Feedback to regulators from investors

A sector in crisis

Investment banks and commercial banks play a key role in the conduit of financing to meet investment needs, and in doing so, they assess the prospects for returns on investment in the light of the scope for market growth and restrictions on such growth. Telecommunication operators and service providers around the world continue to face an extraordinarily adverse climate for generating the financing required to maintain and expand their operations. Regulating the sector in the light of this environment presents challenges that merit a revaluation of some of the aspects of traditional regulatory approaches. The report entitled Feedback to regulators from investors — Telecommunications in crisis: Perspectives of the Financial sector on regulatory Impediments to Sustainable Investment (www.itu.int/ITU-D/treg)   focuses on many issues that would have been a matter of concern, irrespective of the condition of financial markets, and offers some views concerning how regulators may have to reassess their task given the current crisis facing the sector. It is mainly based on a series of discussions with a range of investment bankers and investment analysts, who deal with national and international investment in both developed and developing markets.

In the two years leading up the high water mark of the Internet bubble in March 2000, the enthusiasm of investors for what seemed to be a dynamic sector extended to the group of traditional operators in the market. But as market appraisals of the Internet sector collapsed, valuations of traditional telecommunication operators also collapsed with a vengeance. In addition, acquisitions and business strategies became exposed to increasingly hard assessments. According to the report, the future financial viability of converging telecommunication, media, and Internet sectors are now subject to unprecedented levels of uncertainty as a result of collapsing expectations about the prospects of the Internet, the mobile sector’s plans for third generation (3G) mobile services and core fixed-line telecommunication services, as well as the breakdown of confidence of investors in corporate disclosure and accountability mechanisms.

A fresh new look at the impact of regulation on investment is imperative given current conditions in global financial markets and the views of investors about the prospects for the overall sector. One common theme that ran through the discussions with the financial community concerns whether the regulatory community takes a sufficiently broad view of the sector as a whole, as opposed to fragmented application of focused economic theories and social policies to various specific markets within the sector. A fundamental priority in attracting investment is to ensure that operators and service providers have the necessary flexibility to adapt to changing market conditions and that they are not constrained by traditional models that no longer reflect the reality of the competitive market.

Regulation and the flow of investment into the mobile sector...

Investment flows to the mobile sector and the extraordinarily successful uptake of mobile services in the last ten years occurred in the context of minimal regulation of mobile pricing either at retail or wholesale levels. The report argues that traditional retail level price regulation of fixed-line voice services may no longer be justified, especially given the wide availability of unregulated mobile service offerings. Some commentators in the financial community believe that, given the lower cost of mobile infrastructure compared with fixed network infrastructure, and the effect of competition in the mobile sector, prices for mobile calls are likely to be reduced with the result that more voice calls will migrate from fixed to mobile networks.

The report highlights what it describes as a stark disparity of regulatory treatment between fixed and mobile services, adding that such disparity may itself be partly responsible for the levels of investment that have been, and are being, made in each of these sectors. It states that some governments have insisted on maintaining strict price regulation of fixed-line services but permitted an essentially unregulated regime for the expansion of mobile services. According to the report, in many countries, the dichotomy between the price regulatory framework for fixed and mobile services — tightly regulated in the case of fixed-line services and virtually no price regulation for mobile services — has resulted in expanding mobile infrastructure while fixed-line infrastructure remains static and under-funded.

Learning from 3G licensing

What seems to confront the future development of the mobile sector is a very real threat to the flows of investment that until now financed the huge expansion of mobile infrastructure. What has happened in the past two years with 3G licensing is an enormous extraction of resources on the order of USD 100 billion to finance an unproven next generation of mobile technology, states the report. It further argues that “governments have put themselves beyond the risk of whether future cash flows generating tax revenues would be realized and have shifted risks to operators and investors resulting not only in deflated prospects for 3G services but for the telecommunication sector as a whole by generating a liquidity and financing crisis of the first order”.

Investment flows are likely to serve the telecommunication sector and overall economy best where they are sustainable. The pricing of 3G licences in some European countries offers useful lessons for policy-makers and regulators assessing how to license new services in developing markets. The lessons to be drawn are not so much that auctions are an inappropriate method of granting exclusive rights to scarce resources. Rather, the ability of the sector to sustain the investment needed to develop networks and roll out services is far more important. Licences should not be granted in a way that drains the sector of liquidity and that has a destructive impact on investment flows.

The report further argues that not only has the sector’s ability to invest in the network, technology and services been fundamentally undermined by the scale of financing required for 3G licence fees, but the process of auctioning 3G spectrum has likely created significant distortions with respect to the pricing of other spectrum resources previously granted, as well as with respect to future decisions about the deployment of new spectrum-based services.

Risks and structural hindrances to investment

Investment bankers weigh a wide range of generic risks in assessing investment opportunities, including political risk, legal stability and exchange rate risk. In developing markets, regulatory-specific risk issues that typically come into focus include uncertainties regarding the timing and scope of sector liberalization. A key question often asked is whether in the light of existing competition and planned liberalization, fixed-line operators in particular have sufficient commercial flexibility to deal with increasing competition from mobile operators, call-back service and Internet telephony. Investment bankers’ due diligence meetings with sector ministries and regulatory institutions focus on the official sector’s vision for price regulation and political pressures to build out networks and maintain widely based subsidized pricing schemes for geographical areas and population segments.

Interconnection-related risks typically concern the ability of operators to offer services on a commercial basis, as well as the powers and inclinations of the regulator to become involved in setting interconnection rates as opposed to simply resolving interconnection disputes or intervening in failed negotiations.

Another question often asked by investors is whether written policies are actually followed in practice. The more investors doubt whether regulation will operate as “advertised” the less they will be able to make sound investment decisions based on a clear understanding of how industry players are likely to behave in a given market setting. Involving investors and operators in policy-making and regulatory processes increases the likelihood that high-sounding intentions are actually carried out.

Failure of regulators and policy-makers to address how some very critical regulatory issue is likely to be dealt with is another factor that can deter investment. For example, in some countries, there are still questions as to whether newly created regional companies will be authorized to provide intra-regional, inter-regional and international services in competition with the incumbent long-distance operator and when such competition may be permitted. This has left investment analysts to speculate about how and when the issue will be addressed.

Investment-oriented regulation

Regulatory policies that are well focused on encouraging investment do not merely service the interests of investors but can, and should also, promote the basic policy objectives of widening access to infrastructure and services and establishing a basis for competition in the sector. The report suggests that an investment-oriented approach to regulation may result in, and benefit from, institutional arrangements that are less complex and foster greater involvement of key industry players in consensus building and dispute resolution than there is at present. Effective regulation will not necessarily depend on hornbook application of the precepts underlying telecommunications sector regulation in North America or Europe, the report argues. On the contrary, the increasing jurisdictional complexity of telecommunication regulation around the world may well require the development of new techniques of consensus building both in a national context and in regional settings where new regulatory bodies are now developing. Such consultative mechanisms should put the emphasis on active involvement of operators and investors in formulating future regulatory and industry scenarios. These mechanisms can be in the form of “virtual forums”, which focus on aggregating relevant data and case experience that assist industry players in devising new rules of engagement in the sector. Thus, not only will regulators have the benefit of understanding better the key factors for investment, but such institutional mechanisms may contribute towards improving investor confidence in the regulatory process, and ultimately, in the dynamics of the telecommunication markets in which investors decide to invest.