known as "bill and keep" since each carrier
    bills its own customers for the provision of service and retains all
    of the revenues it generates from its own customer base. Each
    carrier then terminates, without compensation, the traffic
    destined to its customers that originates on another carrier's
    network.