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Haitong Research Warns Openreach “cannot be legally separated” from BT

Wednesday, December 14th, 2016 (9:31 am) - Score 1,302

At the end of last month Ofcom confirmed that they’d force Openreach into “legal separation” from the BT Group (here), which they view as necessary to improve competition / fairness in the UK telecoms and broadband market. But a Haitong Research study warns that Pensions remain a roadblock.

The regulator had been hoping to gain a voluntary agreement from BT on the future of Openreach, but so far the operator has refused to budge on two or three key points. BT is bitterly opposed to Openreach becoming a “legally separate company” (no CEO likes to lose full control over part of their business, even if the BT board would still have a say) and they’re particularly concerned about the related risks / costs of moving staff and pension liabilities to the “new” company.

In keeping with that Ofcom noted that most stakeholders who responded to their consultation felt as if BT had “overstated” the impact on their pension scheme. Similarly an earlier Sky UK (Sky Broadband) commissioned report from pensions law firm Sackers found “no bar [to separation] from a pensions perspective” (here).

However a BT spokesperson disagreed with Sky’s position and warned that “the kind of governance changes they have suggested for Openreach would have a material negative impact on the pension position.”

A team working for Haitong Research has now examined the submissions from trustees of the BT Pension Scheme (BTPS), which were sent to Ofcom as part of their related Strategic Review. The conclusion they’ve reached suggests that Openreach “cannot be legally separated” from BT, even if the operator wanted to do it.

Apparently the BTPS had liabilities of £53bn and a £10bn deficit in June 2015. As a result Haitong Research said that the pension scheme’s trustee’s position must weight above those of other stakeholders. Ofcom similarly admits that the BTPS situation is the single biggest hindrance to pushing through their proposals.

According to the client note (Proactive Investors), legally separating Openreach would render Openreach Co insolvent and hurt BT’s ability to support the BTPS (Covenant)

Statement from Haitong Research’s Client Note

“Because of this, the Trustee’s categorical position is that Ofcom’s proposal to legally separate Openreach is unviable and thus also a big threat to Britain’s digital economy. So even if BT wanted to assent to Ofcom’s wishes, it cannot.”

Naturally Ofcom disagrees with this assessment and their canned statement to the media states that legal separation is still “achievable, proportionate and carefully considered“. The regulator added that under their plan BT would still be able to meet “all” of their pension obligations and Ofcom’s “expert advisors” have proposed a “range of measures to reduce the impact of legal separation on BT’s pension costs.”

However Ofcom may be forgetting that their “expert advisors” do not carry the same weight as an actual trustee, particularly one that has a “legal and fiduciary duty to look after a 300,000 member pension scheme” and its significant financial liabilities.

Ofcom is already preparing to notify the European Commission of their decision to press forward with legal separation, which will take place early in the New Year. But the regulator’s battle may yet be far from won.

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By Mark Jackson
Mark is a professional technology writer, IT consultant and computer engineer from Dorset (England), he also founded ISPreview in 1999 and enjoys analysing the latest telecoms and broadband developments. Find me on Twitter, , Facebook and Linkedin.
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30 Responses
  1. Evan Crissall says:

    Old figures. The state of the BTPS is much worse. From the FT:

    “[UBS] the Swiss bank reckons that for BT, the deficit [of the Defined Benefit Pension Scheme] has widened by some 40 per cent since last June, reaching £14.2bn.”

    https://www.ft.com/content/410b76f2-0705-3bd9-b27c-5c8e9d23444f

    Maybe this is the ultimate BT gameplan :-

    Acquiesce to full separation, so long as all pension liabilities are assumed by the new Openreach plc. That new corporate entity predictably collapses into insolvency. The Government steps in to bail-out the £14bn deficit using the taxpayer-backed Pension Protection Fund. The remainder of BT Group carries on regardless, unencumbered by those old liabilities, now on the public books.

    Sounds about par for course for BT Group plc.

    1. Steve Jones says:

      I am absolutely sure that the BT Board will have a contingency plan whereby they float of those bits BT PLC that will not have accumulated lots of historical pension deficits. EE, BT Global and even most of BT Consumer will have relatively low liabilities which they would still have to buy themselves out of, but it would leave the rump of what would be left with most of the liability due to historical employment records.

      The BT Pension deficit is actually backed by the Crown Guarantee, not the pension protection system. It was put in place at the time of privatisation and its scope has been tested in court.

      Ultimately directors owe their duty of responsibility to the owners. It would be dereliction of duty not to have a contingency plan.

    2. gerarda says:

      @steve jones – unless the pension funding of each BT trading entity has been ring fenced since inception deciding where the historical liabilities are would be almost impossible. Employees will have moved from one business to another with no historical baggage taken with them, and the scheme will have been in surplus for many years in the 80s and 90s. The scheme as a whole is in deficit and the buck eventually stops with BT group.

      Personally I think a lot of these schemes are not as insolvent as they are being evaluated now as investment return will improve with the return of inflation and I cannot see the average obese, sedentary 30-40 year olds having the same life expectancy as the slim, active pre and post war generation who are now enjoying increased longevity.

    3. Steve Jones says:

      @gerarda

      If Ofcom is to force a split, then that allocation job, however, difficult, is going to have to be made. Personally I don’t think it’s as hard as you make out. There are accountants and economists who could do a good job. What will be difficult is getting groups with vested interests to agree with the basis on which the split was made.

      Note that even with the half-baked Ofcom recommendation some form of cash-flow is going to be required from the new OR. That is going to reflect, in part, the deficit. Ofcom have recognised that, so who is going to make that judgement? It clearly impacts directly on where OR’s free cash-flow is to be allocated which has obvious knock-on effects to capital expenditure.

      Much the same also applies to dividend payments. The board of this new OR will have to decide on how much dividend is paid to the parent company. In normal circumstances, the owner of a company has a big say on the importance of that issue, but Ofcom’s “unconventional” proposals with regard to a wholly owned subsidiary (unprecedented in the UK) would seem to just ignore that little matter. That is any influence the owners of a business (that is, ultimately, the shareholders) might have on such matters.

  2. fastman says:

    sounds about par – !!!!

    really — you could not make it up the incredulity of some post on here !!!!

  3. NGA for all says:

    It is not clear Ofcom have made any case. There is a vague wish for more investment but it is not quantified. They have not consulted on a PST sunset date or a fibre transition plan. The WLA 2017 settlement where investment signals could be calibrated for FTTP should work in conjunction with any other changes like more separation. The correct signals from WLA 2017 could switch a £100m a year from PST investment to more fibre. All you really need is a tight rein on is securing the correct level of investment from the cost recovery processes.

    BT has recorded c£900m of state aid in its books for Broadband and there is contracts for at another £500m of work, plus all the capital deferrals and BT’s own capital to invest. Ofcom have not even attempted to examine the lessons learned from what could now be achieved. The numbers are such that if the contracts can enforced the Government could get put all phase1 monies back into FTTP accelerating the process of change already emerging in the BDUK contracts, but which need more demanded of them.

    Ofcom have not done a report on the 2010 ‘fair bet’ with BT. It would show much lower costs, higher take-up and BT taking control of the market with the help of Government aid, but legal separation is not a logical step before a fuller review is done and reported upon with options for the future set forth. None of this was in the DCR.

    Having taken the steps without the legwork, Ofcom will have strengthened BT’s ability to dictate the detail, with no assurance on any new incremental investment.

  4. GNewton says:

    The Haitong report has one flaw: BT is not a normal commercial company, it is a highly regulated entity. BT can’t have it both ways. Either the government completely stops putting public money into this company and let BT stand on its own feet, or BT needs to put up with regulations by Ofcom, including separation. Of course, the crown guarantee for its pension scheme was a big mistake.

    1. Steve Jones says:

      What utter nonsense. BT is not dependent on public subsidies and if BDUK did not exist then the company would continue. What the BDUK project was set up to do was to address areas which were not considered commercially viable and to accelerate the process in some more marginal ones which would have eventually been picked up. Those contracts were put out to tender and BT is in no way dependent on them. It’s just that there would have been large numbers of premises which would either have had to wait a lot longer for upgraded BB or it wouldn’t have happened at all.

      If somebody offered BT the opportunity to remove all regulation that are specific to it in the telecoms market and treat it in the manner that VM is regulated it would be delighted. There would be shareholders doing cartwheels in the street. The regulatory regime for BT is a major drag on the business.

    2. AndyH says:

      “Either the government completely stops putting public money into this company and let BT stand on its own feet”

      This makes no sense to me.

      The government wanted to extend super fast broadband coverage to those areas that existing commercial suppliers were not planning to cover. The tender process for each contract was robust and fair, allowing for many operators to tender. The fact that we had no real competitors on a nationwide level is not BT’s fault. The tenders were one fair and squarely, so any issues with the process should be adddressed at the government rather than the company that won most of the tenders.

    3. GNewton says:

      @Steve Jones: As I said, BT is NOT a normal commercial company, and it is highly regulated, whether you like it as a shareholder or not. It was a big mistake to throw so much public money at BT via the BDUK tendering process which was biased towards propping up BT. It resulted in strengthening BTs market position, hence the need to regulate this company increased, to the point, that Openreach is about to be split off BT by Ofcom.

      The market has been a failure for many areas, hence there won’t be any shareholders doing cartwheels in the street because they’ll have to put up with strict regulations. Nobody forces you to keep shares with this company!

    4. TheFacts says:

      What would have been achieved with the same amount to other companies?

    5. Mark Jackson says:

      @AndyH

      “The tender process for each contract was robust and fair, allowing for many operators to tender. The fact that we had no real competitors on a nationwide level is not BT’s fault.”

      I’d agree that it’s not BT’s fault (more BDUK / Government), but restrictions were placed upon the original BDUK Phase 1 framework that made it incredibly difficult for smaller ISPs to mount a bid unless they had a huge multi-million turnover or engaged in a complicated consortium (somewhat unviable at the time). It was only at BDUK Phase 2 and onwards that we’ve seen more flexibility emerge.

    6. NGA for all says:

      AndyH mostly true but some adjustments were and are needed for the following;
      £2.5bn is likely to be at most £1.4bn or more likely £1.1bn for 55,000 cabinets.
      The promise of £1bn or even £358m for rural which has not materialised in any as yet acceptable form.
      A competition with a company which had no core network, no access network, no wholesale platform and no customers needed care. To ‘win’ a ‘competition’ you only needed to price £1 below the cost of a new access network.
      BT told Parliament that the Framework prices reflected all your learnings from the commercial programme, NI and Cornwall.
      So now we have a £292m capital deferral and underspends in every county as evidence of the above half-truths and BT’s capital is still to be argued over.
      Even with all this there is still a good job of work being done by the engineering community which must be applauded. Think how more could be planned for the UK rural economy without the gaming of costs and capital. I think the progress on OR FTTP in rural is much under reported, which is a pity and so much more is possible.

      Ofcom’s attempt at being selectively independent competition regulator and remaining aloof from BDUK in their attempts to contain BT Group greed while then attempting Legal Separation without doing the necessary preparation in the DCR looks wasteful all round.

      BT regulated or unregulated holds a special position in the market. Upholding BT company values was critical in the BDUK project. The involvement CEO’s early in the project might have meant normal governance rules were breached. This does not explain the ongoing gaming of capital which has yet to be resolved.

    7. Steve Jones says:

      @GNewton

      The nonsense you put out is that BT should either stop getting public money or it should put up with regulation. There simply is no option on the table for Ofcom to withdraw regulation regime, public money or not. Ofcom would want to apply that regulation

      In any event, what you appear not to have noticed was that this particular report (which is an independent investment report) is about the power of the pension trustees to frustrate this plan of Ofcom’s. As it is, the trustees of the pension fund have been rather generous in the period they’ve allowed for the filling of this gap (which is currently growing due to demographics and the way bond returns have been depressed by the actions of the Bank of England).

      Absolutely none of that has to do with the BT board. The pension trustees are (rightly) independent of the company. Their job is to represent the interests of those in the pension scheme. They certainly aren’t going to accept your contention that they should just lay down and accept whatever Ofcom say, even if it imperils the interests of the scheme members.

      Finally, it is not the job of the directors of companies to just ignore the interests of the shareholders. Indeed, it would be illegal to do so. Ofcom still have to work within the framework of the law and if that includes that covering the pension scheme, then they had better be sure of their ground as it would end up in court.

    8. GNewton says:

      @Steve Jones: I should clarify that BT needs some kind of regulation in either case, regardless of the BDUK through which it received public money (though it had no need for it). The crown guarantee was a big mistake, and contributed towards the mess. However, since BT was significantly strengthened through the original (phase 1) BDUK process, the need for an even stricter regulation arose. If Ofcom can’t separate Openreach off BT (which is still the best option, except perhaps for some shareholders, too bad for them), it has other means at its disposal for promoting more independent network infrastructures outside of BT’s control. Either way, you knew the risks before becoming a shareholder!

    9. AndyH says:

      @ Mark

      I’m not too familiar with the specific requirements of Stage 1 of BDUK, but clearly any large scale tendering and procurement process (for the provision of a service over a certain number of years) needs to ensure the financial and service viability of the provider. The UK ISP is fairly consolidated with over 98% (correct me if wrong) of end users being signed up to one of six main providers. I think the main prohibitive factor, explaining why the incumbent provider won the majority of contracts, was the ROI.

    10. MikeW says:

      @AndyH

      You’re right that BT won the BDUK tenders in the final selections through the value-for-money tests – the RoI from the perspective of the local bodies.

      However, they got themselves into the position of winning the tenders because they got through the pre-qualification stages. I can’t remember the details now, but the essential quality needed was: you had to be big, with plenty of £££ backing. That check (which applied to most, but not all of the local bodies) weeded out most altnets, and would have needed VM or someone like Vodafone to come in. In the end Fujitsu was there, backed by VM and Sky.

      But BT won where there were other competitors too (eg in the pilots).

      The question of whether the “tendering process was proper” therefore comes down to whether you think such pre-qualification was valid.

      For myself, I couldn’t say if the details were fair, but I agree with the basic premise behind the pre-qualification. The outcome the country needed (combined) was for a rollout that delivered over 100,000 premises every month for 3 years: this whole thing needed companies and people who could think “big”.

      Just how big? For comparison, the GPO installed lines in 8 million properties in the 70s: that amounted to 65,000 lines per month. That was a time of waiting lists and queues – the GPO and the telecom supply industry couldn’t go faster.

      As another example, look at VM’s project lightning. They too are aiming at 4 million lines, but over a longer period. At the last report, they were running at about 30,000 premises per month.

      In addition, BDUK came into being just after SYDR folded, with the local councils facing huge bills. No-one wanted this project to be the same.

      As a result, I can certainly understand and agree with the reasoning for pre-qualification that aimed at big companies, with secure financial footing.

  5. GNewton says:

    @AndyH: “any issues with the process should be adddressed at the government rather than the company that won most of the tenders” Agreed! When it became clear that it was not a normal tendering process, it should have been withdrawn back then, and a completely different framework should have been worked out.

    1. TheFacts says:

      Acheiving what in terms of coverage?

    2. NGA for all says:

      The £1.7bn of state aid and a contribution of £420m to direct capital costs from BT could do circa 28,000 cabs and some low double digit of FTTP in-fill, plus some FWA and satellite at the edge.

      At £900m state aid reported in BT’s accounts (less the capital of deferral of £292m) we look to be at 26,000 cabs and <1% FTTP.

      So the opportunity remains to do much more if the will remains.

      Do not underestimate the effort to get C&W bidding in H&I where it owned both Pathfinder networks or in Cumbria where its Energis assets had relevance.

      If enough scrutiny occurs the procurement flaws can be addressed, but the job needed doing. This myth of competition is more difficult and it still is, if as reported there is block on distributing 'gainshare' above £127m which will as a capital deferral begin to include the capital owed.

    3. AndyH says:

      In what way was it not a normal tendering process?

      It was an open tendering process that went through the European Union’s Competitive Dialogue procedure. In this sense, it followed all the rules and regulations for tendering and procuring services.

    4. FibreFred says:

      GNewton it was open to many bidders, some didn’t bother others did and pulled out leaving BT

      Sorry about that

    5. NGA for all says:

      AndyH The myth of competition in rural is a real problem, and the cost of competition in rural is really high, just look at the lack of Mobile coverage where competition theory blocks coverage. Mobile Infrastructure Project MIP, Ofcom’s fag packet pre-budget panic attack counter to the 4G coverage obligations impact on auction yield was a real joke – there must be more than one network operator in the middle of nowhere.. sure! Competition as an end it itself loses its usefulness 2 miles outside a town, but then economists think the countryside according to their models like the poor have no reason to exist, so you can ignore them.

      Procurement processes and EU rules assume competition, but running a competition when there is only one fixed network is a bit farcical and where even alt-nets depend upon being the only provider. Hence someone with no access network got on the framework. You would have to appreciate the farce to make sure you did not abuse it.

      I feel for those good folk in C&W. Monday morning they faithfully arrived for a competitive dialogue. There hotel, such was there expectation for business on a freezing Sunday night in February in Carlisle had no food for dinner and no one could be bothered to arrange food for breakfast. I confess to possibly breaching all the procurement rules (in the name of sustaining competition) by fetching a Greggs special at £2.25 each. I did not, perhaps unfairly, make an equivalent offer to what looked like a well breakfasted group from BT. Such was the rush to provide fibre access in rural areas you needed to check your competitive dialogue was not going to be on the same day as your neighbours. Procurement Processes and EU indeed.

    6. MikeW says:

      @NGA
      You might be right that the procurement meant that a company with experience of deploying access networks had an advantage.

      In which case, you’d have thought that VM would be the obvious other contender. Perhaps that is why Fujitsu was there, with VM’s backing.

      And perhaps explains why GC can become a contender now.

      Perhaps that is why Ofcom are trying to create a third “fibre only” infrastructure player now. Even if they only target 10-30% now, they could be a contender for future bids in a decade or so.

    7. NGA for all says:

      MikeW – Agreed. VM not interested in building a new access network in rural, although, like C&W( Voda) VM had more assets in the ground that they seem capable of selling or know about.

      The pre-qualification criteria on the technical side were bent backwards on things like customer service/billing in the hope of finding some interest. No stone left unturned, but customers want to be able to order the same as everyone else largely. I complained bitterly of PIA but operators were clear they want to own an asset so they want to build their own assets, tactical use of PIA for pinch points yes but not beyond that. It is not surprising SLU’s like Callflow are asking for protection.

      I like the alt-nets and Gigaclear emerging is good but no partnerships formed in 2011-12 so the delivery capability could not pass scrutiny no matter how perilously generous you could be in the initial stages of pre-assessment. Support for Fujitsu had to go beyond a press release, and there was absolutely no appetite anywhere for a strategic alternative to Openreach to justify the higher costs.

      The cost of overlaying on existing infrastructure is cheap as we have learned. Even this a bit if surprise to BT I think, and BT procurement is strong.

      My conviction remains that funding available (clawback, underspends and the argument on capital) could fund 500k FTTP in rural, proving that FTTP transition would not be £28bn but an incremental £12bn-£13bn. Over 20 years with a migration from PSTN capex to fibre would be interesting to work through.

      I am not sure what Ofcom hope to achieve with legal separation. It might be about securing more equivalence, not better service, just equal, good or bad. There is no direct link to more investment I can see, well not for rural anyway.

      The future structure of OR might be better discussed where the ambition for fibre was quantified in the DCR. 15-20 year fibre transition – yes or no? PST sunset date. Nothing like this.

      Sorry for irritating you on the BT Capex front but the £292m capital deferral needs to grow and grow and we should not be afraid of demanding a more complete rollout for the money available. The state aid idiocy and desire for ‘competition’ in the final 5% is now holding up a more meaningful discussion on what to do with the money available.

  6. Dumb argument says:

    Oh dear the workers, pension and shareholders all worked up in a froth again LOL

  7. FibreFred says:

    Doesn’t look like this will happen anytime soon then, if ever. Red faces

  8. MikeW says:

    OT
    (@GNewton
    As a followup to the discussion that went on a previous article, take a look at
    http://www.zdnet.com/article/amazon-lightsail-the-private-server-killer/
    That mentions Linode and Digital Ocean as alternatives, but Lightsail seems like an easy way into Amazon’s EC2 & EBS cloud infrastructure)

    1. GNewton says:

      @MikeW: Thank you, I’ll take a look at it. At the moment, we mainly use reseller accounts (WHM/cPanel,full LAMP stack,SSH etc).

    2. MikeW says:

      Understood.

      I think I meant it more as way to allow you to replace the “local” infrastructure so as to reduce your need for upstream speeds when maintaining the client sites (which is what I presume are hosted on those reseller accounts), rather than for hosting the clients. Though you could do the latter too.

      I guess for them to be useful to you, that infrastructure needs a way to load into the reseller accounts from a CLI (say, via scp or sftp), or automatically (say, via rsync). But something that requires you to (say) upload using a cPanel screen on a local desktop in the office won’t be improved that way.

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