Hong Kong Broadband Network Limited and China Mobile...

Appendix B

Determination under

Section 36A of the Telecommunications Ordinance on

Terms and Conditions for Interconnection between

Hong Kong Broadband Network Limited and

China Mobile Peoples Telephone Company Limited

Preliminary Analysis

26 March 2007

Introduction

In accordance with the “Procedures for Making Determination on the

Terms and Conditions of Interconnection under Section 36A of the

Telecommunications Ordinance” (the “Procedures”) issued by the Office of the

Telecommunications Authority (“OFTA”) in October 1995 and revised on 27

September 2001, the Interconnection Determination Committee (“IDC”)

considered all relevant written submissions from the parties to this Determination

and the Telecommunications Authority (“TA”) issues this Preliminary Analysis

(“PA”) to set out the preliminary views of the IDC on the terms and conditions of

interconnection, the reasons for the preliminary views, and how the Determination

is to proceed.

The Request for Determination

2. On 22 March 2004, Hong Kong Broadband Network Limited (“HKBN”)

requested the TA to determine, under section 36A of the Telecommunications

Ordinance (Cap 106) (the “Ordinance”), the level of fixed-mobile interconnection

charge (“FMIC”) between HKBN and China Mobile Peoples Telephone Company

Limited (“Peoples”). The processing of the request for determination was later put

on hold for mediation1. On 10 August 2004, HKBN submitted that the two parties

1 In accordance with paragraph 6 of the Procedures, any proposals, recommendations or views made or expressed by OFTA during the mediation will have no binding effect and be without prejudice to the

failed to reach agreement through commercial negotiations and requested the TA

to resume the determination proceedings.

Legal Basis on which the Determination is to be Made

3. The TA is empowered under the Ordinance to determine the terms and

conditions of interconnection and to issue directions in relation to interconnection

under sections 36A and 36B respectively.

4. The TA considers that the matters under request for determination fall

within the scope of section 36A of the Telecommunications Ordinance because

the matters relate to interconnection to and between the fixed network of HKBN

and the mobile network of Peoples and the parties have failed to reach an

agreement on the financial terms of interconnection. By section 36A(3A) of the

Ordinance, the TA may determine the terms and conditions of interconnection

which may include the interconnection charge.

5. The TA decided to accept HKBN’s request for determination on 13

August 2004, and at that time has taken into account the representations from each

party and the following considerations:

(a) The Government’s policy objectives for the telecommunications

industry

The Government’s policy objectives for the telecommunications

industry are to position Hong Kong as the pre-eminent

telecommunications hub in the region and to provide the widest

range of quality telecommunications services to the community at

reasonable prices. Both fixed and mobile telephony services are

indispensable telecommunications services in Hong Kong.

Interconnection between mobile and fixed networks is necessary to

enable communications between any user connected to one network

with any other user connected to another network. Without such

“any-to-any connectivity” over its networks, Hong Kong cannot

maintain its position as the pre-eminent telecommunications hub in

the region. As interconnection charges are cost components in the exercise of the power by the TA, as and when he considers appropriate. No liability whatsoever will be assumed by OFTA as a result of acting as the mediator.

provision of telecommunications services, interconnection at

reasonable costs is necessary for telecommunications services to be

provided at reasonable prices. Business disputes over the terms and

conditions of interconnection will jeopardize interconnection at

reasonable costs.

(b) Consumer interests

Penetration levels of both fixed and mobile telephony services are

extensive in Hong Kong, reflecting that significant consumer

interest is at stake. It is therefore in the interest of consumers to

ensure that interconnection between mobile and fixed networks is

provided at reasonable costs.

(c) Encouraging efficient investment in telecommunications

infrastructure

The determination would decide on the fair and reasonable

interconnection charges between mobile and fixed networks, and

would facilitate and encourage the operators to make informed

investment decisions in telecommunications infrastructure.

(d) The nature and extent of competition among the parties to the

interconnection concerned and their respective abilities to compete

with each other fairly

HKBN as a fixed telecommunications network services (“FTNS”)

licensee and Peoples as a mobile carrier licensee are not, under the

present licensing regime, in direct competition with each other,

with the exception of the minority of consumers who regard mobile

phone services are viable substitutes for fixed line services.

However, HKBN and Peoples do have to rely on the

interconnection between their networks to meet the expectation of

their customers.

(e) Such other matters as the TA considers appropriate in the particular

circumstances of the case, such as the efforts made by the operators

to secure an agreement with each other within a reasonable time

and the chance for the parties to reach a commercial agreement

within a reasonable time if the negotiations are to be continued

The parties started commercial negotiations in early 2003. The

parties failed to reach any commercial agreement despite OFTA’s

mediation in May 2004. It is considered that the parties have made

sufficient efforts in trying to conclude an agreement, and the

chance for the parties to reach a commercial agreement within a

reasonable time is slim. The TA has also noted that Peoples, in its

letter dated 13 April 2004, signified no objection to the TA

accepting HKBN’s request to make a determination under section

36A.

Scope of Determination

6. Having considered the request for determination submitted by HKBN

and the representation made by Peoples on HKBN’s request, the TA defined the

scope of Determination as follows:

� the effective date of the determined FMIC; and � the level of FMIC payable by Peoples to HKBN.

The Parties’ Submissions

7. In its submission dated 21 September 2004, Peoples requested the TA

to revise the scope of Determination in order to cover the interconnection model

which applies to calls originated on HKBN’s network and terminated on Peoples’

network. Peoples argued that it should not be required to pay HKBN for

originating calls to Peoples because (1) HKBN already recouped the costs of

origination from its subscribers; and (2) HKBN and its subscribers benefited from

the ability to reach Peoples’ subscribers.

8. HKBN disagreed with Peoples’ argument and referred to the TA

Statement entitled Interconnection and Related Competition Issues Statement No.7

(Second Revision) ‘Carrier-to-Carrier Charging Principles’ (first issued in

November 1997 and subsequently revised on 18 March 2002) (“TA Statement

No.7”), which set out the payment direction of FMIC (i.e. mobile operators would

pay fixed operators for originating calls which terminate on mobile networks and

mobile operators would also pay fixed operators for terminating calls which

originate on mobile networks). Furthermore, HKBN argued that the benefits

gained by fixed operators through interconnection with mobile networks as quoted

by Peoples in the submissions were vague and not measurable.

The IDC’s Views

9. The FMIC has been a cost item in the operation of mobile services

since their introduction and this cost should have been taken into account when the

mobile service operators run their businesses. Peoples’ argument that it should not

be required to pay HKBN any interconnection charge at all for calls originated on

HKBN’s network and terminated on Peoples’ network is something which is under

consultation by OFTA in the 2nd Consultation Paper on Deregulation for Fixed

Mobile Convergence published on 14 July 2006. As far as the consultation is

concerned, the TA will consider all submissions received in response to that

consultation and make a decision on the future interconnection charging

arrangement for the whole industry. But as far as the current determination is

concerned, it is not intended to be used as a platform to change the existing

interconnection charging principles set out in the TA Statement No. 7 without any

proper consultation. It is expected that the mobile and fixed operators have

factored the charging principles when they develop their business plans.

Accordingly, when a call is made from a fixed service subscriber to a mobile

service subscriber, an interconnection charge should be payable by the mobile

operator to compensate the fixed operator for the costs incurred in originating the

call.

10. As such, the IDC is of the view that the determined FMIC would be

payable by Peoples to HKBN for:

� calls originated on HKBN’s network and terminated on Peoples’

network; and

� calls originated on Peoples’ network and terminated on HKBN’s

network.

Effective Date of the Determined Charge


11. HKBN was of the view that the determined FMIC should be

retrospectively effective from 1 April 2002 when traffic was first exchanged

between the two interconnected networks.

12. On the other hand, Peoples opined that the determined FMIC should be

effective from the date of Determination since it was the commercial decision of

HKBN to commence interconnection without concluding an agreement with

Peoples and therefore it would not be reasonable for HKBN to request for any

retrospective payment. Peoples submitted that the TA should not intervene in the

commercial decisions of HKBN prior to the date of Determination and this

approach is in line with the TA determination on mobile number portability

(“MNP”) charges dated 19 February 2004. However, HKBN disagreed and

argued that the TA determination on MNP charges is different from this

Determination in that the mobile operators in the former case have commercially

agreed to accept PCCW-HKT Telephone Limited (“PCCW-HKTC”)’s tariffs on

MNP charges whereas in the latter case no commercial agreement has been

concluded between HKBN and Peoples.

13. Peoples claimed that HKBN has unreasonably delayed the negotiation

and billing of FMIC, and it did not receive the first invoice from HKBN until ten

months after traffic was first exchanged between the parties’ networks. It argued

that retrospective arrangement might increase the call charges to be payable by

Peoples’ subscribers in the future. However, according to HKBN, the delay in

billing was attributed to the prolonged approval by the members of the MNP

Administrative Database (“AD”) Industry Forum to allow HKBN to establish its

own MNP AD (Peoples was actually one of the members of the Forum).

Furthermore, HKBN argued that it was the commercial decision of Peoples not to

include the FMIC component when billing its subscribers in the past and should

not be relevant to its obligation to pay FMIC to HKBN.

14. Peoples further requested the TA to take into account the impact of

retrospective application of the determined FMIC on the incentives for parties to

negotiate. It argued that if the determined FMIC is to be applied retrospectively,

there would be no incentive for HKBN to promptly reach commercial agreements

with Peoples, to bill the charges or to seek an early resolution of disputes since the

determined FMIC is payable by Peoples to HKBN for both traffic directions. On

the contrary, if the determined FMIC is not to be applied retrospectively, HKBN

would have an incentive to resolve the dispute promptly.

The IDC’s Views

15. The TA’s power to determine terms and conditions and to apply them

with retrospective effect has been affirmed by the Court2.

16. The TA Statement entitled Interconnection and Related Competition

Issues Statement No. 5 (Revised) ‘Exchange of Traffic between Interconnected

Networks’ (revised on 18 March 2002) (“TA Statement No. 5”) recognized that

commercial negotiations (particularly those on financial terms of interconnection)

might be time-consuming while many of the technical issues could be resolved

more speedily. Given that it is technically feasible for arrangements to be made so

that traffic exchanged between two networks can be suitably metered and records

kept by the two operators concerned, the TA has formed the view in TA Statement

No. 5 that operators should first physically interconnect their networks and

exchange traffic in the absence of an agreement, while at the same time conduct

negotiations with a view to concluding the commercial agreement as soon as

possible. The IDC is therefore of the view that, in order to send the correct signal

to the industry that networks might interconnect physically and traffic might

exchange pending the completion of time-consuming commercial agreement or

regulatory intervention, the determined FMIC should have retrospective effect.

17. The IDC disagrees with Peoples’ comment that, to be in line with the

determination on MNP charges, the determined FMIC should be effective from the

date of Determination. The IDC is of the view that the effective date determined

for the MNP charges bears no relevance to the effective date of this Determination.

In the determination on MNP charges, the mobile operators have commercially

obtained the MNP dipping and porting services offered by PCCW-HKTC under

the published tariffs and the TA, at that time, was of the view that a determination

should not override the services obtained under tariffs which constituted a

commercial arrangement between the mobile operators and PCCW-HKTC. On

the other hand, in this case, there has been no commercial arrangement between

HKBN and Peoples on the level of FMIC. As such, it would be unreasonable for

2 PCCW-HKTC –v- The Telecommunications Authority [2004]747 HKCU 1

Peoples to take the absence of an agreement between the two parties as the consent

by HKBN not to levy any charge on interconnection with Peoples.

18. The IDC takes note of Peoples’ concern that retrospective arrangement

might increase the call charges to be payable by its subscribers in the future. The

TA Statement No.7 set out the payment direction of FMIC (i.e. mobile operators

would pay fixed operators for originating calls which terminate on mobile

networks and mobile operators would also pay fixed operators for terminating

calls which originate on mobile networks). In providing mobile services to its

subscribers, Peoples should have either considered the cost component of FMIC in

relation to the usage of HKBN’s network in its cost calculation since 1 April 2002

when traffic was first exchanged between the two networks, or commercially

decided to absorb the FMIC as the operating costs for its mobile services.

Accordingly, the IDC does not accept Peoples’ argument that the retrospective

arrangement would increase the call charges payable by Peoples’ subscribers in

the future.

19. In its submission, Peoples objected to the retrospective arrangements

based on the argument that if the determined FMIC was not to be applied

retrospectively, HKBN would have an incentive to resolve the dispute promptly.

The IDC considers that, although the TA prefers commercial settlement of

interconnection disputes, either interconnecting party has the right under section

36A to seek the TA’s determination if commercial agreement could not be reached.

The parties should also be aware that the TA is not bound to accept every request

for determination. Each request for determination would be considered on its

individual merits. Therefore the TA’s reserve power to intervene as a final resort

should not affect good faith negotiations between the parties. Moreover, if there is

no retrospective arrangement, Peoples would have the incentive to procrastinate

the dispute.

20. Based on the discussions from paragraphs 15 to 19, the IDC is of the

view that the FMIC to be determined should be effective from 1 April 2002 when

traffic was first exchanged between HKBN’s and Peoples’ networks.

21. For the purpose of this Determination, HKBN has submitted cost data for

the period from 1 April 2002 to 31 August 2004. The IDC considers that it might

not be appropriate to calculate a forward-looking charge based on data of almost

two years ago. As such, the IDC is of the view that the FMIC level should be

determined only for the time period for which HKBN had provided cost data to the

IDC for FMIC calculation, i.e. from 1 April 2002 to 31 August 2004 (the

“Relevant Period”). The FMIC level from 1 September 2004 onwards would be

subject to the commercial negotiation between the two parties and does not form

part of this Determination. If the parties still cannot not reach a commercial

agreement for the FMIC level from 1 September 2004 onwards despite the

settlement of the charges applicable to the Relevant Period by the TA, the TA

might be requested to make another determination which would be expected to

take a much shorter time than the current determination.

Calculation Methodology for FMIC


22. In its submission dated 21 September 2004, HKBN submitted that fully

distributed cost (“FDC”) should be adopted in the calculation of FMIC since it is

the existing cost model adopted by the TA for determining the FMIC. If long run

average incremental cost (“LRAIC”) is adopted in the calculation of FMIC, fixed

operators would not be able to fully recover all the costs incurred in the provision

of interconnection since indirect fixed costs are excluded from the calculation

model.

23. On the other hand, Peoples pointed out that the existing FDC model is

adopted for calculating the FMIC levied by PCCW-HKTC alone. The internet

protocol (“IP”)-based transmission network of HKBN has a different architecture

and cost structure as compared to the circuit-switched transmission network of

PCCW-HKTC and therefore the existing cost model adopted for PCCW-HKTC

could not simply be extended to this Determination. Peoples commented that the

existing cost model of FMIC would result in significant subsidy by mobile service

subscribers to fixed service subscribers since (1) mobile operators are required to

bear the overhead costs of fixed operators which are not included in the Type I

interconnection charge payable between fixed operators; and (2) with FMIC based

on historical costs, mobile operators are required to bear the cost of inefficient

investment decisions made by fixed operators. In view of the growing level of

substitution between fixed and mobile services, Peoples proposed that the LRAIC

cost model adopted in the calculation of Type I interconnection charge between

fixed networks should be applied in this Determination for calculating the FMIC.

The IDC’s Views

24. It should be noted that the FDC cost model referred to in the TA

statement entitled Review of Methodologies for Calculation of Interconnection

Charges for Value-Added Services and Public Mobile Radiotelephone Services

and Local Access Charges dated 25 October 2000 was adopted by the TA in

approving the tariff of FMIC levied by PCCW-HKTC alone3. Other local fixed

operators are not subject to the tariff approval requirement and are allowed to offer

their own interconnection arrangements and FMIC to mobile operators in

accordance with their licence conditions. It means to date, the TA has not

determined the level of FMIC levied by fixed operators under section 36A of the

Ordinance, including that of PCCW-HKTC.

25. In the tariff approval process, the TA shall approve the tariff where in the

TA’s opinion the tariff would not be in contravention of section 7K, 7L or 7N of

the Ordinance or the relevant licence conditions. There is a different legal

threshold which the TA could adopt under section 36A(3B). As such, the fact that

the TA has adopted a FDC model in approving the tariff of PCCW-HKTC bears

no direct reference to the calculation methodology to be adopted in the event of a

determination under section 36A for any fixed operator, including PCCW-HKTC

and others.

26. The calculation model based on FDC and actual traffic allows operators

to fully recover all relevant costs in the infrastructure investment and indirect fixed

costs. The IDC is concerned that such an approach would reward inefficiency (e.g.

whether the operator would be able to recover those costs related to excess

capacity should effective competition exist) and distort investment incentives.

27. LRAIC (defined as the change in total cost to the operator, determined

on a long-run basis, that would occur as a result of the provision of the service

concerned divided by the total quantity of the service provided) is generally

consistent with the principles of cost causality, relevant cost and cost minimisation.

The IDC is of the view that LRAIC should be adopted in this Determination since

3 On 13 January 2005, the TA decided to implement ex post regulation of the tariffs of PCCW-HKTC. However, in accordance with Special Condition 3.4 and Schedule 7 of PCCW-HKTC’s fixed carrier licence, any amendment to any published tariff of PCCW-HKTC for interconnection, which was in force at 1 December 2004 and continues in force, including those interconnections listed in Schedule 7, must first be approved by the TA in writing. In other words, FMIC levied by PCCW-HKTC is still subject to the tariff approval requirement.

(a) charges based on LRAIC could give appropriate signals for investment as they

reflect the costs which an efficient new entrant would incur; and (b) under the

LRAIC approach, the level of FMIC is to be determined according to the resources

which would be needed to provision fixed-mobile interconnection today.

28. Based on the traffic data and network capacity information provided by

HKBN and based on reasonable assumptions made by the IDC, the IDC builds a

model to estimate the efficiency of HKBN’s network in the carriage of voice

traffic. Based on the yearly total call minutes reported by HKBN, the peak hour

data rate for voice traffic carried by the NGN is estimated. If HKBN’s network is

efficiently provisioned, the peak hour data rate for voice traffic should roughly be

equal to the efficient network capacity of HKBN’s network. Otherwise, if the

peak hour data rate for voice traffic is below the efficient network capacity, the

network capacity would be over-provisioned and this would constitute an

inefficiency. Hence, the amount of network inefficiency could be estimated by

comparing the calculated peak hour voice data rate with the efficient network

capacity for voice traffic installed by HKBN. As a result, the IDC estimates that

the network inefficiency found in the backbone network is [ ]%, [ ]% and [ ]% in

fiscal year4 (“FY”) 2002, 2003 and 2004 respectively. Network inefficiency in the

POI links is [ ]% and [ ]% respectively in FY 2003 and 2004, while there is no

network inefficiency in the POI links in FY 2002. For other network components,

the IDC considers that there is no noticeable network inefficiency in FY 2002,

2003 and 2004.

29. Although the IDC is aware of the criticisms against the LRAIC approach,

namely, it could be based around hypothetical network models and might depart

from the ‘real world’ situation, the calculation methodology adopted in the PA of

March 2006 has closely reflected the actual network of HKBN in question while

the network inefficiency has been taken out. In addition, the IDC considers that it

is appropriate to include the cost of capital (“CoC”) for assets used as well as a

reasonable recovery of corporate overhead, when justified, in the LRAIC model.

This should be able to address HKBN’s concern that LRAIC approach would not

be able to fully recover the incurred costs.

4 The fiscal year of HKBN ends on 31 August of that year. For FY 2002, the period relevant to this Determination starts from 1 April 2002 and ends on 31 August 2002.

Costs of Fixed-Mobile Interconnection

(I) Basis for Cost Allocation


30. In its cost model, HKBN objected to adopt bandwidth ratio as the cost

allocation basis since quality of service (“QoS”) management and other limiting

factors which can control traffic attributes for ensuring consistent application

performance are more crucial than bandwidth capacity in its next generation

network (“NGN”). HKBN submitted that in order to ensure voice quality, it has

adopted a QoS control in its NGN such that the transmission of voice packets

always has a higher priority than that of data packets regardless of packet size.

Accordingly, bandwidth capacity is not the most important factor affecting the

performance of the NGN. Instead, HKBN proposed that the cost allocation basis

might be based on application ratio, revenue ratio, subscriber ratio or packet ratio

for apportioning network cost between voice and non-voice traffic.

IDC’s Views

31. The IDC is not convinced by HKBN’s substantiation that bandwidth

capacity is not the most important factor affecting the performance of the NGN.

The IDC is mindful of the fact that HKBN’s current implementation of IP-based

NGN is making extensive use of layer 3 switches that replace routers as the basic

routing/switching equipment in the core network. While routers need to examine

the header of each IP packet and make decision on the forwarding paths for that

packet, layer 3 switches effectively combine the functions of layer 2 switching and

layer 3 routing and are equipped with advanced hardware circuitry to enable the

routing/switching of IP packets at vastly improved speeds. System performance of

layer 3 switches is increasingly determined by the bandwidth throughput of the

switching fabric of the layer 3 switches, rather than by their packet handling

capacity. According to the technical specifications of some commonly available

layer 3 switches5, the bandwidth throughput of the switching fabric is the primary

limiting factor affecting system performance when a mix of voice and non-voice

traffic is being carried.

5 Layer 3 switches under reference include Cisco Catalyst Switch 3550, 3750, 4506 and 4507. Cisco Catalyst Switch 2950 which only possesses layer 2 functionality is also considered.

32. The backbone links connecting the layer 3 switches and other network

components in the NGN are also dimensioned by using bandwidth capacity, but

not by the number of packets passing through. As a result, contemporary network

dimensioning of NGN and other IP-based networks is more focused on optimizing

the overall bandwidth capacity, with lesser emphasis on the packet handling

capacity of the switches or routers.

33. As a result, the IDC is of the view that the bandwidth capacity, instead of

packet handling capacity, is a reasonable measure for network dimensioning of a

NGN and should therefore be applicable to the network established by HKBN.

The consumption of network resources, which directly relates to network cost, by

voice and non-voice traffic could reasonably be quantified by the respective

bandwidth consumed by each type of traffic. Therefore, the respective

percentages of the amount of bandwidth dedicated for voice and non-voice traffic

should serve as the optimal reference for the respective amount of network

resources consumed, and therefore in turn the network cost incurred, by the two

types of traffic.

34. The IDC also considers the other cost allocation methods as proposed by

HKBN, i.e. application ratio, revenue ratio and subscriber ratio, but it is of the

view that these methods are unable to accurately reflect the respective network

resource consumption by voice and non-voice traffic of the NGN. The IDC

considers that

� The application ratio as suggested by HKBN referred to the idea

that since HKBN’s network is carrying two applications, namely

voice application and non-voice application, and hence network

cost should be apportioned using an application ratio of 1:1. The

IDC disagrees to the use of such an application ratio as it is

obvious that the amount of network resource consumed by voice

application is not the same as that by non-voice application. An

application ratio of 1:1 would not be meaningful in assessing the

resource consumption by voice and non-voice traffic.

� Revenue ratio only measures the proportion of revenue generated

by voice and non-voice services. This ratio varies with the

different pricing strategies adopted by HKBN from time to time

and it does not bear any direct relation to the underlying cost of

carrying the voice and non-voice services.

� Finally, subscriber ratio only represents the proportion of users

subscribing to voice and non-voice services respectively. However,

subscribers for voice service generate a totally different amount of

traffic than subscribers for non-voice services. Once again, the

ratio does not bear any direct relation to the network resource

consumption by voice and non-voice traffic.

35. With the above considerations, the IDC is of the view that the respective

percentages of the amount of bandwidth dedicated for voice and non-voice traffic

remain to be the best available reference for the cost allocation between voice and

non-voice traffic.

36. The IDC notes the point made by HKBN that voice traffic would have a

more stringent QoS control than data traffic and that voice packets are being

afforded a higher priority than data packets. The IDC tends to agree that real-time

voice traffic, being time critical and delay sensitive, might consume extra network

resources as the core network might need to reserve certain additional network

capacity for meeting the more stringent QoS requirement. However, the

bandwidth ratio should remain to be the key determining factor for assessing the

amount of network resources consumed by the various types of traffic.

Adjustment is therefore made by multiplying the percentage of bandwidth

dedicated for voice traffic by a factor of [ ] so as to account for the extra network

resource requirement for carrying real-time voice traffic. In addition, the IDC

considers it necessary to apply a similar adjustment to the video traffic of HKBN’s

video broadcasting service, which also has QoS requirement but which is less

stringent than that for voice traffic. This is because while voice traffic is affected

by network latency, packet loss and jitter, video traffic is less sensitive to these

network problems because of the use of buffering techniques and different users’

perception. The IDC therefore applies an adjustment factor of [ ], which is lower

than that for voice traffic, to the percentage of bandwidth dedicated for video

traffic. This adjustment is applicable only to FY 2004 because HKBN launched

video service in that year. The adjusted bandwidth ratios are then used as the cost

allocation bases for the relevant network elements.

37. The IDC therefore decides to use the respective adjusted percentages of

the amount of bandwidth dedicated for voice traffic and non-voice traffic as the

cost allocation basis for all relevant network elements of HKBN’s network where

appropriate. For this purpose, the IDC makes use of the historical network

statistics and subscriber statistics of HKBN to determine the required bandwidth

ratio. HKBN has provided the statistics of the amount of voice and non-voice

traffic carried by its backbone network for the period from 19 February to 18

March 2005. Using the respective amount of voice and non-voice subscribers in

FY 2002, 2003 and 2004, the corresponding amount of voice, data and video

traffic carried by the backbone network in FY 2002, 2003 and 2004 is then

estimated. Taking into account the adjustments as mentioned in paragraph 36

above, the adjusted percentages of the amount of bandwidth dedicated for voice

traffic carried by the backbone network in FY 2002, 2003 and 2004 are then

calculated. Given that the backbone network traffic statistics should reasonably

reflect the network-wide traffic pattern, the result should serve as the best

available reference for approximating the adjusted percentages of the amount of

bandwidth dedicated for voice traffic in the entire network of HKBN. Based on

the information submitted by HKBN, the IDC comes to the conclusion that the

adjusted percentages of the amount of bandwidth dedicated for voice traffic are

[ ]%, [ ]% and [ ]% in FY 2002, 2003 and 2004 respectively.

(II) Relevant Cost Components

38. For the purpose of this Determination, HKBN submitted to the IDC a

cost model which was based on a top-down fully distributed approach. The

financial data was based on the accounting records of HKBN. Each of the cost

components was firstly divided among the voice and non-voice services, and then

it was further apportioned into traffic-sensitive and line-sensitive parts. The costs

for traffic-sensitive part (i.e. the total relevant costs) were then divided by the total

relevant traffic minutes to come up with the unit cost for FMIC. In the cost model,

HKBN submitted the following major cost components of fixed-mobile

interconnection. HKBN’s cost model consisted of financial data for three periods:

(i) from 1 April 2002 to 31 August 2002; (ii) from 1 September 2002 to 31 August

2003; and (iii) from 1 September 2003 to 31 August 2004, which was consistent

with the information in HKBN’s three annual audited statutory accounts from FY

2002 to FY 2004 and its audited Accounting Manual report6 for FY 2004.

6 The Accounting Manual report refers to the annual financial report as stipulated in the Accounting Manual for Fixed Telecommunication Network Services/Fixed Carrier Licenses. HKBN started providing such report to the TA from FY2004.

% of Cost of Each Component over Total Cost

for FMIC Submitted by HKBN

1 Apr 2002

to

31 Aug 2002

1 Sep 2002

to

31 Aug 2003

1 Sep 2003

to

31 Aug 2004

Depreciation

- Metro Ethernet Network [ ]% [ ]% [ ]%

- Voice Switch [ ]% [ ]% [ ]%

- Microwave Distribution System [ ]% [ ]% [ ]%

Other Operating Expenditure

- Repair & Maintenance and Network Operation Expenses

[ ]% [ ]% [ ]%

- Sales & Marketing, Customer Services [ ]% [ ]% [ ]%

- Corporate Overhead [ ]% [ ]% [ ]%

- Leased Transmission Links [ ]% [ ]% [ ]%

- Interconnection Charges [ ]% [ ]% [ ]%

Cost of Capital [ ]% [ ]% [ ]%

Sub-Total 85 % 92 % 93%

Metro Ethernet Network (“MEN”)


39. In HKBN’s model, the cost items under MEN included:

� integrated access devices (“IAD”)

� Ethernet switches

� set-up costs for the design and initial planning of the network

� material costs for building the network; and

� costs paid to contractors for building the network.

40. HKBN submitted that IAD was a network equipment used to connect

other equipment, such as other IADs and/or Ethernet switches. It suggested to

take the network side7 of IAD into account and to allocate the costs using the

application ratio of 1:1 since HKBN’s network was designed to support both voice

and non-voice applications over a unified network. HKBN also proposed other

alternative cost allocation basis, namely revenue ratio, subscriber ratio and packet

ratio.

7 According to HKBN, “network side” refers to those elements or portions of an element that carry the network traffic and are not dedicated to a single user.

41. HKBN explained that it was necessary to deploy a high-end Ethernet

switch in its network in order to implement QoS mechanisms and that the QoS

features of the high-end switch were required for voice applications only. HKBN

claimed that a lower-end switch would have been adequate if its network was not

designed for voice services. As such, the cost difference between the high-end and

low-end switches should be a relevant cost and fully allocated to voice services. It

further submitted that the base costs of the lower-end Ethernet switch should be

equally shared by voice and non-voice services.

42. However, Peoples objected to the inclusion of the cost components under

MEN into the calculation model since they were not traffic-sensitive and were not

relevant to fixed-mobile interconnection.

The IDC’s Views

43. One distinctive feature of NGN is the distributed network architecture

such that network intelligence and switching functions are provisioned in the

customer access network in close proximity to the customer premises. In

traditional time-division multiplexing (“TDM”) telephone switching network, the

customer access network primarily consists of copper wires only, connecting the

customers to the nearest local exchanges. On the other hand, the customer access

network of NGN is typically equipped with advanced network functions like

packet switching capabilities, customer access management, QoS functions, etc. in

addition to the copper wires. The customer access network of NGN therefore

contains traffic-sensitive components as far as the calculation of FMIC is

concerned.

44. The IDC is of the view that the relevancy of each component of MEN as

well as the respective proportion of equipment cost to be allowed in the cost model

should be considered on a case-by-case basis. In essence, only those cost

components of MEN which are traffic-sensitive and voice-related would be

included in the calculation.

IAD

45. The IDC recognizes that the IAD provides conventional interfaces for

ordinary voice-band customer premises equipment. Apart from the interfacing

function which is quite similar to the line cards as found in the TDM networks,

advanced network functions such as protocol adaptation, call control features,

network management capabilities might be available through the IAD. Hence, the

IDC considers that the IAD also contained certain traffic-sensitive cost

components. For the purpose of cost allocation, the proportion of cost related to

the “network side” as quoted by the manufacturer of the IAD should be adopted.

As the IAD might include data access capabilities for the customers and hence

would be carrying both voice and non-voice traffic, its cost should be apportioned

using the cost allocation basis for voice and non-voice traffic as mentioned in

paragraph 37 above.

Ethernet switch

46. In HKBN’s NGN, the Ethernet switch is used as the edge switch which

directly connects the customer premises equipment, with or without the use of

IADs, to the customer access network. As the Ethernet switch essentially

performs switching functions for network traffic, the IDC is of the view that the

Ethernet switch should be fully taken as a traffic-sensitive network element.

47. In the meantime, the IDC notes the point raised by HKBN that the

existing model of Ethernet switch procured by HKBN for its NGN is of an

advanced type providing additional QoS capabilities in support of voice over IP

services. But for the QoS capabilities, HKBN would have procured a lower-end

model of Ethernet switch just sufficient for non-time-critical non-voice

applications. In this regard, HKBN considered that the cost difference between

the existing Ethernet switch model and other lower-end model (“Cost Difference”)

should be fully accounted for in the calculation of FMIC. For this purpose, HKBN

provided the IDC with the cost information of a lower-end equipment model as

reference.

48. The IDC is of the view that QoS capabilities would be essential for the

provision of voice services in the NGN and that it might be necessary to consider

the additional capital investment for the provision of such capabilities. But the

advanced type of Ethernet switch procured by HKBN is also required for its

multicasting features in order for the provision of video broadcasting service. The

IDC considers that the Cost Difference should not be borne entirely by voice

service, and that video broadcasting service should also play a part here. As a

result, only the part of the Cost Difference relevant to voice traffic should be

accounted for. For this purpose, the IDC decides to use the ratio of the amount of

voice traffic to video traffic as the basis of apportionment. Similarly, since HKBN

provided video broadcasting service starting from FY 2004, the above adjustment

would only be applicable to that year.

49. In the meantime, the IDC considers that the lower-end model of

equipment as suggested by HKBN might not be a comparable model for the

provision of carrier grade data services with high reliability. Instead, the IDC

makes reference to the cost information of a lower-end carrier grade model, i.e.

Cisco Catalyst Express 500 Switch8, supplied by the same manufacturer from

which HKBN has procured the current Ethernet switch. In addition, the base cost

of the lower-end Ethernet switch should be shared by voice and non-voice services

in accordance with the cost allocation basis mentioned in paragraph 37.

Set-up costs for the design and initial planning of the network, material costs as

well as costs paid to contractors for building the network

50. These three cost items all relate to the construction and material cost of

the in-building facilities of the customer access network, which is partly similar to

the ordinary blockwiring systems found in the customer buildings. HKBN

proposed the respective cost allocation percentages for traffic-sensitive

components of these cost items. Comparing the percentages proposed by HKBN

with the available market reference on the cost information of typical blockwiring

systems in Hong Kong, the IDC finds that the proposed percentages are reasonable

and therefore makes use of the figures so provided in making this Determination.

51. For the voice-related component of these three cost items, the IDC is not

convinced by HKBN’s proposal to assume an equal cost sharing between voice

and non-voice services. The IDC considers that the best available reference

should be the respective adjusted percentages of the amount of bandwidth

dedicated for voice and non-voice traffic i.e. the cost allocation basis as mentioned

in paragraph 37.

8 Model number is WS-CE500-24TT.

Voice Switch


52. HKBN quoted a reference from its supplier that [ ]% of the costs of

voice switches are traffic-sensitive and the remaining [ ]% are line-sensitive. As

such, [ ]% of the costs of those voice switches which were dedicated to local fixed

voice services should be considered relevant in the cost model.

53. However, Peoples objected to the inclusion of voice switches into the

calculation model since they were not traffic-sensitive and were not relevant to

fixed-mobile interconnection.

The IDC’s Views

54. The voice switch basically provides the NGN with traditional voice

switching function and is responsible for interconnecting the NGN with the

networks of other operators. The IDC considers that the voice switch is dedicated

for the carriage of voice traffic only and therefore the cost of voice switch should

be fully considered as voice-related component. Regarding the percentage of the

traffic-sensitive component of a voice switch, the IDC considers it appropriate to

adopt the figure quoted by the voice switch supplier. Hence, the cost allocation

basis proposed by HKBN is generally acceptable.

Microwave Distribution System


55. The existing microwave distribution system were deployed by HKBN as

a backup path for voice services. HKBN explained that it was essential to provide

backup path since both network and switching equipment were installed in

customer premises but majority of the building management offices/Incorporated

Owners of buildings only allowed single fibre access to their buildings (i.e. no

backup path). If no backup facilities were provided, the service restoration time

would be longer in case of fibre damage. Regarding the allocation basis for costs

of the microwave system, HKBN made the following proposal:

� In those sites where the self-built fibre network was not in place yet

and both voice and non-voice services were served by microwave

system only – costs of the microwave system should be shared

between voice and non-voice services equally.

� In those sites where the self-built fibre network was not in place yet

and both voice and non-voice services were served by microwave

system as well as leased fast Ethernet links – costs of the microwave

system should be fully allocated to non-voice services.

� In those sites where the self-built fibre network and the microwave

system were both in place – costs of the microwave system should

be fully allocated to voice services.

56. However, Peoples objected to the inclusion of the microwave system

into the calculation model since they were not traffic-sensitive and were not


The IDC’s Views

57. The IDC notes the different functions of the microwave systems under

different network configuration scenarios as reported by HKBN. In the first

scenario where both voice and non-voice traffic are being served by the

microwave system only, the IDC agrees that the microwave system is providing

network connectivity between core network and customer access network and that

its cost should be fully traffic-sensitive. As the microwave system is carrying both

voice and non-voice traffic, the cost allocation basis for voice and non-voice

traffic mentioned in paragraph 37 above should be adopted.

58. In the second scenario, the IDC notes that for those sites with both

microwave system and leased fast Ethernet links, the microwave system would

only carry non-voice traffic and therefore the cost of microwave system would not

be accounted for in the calculation of mobile interconnection charge.

59. For the last scenario, the information provided by HKBN indicates that it

only came into being in FY 2004, but not before. The IDC finds it difficult to

accept HKBN’s argument that on the one hand backup path for voice traffic is a

necessity for those sites with both self-built fibre links and microwave system,

while on the other hand provision of backup path is not deemed to be necessary for

(i) sites with microwave system only and (ii) sites with microwave system plus

leased fast Ethernet links.

60. The IDC understands that the microwave system was built by HKBN

when it first launched its local wireless FTNS services. However, after HKBN

had modified its local wireless FTNS licence in April 2002 to include the

operation of local wireline-based FTNS as from 1 January 2003, it switched to the

use of self-built fibre network as the preferred means to reach its customers. In the

view of the IDC, the cost incurred for the use of the microwave system for those

sites with self-built fibre network is not necessary for the interconnection between

HKBN and other mobile network operators. The IDC therefore concludes that for

those sites where the self-built fibre network and the microwave system are both

present, the cost of the microwave system should not be accounted for in this

Determination.

Repair & Maintenance and Network Operation Expenses


61. According to HKBN, there were two types of maintenance, namely

general service maintenance (related to both voice and non-voice services) and

specific maintenance. HKBN suggested that those network-related expenses

which could be categorised to voice services only should be entirely considered in

the calculation model. On the other hand, those expenses which could not be

clearly categorised should be allocated to voice and non-voice services in the ratio

of 1:1. Alternatively, HKBN proposed to allocate repair maintenance costs and

network operation costs using maintenance ticket ratio9.

62. However, Peoples was of the view that almost all the network-related

expenses were line-sensitive and should not be considered relevant in the

calculation model. Peoples submitted that only traffic-sensitive costs should be

included in the model and allocated by call minutes.

9 According to HKBN, maintenance ticket ratio is based on the number of complaints from customers in relation to voice and non-voice services. HKBN argued that if there are more complaints on voice services, it would need to incur more human resources to handle the complaints and therefore more costs should be allocated to the voice services. That is the reason why HKBN considered that maintenance ticket ratio could be an alternative to application ratio of 1:1 in cost allocation.

The IDC’s Views

63. In assessing the appropriateness of cost allocation methodology, the IDC

is mindful of the principles of cost causality and relevant cost. HKBN submitted

that the repair and maintenance work was primarily initiated by the subscriber

complaints. Accordingly, the number of complaints for voice services is a key

cost driver of the repair and maintenance expenses. In this connection, the IDC

considers that among all the allocation bases proposed by HKBN, the maintenance

ticket ratio is the most appropriate as it could closely and objectively reflect the

relevant cost attributable to the provision of voice service. It is therefore

reasonable to share the common repair & maintenance and network operation

costs based on the maintenance ticket ratio between voice and non-voice services.

Nonetheless, the IDC notes that the average maintenance ticket ratio for FY 2002

is based on the number of voice complaints starting from FY 2003, and the

proportion of voice subscriber over total subscriber in FY 2002 is just around [ ]%

of that of FY 2003. The IDC considers that the number of voice complaints

should correlate with that of voice subscribers. Assuming that the service level

remained constant in FY 2002 and FY 2003, the IDC is of the view that the

estimated maintenance ticket ratio for FY 2002 should be adjusted to [ ]% of that

of FY 2003.

64. The TA Statement No. 7 stated that “the LRAIC should be based on the

incremental cost of the “entire conveyance service”, i.e. the conveyance service

for the calls of the carrier’s own customers (including service providers) and the

interconnecting service for the other carriers interconnected with the carrier in

question.” The IDC considers that the “entire voice conveyance service” is a

relevant consideration in evaluating as to whether the expenses are causally related

with fixed-mobile interconnection service. In other words, any expenditure which

is not attributable to the voice conveyance service should not be absorbed in the

cost model. As such, the IDC is inclined to subscribe to Peoples’ view that the

line sensitive costs, which are generally not deployed for the voice conveyance

service, should be excluded from the model. Nonetheless, the IDC is not

convinced that all network-related expenses are line-sensitive. Based on HKBN’s

submissions, its network equipment under repair encompasses both line- and

traffic-sensitive components. As such, the IDC is of the view that an allocation

methodology similar to that of the relevant network equipment should be adopted

for network-related expenses (the allocation methodologies of network equipment

have been discussed in the preceding paragraphs). For those network-related

expenses which could not be identified to any relevant network equipment, they

should be allocated based on the proportion of total depreciation between the line-

and traffic-sensitive network components.

Sales & Marketing, Customer Services


65. In HKBN’s cost model, the following cost items were included.

� Operating costs for running the customer service centre, which

processed customer service orders, bill enquiries, product and

service enquiries as well as complaints on voice quality. According

to HKBN, its customers sometimes made complaints and enquiries

to its customer service centre when they could not make calls to

mobile number or experienced quality problem with mobile services

and therefore this cost component was relevant to fixed-mobile

interconnection

� Installation services

� Billing and collection costs for HKBN’s subscribers and other

operators

� Marketing costs on (1) negotiating and liaising with mobile

operators on interconnection services; (2) conducting and

administering competitive analysis on mobile services; and (3)

administering market planning, market forecasts and pricing

analysis on voice products and services against mobile products and

services

� Product advertising

� Sales administration for fixed-mobile interconnection (e.g. contract

management, quotations, sales orders, liaisons, etc.)

� Product development for developing and improving logistics of

fixed-mobile interconnection.

66. Among these expenses, HKBN suggested that expenses which could be

categorised to voice services only should be entirely considered in the calculation

model. On the other hand, expenses which could not be clearly categorised should

be allocated to voice and non-voice services in the ratio of 1:1. Alternatively,

HKBN proposed to allocate costs using revenue ratio, subscriber ratio or packet

ratio.

67. However, Peoples objected to the inclusion of the above cost

components into the calculation model since these activities were principally for

the benefit for HKBN only and the associated costs were not relevant to fixed-

mobile interconnection.

The IDC’s Views

68. The IDC is of the view that all the expenses mentioned in paragraph 65

should not be absorbed in the calculation model due to the following reasons:

� Expenditures related to voice services might not necessarily be

relevant to fixed-mobile interconnection. The nature of the

aforementioned expenses is largely related with customer

acquisition which is too remote to be allowed in the calculation

model of FMIC. In addition, some of the expenses (e.g. billing and

collection) are mostly driven by the number of customers.

� For certain services provided to subscribers (e.g. installation), it is

considered inappropriate for HKBN to recover the costs through

fixed-mobile interconnection. Rather, it is more reasonable to

recover the installation cost from its subscribers. As a matter of fact,

HKBN considers certain customer service costs (such as directory

services) irrelevant and excludes them from the cost model. It

follows that other expenditures of similar nature should also be

taken out from the cost model.

� According to HKBN, certain marketing and product development

costs are related to the negotiation and liaison with mobile operators

as well as the development of logistics for fixed-mobile

interconnection. The IDC tends to accept that the nature of these

expenditures is relevant to fixed-mobile interconnection.

Nonetheless, it should be noted that the major development cost

should have either been capitalised in capital expenditure or

captured in network-related expenses, while other

administrative/operating expenditures are of general nature and

therefore should be captured in corporate overhead.

Corporate Overhead


69. According to HKBN’s cost model, corporate overhead mainly included

executive planning (e.g. salaries and related staff costs as well as management and

administrative expenses incurred by the management office), procurement and

materials management, finance and accounting, information technology,

regulatory affairs, research and development. Among these expenses, HKBN

suggested that expenses which could be categorised to voice services only should

be entirely considered in the calculation model. On the other hand, expenses

which could not be clearly categorised should be allocated to voice and non-voice

services in the ratio of 1:1. Alternatively, HKBN proposed to allocate costs using

revenue ratio, subscriber ratio or packet ratio.

70. However, Peoples objected to the inclusion of corporate overhead into

the calculation model since most, if not all, of the expenses were not traffic-

sensitive and were not relevant to fixed-mobile interconnection.

The IDC’s Views

71. Corporate overhead refers to the general expenses supporting all

services and related activities of an organisation, and is not driven by a particular

service or activity. The cost allocation basis suggested by HKBN neglects the cost

apportionment between the line- and traffic-sensitive network components, let

alone the inter-relationship between different activities and services. The IDC

opines that a more pertinent cost allocation principle would be to base on the

proportion of the total cost already allocated to the traffic-sensitive network

components.

72. According to the traffic information submitted by HKBN, traffic to and

from mobile operators accounts for a significant portion of the total traffic for FY

2003 and FY 2004 (i.e. [ ]% and [ ]% respectively) and the IDC is therefore of

the view that it is appropriate to allow corporate overhead for these two years. For

FY 2002, fixed-mobile interconnection traffic did not constitute a significant

portion of the total network traffic (i.e. only [ ]%), and arguably corporate

overhead should not be allowed for this year. Nevertheless, having considered

that HKBN might need to deploy more resources on logistics development in FY

2002 when it first provisioned fixed-mobile interconnection, the IDC tends to

accept that corporate overhead should also be allowed for FY 200210. Having

reviewed the cost information submitted by HKBN, the IDC considers that the

level of corporate overhead, which is around [ ]% of the total relevant costs

allowed in the cost model for each of the three years, is reasonable. The corporate

overhead allowed is apportioned by the total cost already allocated to the traffic-

sensitive network components.

Leased Transmission Links


73. Leased transmission links referred to the periodic lease payments

directly related to the provision of network capacities. HKBN submitted that the

costs incurred in the leased links should be entirely taken into account in the cost

calculation so long as they were primarily for voice services. According to HKBN,

those leased lines with lower capacity were for voice services only and therefore

all these costs should be considered relevant in the cost model. For those leased

lines with higher capacity, at least [ ]% of the available bandwidth was reserved

for voice services and on some occasions, voice services would also occupy the

remaining [ ]% as voice traffic had a higher priority over non-voice traffic. Hence,

HKBN considered that all the costs incurred for leased links should be accounted

for in the calculation model.

74. However, Peoples objected to the inclusion of leased transmission links

into the calculation model since they were not traffic-sensitive and were not


The IDC’s Views

75. From the submission of HKBN, the leased transmission links are used

for providing network connectivity for its core network and customer access

network. As it is understandable that fixed network operators, especially for those

who have newly entered the market, might have the need to lease circuits from

other operators in order to expedite network and service rollout, the IDC is of the

view that the cost incurred in the rental of leased transmission links should be

accounted for and that these leased transmission links should be deemed as traffic-

10 The relevant period for FY 2002 starts from 1 April 2002 and ends on 31 August 2002.

sensitive. For verification purpose, site visits to inspect selected sites with leased

transmission links were conducted. The leased transmission links in those selected

sites were found to be properly installed and were operating in normal condition.

76. However, the IDC disagrees with HKBN that cost incurred in all leased

transmission links should be fully treated as voice-related in the cost model

because some of the leased transmission links are in fact carrying both voice and

non-voice traffic. The IDC considers that the cost of those leased transmission

links carrying both voice and non-voice traffic should be apportioned according to

the cost allocation basis as mentioned in paragraph 37. It follows that for those

transmission links carrying voice traffic only (e.g. the Fast Ethernet leased

transmission links of 30M or below), the entire cost would be accounted for in the

Determination.

Interconnection Charges


77. In its cost model, HKBN included Type I interconnection charges and

public non-exclusive telecommunications service (“PNETS”) charges paid to other

fixed network operators.

78. Peoples submitted that only traffic-sensitive cost components should be

considered relevant in the calculation model. It was of the view that this cost item

was not relevant to fixed-mobile interconnection.

The IDC’s Views

79. Type I interconnection charge is an interconnection charge payable by

local fixed carriers for the cost incurred in terminating local calls in the network of

another local fixed carrier whilst the PNETS charge is an interconnection charge

payable by the value-added services (“VAS”) providers to the local fixed carriers

for the use of fixed network in connecting the VAS customers to the facilities of

the VAS providers with “dialled-up” access. During the Relevant Period, Peoples

and HKBN did not have direct interconnection. According to paragraphs 27 and

28 of TA Statement No. 7, Peoples should pay the necessary originating and

terminating FMIC to HKBN, and Peoples should also pay interconnection charge

to the transiting fixed carriers. There should be no payment of Type I

interconnection charge or PNETS charge between HKBN and the transiting fixed

carriers for delivering Peoples’ traffic in either direction. As such, the IDC is of

the view that Type I interconnection charge and PNETS charge do not come into

play in this Determination and therefore excludes these charges from the cost

model.

CoC


80. The existing cost model for calculating FMIC for PCCW-HKTC adopted

a CoC at 15%. However, HKBN explained that as a new entrant to the FTNS

market, its risk profile was substantially higher than that of PCCW-HKTC. It

proposed that a CoC at 18% should be adopted in the calculation model. HKBN

referred to the TA determination on the level of LAC dated 4 May 2004 and

opined that a CoC at 18% represented a fair and adequate compensation to the

fixed operators.

81. On the other hand, Peoples argued that the CoC adopted in the

determination on LAC was not relevant to this Determination since LAC was

different from FMIC in nature and the charging principles were different. In its

submission, Peoples proposed that the CoC to be adopted in the calculation of

FMIC payable to HKBN should be significantly lower than 15% (i.e. the CoC

adopted by the TA when determining the Type I interconnection charge between

PCCW-HKTC and Wharf T&T Limited in 199811) because (1) low interest rate

had been maintained in Hong Kong since 2002 when HKBN entered the market;

(2) HKBN was able to build its network with the latest technology and had no

investment commitment in its licence conditions; and (3) HKBN was able to adopt

a “cherry-picking” strategy to provide services to profitable areas only.

82. In HKBN’s cost model, it included two CoC, one based on the net book

value of the capital expenditure and the other based on the operating expenditure.

HKBN explained that CoC represented the opportunity cost of service costs and

operating expenditure (excluding depreciation) invested in the provision of voice

service, and it was fair and reasonable to take into account CoC on operating

expenditure in the cost model. Peoples objected to this and argued that CoC on

11 TA Determination on the Terms and Conditions of Interconnection between Hong Kong Telephone Company Limited (now PCCW-HKTC) nd New T&T Hong Kong Limited (now Wharf T&T Limited) dated 21 August 1998

operating expenditure was not relevant to the calculation of any interconnection

charges based on cost recovery principle.

83. In its further submissions made on 7 July and 10 August 2006, HKBN

proposed a ‘project-specific’ model for its CoC. Accordingly, HKBN submitted a

list of companies whose core businesses are the operation of a new generation

fixed telecommunications network in a metropolitan area. HKBN also submitted

the corporate debt rating criteria employed by Standard & Poors (S&P) as a

reference for its cost of debt. Based on stock market data of the comparables, the

average trading yield-to-maturity (YTM) of telecom companies of various credit

ratings according to S&P, together with its own statutory account information,

HKBN submitted that its CoC should be 18.91%.

The IDC’s Views

84. In accordance with Section 36A(3B) of the Ordinance, the charges in a

determination shall be based on the relevant reasonable costs attributable to

interconnection. Since the FMIC to be determined in this case reflects the cost in

relation to the usage of HKBN’s network, the IDC is of the view that the CoC to

be adopted in this Determination should be the weighted-average cost of capital

(“WACC”) of HKBN using data of the Relevant Period.

85. Based on cost recovery principle, both the operating and capital

expenditure should be allowed in the cost model so long as the expenditure is

relevant to fixed-mobile interconnection. The operating expenditure is normally

recognised when incurred whilst the capital expenditure is amortised over the

useful life of equipment and absorbed in the cost model in the form of depreciation.

In order to compensate for the unamortised cost, a CoC based on the average net

book value of the capital expenditure is generally allowed. This is in line with the

TA Statement No. 7 which stated that charges for interconnection should be “cost

based, including a cost of capital for the assets used in provision of

interconnection services”. Accordingly, the IDC does not accept HKBN’s request

of including CoC on operating expenditure into the cost model.

86. The IDC accepts HKBN’s view that the CoC model should be project-

specific.

87. As for the list of comparable companies submitted by HKBN, the IDC

accepts that these companies are of comparable business profiles to that of HKBN

in the sense that they all operate new generation telecom networks in metropolitan

areas. The IDC is aware that each of these companies has certain non-core

businesses that are not directly comparable to HKBN, but they tend to be

relatively minor and averaged-out in modelling. Therefore, the IDC agrees that

the average asset beta of these companies is comparable to that of HKBN.

However, in comparing equity beta, adjustments need to be made to offset the

differences in financial leverage positions of these companies. This adjustment

has been made in HKBN’s submission of 10 August 2006.

88. In the WACC model submitted by HKBN, “loan from ultimate holding

company” (CTI), which accounted for a significant portion of HKBN’s funding on

its balance sheet during the Relevant Period, was classified as debt. The IDC

disagrees, and takes the view that it should be classified as equity, because (i)

HKBN is 100% owned by CTI; (ii) according to HKBN’s statutory accounts, this

loan is interest-free and unsecured; (iii) HKBN confirms that the term of this loan

is of an indefinite period; and (iv) in a submission of 7 February 2007, PA

Consulting opined upon HKBN’s request that an interest-free loan from a parent

company to a wholly-owned subsidiary is “clearly not on commercial terms”, and

is “of no relevance in estimating the cost of debt that the subsidiary would incur if

it raised non-recourse debt finance from the capital markets”. The IDC considers

that by treating HKBN’s loan from its parent company as equity, the

administrative distortion of a zero interest rate can be avoided. Instead, HKBN is

compensated by its cost of equity for this particular portion of its funding.

89. On the other hand, HKBN’s calculation has not included some off-

balance-sheet items such as operating lease and other commitments. The IDC

considers that these items should be capitalized as debt in the WACC model. The

capitalization rate is based on HKBN’s cost of debt.

90. The IDC notes that according to HKBN’s statutory account, the actual

interest incurred during the Relevant Period on its long-term bank loan was at a

fixed rate of 2.75%. Since this rate is below risk-free rate, the IDC agrees that it

does not reflect the commercial reality of HKBN’s financing cost. Instead, the

IDC accepts that S&P is a renowned credit agency, and that its corporate credit-

rating criteria is a useful reference for estimating HKBN’s cost of debt.

91. Based on statutory account information, the IDC has calculated HKBN’s

key financial ratios, compared them with the three-year (2002-04) utilities median

under S&P’s Corporate Ratings Criteria 2006 and concluded that the financial risk

profile of HKBN can be rated as “minimal”. On the other hand, the IDC is also

aware of the generally negative investment sentiment towards new-entrant telecom

network business during the Relevant Period. According to the business/financial

risk matrix of S&P’s Corporate Ratings Criteria 2006, a company with “minimal”

financial risk but with a “vulnerable” business risk profile should be rated a “BB”.

According to HKBN’s submission on “Global Benchmarks for Bond Yield to

Maturity 2002-2004”, the average yield for “BB” rated telecom companies was

7.924%. As a sanity check, this rate is well above risk-free rate and below

HKBN’s pre-tax cost of equity of 16.4%. Overall, the IDC is satisfied that 7.924%

is a reasonable level of cost of debt for HKBN.

92. HKBN submitted that its effective tax rate during the relevant period was

0%. However, the IDC considers that first, the WACC used for this

Determination should be pre-tax because interconnection charges are settled

before tax. Second, the correct modelling input should be marginal tax rate. Since

interconnection income would marginally reduce HKBN’s tax benefits which

would only be deferred but not written-off, the IDC assumes the marginal tax rate

at 16.9% based on the time-weighted historical average corporate tax rate levied

by the HKSAR Government during the Relevant Period.

93. Based on the above adjustments that the IDC has made to HKBN’s

submitted WACC model, the CoC for HKBN adopted in this Determination is

calculated to be 14.3% (for details, please refer to the Appendix C).

Source: S&P

Source: S&P, HKBN, OFTA

Quantity of the Service Provided


94. In its submission made on 7 July 2006, HKBN provided detailed traffic

information by (i) breaking down 9 call types into 19 sub-categories; (ii) pointing

out that some sub-categories duplicated with each other; and (iii) splitting its

network into “switching network” and “transmission network” and dividing the

relevant network costs by the relevant traffic minutes.

Category Switching

Network

Transmission

Network 2002 2003 2004

External Traffic

1. On-net calls from HKBN fixed line customers to 001, 002 and 003

Yes Yes [ ] [ ] [ ]

2. External call from Reach and all ETS to HKBN fixed line customers.

Yes Yes [ ] [ ] [ ]

HKBN’s Direct

Subscriber to/from Other FTNS Direct Subscriber 3. On-net calls from HKBN fixed

line customers to ETS behind other FTNS

Yes Yes [ ] [ ] [ ]

Indirect External Traffic via

Calling Card

4. This traffic type is not applicable to HKBN

N/A N/A [ ] [ ] [ ]

Indirect External Traffic via HKBN’s 0030

5. Off-net call from other fixed or mobile to 0030

Yes No [ ] [ ] [ ]

HKBN

55.3

147.6

59.3

75.2

25.0

0.0

9.4

HKBN

55.3

147.6

59.3

75.2

25.0

0.0

9.4

Category Switching

Network

Transmission

Network 2002 2003 2004

Internal Traffic

6. On-net call from HKBN fixed line customers to PSTN

Yes Yes [ ] [ ] [ ] HKBN’s Direct

Subscriber to/from Other FTNS Direct Subscriber

7. On-net call from PSTN to HKBN fixed line customers

Yes Yes [ ] [ ] [ ]

8. On-net call from HKBN fixed line customers to Mobile

Yes Yes [ ] [ ] [ ] HKBN’s Direct

Subscriber to/from Mobile

Subscriber

9. On-net call from Mobile to HKBN fixed line customers

Yes Yes [ ] [ ] [ ]

HKBN’s Network

to/from other FTNS/Mobile Network via 20X Traffic

10. On-net call from HKBN fixed line customers to the 20x of other FTNS

Yes Yes [ ] [ ] [ ]

11. On-net call from HKBN fixed line customers to 006/7/8/9, 900 and 18x

Yes Yes [ ] [ ] [ ]

12. Off-net call from other fixed or mobile to 0030

Duplicated with item 5


[ ] [ ] [ ]

13. On-net dial up call from HKBN fixed line customers to ISP behind HKBN

Yes Yes [ ] [ ] [ ]

14. Off-net dial up call from other FTNS to ISP behind HKBN

Yes No [ ] [ ] [ ]

HKBN’s Network

to/from other FTNS/Mobile Network via XXX Traffic

15. On-net call from HKBN fixed line customers to ETS behind HKBN

Yes Yes [ ] [ ] [ ]

HKBN’s Intra-network

Traffic

16. On-net call between HKBN fixed line customers Yes Yes [ ] [ ] [ ]

17. On-net dial-up call from HKBN fixed line customers to ISP behind HKBN

Duplicated with item

13


[ ] [ ] [ ]

18. On-net dial-up call from HKBN fixed line customers to ISP behind other FTNS

Yes Yes [ ] [ ] [ ]

HKBN’s Internet Traffic

19. Off-net dial-up call from other FTNS to ISP behind HKBN

Duplicated with item

14


[ ] [ ] [ ]

Total switching network [ ] [ ] [ ]

Total transmission network [ ] [ ] [ ]

The IDC’s Views

95. The IDC agrees with HKBN that some sub-categories duplicate with

each other and that its network should be split into “switching network” and

“transmission network” for the purpose of calculating the interconnection charge.

(III) Unit Cost of Fixed-Mobile Interconnection


96. According to HKBN’s revised calculation model submitted on 7 July

2006, the unit cost of fixed-mobile interconnection was 54 cents, 17 cents and 10

cents per occupancy minute for the FY ended 31 August 200212, 31 August 2003

and 31 August 2004 respectively.

97. Peoples did not make any proposal in its submissions on the unit rate.

However, it considered that the rate should be capped at the level of the regulated

interconnection charge levied by the incumbent operator, since no party should be

allowed to enter the market if it was less efficient than the incumbent operator.

Furthermore, Peoples suggested that the cost information submitted by HKBN

should be scrutinised by independent professionals or experts in IP-based

networks providing integrated services.

The IDC’s Views

98. The IDC takes note of HKBN’s concern that a LRAIC cost model might

not be able to fully compensate all the costs incurred for the provision of fixed-

mobile interconnection. As a matter of fact, in the case of HKBN’s network, the

IDC is of the view that the level of unit cost would not differ significantly if FDC

is adopted in the calculation model. Firstly, since HKBN’s network is newly built

using the latest technology, the IDC has adopted the actual cost incurred by

HKBN as the current cost in the LRAIC model. Secondly, as mentioned in

paragraph 29, a fair amount of corporate overhead has been allowed in the

calculation model to allow HKBN to recover a reasonable portion of its indirect

fixed costs.

12 For FY 2002, the applicable period starts from 1 April 2002 and ends on 31 August 2002.

99. The IDC takes note of Peoples’ suggestion that the cost information

submitted by HKBN should be scrutinised by independent IP experts. In fact, the

Procedures addressed the issue of appointing outside experts. Paragraph 4 of the

Procedures stated that "[t]he TA may appoint an Interconnection Determination

Committee composing of members from the Office of the Telecommunications

Authority and, where necessary, other government departments or outside

experts/consultants to assist him in performing his statutory functions under

section 36A”. For this Determination, the TA is satisfied that the staff of OFTA

are able to perform the required analysis and does not consider it necessary to

appoint any outside experts to assist him in performing his statutory functions

under section 36A.

100. Based on the discussions in the preceding paragraphs, the unit cost of

fixed-mobile interconnection calculated based on LRAIC is calculated as follows:

� 9.78 cents per occupancy minute for the period from 1 April 2002 to

31 August 2002;

� 4.26 cents per occupancy minute for the period from 1 September

2002 to 31 August 2003; and


2003 to 31 August 2004.

Revised Unit Cost based on LRAIC 1 Apr 2002 1 Sep 2002 1 Sep 2003

to to to

(Unit: HK$)

31 Aug 2002 31 Aug 2003 31 Aug 2004

Local Transmission

Network

Depreciation

- Metro Ethernet Network [ ] [ ] [ ]

- Microwave Distribution System [ ] [ ] [ ]

- Others [ ] [ ] [ ]



[ ] [ ] [ ]

- Sales & Marketing, Customer Services

0 0 0

- Corporate Overhead [ ] [ ] [ ]

- Leased Transmission Links [ ] [ ] [ ]

- Interconnection Charges 0 0 0

- Others [ ] [ ] [ ]

Cost of Capital [ ] [ ] [ ]

Total Costs [ ] [ ] [ ]

1 Apr 2002 1 Sep 2002 1 Sep 2003

to to to

(Unit: HK$)

31 Aug 2002 31 Aug 2003 31 Aug 2004

Traffic Volume (min) [ ] [ ] [ ]

Revised Unit Cost (cents per

min) 7.59 2.86 1.68

Switching Network

Depreciation - Voice Switch [ ] [ ] [ ]

- Others [ ] [ ] [ ]



[ ] [ ] [ ]

- Sales & Marketing, Customer Services

0 0 0

- Corporate Overhead [ ] [ ] [ ]

- Leased Transmission Links [ ] [ ] [ ]

- Interconnection Charges 0 0 0

- Others [ ] [ ] [ ]

Cost of Capital [ ] [ ] [ ]

Total Costs [ ] [ ] [ ]

Traffic Volume (min) [ ] [ ] [ ]

Revised Unit Cost (cents per

min) 2.19 1.40 1.24

Local Transmission and

Switching Network

Total Revised unit cost

(cents per min) 9.78 4.26 2.92

101. For comparison, the IDC has also calculated the unit cost based on the

FDC model. The calculation results as shown in the following table confirm that

the level of unit cost based on LRAIC and FDC does not differ significantly from

each other. Accordingly, the IDC considers that LRAIC should be adopted as the

calculation methodology for this Determination.

Comparison between Revised Unit Costs based on LRAIC and FDC (Unit: cents per min) 1 Apr 2002

to

31 Aug 2002

1 Sep 2002

to

31 Aug 2003

1 Sep 2003

to

31 Aug 2004

Revised Unit Cost based on LRAIC 9.78 4.26 2.92

Revised Unit Cost based on FDC 9.86 5.02 3.40

Ratio of LRAIC to FDC Revised Unit Cost 99% 85% 86%

Level of the Determined FMIC

The IDC’s Views

102. While the IDC is of the view that the level of the determined FMIC

should reflect the unit cost of fixed-mobile interconnection of HKBN, the IDC

notes that the calculated unit cost of HKBN for the period from 1 April 2002 to 31

August 2002 is much higher than that of the incumbent carrier PCCW-HKTC for

the same period13. As a matter of principle, the IDC shall reasonably adhere to the

interconnection charging principles as set out in the TA Statement No.7 when

determining the interconnection charge so as to encourage and motivate operators

to use facilities efficiently. A determined interconnection charge higher than the

incumbent’s rate would give a wrong signal to the industry that the TA would

reward inefficiency and encourage inefficient entry into the market. As such, the

IDC considers that it is appropriate to cap the level of the determined FMIC at the

rate charged by PCCW-HKTC during the relevant periods.

103. It is relevant to point out that this principle is shared by other overseas

regulatory bodies such as Australian Competition & Consumer Commission

(“ACCC”) which also adopts a similar approach of capping the level of new

entrants’ interconnection charges at the incumbent’s rates. ACCC does not

consider that there are sound arguments for charges by smaller networks for

terminating services being set above those of an efficient large network. It

acknowledges that in the initial stages of network rollout, smaller carriers may

well have higher costs than incumbents. However, such cash flow issues are of a

short term nature which should be dealt with as part of a new carrier’s business

planning process and not form the justification for higher charges over an

extended period of time. In those situations where the costs of the smaller network

are higher in the long term than those of an efficient larger network the question

arises as to whether inefficient entry is occurring in the market. Smaller network

operators who cannot price at or below that of the total service long-run

incremental cost (“TSLRIC”) price of the larger network for the same service

functionality because of higher costs over time are less efficient than the

incumbent operator. In terms of efficient pricing principles, the imposition by a

smaller network of prices that were clearly above the prices for the same service

13 The fixed-mobile interconnection charge of PCCW-HKTC was 4.8 cents per min for the period from 1 October 2001 to 30 September 2002, 4.5 cents per min for the period from 1 October 2002 to 30 September 2003 and 4.36 cents per min after 1 October 2003.

by a larger network over time would promote inefficient entry and investment by

smaller networks and would not be in the long-term interests of end users. More

specifically it would be in breach of the economic efficiency principle.

Accordingly, ACCC would not favour mandating a price either in an access

undertaking or in an arbitration determination that allowed a smaller network to

set long-term prices that were clearly above those of the incumbent’s TSLRIC

charges for the same service functionality14.

104. Federal Communications Commission (“FCC”) also adopted a similar

concept in the reform of access charge imposed by competitive local exchange

carriers (“CLECs”) on interexchange carriers. It revised the tariff rules to try to

align tariffed CLEC access rates with those of the incumbent local exchange

carriers (“ILECs”). CLEC access rates that are at or below the benchmark (i.e. the

access rates of ILECs) will be presumed to be just and reasonable and CLECs may

impose them by tariffs. Above the benchmark, CLEC access services will be

mandatorily detariffed, so CLECs must negotiate the higher rates with the

interexchange carriers. In analysing the comments received, FCC found the

argument that “it is highly unusual for a competitor to enter a market at a price

dramatically above the price charged by the incumbent, absent a differentiated

service offering” persuasive15.

105. With the level of FMIC capped at the rate charged by PCCW-HKTC

during the relevant periods, the IDC is of the preliminary view that the level of

FMIC payable by Peoples to HKBN for (i) calls originated on HKBN’s network

and terminated on Peoples’ network; and (ii) calls originated on Peoples’ network

and terminated on HKBN’s network, should be determined as follows:

� 4.8 cents per occupancy minute for the period from 1 April 2002 to

31 August 2002;


2002 to 31 August 2003; and


2003 to 31 August 2004.

14 “Revised pricing guidelines for access prices of PSTN terminating and originating access services provided by non-dominant or smaller fixed networks” issued by ACCC in January 2002. 15 “Reform of Access Charges Imposed by Competitive Local Exchange Carriers – Seventh Report and Order and Further Notice of Proposed Rulemaking” released by FCC on 27 April 2001.

Terms and Conditions Outside the Scope of Determination


106. In addition to the level and effective date of FMIC, HKBN also proposed

the following terms and conditions for interconnection, which were outside the

scope of the Determination.

� Peoples shall pay all outstanding invoices issued by HKBN within

30 calendar days from the date of Determination.

� Peoples shall pay all future invoices to be issued by HKBN within

30 calendar days from the date of invoice.

� All invoices issued by HKBN to Peoples would be presumed to be

accurate and correct unless the contrary was proved.

� Peoples shall pay HKBN an overdue interest at 2% above the prime

lending rate of the Hongkong and Shanghai Banking Corporation

Limited per annum on the overdue amounts until payment had been

paid in full.

� For better provisioning of additional network resources for upsurge

traffic volume, Peoples shall provide HKBN with traffic forecast for

every and the succeeding quarter for traffic originating on and

terminating on HKBN’s network.

107. In response to the above requests from HKBN, Peoples commented that

these terms and conditions were outside the scope of Determination and should not

be taken into consideration.

The IDC’s Views

108. The IDC believes that once the level of the charge is determined, the two

parties would be bound to reach a settlement agreement. The IDC is also of the

view that it is more appropriate to determine the settlement terms through

commercial negotiations of the two parties. Having considered the nature of these

issues, the IDC considers that it is likely for the parties to make commercial

agreement on these terms within reasonable time after the TA has determined the

level and the effective date of the FMIC.

How the Determination is to Proceed

109. HKBN and Peoples are now invited to make representations to the TA

in relation to this revised PA. The representations should reach the TA in written

form no later than 26 April 2007.

110. If HKBN and Peoples wish to re-engage in commercial discussions, the

TA will consider allowing the parties to resume commercial negotiations on the

subject of the Determination.

111. If the TA decides that commercial negotiations should not be resumed

or that the parties could not come to an agreement expeditiously, he will

proceed to make a determination on the subject matter.

Office of the Telecommunications Authority

26 March 2007

Appendix C

The WACC model

1. WACC is an average between pre-tax cost of debt (RD) and pre-tax cost

of equity (RE), weighted by the debt (D) and equity (E) finance positions of the

entity:

WACC = (D/(D+E)) x RD + (E/(D+E)) x RE / (1- T)

2. The debt position (D) is HK$243 million, based on a historical average

of HKBN’s total outstanding debt during the Relevant Period, including

adjustments made on capitalizing off-balance-sheet commitments. The cost of

debt (RD) is 7.92%, based on a historical average trading yield-to-maturity of the

debt of international telecom companies rated ‘BB’ by S&P during the Relevant

Period, as submitted by HKBN with Bloomberg quoted as the data source.

3. The equity position (E) is HK$728 million, based on HKBN’s historical

average book value of equity during the Relevant Period, including the unsecured,

interest-free loan from ultimate holding company, CTI.

4. The tax rate (T) is 16.9%, based on the time-weighted historical average

corporate tax rate levied by the HKSAR Government during the Relevant Period.

The corporate tax rate was increased from 16% to 17.5% in April 2003. Pre-tax

WACC is used because interconnection payments are settled on a pre-tax basis.

5. The pre-tax cost of equity (RE) is 16.4%, based on the capital asset

pricing model (“CAPM”), formulated as follows:

RE = [RF + β x (RM− RF)] / (1 – T)

6. RF (risk-free rate) is 4.37%, based on the monthly historical average

between Hong Kong Monetary Authority (“HKMA”) 10-year bond rate and the

Federal Reserve 10-year bond rate during the Relevant Period. Both local and

international interest rates are taken into account to reflect both the regional and

international market risks. The 10-year duration is chosen to match the typical

investment horizon of telecommunications network infrastructure.

7. RM (market return) is 12.1%, based on annualised historical average16

return of the Hang Seng Index (“HSI”) and the Datastream World Telecom Index

(“DSWTI”) over a 30-year period ending August 2004, consistent with the

Relevant Period. HSI and DSWTI reflect local market risks and global industry

risks respectively. The 30-years’ historical time series was chosen to minimise

statistical error and business cycle fluctuations.

8. β (systematic risk coefficient) is 1.20, based on the average asset

(unlevered) beta of 0.90 between a list of international comparable companies

submitted by HKBN, adjusted for HKBN’s leverage position.

9. Based on the WACC model above, the CoC for HKBN is calculated to

be 14.3%.

16 Both arithmetic and geometric average are taken into account.

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