legal and regulatory framework

8/3/2019 Legal and Regulatory Framework

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Legal Framework

An effective regulatory and legal framework is indispensable for theproper and sustained growth of the company. In rapidly changingnational and global business environment, it has become necessarythat regulation of corporate entities is in tune with the emergingeconomic trends, encourage good corporate governance andenable protection of the interests of the investors and otherstakeholders. Further, due to continuous increase in thecomplexities of business operation, the forms of corporateorganizations are constantly changing. As a result, there is a needfor the law to take into account the requirements of different kinds ofcompanies that may exist and seek to provide common principles towhich all kinds of companies may refer while devising theircorporate governance structure.

The important legislations for regulating the entire corporatestructure and for dealing with various aspects of governance incompanies are Companies Act, 1956 and Companies Bill, 2004.These laws have been introduced and amended, from time to time,to bring more transparency and accountability in the provisions ofcorporate governance. That is, corporate laws have been simplified

so that they are amenable to clear interpretation and provide aframework that would facilitate faster economic growth.

Secondly, the Securities Contracts (Regulation) Act, 1956,Securities and Exchange Board of India Act, 1992 and DepositoriesAct, 1996 have been introduced by Securities and Exchange Boardof India (SEBI), with a view to protect the interests of investors in thesecurities markets as well as to maintain the standards of corporategovernance in the country.

Companies Laws

The Ministry of Corporate Affairs (MCA) is the main authority for regulating and promoting efficient, transparent andaccountable form of corporate governance in the Indian corporate sector. It is constantly working towards improvement in

the legislative framework and administrative set up, so as to enable easy incorporation and exit of the companies, as well asconvenient compliance of regulations with transparency and accountability in corporate governance. It is primarily concernedwith administration of the Companies Act, 1956 and related legislations.

1. The Companies Act, 1956 is the central legislation in India that empowers the Central Government to regulate theformation, financing, functioning and winding up of companies. It applies to whole of India and to all types of companies,whether registered under this Act or an earlier Act. It provides for the powers and responsibilities of the directors andmanagers, raising of capital, holding of company meetings, maintenance and audit of company accounts, powers ofinspection, etc. That is, it empowers the Central Government to inspect the books of accounts of a company, to directspecial audit, to order investigation into the affairs of a company and to launch prosecution for violation of the Act. Theseinspections are designed to find out whether the companies conduct their affairs in accordance with the provisions of theAct, whether any unfair practices prejudicial to the public interest are being resorted to by any company or a group ofcompanies and to examine whether there is any mismanagement which may adversely affect any interest of theshareholders, creditors, employees and others.

The main objectives with which this Act has been introduced are to:- (i) help in the development of companies on healthylines; (ii) maintain a minimum standard of good behaviour and business honesty in company promotion and management;(iii) protect the interests of the shareholders as well as the creditors; (iv) ensure fair and true disclosure of the affairs ofcompanies in their annual published balance sheet and profit and loss accounts; (v) ensure proper standard of accountingand auditing; (vi) provide fair remuneration to management and Board of Directors as well as to company's employees; etc.

The Companies Act, 1956 has elaborate provisions relating to the Governance of Companies, which deals withmanagement and administration of companies. It contains special provisions with respect to the accounts and audit,directors remuneration, other financial and non-financial disclosures, corporate democracy, prevention of mismanagement,

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etc.

Every company shall in each year, hold in addition to any other meetings, a general meeting as its annual general meetingand shall specify the meeting as such in the notices calling it; and not more than fifteen months shall elapse between thedate of one annual general meeting of a company and that of the next. At each annual general meeting, every companyshall appoint an auditor or auditors to hold office from the conclusion of that meeting until the conclusion of the next annualgeneral meeting and shall, within seven days of the appointment, give intimation thereof to every auditor so appointed.

Every auditor of a company shall have a right of access at all times to the books and accounts and vouchers of thecompany, whether kept at the head office of the company or elsewhere, and shall be entitled to require from the officers ofthe company such information and explanations as the auditor may think necessary for the performance of his duties asauditor.

The auditor shall inquire:- (i) whether loans and advances made by the company on the basis of security have been properlysecured and whether the terms on which they have been made are not prejudicial to the interests of the company or itsmembers; (ii) whether transactions of the company which are represented merely by book entries are not prejudicial to theinterests of the company; etc.

In the case of every company, a meeting of its Board of directors shall be held at least once in every three months and atleast four such meetings shall be held in every year. Every director of a company who is in any way, whether directly orindirectly, concerned or interested in a contract or arrangement, or proposed contract or arrangement, entered into or to beentered into, by or on behalf of the company, shall disclose the nature of his concern or interest at a meeting of the Board ofdirectors.

No director of a company shall, as a director, take any part in the discussion of, or vote on, any contract or arrangemententered into, or to be entered into, by or on behalf of the company, if he is in any way, whether directly or indirectly,concerned or interested in the contract or arrangement; nor shall his presence count for the purpose of forming a quorum atthe time of any such discussion or vote; and if he does vote, his vote shall be void.

Every company shall keep one or more registers in which shall be entered separately particulars of all contracts orarrangements, including the following particulars to the extent they are applicable in each case, namely:- (i) the date of thecontract or arrangement; (ii) the names of the parties thereto; (iii) the principal terms and conditions thereof; (iv) in the caseof a contract or arrangement to which this Act applies, the date on which it was placed before the Board; (v) the names ofthe directors voting for and against the contract or arrangement and the names of those remaining neutral. Further, everycompany shall keep at its registered office a register of its directors, managing director, managing agent, secretaries andtreasurers, manager and secretary.

The remuneration payable to the directors of a company, including any managing or whole-time director, shall bedetermined, either by the articles of the company, or by a resolution or, if the articles so require, by a special resolution,passed by the company in general meeting; and the remuneration payable to any such director determined as aforesaidshall be inclusive of the remuneration payable to such director for services rendered by him in any other capacity. However,any remuneration for services rendered by any such director in any other capacity shall not be so included if: - (i) the servicesrendered are of a professional nature; and (ii) in the opinion of the Central Government, the director possesses the requisitequalifications for the practice of the profession.

A director may receive remuneration by way of a fee for each meeting of the Board, or a committee thereof, attended byhim. A director who is neither in the whole-time employment of the company nor a managing director may be paidremuneration, either by way of a monthly, quarterly or annual payment with the approval of the Central Government; or byway of commission if the company by special resolution authorises such payment. However, the remuneration paid to suchdirector, or where there is more than one such director, to all of them together, shall not exceed:- (i) one per cent of the netprofits of the company, if the company has a managing or whole-time director, a managing agent or secretaries and

treasurers or a manager; (ii) three per cent of the net profits of the company, in any other case.

Every public company having paid-up capital of not less than five crores of rupees shall constitute a committee of the Boardknows as 'Audit Committee' which shall consist of not less than three directors and such number of other directors as theBoard may determine of which two thirds of the total number of members shall be directors, other than managing or whole-time directors. The annual report of the company shall disclose the composition of the Audit Committee. The auditors, theinternal auditor, if any, and the director-in-charge of finance shall attend and participate at meetings of the Audit Committeebut shall not have the right to vote.

The Audit Committee should have discussions with the auditors periodically about internal control systems, the scope of



audit including the observations of the auditors and review the half-yearly and annual financial statements before submissionto the Board and also ensure compliance of internal control systems. It shall have authority to investigate into any matter inrelation to the items specified by the Board and for this purpose, shall have full access to information contained in therecords of the company and external professional advice, if necessary. The recommendations of the Audit Committee onany matter relating to financial management, including the audit report, shall be binding on the Board. If the Board does notaccept the recommendations of the Audit Committee, it shall record the reasons thereof and communicate such reasons tothe shareholders.

Besides, a listed public company may, and in the case of resolutions relating to such business as the Central Governmentmay, by notification, declare to be conducted only by postal ballot, shall, get any resolution passed by means of a postalballot, instead of transacting the business in general meeting of the company. Where a company decides to pass anyresolution by resorting to postal ballot, it shall send a notice to all the shareholders, along with a draft resolution explainingthe reasons thereof, and requesting them to send their assent or dissent in writing on a postal ballot within a period of thirtydays from the date of posting of the letter. If a resolution is assented to by a requisite majority of the shareholders by meansof postal ballot, it shall be deemed to have been duly passed at a general meeting convened in that behalf. However, if ashareholder sends his assent or dissent in writing on a postal ballot and thereafter any person fraudulently defaces ordestroys the ballot paper or declaration of identify of the shareholder, such person shall be punishable with imprisonment fora term which may extend to six months or with fine or with both.

2. In the competitive and technology driven business environment, while corporates require greater autonomy of operationand opportunity for self-regulation with optimum compliance costs, there is a need to bring about transparency throughbetter disclosures and greater responsibility on the part of corporate owners and management for improved compliance. Inresponse to such changing corporate climate, the Companies Act, 1956 has been amended from time to time so as toprovide more transparency in corporate governance and protect the interests of small investors, depositors and debentureholders, etc.

The important step in this direction has been the Companies Bill, 2004, which has been introduced to provide thecomprehensive review of the company law. It contained important provisions relating to corporate governance, like,independence of auditors, relationship of auditors with the management of company, independent directors with a view toimprove the corporate governance practices in the corporate sector. It is subjected to greater flexibility and self-regulation bycompanies, better financial and non-financial disclosures, more efficient enforcement of law, etc.

This amendment to the Companies Act 1956 mainly focused on reforming the audit process and the board of directors. Itmainly aimed at:- (i) laying down the process of appointment and qualification of auditors, (ii) prohibiting non-audit servicesby the auditors; (iii) prescribing compulsory rotation, at least of the Audit Partner; (iv) requiring certification of annual auditedaccounts by both CEO and CFO; etc. For reforming the boards, the bill included that remuneration of non-executivedirectors can be fixed only by shareholders and must be disclosed. A limit on the amount which can be paid would also be

laid down. It is also envisaged that the directors should be imparted suitable training. However, among others, anindependent director should not have substantial pecuniary interest in the company‘s shares.

SEBI Laws

An improved corporate governance is the key objective of the regulatory framework in the securities market.Accordingly, Securities and Exchange Board of India (SEBI) has made several efforts with a view to evaluate theadequacy of existing corporate governance practices in the country and further improve these practices. It is implementingand maintaining the standards of corporate governance through the use of its legal and regulatory framework, namely:-

1. Securities Contracts (Regulation) Act, 1956

This Act was enacted to prevent undesirable transactions and to check speculation in the securities by regulating thebusiness of dealing therein. Any stock exchange, which is desirous of being recognised, may make an application in theprescribed manner to the Central Government. Every application shall contain such particulars as may be prescribed, andshall be accompanied by a copy of the bye-laws of the stock exchange for the regulation and control of contracts as well asa copy of the rules relating in general to the constitution of the stock exchange, and in particular to:- (i) the governing body ofsuch stock exchange, its constitution and powers of management and the manner in which its business is to be transacted;(ii) the powers and duties of the office bearers of the stock exchange; (iii) the admission into the stock exchange of variousclasses of members, the qualifications for membership, and the exclusion, suspension, expulsion and re-admission ofmembers there from or there into; (iv) the procedure for the registration of partnerships as members of the stock exchange,in cases where the rules provide for such membership; and the nomination and appointment of authorised representativesand clerks.

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Every recognised stock exchange shall furnish the Central Government with a copy of the annual report, and such annualreport shall contain such particulars as may be prescribed. It may make rules or amend any rules made by it to provide forall or any of the following matters, namely:- (i) the restriction of voting rights to members only in respect of any matter placedbefore the stock exchange at any meeting; (ii) the regulation of voting rights in respect of any matter placed before the stockexchange at any meeting so that each member may be entitled to have one vote only, irrespective of his share of the paid-up equity capital of the stock exchange; (iii) the restriction on the right of a member to appoint another person as his proxy toattend and vote at a meeting of the stock exchange; etc.

If, in the opinion of the Central Government, an emergency has arisen and for the purpose of meeting the emergency, theCentral Government considers it expedient so to do, it may, by notification in the Official Gazette, for reasons to be set outtherein, direct a recognised stock exchange to suspend such of its business for such period not exceeding seven days andsubject to such conditions as may be specified in the notification, and, if, in the opinion of the Central Government, theinterest of the trade or the public interest requires that the period should be extended, it may, by like notification extend thesaid period from time to time.

Securities Contracts (Regulation) Amendment Act, 2007 has been enacted in order to further amend the SecuritiesContracts (Regulation) Act, 1956, with a view to include securitisation instruments under the definition of 'securities' andprovide for disclosure based regulation for issue of the securitised instruments and the procedure thereof. This has beendone keeping in view that there is considerable potential in the securities market for the certificates or instruments undersecuritisation transactions. Further, replication of the securities markets framework for these instruments would facilitatetrading on stock exchanges and, in turn, help development of the market in terms of depth and liquidity.

2. Securities and Exchange Board of India Act, 1992

This Act was enacted to protect the interests of investors in securities and to promote the development of, and to regulate,the securities market and for matters connected therewith or incidental thereto. For this purpose, the SEBI (the Board), byregulation, specify:- (i) the matters relating to issue of capital, transfer of securities and other matters incidental thereto; and(b) the manner in which such matters shall be disclosed by the companies.

No stock-broker, sub-broker, share transfer agent, banker to an issue, trustee of trust deed, registrar to an issue, merchantbanker, underwriter, portfolio manager, investment adviser and such other intermediary who may be associated withsecurities market shall buy, sell or deal in securities except under, and in accordance with, the conditions of a certificate ofregistration obtained from the Board in accordance with the regulations made under this Act.

No depository, participant, custodian of securities, foreign institutional investor, credit rating agency, or any otherintermediary associated with the securities market as the Board may by notification in this behalf specify, shall buy or sell or

deal in securities except under and in accordance with the conditions of a certificate of registration obtained from the Boardin accordance with the regulations made under this Act.

Further, no person shall sponsor or cause to be sponsored or carry on or caused to be carried on any venture capital fundsor collective investment scheme including mutual funds, unless he obtains a certificate of registration from the Board inaccordance with the regulations.

Every application for registration shall be in such manner and on payment of such fees as may be determined byregulations. The Board may, by order, suspend or cancel a certificate of registration in a prescribed manner, as may bedetermined by regulations under this Act. However, no order shall be made unless the person concerned has been given areasonable opportunity of being heard.

3. Depositories Act, 1996

This Act was enacted to provide for regulation of depositories in securities and for matters connected therewith or incidentalthereto. It provides for the introduction of scripless trading system and settlement, which is considered necessary for theeffective functioning of the securities markets. As per the Act, the term 'depository' means "a company formed andregistered under the Companies Act, 1956 and which has been granted a certificate of registration under sub-section (1A) ofsection 12 of the Securities and Exchange Board of India Act, 1992".

No depository shall act as a depository unless it obtains a certificate of commencement of business from the Board (theSEBI). The Board shall grant a certificate only if it is satisfied that the depository has adequate systems and safeguards toprevent manipulation of records and transactions. However, a certificate shall not be refused unless the depositoryconcerned has been given a reasonable opportunity of being heard.











A depository shall enter into an agreement with one or more participants as its agent, in such form as may be specified bythe bye-laws. Any person, through a participant, may enter into an agreement, in such form as may be specified by the bye-laws, with any depository for availing its services. Any such person shall surrender the certificate of security, for which heseeks to avail the services of a depository, to the issuer in such manner as may be specified by the regulations. The issuer,on receipt of certificate of security, shall cancel the certificate of security and substitute in its records the name of thedepository as a registered owner in respect of that security and inform the depository accordingly. A depository shall, onreceipt of information, enter the name of the person referred in its records, as the beneficial owner.

On receipt of intimation from a participant, every depository shall register the transfer of security in the name of thetransferee. If a beneficial owner or a transferee of any security seeks to have custody of such security, the depository shallinform the issuer accordingly.

Every person subscribing to securities offered by an issuer shall have the option either to receive the security certificates orhold securities with a depository. Where a person opts to hold a security with a depository, the issuer shall intimate suchdepository the details of allotment of the security, and on receipt of such information the depository shall enter in its recordsthe name of the allottee as the beneficial owner of that security.

A depository shall be deemed to be the registered owner for the purposes of effecting transfer of ownership of security onbehalf of a beneficial owner. However, it shall not have any voting rights or any other rights in respect of securities held by it.The beneficial owner shall be entitled to all the rights and benefits and be subjected to all the liabilities in respect of hissecurities held by a depository.

The Board, on being satisfied that it is necessary in the public interest or in the interest of investors so to do, may, by orderin writing,:- (i) call upon any issuer, depository, participant or beneficial owner to furnish in writing such information relating tothe securities held in a depository as it may require; or (ii) authorise any person to make an enquiry or inspection in relationto the affairs of the issuer, beneficial owner, depository or participant, who shall submit a report of such enquiry or inspectionto it within such period as may be specified in the order.

Title of the chapter 23

The legal and regulatoryframework forenvironmental protection

in IndiaIntroductionOver the years, together with a spreading of environmental consciousness, therehas been a change in the traditionally-held perception that there is a trade-offbetween environmental quality and economic growth as people have come tobelieve that the two are necessarily complementary. The current focus onenvironment is not new—environmental considerations have been an integralpart of the Indian culture. The need for conservation and sustainable use ofnatural resources has been expressed in Indian scriptures, more than threethousand years old and is reflected in the constitutional, legislative and policyframework as also in the international commitments of the country.Even before India‘s independence in 1947, several environmental legislation existed but the real impetus for bringing about a well-developed frameworkcame only after the UN Conference on the Human Environment (Stockholm,1972). Under the influence of this declaration, the National Council forEnvironmental Policy and Planning within the Department of Science andTechnology was set up in 1972. This Council later evolved into a full-fledgedMinistry of Environment and Forests (MoEF) in 1985 which today is the apexadministrative body in the country for regulating and ensuring environmentalprotection. After the Stockholm Conference, in 1976, constitutional sanction was



given to environmental concerns through the 42nd Amendment, whichincorporated them into the Directive Principles of State Policy and FundamentalRights and Duties.Since the 1970s an extensive network of environmental legislation has grownin the country. The MoEF and the pollution control boards (CPCB i.e. CentralPollution Control Board and SPCBs i.e. State Pollution Control Boards) togetherform the regulatory and administrative core of the sector.A policy framework has also been developed to complement the legislativeprovisions. The Policy Statement for Abatement of Pollution and the NationalConservation Strategy and Policy Statement on Environment and Developmentwere brought out by the MoEF in 1992, to develop and promote initiatives forthe protection and improvement of the environment. The EAP (Environmental

2Action Programme) was formulated in 1993 with the objective of improvingenvironmental services and integrating environmental considerations in todevelopment programmes.

Other measures have also been taken by the government to protect andpreserve the environment. Several sector-specific policies have evolved, whichare discussed at length in the concerned chapters.This chapter attempts to highlight only legislative initiatives towards theprotection of the environment.

Legislation for environmental protection inIndiaWater Water quality standards especially those for drinking water are set by theIndian Council of Medical Research. These bear close resemblance to WHOstandards. The discharge of industrial effluents is regulated by the Indian

Standard Codes and recently, water quality standards for coastal water marineoutfalls have also been specified. In addition to the general standards, certainspecific standards have been developed for effluent discharges from industriessuch as, iron and steel, aluminium, pulp and paper, oil refineries,petrochemicals and thermal power plants. Legislation to control water pollutionare listed below.

Water (Prevention and Control of Pollution) Act, 1974This Act represented India‘s first attempts to comprehensively deal with environmental issues. The Act prohibits the discharge of pollutants into waterbodies beyond a given standard, and lays down penalties for non-compliance.The Act was amended in 1988 to conform closely to the provisions of the EPA,

1986. It set up the CPCB (Central Pollution Control Board) which lays downstandards for the prevention and control of water pollution. At the State level,the SPCBs (State Pollution Control Board) function under the direction of theCPCB and the state government.

Water (Prevention and Control of Pollution) Cess Act, 1977This Act provides for a levy and collection of a cess on water consumed byindustries and local authorities. It aims at augmenting the resources of thecentral and state boards for prevention and control of water pollution.



Following this Act, The Water (Prevention and Control of Pollution) Cess Rules wereLegal and regulatory framework 25

formulated in 1978 for defining standards and indications for the kind of andlocation of meters that every consumer of water is required to install.

Air

Air (Prevention and Control of Pollution) Act, 1981To counter the problems associated with air pollution, ambient air qualitystandards were established, under the 1981 Act. The Act provides means for thecontrol and abatement of air pollution. The Act seeks to combat air pollution byprohibiting the use of polluting fuels and substances, as well as by regulatingappliances that give rise to air pollution. Under the Act establishing oroperating of any industrial plant in the pollution control area requires consentfrom state boards. The boards are also expected to test the air in air pollutioncontrol areas, inspect pollution control equipment, and manufacturingprocesses.National Ambient Air Quality Standards (NAAQS) for major pollutantswere notified by the CPCB in April 1994. These are deemed to be levels of air

quality necessary with an adequate margin of safety, to protect public health,vegetation and property (CPCB 1995 cited in Gupta, 1999). The NAAQSprescribe specific standards for industrial, residential, rural and other sensitiveareas. Industry-specific emission standards have also been developed for ironand steel plants, cement plants, fertilizer plants, oil refineries and thealuminium industry. The ambient quality standards prescribed in India aresimilar to those prevailing in many developed and developing countries.To empower the central and state pollution boards to meet graveemergencies, the Air (Prevention and Control of Pollution) Amendment Act , 1987,was enacted. The boards were authorized to take immediate measures to tacklesuch emergencies and recover the expenses incurred from the offenders. The

power to cancel consent for non-fulfilment of the conditions prescribed has alsobeen emphasized in the Air Act Amendment.The Air (Prevention and Control of Pollution) Rules formulated in 1982, definedthe procedures for conducting meetings of the boards, the powers of thepresiding officers, decision-making, the quorum; manner in which the recordsof the meeting were to be set etc. They also prescribed the manner and thepurpose of seeking assistance from specialists and the fee to be paid to them.Complementing the above Acts is the Atomic Energy Act of 1982, which wasintroduced to deal with radioactive waste. In 1988, the Motor Vehicles Act, wasenacted to regulate vehicular traffic, besides ensuring proper packaging,labelling and transportation of the hazardous wastes. Various aspects ofLegal and regulatory framework 26

vehicular pollution have also been notified under the EPA of 1986. Massemission standards were notified in 1990, which were made more stringent in1996. In 2000 these standards were revised yet again and for the first timeseparate obligations for vehicle owners, manufacturers and enforcing agencieswere stipulated. In addition, fairly stringent Euro I and II emission norms werenotified by the Supreme Court on April 29, 1999 for the city of Delhi. Thenotification made it mandatory for car manufacturers to conform to the Euro Iand Euro II norms by May 1999 and April 2000, respectively, for new noncommercial



vehicle sold in Delhi.

Forests and wildlife The Wildlife (Protection) Act, 1972, Amendment 1991The WPA (Wildlife Protection Act), 1972, provides for protection to listedspecies of flora and fauna and establishes a network of ecologically-important

protected areas. The WPA empowers the central and state governments todeclare any area a wildlife sanctuary, national park or closed area. There is ablanket ban on carrying out any industrial activity inside these protected areas.It provides for authorities to administer and implement the Act; regulate thehunting of wild animals; protect specified plants, sanctuaries, national parksand closed areas; restrict trade or commerce in wild animals or animal articles;and miscellaneous matters. The Act prohibits hunting of animals except withpermission of authorized officer when an animal has become dangerous tohuman life or property or so disabled or diseased as to be beyond recovery(WWF-India, 1999). The near-total prohibition on hunting was made moreeffective by the Amendment Act of 1991.

The Forest (Conservation) Act, 1980This Act was adopted to protect and conserve forests. The Act restricts thepowers of the state in respect of de-reservation of forests and use of forestlandfor non-forest purposes (the term ‗non-forest purpose‘ includes clearing anyforestland for cultivation of cash crops, plantation crops, horticulture or anypurpose other than re-afforestation).

General Environment (Protection) Act, 1986 (EPA)This Act is an umbrella legislation designed to provide a framework for the coordinationof central and state authorities established under the Water(Prevention and Control) Act, 1974 and Air (Prevention and Control) Act, 1981.Legal and regulatory framework 27

Under this Act, the central government is empowered to take measuresnecessary to protect and improve the quality of the environment by settingstandards for emissions and discharges; regulating the location of industries;management of hazardous wastes, and protection of public health and welfare.From time to time the central government issues notifications under the EPAfor the protection of ecologically-sensitive areas or issues guidelines for mattersunder the EPA.Some notifications issued under this Act are:

Doon Valley Notification (1989), which prohibits the setting up of an industryin which the daily consumption of coal/fuel is more than 24 MT (milliontonnes) per day in the Doon Valley.

Coastal Regulation Zone Notification (1991), which regulates activities alongcoastal stretches. As per this notification, dumping ash or any other waste inthe CRZ is prohibited. The thermal power plants (only foreshore facilitiesfor transport of raw materials, facilities for intake of cooling water andoutfall for discharge of treated waste water/cooling water) require clearancefrom the MoEF.

Dhanu Taluka Notification (1991), under which the district of Dhanu Talukahas been declared an ecologically fragile region and setting up power plantsin its vicinity is prohibited.



Revdanda Creek Notification (1989), which prohibits setting up industries inthe belt around the Revdanda Creek as per the rules laid down in thenotification.

The Environmental Impact Assessment of Development Projects Notification , (1994and as amended in 1997). As per this notification:

ll projects listed under Schedule I require environmental clearancefrom the MoEF.

require clearance from the MoEF.if

located in fragile regions must obtain MoEF clearance.

MoEF clearance and are further required to obtain a LOI (Letter OfIntent) from the Ministry of Industry, and an NOC (No ObjectionCertificate) from the SPCB and the State Forest Department if thelocation involves forestland. Once the NOC is obtained, the LOI isconverted into an industrial licence by the state authority.

Legal and regulatory framework 28also stipulated procedural requirements for the

establishment and operation of new power plants. As per thisnotification, two-stage clearance for site-specific projects such as pitheadthermal power plants and valley projects is required. Site clearance isgiven in the first stage and final environmental clearance in the second.A public hearing has been made mandatory for projects covered by thisnotification. This is an important step in providing transparency and agreater role to local communities.

Ash Content Notification (1997), required the use of beneficiated coal with ashcontent not exceeding 34% with effect from June 2001, (the date later wasextended to June 2002). This applies to all thermal plants located beyond one

thousand kilometres from the pithead and any thermal plant located in anurban area or, sensitive area irrespective of the distance from the pitheadexcept any pithead power plant.

Taj Trapezium Notification (1998), provided that no power plant could be setup within the geographical limit of the Taj Trapezium assigned by the TajTrapezium Zone Pollution (Prevention and Control) Authority.

Disposal of Fly Ash Notification (1999) the main objective of which is toconserve the topsoil, protect the environment and prevent the dumping anddisposal of fly ash discharged from lignite-based power plants. The salientfeature of this notification is that no person within a radius of 50 km from acoal-or lignite-based power plant shall manufacture clay bricks or tiles

without mixing at least 25% of ash with soil on a weight-to-weight basis. Forthe thermal power plants the utilisation of the flyash would be as follows:-or lignite-based power plant shall make available ash for at least

ten years from the date of publication of the above notification without anypayment or any other consideration, for the purpose of manufacturing ashbasedproducts such as cement, concrete blocks, bricks, panels or any othermaterial or for construction of roads, embankments, dams, dykes or for anyother construction activity.



environmental clearance conditions stipulating the submission of an actionplan for full utilisation of fly ash shall, within a period of nine years from thepublication of this notification, phase out the dumping and disposal of flyash on land in accordance with the plan.a

a Details of the notification available on http://envfor.nic.in/legis/hsm/flyash.html

Legal and regulatory framework 29

Rules for the Manufacture, Use, Import, Export and Storage of Hazardous Microorganisms/ Genetically Engineered Organisms or Cell were introduced in 1989 withthe view to protect the environment, nature and health in connection with genetechnology and micro-organisms, under the Environmental Protection Act,1986. The government in 1991, further decided to institute a national labelscheme for environmentally-friendly products called the ‗ECOMARK‘. The scheme attempts to provide incentives to manufactures and importers to reduceadverse environmental impacts, reward genuine initiatives by companies, andimprove the quality of the environment and sustainability of availableresources. Besides the above attempts, notifications pertaining to Recycled Plastics Manufacture and Usage Rules, 1999 were also incorporated under theEnvironment (Protection) Act of 1986.

The Environment (Protection) Rules, 1986These rules lay down the procedures for setting standards of emission ordischarge of environmental pollutants. The Rules prescribe the parameters forthe Central Government, under which it can issue orders of prohibition andrestrictions on the location and operation of industries in different areas. TheRules lay down the procedure for taking samples, serving notice, submittingsamples for analysis and laboratory reports. The functions of the laboratoriesare also described under the Rules along with the qualifications of theconcerned analysts.

The National Environment Appellate Authority Act, 1997This Act provided for the establishment of a National Environment Appellate

Authority to hear appeals with respect to restriction of areas in which anyindustry operation or process or class of industries, operations or processescould not carry out or would be allowed to carry out subject to certainsafeguards under the Environment (Protection) Act, 1986.In addition to these, various Acts specific to the coal sector have beenenacted. The first attempts in this direction can be traced back to the Mines Act,1952 , which promoted health and safety standards in coal mines. Later the Coal Mines (Conservation and Development) Act (1974) came up for conservation of coalduring mining operations. For conservation and development of oil and naturalgas resources a similar legislation was enacted in 1959.

Hazardous wastes

Legal and regulatory framework 30There are several legislation that directly or indirectly deal with hazardouswaste. The relevant legislation are the Factories Act, 1948, the Public LiabilityInsurance Act, 1991, the National Environment Tribunal Act, 1995 and somenotifications under the Environmental Protection Act of 1986. A briefdescription of each of these is given below.Under the EPA 1986, the MoEF has issued several notifications to tackle theproblem of hazardous waste management. These include:



Hazardous Wastes (Management and Handling) Rules, 1989 , which brought outa guide for manufacture, storage and import of hazardous chemicals and formanagement of hazardous wastes.

Biomedical Waste (Management and Handling) Rules, 1998, were formulatedalong parallel lines, for proper disposal, segregation, transport etc. ofinfectious wastes.

Municipal Wastes (Management and Handling) Rules, 2000, whose aim was toenable municipalities to dispose municipal solid waste in a scientificmanner.

Hazardous Wastes (Management and Handling) Amendment Rules, 2000 , a recentnotification issued with the view to providing guidelines for the import andexport of hazardous waste in the country.

Factories Act, 1948 and its Amendment in 1987The Factories Act, 1948 was a post-independence statute that explicitly showedconcern for the environment. The primary aim of the 1948 Act has been toensure the welfare of workers not only in their working conditions in thefactories but also their employment benefits. While ensuring the safety and

health of the workers, the Act contributes to environmental protection. The Actcontains a comprehensive list of 29 categories of industries involving hazardousprocesses, which are defined as a process or activity where unless special care istaken, raw materials used therein or the intermediate or the finished products,by-products, wastes or effluents would:

ution of the general environment

Public Liability Insurance Act (PLIA), 1991The Act covers accidents involving hazardous substances and insurancecoverage for these. Where death or injury results from an accident, this Actmakes the owner liable to provide relief as is specified in the Schedule of the

Act. The PLIA was amended in 1992, and the Central Government wasLegal and regulatory framework 31

authorized to establish the Environmental Relief Fund, for making reliefpayments.

National Environment Tribunal Act, 1995The Act provided strict liability for damages arising out of any accidentoccurring while handling any hazardous substance and for the establishment ofa National Environment Tribunal for effective and expeditious disposal of casesarising from such accident, with a view to give relief and compensation fordamages to persons, property and the environment and for the mattersconnected therewith or incidental thereto.a

International agreements on environmentalissuesIndia is signatory to a number of multilateral environment agreements (MEA)and conventions. An overview of some of the major MEAs and India‘s obligations under these is presented below. These are discussed at length in therespective chapters.

Convention on International Trade in Endangered Species of wild fauna and flora (CITES), 1973



The aim of CITES is to control or prevent international commercial trade inendangered species or products derived from them. CITES does not seek todirectly protect endangered species or curtail development practices thatdestroy their habitats. Rather, it seeks to reduce the economic incentive to poachendangered species and destroy their habitat by closing off the internationalmarket. India became a party to the CITES in 1976. International trade in allwild flora and fauna in general and species covered under CITES is regulated

jointly through the provisions of The Wildlife (Protection) Act 1972, theImport/Export policy of Government of India and the Customs Act 1962 (Bajaj,1996).

Montreal Protocol on Substances that deplete the Ozone Layer (to the Vienna Convention for the Protection of the Ozone Layer), 1987 The Montreal Protocol to the Vienna Convention on Substances that deplete theOzone Layer, came into force in 1989. The protocol set targets for reducing thea For details refer to http://envfor.nic.in

Legal and regulatory framework 32

consumption and production of a range of ozone depleting substances (ODS). Ina major innovation the Protocol recognized that all nations should not be treatedequally. The agreement acknowledges that certain countries have contributed toozone depletion more than others. It also recognizes that a nation‘s obligation to reduce current emissions should reflect its technological and financial ability todo so. Because of this, the agreement sets more stringent standards andaccelerated phase-out timetables to countries that have contributed most toozone depletion (Divan and Rosencranz, 2001).India acceded to the Montreal Protocol along with its London Amendmentin September 1992. The MoEF has established an Ozone Cell and a steeringcommittee on the Montreal Protocol to facilitate implementation of the India

Country Program, for phasing out ODS production by 2010.To meet India‘s commitments under the Montr eal Protocol, the Governmentof India has also taken certain policy decisions.

-out projects funded by theMultilateral Fund are fully exempt from duties. This benefit has been alsoextended to new investments with non-ODS technologies.

with ODS technologies.The Gazette of India on 19 July 2000 notified rules for regulation of ODSphase-out called the Ozone Depleting Substances (Regulation and Control) Rules,2000 . They were notified under the Environment (Protection) Act, 1986. Theserules were drafted by the MoEF following consultations with industries and

related government departments.Basel Convention on Transboundary Movement of Hazardous Wastes, 1989 Basel Convention, which entered into force in 1992, has three key objectives:

city to disposehazardous wastes in an environmentally sound manner.



India ratified the Basel Convention in 1992, shortly after it came into force.The Indian Hazardous Wastes Management Rules Act 1989, encompasses someof the Basel provisions related to the notification of import and export ofhazardous waste, illegal traffic, and liability.Legal and regulatory framework 33

UN Framework Convention on Climate Change (UNFCCC), 1992 The primary goals of the UNFCCC were to stabilize greenhouse gas emissionsat levels that would prevent dangerous anthropogenic interference with theglobal climate. The convention embraced the principle of common butdifferentiated responsibilities which has guided the adoption of a regulatorystructure.India signed the agreement in June 1992, which was ratified in November 1993.As per the convention the reduction/limitation requirements apply only todeveloped countries. The only reporting obligation for developing countriesrelates to the construction of a GHG inventory. India has initiated thepreparation of its First National Communication (base year 1994) that includes

an inventory of GHG sources and sinks, potential vulnerability to climatechange, adaptation measures and other steps being taken in the country toaddress climate change. The further details on UNFCC and the Kyoto Protocolare provided in Atmosphere and climate chapter.

Convention on Biological Diversity, 1992 The Convention on Biological Diversity (CBD) is a legally binding, frameworktreaty that has been ratified until now by 180 countries. The CBD has three mainthrust areas: conservation of biodiversity, sustainable use of biological resourcesand equitable sharing of benefits arising from their sustainable use.The Convention on Biological Diversity came into force in 1993. Manybiodiversity issues are addressed in the convention, including habitat

preservation, intellectual property rights, biosafety, and indigenous peoples‘ rights.India‘s initiatives under the Convention are detailed in the chapter onBiodiversity. These include the promulgation of the Wildlife (Protection) Act of1972, amended in 1991; and participation in several international conventionssuch as CITES.

UN Convention on Desertification, 1994 Delegates to the 1992 UN Conference on Environment and Development(UNCED) recommended establishment of an intergovernmental negotiatingcommittee for the elaboration of an international convention to combatdesertification in countries experiencing serious drought and/or desertification.Legal and regulatory framework 34

The UN General Assembly established such a committee in 1992 that laterhelped formulation of Convention on Desertification in 1994.The convention is distinctive as it endorses and employs a bottom-upapproach to international environmental cooperation. Under the terms of theconvention, activities related to the control and alleviation of desertification andits effects are to be closely linked to the needs and participation of local landusersand non-governmental organizations. Seven countries in the South Asianregion are signatories to the Convention, which aims at tackling desertification



through national, regional and sub-regional action programmes. The RegionalAction Programme has six Thematic Programme Networks (TPN's) for theAsian region, each headed by a country task manager. India hosts the networkon agroforestry and soil conservation. For details refer to the land resourcechapter.

International Tropical Timber Agreement and The International Tropical Timber Organisation (ITTO),1983, 1994 The ITTO established by the International Tropical Timber Agreement (ITTA),1983, came into force in 1985 and became operational in 1987a . The ITTOfacilitates discussion, consultation and international cooperationon issues relating to the international trade and utilization of tropical timberandthe sustainable management of its resource base. The successor agreement to theITTA (1983) was negotiated in 1994, and came into force on 1 January 1997. Theorganization has 57 member countries. India ratified the ITTA in 1996.

An assessment of the legal and regulatoryframework for environmental protection inIndiaThe extent of the environmental legislation network is evident from the abovediscussion but the enforcement of the laws has been a matter of concern. Onecommonly cited reason is the prevailing command and control nature of theenvironmental regime. Coupled with this is the prevalence of the all-or –nothingapproach of the law; they do not consider the extent of violation. Fines arelevied on a flat basis and in addition, there are no incentives to lower thedischarges below prescribed levels.a For details refer to the web site: www.itto.or.jp/Index.html

Legal and regulatory framework 35Some initiatives have addressed these issues in the recent past. TheGovernment of India came out with a Policy Statement for Abatement ofPollution in 1992, before the Rio conference, which declared that market-basedapproaches would be considered in controlling pollution. It stated thateconomic instruments will be investigated to encourage the shift from curativeto preventive measures, internalise the costs of pollution and conserveresources, particularly water. In 1995, the Ministry of Environment and Forest(MoEF) constituted a task force to evaluate market-based instruments, whichstrongly advocated their use for the abatement of industrial pollution. Variouseconomic incentives have been used to supplement the command-and-controlpolicies. Depreciation allowances, exemptions from excise or customs dutypayment, and arrangement of soft loans for the adoption of clean technologiesare instances of such incentives. Another aspect that is evident is the shift in thefocus from end-of-pipe treatment of pollution to treatment at source. The role ofremote sensing and geographical information systems in natural resourcemanagement and environmental protection has also gained importance overtime (Box 2.1).An important recent development is the rise of judicial activism in theenforcement of environmental legislation. This is reflected in the growth of



environment-related public litigation cases that have led the courts to takemajor steps such as ordering the shut-down of polluting factories.Agenda 21 highlights the need for integration of environmental concerns atall stages of policy, planning and decision-making processes including the useof an effective legal and regulatory framework, economic instruments and otherincentives. These very principles were fundamental to guiding environmentalprotection in the country well before Rio and will be reinforced, drawing onIndia‘s own experiences and those of other countries. Legal and regulatory framework 36

Box 2.1 Natural resource management and environmental protection:use of remote sensingIndia has made commendable advances in the use of emote sensingfor natural resource management. The major achievements can beclassified as follows:Use of remote sensing in integrating environment anddevelopment at the policy planning and management levels: Thecountry has an extensive and integrated institutional infrastructure and

focussed programme elements to enable integration of environmentalconcerns in decision making. The main initiatives include:National Natural Resource Management Systems : An integratedresource management system aimed at optimal utilisation of thecountry's natural resources through a systematic inventory of resourceavailability using remote sensing in conjunction with other techniquesRemote sensing for sound environmental management : Remotesensing is playing an important role in providing information on physicalenvironmental parametres, such as land and climate, vegetation, soils,water, terrain and slope, land sue, air and water pollution etc. Throughthe use of Geographical Information Systems, this information is

integrated with relevant collateral information to evolve solutions tomany environment issues. Notable achievements have been made inthe area of regular forest cover mapping and monitoring as well asdetection and monitoring of natural disasters along with assessment ofthe associated damages.Role of remote sensing in strengthening the legal and regulatoryframework for environmental protectionRemote sensing has established itself as an operational means toprovide reliable information and bench mark survey mechanisms in thecontext of (i) making laws and regulations more effective (ii)establishing judicial and administrative procedures, (iii) providing legal

reference and support services, (iv) developing effective nationalprogrammes for reviewing and enforcing compliance with national,state and local laws on environment and development. A number ofcase studies in the country demonstrate the application of remotesensing in this context- these cover forest encroachment studies,mapping of coastal regulation zones, enforcement of environmentallegislation, environmental impact assessments, vegetation changedetection studies and land use planning studies



Generation of natural resources information towardsstrengthening the national accounting system: Endeavors includethe setting up of a National Spatial Data Infrastructure (to build arepository of natural resource information), National (Natural)Resources Information System (to provide integrated information on

natural resources, socio-economic factors etc),Groundwater Prospects Zone Mapping, Bio-resource Data Base,Wasteland Mapping, and the Integrated Mission for SustainableDevelopment. The IMSD project aimed at generating action plans toenhance the productivity and quality of natural resources. The projectcovered 85 million ha of problem lands falling in 175 districts in thecountry and has been successful in evolving action plans withcommunity participation to address several issues including enrichinggroundwater potential and increasing cropping intensity.

Legal and Regulatory Framework

IntroductionA2.1 This sets out the relevant main provisions of the legal and regulatoryframework that applies to issues considered in this Explanatory Statement. Inparticular, the following is covered below:• generally about the framework under the EC CommunicationsDirectives;• the implementing UK legislation, the Communications Act 2003;• the procedures and the three stages for market reviews;• the reasons why ex ante regulation is needed as opposed to relyingon competition law remedies;• Ofcom‘s statutory Notifications of its decisions; • Impact Assessments; and• the key features and legal basis of the charge control regime.A2.2 Sections 3 to 6 of this Explanatory Statement deal, in effect, with thesubstantive application of those main provisions to Ofcom‘s considerations set out in this document.

A2.3 There is a key distinction to be drawn between Ofcom‘s treatment of the five different markets considered in this document. Two of those markets (intertandemconveyance and transit, and local-tandem conveyance and transit) aredefined and analysed in the same depth as previous market reviews (see Section3). For the other three markets (call origination, single transit, call termination),Ofcom is satisfied that there has not been a material change to those marketsthat would justify more extensive analysis in this document (see Annex 5).The Framework under the EC Communications DirectivesA2.4 A new regulatory framework for electronic communications networks (―ECN‖) and electronic communications services (―ECS‖), associated facilities and associated services entered into force on 25 July 2003. The framework isdesigned to create harmonised regulation across the European Community(―EC‖) and is aimed at reducing entry barriers and fostering prospects for effective competition to the benefit of consumers.A2.5 The new regulatory framework adopted by the European parliament and theCouncil in 2002 is established by the following five EC CommunicationsDirectives:



• Directive 2002/21/EC on a common regulatory framework forelectronic communications networks and services (the ―Framework Directive‖); 94• Directive 2002/19/EC on access to, and interconnection of, electroniccommunications networks and associated facilities (the ―Access and

Interconnection Directive‖); • Directive 2002/20/EC on the authorisation of electroniccommunications networks and services (the ―Authorisation Directive‖); • Directive 2002/22/EC on universal service and users' rights relating toelectronic communications networks and services , (the ―Universal Service Directive‖); and • Directive 2002/58/EC concerning the processing of personal data andthe protection of privacy in the electronic communications sector (the―Privacy Directive‖). A2.6 The Framework Directive provides the overall structure for the new regulatoryregime and sets out fundamental rules and objectives which read across all fiveDirectives.

A2.7 Article 8 of the Framework Directive sets out three key policy objectives whichhave been taken into account in the preparation of this document, namelypromotion of competition, development of the internal market and the promotionof the interests of the citizens of the European Union.A2.8 The Access and Interconnection Directive sets out the terms on whichproviders may access each others‘ networks and services with a view to providing publicly available electronic communications services.A2.9 The Authorisation Directive establishes a new system whereby any personwill be generally authorised to provide electronic communications services and/ornetworks without prior approval. Authorisation systems, such as individual orclass licences, involving explicit decisions or administrative acts by a nationalregulatory authority (―NRA‖), such as Ofcom, permitted under the previous EC

Directives adopted in 1997 are now prohibited. That said, an NRA may imposeon ECN and ECS providers specific obligations permitted under the ECCommunications Directives, such as obligations on operators designated ashaving significant market power (―SMP‖) specified in the Access and Interconnection Directive.A2.10 The Universal Service Directive defines a basic set of services that must beprovided to end-users.

A2.11 The Privacy Directive establishes users‘ rights with regard to the privacy of their communications.

The Communications Act 2003A2.12 The EC Communications Directives (apart from the Privacy Directive, whichwas implemented by regulations that came into force on 11 December 2003)

were implemented in the UK by the Communications Act 2003 (the ―2003 Act‖) with effect from (and including) 25 July 2003.A2.13 In particular, Part 2 of the 2003 Act sets out the majority of that Act‘s provisions that implement the EC Communications Directives. Sections 32, 45-50, and 78-90 of that Part are of particular importance. In addition, Ofcom is95required to act in accordance with its general and specific duties in sections 3and 4 of the 2003 Act, respectively.A2.14 Under section 3, Ofcom must, in carrying out its functions, further the



interests of citizens in relation to communications matters and the interests ofconsumers in relevant markets, where appropriate by promoting competition. Asto the latter, Ofcom must have regard, in particular, to the interests of thoseconsumers in respect of choice, price, quality of service and value for money.This corresponds to the policy objective in Article 8(2) of the Framework Directivewhere competition shall be promoted by inter alia ensuring that users (including

disabled users) derive maximum benefit in terms of choice, price and quality.A2.15 The three key policy objectives under that Article 8 have been set out above.NRAs must take all reasonable measures which are aimed at achieving them.This has been implemented in section 4 of the 2003 Act by requiring that Ofcomacts in accordance with the six Community requirements set out in this section.Where it appears to Ofcom that its general duties conflict with its section 4 duties,priority must be given to the latter.A2.16 From 25 July 2003 until 29 December 2003, the Director General ofTelecommunications and his office, the Office of Telecommunications (―Oftel‖) carried out the functions and responsibilities under the 2003 Act relating to theEC Communications Directives. On 29 December 2003, Ofcom took over thosefunctions and responsibilities, and it assumed the powers of the five former

regulators it has replaced, including Oftel.The Market ReviewsA2.17 The EC Communications Directives require NRAs to carry out reviews ofcompetition in communications markets to ensure that regulation remainsappropriate and proportionate in the light of changing market conditions.A2.18 The markets reviewed in this Explanatory Statement were first reviewed in2003 by Oftel (see further below as to the current market definitions).A2.19 Each market review has three stages, namely:

• definition of the relevant market or markets;

• assessment of competition in each market, in particular whether anyundertakings have SMP in a given market; and

• assessment of appropriate regulatory obligations where there has been afinding of SMP.A2.20 These three stages will be considered, in turn, below. But more detailedrequirements and guidance concerning the conduct of market reviews areprovided in the EU Communications Directives, the 2003 Act and in additionaldocuments issued by the European Commission. As required by the new regime,in conducting this review, Ofcom have taken the utmost account of the twoEuropean Commission documents discussed below.96

Market Definition StageGeneral A2.21 The first market review stage concerns the identification of a services market(i.e. market definition). Section 79(1) of the 2003 Act provides that, before amarket power determination may be considered, Ofcom must identify the marketwhich is, in its opinion, the one which, in the circumstances of the UnitedKingdom, is the market in relation to which it is appropriate to consider makingsuch a determination and to analyse that market. The procedure for marketdefinitions (known as ‗services market identifications‘ under the 2003 Act) is set out mainly in Article 15 of the Framework Directive and sections 78 to 86 of the2003 Act.A2.22 Article 15(3) of the Framework Directive requires that NRAs shall, taking the



utmost account of two documents published by the European Commission,define the relevant markets appropriate to national circumstances , in particularrelevant geographic markets within their territory, in accordance with theprinciples of competition law. These two documents will be considered in turn.The Recommendation on relevant product and service markets A2.23 The European Commission has identified in its first recommendation36 on

relevant product and service markets, adopted on 11 February 2003 (the―Recommendation‖) in accordance with Article 15(1) of the Framework Directive, a set of product and service markets within the electronic communications sector,in which ex ante regulation may be warranted.A2.24 The Recommendation seeks to promote harmonisation across the EC byensuring that the same markets are subject to a market analysis in all theMember States.A2.25 However, as the above-mentioned Article 15(3) makes it clear, NRAs are ableto regulate markets that differ from those identified in the Recommendationwhere this is justified by national circumstances and where the Commission doesnot raise any objections under Article 7(4) of the Framework Directive.Accordingly, NRAs are to define relevant markets appropriate to national

circumstances, provided that they take due account of the markets listed in theRecommendation. This obligation has been imposed on Ofcom under section79(2) of the 2003 Act.A2.26 According to Article 15(1) of the Framework Directive, the EuropeanCommission shall regularly review its Recommendation. Before adopting a newRecommendation, the European Commission must consult publicly as well aswith the NRAs. It stated in its first Recommendation that it would review the needfor any update no later than 30 June 2004 on the basis of market developments.A2.27 However, on 16 June 2004, the European Commission issued a pressrelease stating that, rather than launching a review of the Recommendation atthat stage, it had decided to ―reschedule the date for the launch of such a review 36 Commission Recommendation of 11 February 2003 on relevant product and service

markets within the electronic communications sector susceptible to ex ante regulation inaccordance with Directive 2002/21/EC of the European Parliament and of the Council on acommon regulatory framework for electronic communication networks and services,(2003/311/EC), OJ L 114/45, 8.5.2003.

97until the end of 2005‖. Its reasons for delaying the review were, firstly, that asignificant number of Member States had not even transposed the ECCommunications Directives; secondly, many Member States had yet to completethe first round of requisite market analyses; thirdly, the pace of change in themarkets for electronic communication was not such that an early review wouldappear justified; and, fourthly, launching a review could lead to substantialdisruption for the NRAs and increase the level of uncertainty related to regulatoryintervention.

A2.28 Until such a review has been concluded, the European Commission‘s 18 product and service markets listed in the Annex to the current Recommendation,which it has identified and recommended that NRAs should analyse, are therelevant markets that Ofcom must consider.Guidelines for market analysis and the assessment of SMP A2.29 The second document is guidelines37 for market analysis and the assessmentof SMP (the ―SMP Guidelines‖) published, in accordance with Article 15(2) of the Framework Directive, by the European Commission in July 2002.



A2.30 As noted above, Ofcom is also required under the said Article 15(3) (asimplemented in section 79(2) of the 2003 Act) to take the utmost account of theSMP Guidelines when identifying a services market (see further below for themarket analysis (SMP) stage).A2.31 Oftel published its own additional guidelines on the criteria to assess effectivecompetition, which can be found at http://www.ofcom.org.uk/static/archive/oftel/

publications/about_oftel/2002/smpg0802.htm . These supplement the SMPGuidelines and have been taken into account by Ofcom, where appropriate.Ofcom’s approach to services market identifications A2.32 There are two dimensions to the definition of a relevant market:

• the relevant products to be included in the same market; and

• the geographic extent of the market.A2.33 In defining the markets in accordance with the principles of competition law,Ofcom‘s approach to service market identifications follows, to start with, that usedby UK competition authorities (see, for instance, the competition law guideline bythe Office of Fair Trading (―OFT‖) entitled ‘Market Definition – Understanding competition law’ , December 2004, that can be found at:http://www.oft.gov.uk/NR/rdonlyres / 972AF80C-2D74-4A63-84B3-

27552727B89A/0/OFT403.pdf) and is in line with those used by European andUS competition authorities.A2.34 Market boundaries are determined by identifying constraints on the pricesettingbehaviour of firms. There are two main competitive constraints toconsider: how far it is possible for customers to substitute other services for thosein question (i.e. demand side substitution); and how far suppliers could switch, or37 Commission guidelines on market analysis and the assessment of significant market powerunder the Community regulatory framework for electronic communications networks andservices, (2002/C 165/03), OJ C 165/6, 11.7.2002.

98increase, production to supply the relevant products or services (i.e. supply-sidesubstitution) following a price increase.

A2.35 In this assessment, supply side substitution will be considered as a low costform of entry, which could take place within a relatively short period of time. TheOFT states, in its above-mentioned OFT Market Definition guideline, the relativelyshort period to be within a year. That is, for supply side substitution to berelevant, there would need to be additional competitive constraints arising fromentry into the supply of the service in question, from suppliers who are able toenter quickly and at low cost, by virtue of their existing position in the supply ofother services. As discussed below, only those supply side substitutionpossibilities that are viable in the absence of unregulated wholesale inputs will beconsidered as relevant to the analysis.

A2.36 The concept of the ‗hypothetical monopolist test‘ is a useful tool to identify close demand side and supply side substitutes. A product is considered to

constitute a separate market if a hypothetical monopoly supplier could impose asmall but significant, non-transitory price increase (―SSNIP‖) above the competitive level without losing sales to such a degree as to make thisunprofitable. If such a price rise would be unprofitable, because consumers wouldswitch to other products, or because suppliers of other products would begin tocompete with the monopolist, then the market definition should be expanded toinclude the substitute products.A2.37 There might be suppliers who provide other retail and wholesale services butwho might also be materially present in the provision of demand side substitutes



to the service for which the hypothetical monopolist has raised its price. However,such suppliers are not relevant to supply side substitution, as they supplyservices already identified as demand side substitutes. As such, their entry hasalready been taken into account and so supply side substitution cannot providean additional competitive constraint on the hypothetical monopolist. However, theimpact of expansion by such suppliers can be taken into account in the

assessment of market power.A2.38 Sometimes an additional consideration is whether there are common pricingconstraints across customers, services or areas such that they should beincluded within the same relevant market even if demand and supply sidesubstitution are not present.Relationship between the wholesale and retail markets A2.39 In this Explanatory Statement, the relevant markets have been consideredboth at the retail and the wholesale level. Consideration of the relevant retailmarkets logically precedes the analysis of the wholesale markets, since thedemand for wholesale services is derived from the demand for retail services.A2.40 The purpose of this review of the markets is to assess whether a provider hasSMP in a wholesale market and to identify appropriate remedies to address the

existence of market power, i.e. the identified competition problem.A2.41 It is, therefore, necessary for the definition of retail markets to be undertakenin the absence of regulation of wholesale services. To do otherwise would meanthat the wholesale market power assessment would depend on a retail marketdefinition that relied on a wholesale remedy arising from the finding of wholesale99market power. This would be a circular and incorrect approach to marketdefinition.A2.42 Accordingly, the demand side and supply side substitution possibilities at theretail level are considered only if they are viable in the absence of regulatedwholesale inputs.Retail geographic market

A2.43 In addition to the products to be included within a market, market definitionalso requires the geographic extent of the market to be specified. The geographicmarket is the area within which demand side and/or supply side substitution cantake place and is defined using a similar approach to that used to define theproduct market. Ofcom has considered the geographic extent of each relevantmarket covered in this market review.A2.44 There are a number of possible approaches to geographic market definition.One approach would be to begin with a narrowly-defined area and then considerwhether a price increase by a hypothetical monopolist in that narrowly definedarea would encourage customers to switch to suppliers located outside the area(demand-side substitution) or operators outside the area to begin to offer servicesin the area (supply-side substitution). If supply and/or demand side substitution is

sufficient to constrain prices then it is appropriate to expand the geographicmarket boundary.A2.45 Ofcom recognises that in certain telecommunications (product) markets in theUK, there could be different competitive pressures in different geographic areas.An obvious example is local access where BT competes with cable operatorswho have local franchises. Another is trunk segments of leased lines. In thesecircumstances it might be possible to identify separate geographic markets forsome services. However, a number of difficulties would then arise. In particular,the definition of separate geographic markets using the hypothetical monopolist



test as outlined above would likely lead to a proliferation of markets. This, whenconsidered along with the dynamic nature of telecommunications markets, wouldlikely mean that the boundary between areas where there are differentcompetitive pressures would be unstable and change over time, rendering themarket definition obsolete. It is not clear that determining ex-ante where theboundary would be is an exercise that could be carried out with any degree of

accuracy.A2.46 Because of the difficulties associated with defining separate geographicareas, there is a risk that inappropriate decisions would be made about theimposition or removal of regulations, which could be detrimental to consumersand competition. In any case, even if separate narrow local markets were to bedefined it is likely that BT would continue to have SMP in many of these markets.Therefore, such a detailed approach is unlikely to add significant benefit to theregulatory outcome being proposed.A2.47 An alternative approach is to define geographic markets in a broader sense.This involves defining a single geographic market but recognising that this singlemarket has local geographical characteristics. That is to say, recognising thatwithin the single market there are areas where competition is more developed

than in other areas. This avoids the difficulties of proliferation and instability.100European Commission’s approach to market definition A2.48 In formulating its approach to market definition, Ofcom has taken due accountof the Recommendation.A2.49 The 7th recital to the Recommendation clearly states that the starting point formarket definition is a characterisation of the retail market over a given timehorizon, taking into account the possibilities for demand and supply sidesubstitution. The wholesale market is identified subsequently to this exercisebeing carried out in relation to the retail market. This approach is repeated insection 3.1 of the Explanatory Memorandum to the Recommendation (the ―EM‖) and is exactly that set out above and followed by Ofcom.

A2.50 Section 3.1 of the EM also states that, because any market analysis isforward looking, markets are to be defined prospectively taking account ofexpected or foreseeable technological or economic developments over areasonable horizon linked to the timing of the next market review. Again, this isthe approach followed by Ofcom.A2.51 Furthermore, section 3.1 of the EM states that market definition is not an endin itself, but a means to assessing effective competition for the purposes of ex ante regulation. Ofcom has adopted an approach by which this consideration is atthe centre of its analysis. The purpose of market definition is to illuminate thesituation with regard to competitive pressures. For example, Ofcom's approach tosupply side substitution explicitly identifies as the key issue the question ofwhether additional competitive constraints on pricing are brought to bear by

additional suppliers entering the market. Thus, the key issue is not the marketdefinition for its own sake, but an identification of the extent and strength ofcompetitive pressures.A2.52 Also, section 4 of the EM states that retail markets should be examined in away that is independent of the infrastructure being used, as well as in accordancewith the principles of competition law. Again, this approach is key to Ofcom'sanalysis. As seen from the above, Ofcom's approach is based on a competitionlaw assessment of markets and an assessment of the extent to which switchingamong services by consumers constrains prices, irrespective of the infrastructure



used by the providers of those services.Current market definitions for fixed narrowband markets A2.53 The narrowband markets covered in this document were last assessed byOftel, with its conclusions published in November 2003. Four of those marketswere covered in one document, the Market Review 2003 Statement38, whereasfixed call termination was covered in a separate document, the Fixed Call

Termination Statement39.38 Document entitled ‗Review of the fixed narrowband wholesale exchange line, call origination, conveyance and transit markets — Identification and analysis of markets,determination of market power and the setting of SMP conditions — Final ExplanatoryStatement and Notification‘ published by the Director General of Telecommunications on 28 November 2003;http://www.ofcom.org.uk/legacy_regulators/oftel/narrowband_mkt_rvw/nwe/fixednarrowbandst

atement.pdf.39 Document entitled ‗Review of fixed geographic call termination markets — Identification andanalysis of markets, determination of market power and setting of SMP conditions — Final

101A2.54 These documents defined the following markets for the purposes of regulationof wholesale narrowband interconnect services for the UK (excluding the Hullarea in markets other than fixed call termination) in respect of BT:• Call originationUK market definition: Call origination on fixed public narrowband networks(paragraph 1(a)(vi) of the Notification in Annex A to the Market Review2003 Statement).Commission’s market definition: Call origination on the public telephonenetwork provided at a fixed location. For the purposes of thisRecommendation, call origination is taken to include local call conveyanceand delineated in such a way as to be consistent with the delineatedboundaries for the markets for call transit and for call termination on thepublic telephone network provided at a fixed location (point 8 of the Annexto the Recommendation).

• Local-tandem conveyance/transit (“LTC/LTT”) UK market definition: Local-tandem conveyance and transit on fixedpublic narrowband networks (paragraph 1(a)(vii) of the Notification inAnnex A to the Market Review 2003 Statement).Commission’s market definition: Call origination on the public telephonenetwork provided at a fixed location. For the purposes of thisRecommendation, call origination is taken to include local call conveyanceand delineated in such a way as to be consistent with the delineatedboundaries for the markets for call transit and for call termination on thepublic telephone network provided at a fixed location (point 8 of the Annexto the Recommendation).

• Inter-tandem conveyance (“ITC”) /inter -tandem transit (“ITT”) UK market definition: Inter-tandem conveyance and transit on fixed publicnarrowband networks (paragraph 1(a)(viii) of the Notification in Annex Ato the Market Review 2003 Statement).Commission’s market definition: Transit services in the fixed publictelephone network. For the purposes of this Recommendation, transitservices are taken as being delineated in such a way as to be consistentwith the delineated boundaries for the markets for call origination and forcall termination on the public telephone network provided at a fixed



location (point 10 of the Annex to the Recommendation).

• Single transitUK market definition: Single transit on fixed public narrowband networks(paragraph 1(a)(ix) of the Notification in Annex A to the Market Review2003 Statement).Explanatory Statement and Notification‘ published by the Director General of

Telecommunications on 28 November 2003; http://www.ofcom.org.uk/legacy_regulators/oftel/ narrowband_mkt_rvw/Eureviewfinala1.pdf.

102Commission’s market definition: Transit services in the fixed publictelephone network. For the purposes of this Recommendation, transitservices are taken as being delineated in such a way as to be consistentwith the delineated boundaries for the markets for call origination and forcall termination on the public telephone network provided at a fixedlocation (point 10 of the Annex to the Recommendation).

• TerminationUK market definition: Fixed geographic call termination provided by BT(paragraph 1(a) of the Notification in Annex B to the Fixed Call

Termination Statement).Commission’s market definition: Call termination on individual publictelephone networks provided at a fixed location. For the purposes of thisRecommendation, call termination is taken to include local callconveyance and delineated in such a way as to be consistent with thedelineated boundaries for the markets for call origination and for calltransit on the public telephone network provided at a fixed location (point9 of the Annex to the Recommendation).A2.55 For the purposes of this Explanatory Statement, Ofcom considered itappropriate for reasons set out in Section 2 of this document to review themarkets of LTC/LTT and ITC/ITT.Market (SMP) Analysis Stage

General A2.56 The second market review stage concerns the assessment of competition ineach identified services market to decide whether any undertaking has SMP.A2.57 Article 16(1) of the Framework Directive provides that NRAs must, as soon aspossible after the adoption of the Recommendation or any updating thereof, carryout an analysis of the relevant markets, taking the utmost account of the SMPGuidelines. Ofcom‘s obligation to take due account of the SMP Guidelines in this context is set out in section 79(3) of the 2003 Act.A2.58 In carrying out a market analysis, the key issue for an NRA is to determinewhether the market in question is effectively competitive. The 27th recital to theFramework Directive clarifies the meaning of that concept. Namely, ―[i]t is essential that ex ante regulatory obligations should only be imposed where there

is not effective competition, i.e. in markets where there are one or moreundertakings with significant market power, and where national and Communitycompetition law remedies are not sufficient to address the problem‖. A2.59 Thus, Article 16 further prescribes, in effect, what regulatory action NRAsmust take depending upon whether or not the market in question has been foundeffectively competitive. If it has, then NRAs are prohibited to impose specific(SMP) obligations and must withdraw such obligations where they exist. On theother hand, where the market is not effectively competitive, the NRAs mustidentify the undertakings with SMP on that market and shall impose on them



appropriate obligations.103A2.60 Indeed, paragraphs 21 and 114 of the SMP Guidelines provide that merelydesignating an undertaking as having SMP on a given market without imposingany appropriate regulatory obligations is inconsistent with the new regulatoryframework, notably Article 16(4) of the Framework Directive. In other words,

NRAs must impose at least one regulatory obligation on an SMP operator.A2.61 Under the 2003 Act, the process of designating an undertaking as havingSMP is referred to as the making of a market power determination under section79. To reflect the provisions in Article 16, there is a close link in this analysis withthe imposition of remedies. This is because section 45 of the 2003 Act details thevarious conditions that may be set under the new regime. Section 46 of the 2003Act prescribes who those conditions may be imposed upon.A2.62 In relation to SMP services conditions, section 46(7) provides that they maybe imposed on a particular person who is a communications provider or a personwho makes associated facilities available and who has been determined to havesignificant market power in a ―services market‖ (i.e. a specific market for electronic communications networks, electronic communications services or

associated facilities). Accordingly, having identified the relevant market, Ofcom isrequired to analyse the market in order to assess whether any person or personshave SMP as defined in section 78 of the 2003 Act (Article 14 of the FrameworkDirective).Approach used to assess SMP A2.63 Under the EC Communications Directives and the said section 78, theconcept of SMP is defined so that it is equivalent to the competition law conceptof dominance. Article 14(2) of the Framework Directive provides: ―[a]n undertaking shall be deemed to have significant market power if, eitherindividually or jointly with others, it enjoys a position equivalent to dominance,that is to say a position of economic strength affording it the power to behave toan appreciable extent independently of competitors, customers and ultimately

consumers‖. A2.64 Further, Article 14(3) of the Framework Directive provides that: ―[w]here an undertaking has significant market power on a specific market, it may also bedeemed to have significant market power on a closely related market, where thelinks between the two markets are such as to allow the market power held in onemarket to be leveraged into the other market, thereby strengthening the marketpower of the undertaking‖. A2.65 Therefore, in the relevant market, one or more undertakings may bedesignated as having SMP where that undertaking, or undertakings, enjoy aposition of dominance. Also, an undertaking may be designated as having SMPwhere it could lever its market power from a closely related market into therelevant market, thereby strengthening its market power in the relevant market.

A2.66 In assessing whether BT has SMP in the relevant markets in question, Ofcomhas taken the utmost account of the SMP Guidelines as well as Oftel‘s supplemental guidelines, as referred to above, in its market power assessment.In particular, the analyses in Sections 4 and 5 provide an assessment of SMP inthe two markets in question against the criteria set out in those guidelines, suchas market shares, ease of market entry, and economies of scale.104The relationship between the market reviews and Competition Act 1998 and Enterprise Act 2002 investigations



A2.67 The economic analyses carried out in this Explanatory Statement are for thepurposes of determining whether an undertaking or undertakings have SMP inrelation to the markets in question. It is without prejudice to any economicanalysis that may be carried out in relation to any investigation or decisionpursuant to the Competition Act 1998 or the Enterprise Act 2002.A2.68 The fact that economic analysis carried out for a market review is without

prejudice to future competition law investigations and decisions is recognised in Article 15(1) of the Framework Directive which provides that: ―…The recommendation shall identify…markets…the characteristics of which may be such as to justify the imposition of regulatory obligations …without prejudice to markets that may be defined in specific cases under competition law…‖. A2.69 Its intention is further evidenced in the SMP Guidelines, which state:

• Paragraph 25: ―… Article 15(1) of the Framework Directive makes clear that the market to be defined by NRAs for the purpose of ex ante regulation are without prejudice to those defined by national competitionauthorities and by the Commission in the exercise of their respectivepowers under competition law in specific cases.‖ (repeated in paragraph 37);

• Paragraph 27: ―…Although NRAs and competition authorities, when examining the same issues in the same circumstances and with the sameobjectives, should in principle reach the same conclusions, it cannot beexcluded that, given the differences outline above, and in particular thebroader focus of the NRAs‘ assessment, markets defined for the purposes of competition law and markets defined for the purpose of sector-specificregulation may not always be identical‖; and

• Paragraph 28: ―…market definitions under the new regulatory framework, even in similar areas, may in some cases, be different from those marketsdefined by competition authorities.‖ A2.70 In addition, it is up to all providers to ensure that they comply with their legalobligations under all the laws applicable to the carrying out of their businesses. It

is incumbent upon all providers to keep abreast of changes in the markets inwhich they operate, and in their position in such markets, which may result inlegal obligations under the Competition Act 1998 or Enterprise Act 2002 applyingto their conduct.The need for ex-ante regulationNature of the competition problem identified A2.71 Before turning to the last stage market review stage concerning remedies, it isnecessary to consider whether competition law remedies are sufficient to addressthe problem. This consideration is necessary to establish, in line with the abovementioned27th recital to the Framework Directive, whether or not a market iseffectively competitive. (In this context, it is to be noted that the importance ofidentifying that problem reappears under Article 8(4) of the Access and

Interconnection Directive. This is because obligations imposed in accordance105with Article 8 shall be based on the nature of the problem identified, proportionateand justified in the light of the objectives laid down in Article 8 of the FrameworkDirective.)

A2.72 Ofcom‘s own guidelines on Impact Assessment note that Ofcom will consider the option of no regulation in its impact assessment process. Seewww.ofcom.org.uk/about/accoun/policy_making/#content for further details.



A2.73 In this light, it is considered below whether ex ante regulation is justified in themarkets identified in Sections 4 and 5 or whether it would be sufficient to rely oncompetition law alone to address market failures, while noting the EuropeanCommission‘s view in paragraphs 21 and 114 of the SMP Guidelines aboutimposing at least one SMP remedy.Appropriate to promote the development of competition

A2.74 As a competitive market will produce a more efficient outcome than aregulated market, the promotion of competition is central to securing the bestdeal for the consumer in terms of quality, choice and value for money.A2.75 Where markets are effectively competitive, ex post competition law issufficient to deal with any competition abuses that may arise. However, withoutthe imposition of ex ante regulations to promote actively the development ofcompetition in a non-effectively competitive market, it is unlikely that ex post general competition law powers will be sufficient to ensure that effectivecompetition becomes established. For example, this is because ex post powersprohibit abuse of dominance rather than the holding of a dominant position. Exante powers can be utilised to reduce the level of market power in a market andthereby encourage effective competition to become established.

A2.76 The risk is not all one way as use of some ex ante measures can themselveslimit or add nothing to the development of competition. Ofcom has recognisedthis in removing some regulation where markets are not effectively competitive.A2.77 Ofcom considers that ex ante regulation is necessary in most of the marketscovered by this Explanatory Statement and Notification. The remediesconsidered in Section 4 are appropriate to promote the development ofcompetition in downstream narrowband markets. A failure to regulate BT in thesemarkets is likely to affect the development of competition in that competingproviders would be unlikely to provide intermediate or retail services withoutwholesale services provided by BT. In the absence of regulation, BT would havelittle incentive to provide such wholesale services.A2.78 It is preferable to apply regulation at the wholesale level as this both

addresses SMP issues in the wholesale markets and promotes competition indownstream markets that rely on wholesale inputs. This fits with the requirementthat NRAs take measures which meet the objective of encouraging efficientinvestment in infrastructure and promoting innovation (see Article 8(2) of theFramework Directive and section 4 of the 2003 Act). The regulation of wholesalemarkets encourages competing providers to purchase wholesale products andcombine them with their own networks to create products in competition with BT.106Characteristics of communications markets in general A2.79 Generally, the case for ex ante regulation in communications markets isbased on the existence of market failures which, by themselves or incombination, mean that competition might not be able to become established if

the regulator relied solely on its ex post competition law powers established fordealing with more conventional sectors of the economy. Therefore, it isappropriate for ex-ante regulation to be used to address these market failuresand entry barriers that might otherwise prevent effective competition frombecoming established. By imposing ex ante regulation that will promotecompetition, it may be possible to reduce the need for such regulation as marketsbecome more competitive, with greater reliance on ex-post competition law.A2.80 The European Commission has stated, in paragraph 3 of section 3.2 of theEM, that ex ante regulation is justified: "[…] where the compliance requirements



of an intervention to redress a market failure are extensive (e.g. the need fordetailed accounting for regulatory purposes, assessment of costs, monitoring ofterms and conditions including technical parameters etc) or where frequentand/or timely intervention is indispensable, or where creating legal certainty if ofparamount concern.[…])." This is the case f or many markets where persistentSMP leads to a risk of a firm setting excessive prices and the need for efficiency

incentives, where a charge control would be justified, or where there is likely tobe a need for intervention to set detailed terms and conditions for access tonetworks. Indeed, this is the case for all the markets dealt with in this review.Market dominance A2.81 Although communications markets have in general become increasinglycompetitive over time, this is from a position in which most were controlled by alegacy monopoly operator. The increase in competition that has occurredinevitably reflects the imposition of ex ante regulation to counter the marketpower of the legacy operator. Moreover, despite this, the legacy operatorremains, in Ofcom‘s view, dominant in all except one of the markets in this review. Therefore, it is appropriate to continue to impose ex ante regulations inthese markets in order to ensure that effective competition can become

established.Network externality effects A2.82 Externality effects are present in the markets in this review. In particular, thenetwork externality effect, which means that the value of a network to its usersincreases more than proportionately with the number of subscribers, gives thelarge incumbent network a great advantage over potential competitors. Forexample, the value of a large network might be little affected if it refused todeliver calls to or accept calls from a much smaller entrant, but the latter mightfind it impossible to attract subscribers as a result. As a consequence, this wouldenable the incumbent to exclude rivals from the market by refusing tointerconnect with them or doing so only on onerous terms.A2.83 General ex post competition law powers may not be sufficient to address the

effects of the network externality. This is because the network externality effectgenerally re-enforces a dominant position and under general competition lawthere is no prohibition on holding a position of dominance in itself. Therefore, itmay be more appropriate to address the impact of network externality through ex 107ante obligations, for example by requiring interconnection with the incumbent‘s network.Entry barriers A2.84 The communications networks in this review are characterised by economiesof scale, that is, average costs fall as output increases. Economies of scale resultfrom the fact that a high proportion of the costs of a communications network arefixed while marginal costs (the costs of an extra unit of output) are relatively low.

A2.85 While the extent of economies of scale varies in different parts of the network,their existence means that a large network will tend to have lower average coststhan a smaller one. Successful entry by new network operators will thereforerequire significant investment and most of this will be sunk costs, in the sensethat the costs will not be recoverable if the entrant decides to exit the market.Significant sunk costs create an asymmetry in the market between incumbentsand potential entrants that the former could exploit to deter entry, if allowed to.Incumbents could exploit this asymmetry by signalling to a potential entrant that,if it were to enter the market, prices would be too low to cover sunk costs. Entry



might therefore be deterred.A2.86 Also, although entry at the retail level by operators without their own networksis likely to require relatively smaller sunk investments, it is also likely to requireregulated supply of wholesale inputs if retail competition is to become establishedwhere there is market power at the network level.A2.87 Therefore, in the communications markets covered by this Explanatory

Statement, especially where there is a requirement for larger sunk investments,ex ante regulation is appropriate to address the effect of this barrier to entry.A2.88 Ofcom does recognise, however, that inappropriate ex ante regulation canhave the effect of limiting competition. In formulating remedies to overcome SMP,it is important to consider the extent to which the proposed remedies will addressthe specific problem identified.

Remedies StageSubject matter of the SMP remedies A2.89 The third and final market review stage concerns remedies. As noted above,Article 16 of the Framework Directive dictates the imposition or removal of SMPremedies depending upon whether or not a finding of SMP in an identifiedservices market has been made. Where an SMP finding has been made, Ofcom

will consider what appropriate SMP remedies are available.A2.90 Under section 45 of the 2003 Act, Ofcom is empowered generally to set SMPservices conditions authorised or required by sections 87 to 92. The latterimplement Articles 9 to 13 of the Access and Interconnection Directive andArticles 17 to 19 of the Universal Service Directive. In addition, Ofcom‘s power to set such conditions includes additional powers specified in section 45(10), suchas powers to include provisions in SMP services conditions for Ofcom to makedirections in respect of specified markets.A2.91 The SMP obligations relevant to the markets covered by this ExplanatoryStatement are discussed in Section 6.108A2.92 Section 46 of the 2003 Act provides that SMP services conditions set under

section 45 may only be applied if the person to whom they are to apply is acommunications provider (or a person who makes associated facilities available)and is a person whom Ofcom has determined to be a person having SMP in aservices market. It is therefore important to consider the precise identity of theregulated entity on whom it is appropriate to impose obligations.Regulated entity A2.93 As noted above, section 46 provides that a person to whom an SMP servicescondition is applied must be a ‗communications provider‘ or a ‗person‘ who makes associated facilities available and a ‗person‘ who Ofcom has determined to have SMP in a specific market for electronic communications networks,electronic communications services or associated facilities (i.e. the ‗services market‘).

A2.94 Article 16 of the Framework Directive requires that, where an NRAdetermines that a relevant market is not effectively competitive, it shall identify―undertakings‖ with SMP on that market and impose appropriate specific regulatory obligations. For the purposes of EC competition law, ―undertaking‖ includes companies within the same corporate group (Viho v Commission CaseC-73/95 P [1996] ECR I-5447), for example, where a company within that groupis not independent in its decision making.A2.95 Ofcom considers it appropriate to prevent a dominant provider to whom aSMP service condition is applied, which is part of a group of companies,



exploiting the principle of corporate separation. The dominant provider should notuse another member of its group to carry out activities or to fail to comply with acondition, which would otherwise render the dominant provider in breach of itsobligations. For this reason, Ofcom proposes that the obligations detailed in thisExplanatory Statement and Notification should apply to BritishTelecommunications plc and any BT subsidiary or holding company, or any

subsidiary of that holding company, all as defined by Section 736 of theCompanies Act 1985 as amended by the Companies Act 1989.The legal tests A2.96 However, before Ofcom can set or modify SMP services conditions on such aregulated entity, it must be satisfied that certain legal tests have been satisfied inrelation to each and every condition.A2.97 In Section 6 and Annex 4 of this Explanatory Statement, Ofcom sets out itsreasons explaining why those tests would be satisfied based on evidencepresently before Ofcom. In addition to need of satisfying the general and specificduties, the appropriateness of the remedy and identifying the nature of thecompetition problem mentioned above, Ofcom must satisfy a number ofadditional tests.

A2.98 First, under section 47(2) of the 2003 Act, Ofcom must show for each andevery SMP services condition that it is:

• objectively justifiable in relation to the networks, services, facilities,apparatus or directories to which it relates;109

• not such as to discriminate unduly against particular persons or against aparticular description of persons;

• proportionate to what the condition or modification is intended to achieve;and

• in relation to what it is intended to achieve, transparent .A2.99 Secondly, each of the tests set out in section 87(4) of the 2003 Act whichOfcom considers relevant must be satisfied. That section requires that Ofcom:―…must take into account, in particular, the following factors— (a) the technical and economic viability, having regard to the state ofmarket development, of installing and using facilities that would makethe proposed network access unnecessary;(b) the feasibility of the provision of the proposed network access;(c) the investment made by the person initially providing or makingavailable the network or other facility in respect of which an entitlementto network access is proposed;(d) the need to secure effective competition in the long term;(e) any rights to intellectual property that are relevant to the proposal; and(f) the desirability of securing that electronic communications services areprovided that are available throughout the member States.‖

A2.100 It is to be emphasised that this list is not exhaustive and other reasons cantherefore be added by Ofcom for imposing the access obligation(s) in question.A2.101 Thirdly, in addition to the above-mentioned tests, Ofcom must also satisfy thetests set out in section 88 of the 2003 Act in relation to network access pricingetc. obligations, namely: price control; cost orientation and cost recovery rules;use of cost accounting system rules; obligations to adjust prices.A2.102 Section 88 only allows Ofcom to impose such obligations where:

• it appears to Ofcom from the market analysis carried out for the purpose



of setting that condition that there is a relevant risk of adverse effectsarising from price distortion (see below for the meaning of this term); and

• It also appears to Ofcom that the setting of the condition is appropriate forthe purposes of promoting efficiency, promoting sustainable competition,and conferring the greatest possible benefits on the end-users of publicelectronic communications services. In considering these matters, Ofcom

may have regard to the prices at which services are available incomparable competitive markets and may determine what they considerto represent efficiency by using such cost accounting methods as theythink fit.A2.103 There is a relevant risk of adverse affects arising from price distortion if theSMP designated undertaking might fix and maintain some or all of its prices at an110excessively high level, or impose a price squeeze, so as to have adverseconsequences for end-users of public electronic communications services.A2.104 In addition, Ofcom must show that in setting the network access pricingobligation it has taken account of the extent of the SMP provider‘s investment in the matters to which the condition relates.

A2.105 It is to be noted that the term ―price control‖ has not been defined in the EC Communications Directives. The 20th recital to the Access and InterconnectionDirective suggests that it could cover a range of obligations concerning prices:―Price control may be necessary when market analysis in a particular marketreveals inefficient competition. The regulatory intervention may be relativelylight, such as an obligation that prices for carrier selection are reasonable aslaid down in Directive 97/33/EC, or much heavier such as an obligation thatprices are cost oriented to provide full justification for those prices wherecompetition is not sufficiently strong to prevent excessive pricing. In particular,operators with significant market power should avoid a price squeezewhereby the difference between their retail prices and the interconnectionprices charged to competitors who provide similar retail services is not

adequate to ensure sustainable competition. When a national regulatoryauthority calculates costs incurred in establishing a service mandated underthis Directive, it is appropriate to allow a reasonable return on the capitalemployed including appropriate labour and building costs, with the value ofcapital adjusted where necessary to reflect the current valuation of assets andefficiency of operations. The method of cost recovery should be appropriateto the circumstances taking account of the need to promote efficiency andsustainable competition and maximise consumer benefits.‖ A2.106 Article 12 of that Directive, however, expressly empowers NRAs to imposeobligations on operators to meet reasonable requests for access to, and use of,specific network elements and associated facilities, inter alia in situations wherethe NRA considers that denial of access or unreasonable terms and conditions

having a similar effect would hinder the emergence of a sustainable competitivemarket at the retail level, or would not be in the end-user's interest, and thatNRAs may attach to those obligations conditions covering fairness,reasonableness and timeliness.A2.107 In the light of the potential interplay between these provisions, Ofcom hasaddressed the section 88 test also under the requirement to provide networkaccess on fair and reasonable terms and conditions, including charges.The material change test A2.108 Under specific circumstances, Ofcom can set, modify or revoke an SMP



services condition without conducting a new market analysis process. Theframework for doing this, and Ofcom‘s intention to follow this procedure for certain of the services covered in this Explanatory Statement, are describedbelow.A2.109 Where Ofcom seeks to set, modify or revoke an SMP services condition, itmay only do so under section 86 of the 2003 Act if it is satisfied that there has

not, since the condition was set or last modified, or since the relevant marketpower determination was made (as the case may be), been a material change in111the market identified or otherwise used for the purposes of the market powerdetermination by reference to which the condition was set or last modified.A2.110 The alternative way of setting, modifying or revoking an SMP servicescondition, rather than satisfying that material change test, is for Ofcom to review,under section 84 of the 2003 Act, the market power determination by reference towhich the condition in question was set.A2.111 Section 84 requires Ofcom to carry out further analyses of the identifiedservices market either:

• where Ofcom considers it an appropriate interval to do so for the

purposes of reviewing market power determinations made on the basis ofan earlier analysis or deciding whether to make proposals for themodification of SMP services conditions set by reference to a marketpower determination made on such a basis (section 84(2)); or

• as soon as reasonably practicable after recommendations are made bythe European Commission that affect the matters that were taken intoaccount, or could have been taken into account, in the case of the lastanalysis of the market in question (section 84(3)).A2.112 For reasons set out in Section 2, Ofcom considers it an appropriate interval,at present, to carry out further analyses of the LTC and ITC/ITT markets both toreview the relevant market power determinations and to propose suchmodifications to the applicable SMP services conditions as are appropriate.

A2.113 As regards the other identified services markets covered in this ExplanatoryStatement (i.e. fixed call origination, fixed call termination and single transit) inwhich Ofcom is setting the new NCCs discussed in this document, Ofcom is, inaccordance with section 86(1)(b) of the 2003 Act, setting those NCCs in the formof SMP services conditions by reference to the respective market powerdeterminations made in relation to those markets in which OFCOM is satisfiedthere have been no material change since those determinations were made inNovember 2003. Ofcom‘s reasons for maintaining that view are set out, in particular, at Annex 5.A2.114 In this context, it is to be noted that, were any material changes in economicand technological developments to occur in these markets in the future, Ofcomwill consider appropriate timings for carrying out a market review of them under

section 84(2) of the 2003 Act. As seen above, it is also possible that theEuropean Commission would make a new Recommendation within the proposedperiod of the new NCCs that might affect the matters previously taken intoaccount in making BT‘s market power determinations made in 2003. If so, this would trigger an Ofcom review of the relevant markets under section 84(3) of the2003 Act.ERG Common Position on Remedies A2.115 At a plenary meeting on 1-2 April 2004, the European Regulators Group(―ERG‖) adopted a revised version of its document entitled ‗ERG Common



Position on the approach to Appropriate remedies in the new regulatoryframework‘, ERG (03) 30rev1, (the ―Common Position on Remedies‖). 112

A2.116 That document sets out NRAs‘ views on imposing remedies in a manner that contributes to the development of the internal market and ensures a consistentapplication of the new regulatory framework under the EC Communications

Directives.A2.117 Ofcom has therefore taken into account those views in consideringappropriate remedies. For instance, the first principle set out in The Common Position on Remedies states that the ―NRA must produce reasoned decisions in line with their obligations under the Directives [and] that the remedy selected[must] be based on the nature of the problem identified‖. As explained in Section 6 of this Explanatory Statement, Ofcom‘s decisions are based on the nature of the competition problems identified. More generally, Ofcom considers that itsapproach to determining SMP remedies is consistent with the Common Position on Remedies which in turn reflects the requirements of the EC CommunicationsDirectives which are addressed in this Explanatory Statement.Ofcom’s Notifications of Proposals

Public (national) consultation & notification of Ofcom’s findings A2.118 Ofcom is required to give interested parties an opportunity to comments on itsproposals contained in this Explanatory Statement. That statutory obligation toconsult is set out in:

• section 49(4) of the 2003 Act in respect of any proposed modifications toDirections given under SMP services conditions, such as ConditionAA1(a), see Annex 6 of this document; and

• sections 48(2) and 80(1) of the 2003 Act in respect of any proposals onservices market identifications, market power determinations andmodifications to the relevant SMP services conditions, of the 2003 Actin accordance with Article 6 of the Framework Directive where the proposeddraft measures have a significant impact on the relevant markets.

A2.119 Ofcom is entitled, by virtue of section 80(2) of the 2003 Act, to publish asingle notification of its proposals as to services market identifications, marketpower determinations and modifications to the relevant SMP services conditions.A2.120 At Annex 5 (Part I) of its consultation document of 23 March 2005, Ofcompublished a single notification containing all such proposals. Also, at Part II of thatAnnex, Ofcom published its statutory notification in respect of its proposedwithdrawal of the Credit Vetting Direction in specified respects.A2.121 To conclude the consultation process and in making its final decisions inrespect of services market identifications, market power determinations andmodifications to, as well as setting and revocation of, the relevant SMP servicesconditions, Ofcom is required to publish a notification under sections 48(1), 79(4)and 86 of the 2003 Act. Again, by virtue of section 79(5) of the 2003 Act, Ofcom

may publish a single notification in respect of all of those matters. Ofcom istherefore publishing such a notification at Annex 3 (Part I) of this ExplanatoryStatement. The withdrawal of the Credit Vetting Direction in specified respects ispublished at Part II of that Annex.113Obligation to inform the European Commission, other NRAs and the Secretary of State – Parallel consultation under Article 7 & notification of Ofcom’s findings A2.122 As required by Article 7(3) of the Framework Directive and sections 50 and 81



of the 2003 Act, draft decisions contained in the consultation document were alsosent to the European Commission, the NRAs of every other Member State andthe Secretary of State.A2.123 As Ofcom considered that those draft measures might affect trade betweenMember States, the European Commission and the other NRAs were thusprovided with an opportunity to comment on Ofcom‘s proposals. The European

Commission responded to this consultation to state that it had examined Ofcom‘s notifications, but that it had no comments.A2.124 If the European Commission believes that the market definitions proposed inthe consultation document, or Ofcom‘s pr oposals to designate BT as having SMPin the LTC market and to not designate BT as having in the ITC/ITT market SMP,would create a barrier to the single market or if it has serious doubts as to itscompatibility with Community law, and issues a notification under Article 7(4) ofthe Framework Directive, Ofcom would be required by section 82 of the 2003 Actto delay adoption of these draft measures for a further period of two months whilethe European Commission considered its position. However, as seen from theEuropean Commission‘s response mentioned above, it had no comments on Ofcom‘s proposals and it has thus not made a notification for the purposes of the

said Article 7(4).A2.125 In accordance with Article 7(5) of the Framework Directive and sections 50and 81 of the 2003 Act, Ofcom has sent copies of its final measures (that is tosay, this Explanatory Statement including the statutory notification and withdrawalof direction in specified respects as published in Parts I and II, respectively, ofAnnex 3 of this document) to the European Commission and the Secretary ofState.Steps following the outcome of the consultation process A2.126 When Ofcom has considered any representations duly made in response tothe proposals set out in this document, including any made by the EuropeanCommission and other NRAs, it may under sections 48(5) and 80(6) of the 2003Act give effect to these proposals, with or without modifications, by making the

services market identifications, market power determinations and modifications tothe SMP services conditions in question. Ofcom would do so by publishing afurther notification accompanied by a further and final explanatory statement.Thereafter, the markets and the new regulatory remedies that have beenimposed will be reviewed at appropriate intervals, as discussed above. Asregards the proposed modified directions, Ofcom may under section 49(9) of the2003 Act give effect to them, with or without modifications, after havingconsidered any consultation responses.A2.127 As discussed further in Section 6 of this Explanatory Statement, Ofcom hasdecided to give effect to its proposals with certain modifications. However, forreasons set out in that Section, Ofcom does not consider that its final decisions inthese respects have been modified (as compared to its initial proposals) to such

an extent that it could be regarded as substantially and materially changed fromits initial proposals. Rather, Ofcom has made only such modifications necessaryto take into account certain consultation responses and to give effect to matters114implicitly clear from its initial proposals. Therefore, Ofcom considers that, on themost basic features of its proposals, BT and other stakeholders have been givena sufficient and adequate opportunity to express their views and so influenceOfcom. As a result, Ofcom does not consider there is a need to re-consult onthese non-material modifications.



Impact AssessmentA2.128 The analysis presented in Section 6 of this document, when read inconjunction with the rest of this document, represents an Impact Assessment(―IA‖), as defined by section 7 of the 2003 Act. A2.129 IAs provide a valuable way of assessing different options for regulation andshowing why the preferred option was chosen. They form part of best practice

policy-making and are commonly used by other regulators. This is reflected insection 7 of the 2003 Act, which means that generally we have to carry out IAswhere our proposals would be likely to have a significant effect on businesses orthe general public, or when there is a major change in Ofcom‘s activities. In accordance with section 7, in producing the IA in this document Ofcom has hadregard to such general guidance as it considers appropriate, including relatedCabinet Office guidance.

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