This Briefing Report, prepared in conjunction with the seventh ITU Regulatory
Colloquium, concerns the international economic relationships between telecommunications
operators which enable them to connect international calls. It focuses on how these
relationships are evolving, and on the regulatory policies affecting them. It summarises
the existing arrangements concerning accounting rates and settlements; analyses the
intense pressures for change; and suggests the kinds of changes that could result.
It also presents the authors personal view of which outcomes should be preferred,
and what choices by national policy makers and regulators will make such outcomes
probable. This is strictly a personal view. Neither it, nor any other part of this
report, necessarily represents the views of the Colloquium participants, the ITU, or its
constituent members: rather, the report represents a starting point for debate on the
issues and policy options.
This summary discusses in turn:
- Two radically different kinds of economic relationships for international
telecommunications: a new approach based on open competitive markets, with little
distinction between international and domestic operations; and the traditional approach
based on the exchange of traffic between operators in different countries.
- The existing situation.
- The pressures for change.
- Possible outcomes, summarised in the form of three scenarios.
- The policy issues that governments and regulators face in this field.
The early stages of the transition from monopoly to competition in telecommunications
saw a relatively small number of countries move towards a new industry structure for fixed
telecommunications based on multiple competing operators. Until the mid-1990s, this had
happened in only a few countries: specifically Australia, Chile, Finland, Japan, New
Zealand, Sweden, the UK and the US. Since then, governments in some countries have begun
to extend to foreign telecommunications operators the rights of competitive entry, and the
regulatory protections designed to make competition possible, that they previously offered
only to national competitors. For example, within most of the 15-country European Union
(EU) such a policy applies to competitive entry by operators from any EU country, with
effect from January 1st, 1998. Such changes will transform the marketplace for
international telecoms services over the next few years.
Open Competition and Interconnection
Accross Frontiers: the Idea
of a "Single Market"
Extending pro-competitive policies to foreign telecoms operators has far-reaching
implications for the way international calls will be carried, and the associated financial
arrangements. Within any group of countries which allow unrestricted market entry by
foreign (or foreign-owned) operators and which also grant such operators interconnection
rights, there need be little distinction between international calls and those flowing
within a single country ("domestic calls"). In such an environment, regulators
can and should treat domestic and foreign operators, in a non-discriminatory way, in the
interests of fair and efficient competition. This implies that international calls will be
carried via the public network in the destination country under arrangements just like
those that apply to domestic long-distance calls. International calls will pay
interconnect charges that are the same as those for domestic long-distance calls or at
least similar. The interconnect service provided is essentially the same in both cases.
For calls within the EU, for example, the difference will disappear as a result of EU
legislation. A domestic long-distance call can be brought into, say, Glasgow in Scotland
by one of the new competitors to BT can be terminated there via BTs local network
and interconnect service for approximately 0.6 of a UK penny per minute (approximately one
US cent at todays exchange rate). From 1.1.98, the EU legislation gives a French
telecoms operator the right to bring a call into Glasgow from Paris and terminate it,
again via BT's network, at the same rate.This kind of situation is radically unlike the
traditional way of handling international traffic and compensating participating telecoms
operators, which we describe in Section 2 of this summary.
International calls will no doubt continue to be priced to end-users somewhat higher
than domestic long-distance calls, even for calls that both originate and terminate in
countries where competition is unrestricted. The difference is likely to be relatively
modest however, reflecting only the (relatively small) difference in network costs;
remaining differences in interconnect charges, if any; the greater complexity of business
processes for international calls; and probably some persistence of higher-than-average
profit margins reflecting the perceived value of international calls.
If the reader objects to this picture on the grounds that it is too idealised and
hypothetical, he or she is right on the first count, and wrong on the second. Such
situations are not hypothetical: they exist today, and more are coming into existence at a
rapid rate. It is true that the description is somewhat idealised: in practice,
innumerable regulatory and commercial battles will be fought before the details of the new
landscape of a fully competitive international market can be seen clearly. There is,
however, no reasonable doubt about the general direction of events.
This report uses the term Single Market to refer to situations of the
kind just described. Specifically, this report uses the phrase to mean a group of two or
more countries where telecoms operators based in any country in the group can:
- sell international services in any other country in the group.
- extend their network into any other country in the group and establish network Points of
Presence (PoPs), there; and further extend its network all the way to the destination
customer's premises where that is commercially viable
- interconnect their PoPs to the public switched network of the incumbent telecoms
operator in any other country in the group, and terminate international calls (or
originate them) on the same interconnect terms and at the same interconnect prices that
domestic operators pay.
Single Markets in Practice
Single Markets that fit this definition already exist: so far, however, they consist
only of a few pairs of countries. The US and the UK form a rough approximation of a Single
Market. US operators can and do operate extensively in the UK, largely in the manner
described above. To some degree UK-based operators do the same in the US, though they
still face severe regulatory obstacles and constraints. End-user prices ("collection
rates") for calls between the two countries have plunged. In 1992, BT's "headline"
price (before allowing for discount plans) for UK-to-US calls in the peak period was 51
pence (84¢) per minute. By 1995 this price had fallen to around 42 pence (69¢) per
minute. By late 1997 BT's headline price had fallen to 24 pence (38¢) per minute; several
operators were connecting daytime calls from the UK to the United States at prices in the
range 8-15 pence (about 13-25¢) per minute).
Other existing Single Markets comprising pairs of countries include Canada-UK,
Sweden-UK, New Zealand-US, and Canada-US. Each of these pairs is characterised by
relatively low end-user prices, high and fast-growing traffic volumes, and diverse and
fast-changing industry structures and arrangements for handling international traffic.
The domain of Single Markets is about to expand dramatically. It will not be limited to
a few pairs of countries but will include large multilateral groups of countries as well.
With effect from January 1st, 1998, most of the 15-country European Union (EU) together
with the 3 countries associated with the EU through the European Economic Area (EEA), plus
Switzerland, will form a Single Market for telecommunications. Telecoms operators from any
EU country will be entitled to build network plant and conduct operations anywhere within
this Single Market. They will be able to terminate their calls, including international
calls, via the incumbent operators' networks. It also seems clear that as a result of the
EU Interconnection Directive the interconnect charge payable for international calls will
be the same as the interconnect charge for terminating domestic long-distance calls, at
least for international traffic within the EU. In practice there will no doubt be the
usual delays and difficulties in implementing the new rules. Clearly Single Market
conditions in the EU won't come into existence overnight. There are already controversies
and delays in adapting national laws, regulations and practices to comply with the EU
legislation. During 1997 the European Commission began to put pressure on several EU
governments which had been slow in complying with the legislation. After insisting that it
would not hesitate to start legal proceedings if they did not stick to the deadlines in
the regulatory package, it opened legal "infringement proceedings" against
Belgium, Denmark, Germany, Greece, Italy, Luxembourg and Portugal.
An even more extensive Single Market is beginning to emerge. Twenty out of a total of
sixty-nine countries participating in the World Trade Organisation (WTO) Basic
Telecommunications Agreement of February 15th, 1997 (including nine of the 15 EU
countries) agreed to terms which, when fully implemented, will effectively make these
countries into a "Single Market" as well. As an informal designation, this
report calls these twenty countries the "Group A" countries. A further twelve
countries have made commitments which, while somewhat less extensive, still allow
considerable scope for trans-national competition.We call these countries "Group
B". The two groups are shown together with the criteria defining them in Exhibit ES.1
THE SINGLE MARKET EMERGING FROM THE 1997 BASIC TELECOMMUNICATIONS
- open entry for foreign competitors in basic fixed services, domestic and international,
- unrestricted right of foreign operators to establish networks
- non-discriminatory interconnection at cost-based prices
- non-discriminatory interconnection at cost-based prices
- open entry to new competitors with foreign participation
* Some foreign ownership restrictions on incumbent operators only
The 1997 agreement was originally intended to come into force on January 1st, 1998.
This date has been changed to February 5th, 1998 because some of the participating
countries had not completed ratification or other national procedures required for
confirmation of the agreement on time.
In this wide Single Market, the Basic Telecommunications Agreement requires that
telecoms operators based in any of the twenty countries be permitted to operate on the
same basis as a domestic operator in any other country among the twenty. Moreover,
according to the agreement (following the Most Favoured Nation principle: MFN), the same
rights must also be granted to operators from any WTO country. While there are
signs that full implementation of this agreement will not be easy, fast or uncontentious,
there can be no doubt about the strength or scope of the move towards a Single Market and
little doubt that a Single Market will in fact be implemented among most, if not all, of
the twenty Group A countries (and possibly among even more WTO countries) within the next
Of course, even after the EU Single Market for telecommunications is in place, and the
WTO telecoms agreement is more or less fully implemented, the majority of countries in the
world will not yet be members of a Single Market. The great majority of "relations"
between pairs of countries for the carriage of international traffic still will not fall
within a Single Market, but most of the heavy-traffic routes will be between pairs
of countries within a Single Market. Most of the world's international telecoms traffic
will flow within one or other of the Single Market groupings, and the Single Market type
of environment will consequently shape the way such traffic is carried.
Unrestricted competitive carriage of international traffic in a Single Market is very
different from the environment in which the traditional international arrangements were
developed. The differences are summed up in Exhibit ES.2. Essentially, the traditional
relationships for handling traffic from one country to another (which the ITU calls "jointly
provided service") were established between pairs of operators, one in each country.
Usually, these operators were monopolies; generally they were authorised only to operate
in their own "home" country. The financial arrangements between them which this
report refers to as the "traditional arrangements" (and which are described in
the next section of the Summary) were well adapted to such a situation, which economists
call a bilateral monopoly.
Once the monopoly conditions that gave rise to the traditional arrangements are wholly
or partly replaced by a competitive market, challenges to the traditional arrangements,
and alternatives to them, naturally emerge. A Single Market opens up many new alternatives
to telecoms operators in terms of how they carry their international traffic; what role
other operators play in the process; and how (and how much) these other operators are
COMPARISON OF "SINGLE MARKET" ENVIRONMENT WITH
TRADITIONAL ENVIRONMENT FOR HANDLING OF INTERNATIONAL TRAFFIC
|Can operator from "Country A"
operate (carry traffic, own facilities) in Country B?
|Do regulatory rules grant operator from
Country A automatic interconnection rights in Country B?
|Are per-minute rates for terminating domestic
calls via the domestic network (interconnect charges) different from the corresponding
charges for international calls, for comparable use of the domestic network?
(may be some exceptions)5
|How are payments from A to B for termination
of international calls in Country B determined?
||By market competition,
negotiation, or regulatory determination of interconnect charges covering both domestic
and international calls6
||By bilateral negotiation
between monopoly carriers in Country A and Country B
|1 The Single Market
concept is explained in Section 1 of the Executive Summary.
Entries assume legislation, regulation and in practice all conform to Single Market
requirements as defined in this report. Commitments of "Group A" countries in
the WTO Basic Telecommunications Agreement conform to these requirements, as does the EU
telecoms legislation (except temporarily in EU countries granted an extension of the
3 Except for "Country Direct", card calling
services and callback.
4 Other than traditional settlement arrangements. Under these
arrangements, correspondents have the right to rely on an existing settlement rate
previously agreed, if operators fail to agree to a new one. For US operators, however,
this may be over-ridden by the FCCs 1997 decisions in the "Benchmark"
5 Operator(s) may be able to charge a premium interconnect
rate for international calls, making a higher contribution to joint and common costs and
USO costs than the domestic interconnect rate, provided the regulator approves that: this
would not violate Single Market rules if (a) the rate still meets criteria for a
"cost-orientation" and (b) both domestic and foreign operators pay the same
rate. Enforcing (b) for the incumbent operator is, however, impossible unless the
regulator also imposes accounting separation, as in the UK.
6 Interconnect rates are likely to be regulated where (as is
usually the case) local bottleneck monopolies remain.
We refer to these alternatives as "new modes of operation", and describe them
below in Section 3 of this Summary. In brief, they are:
- Refile, hubbing or re-origination
- International alliances of telecommunications operators
- The extension of foreign operators' networks into the destination countries to Points of
Presence (PoPs) they establish there; or in some cases even the extension of foreign
operators' networks all the way to customers' premises in those countries. Such
arrangements are sometimes called "facilities-based entry" or "self-termination".
- Internet telephony
Contrary to claims often made, the "new modes of operation" will not necessarily
entirely replace arrangements of the traditional kind. These may remain in use as one as
of the widening range of alternative methods available to operators. Their
simplicity means that, in this authors opinion, they are likely to remain in use for
a substantial amount of international traffic, even between "Single Market"
The level of charges (settlement rates) paid by one operator to another within
the traditional arrangements is a different matter, however. For the traditional
arrangements to remain in use alongside the "new modes of operation", settlement
rates will have to fall to levels that are competitive (from the point of view of net
payers of settlement payments) with the new alternatives. This means lowering them to the
point where paying settlements is comparable to the cost of terminating a call:
- via leased-line resale, or...
- using the foreign operator's trans-national network all the way to a PoP in the
destination country, plus interconnect charges between the PoP and the customer, or...
- via the foreign operators network all the way to the customers premises in
the destination country, if the foreign operator has a local network in the distant city
(as WorldCom/MFS has in several European cities).
For major operators on major routes between Single Market countries, self-termination
may well become the predominant mode of operation.
Most international traffic is still carried today under what this report calls the
"traditional arrangements". These are based on international bilateral
relationships (referred to as relations) between pairs of nationally-based
telecommunications operators, often referred to as "correspondents". Part II of
this report describes the details of these arrangements, many (but not all) of which are
based on Recommendations of the ITUs telecommunications standardisation sector,
known as ITU-T. The essential features are simple:
- If the number of minutes of traffic flowing from Country "A" to Country
"B" exceeds the flow of traffic in the reverse direction, the operator in
Country A makes a net payment ("settlement") to the operator in Country B based
on the net flow of traffic from A to B (that is, the volume of traffic from A to B,
minus the volume from B to A).
- The size of the net payment is calculated from the net flow of traffic (measured in
minutes) multiplied by an amount of money per minute agreed upon between the two
operators. This amount is based on a negotiated price called the accounting rate.
In most cases, the same accounting rate generally applies in both directions: A to B, and
B to A. The amount paid per minute from one operator to its "correspondent" is
usually half the accounting rate. It is called the settlement rate. (Some national
regulators, the FCC in the United States in particular, require the accounting rate to be
the same for all operators serving a particular country. Others, like DTI and Oftel in the
UK, generally do not.) Modified arrangements apply when the traffic flows from A to B
indirectly via a third country (the "transit" country). The accounting rate and
settlement rate are intended, according to ITU Recommendations, to reflect the cost of
carrying international calls, although how close they are to really doing so is one of the
key issues in the current controversy. They have no necessary relationship to the prices
charged to end-users for international calls (which are referred to in this context as collection
charges or collection rates).
- Where there are multiple operators at one end of the "relation", or at both
ends, operating agreements between pairs of correspondents may stipulate proportionate
return, though this is not a feature of the ITU Recommendations. Proportionate return
means that if an operator in Country A originates, say, 35% of the total traffic flowing
from Country A to a particular telecoms operator in Country B, that operator in Country B
must send 35% of its return traffic flowing in the other direction back to the same
operator in Country A. Regulators in Country A may insist on this, especially if there is
a telecoms monopoly in Country B. In particular, a requirement for proportionate return is
a major feature of the International Settlements Policy (ISP) of the Federal
Communications Commission (FCC) in the United States. On the other hand, regulatory
authorities in most other countries with competitive telecoms markets (Australia, for
example) do not require proportionate return. Regulators that do require it
typically justify this on the grounds that proportionate return prevents the operator in
Country B from obtaining excessive bargaining power through allocating return traffic
among Country A's several competing operators ("whipsawing"). However,
proportionate return tends to favour established operators and raises barriers to entry,
and therefore tends to impede the transition to a fully competitive market for
Those aspects of the "traditional arrangements" that are codified in ITU-T
Recommendations have been very influential. While the Recommendations are not legally
binding, their main structural features were developed by consensus in the
telecommunications industry, and the main features are widely followed, in practice. The
key points are reviewed in Chapter 6 of this report. In addition to what we call the
"traditional arrangements", the Recommendations do also allow for a variety of
alternative arrangements such as "Sender Keeps All" where no settlement payments
are made. (In practice, the most important example of SKA is the Internet, which carries
international traffic without any form of settlement payment. Its international links,
however, which predominantly run to and from the US, are paid for by the non-US Internet
Merits of the Traditional Arrangements
The "traditional arrangements" have some virtues. They are simple to
administer: no minor matter when there are over 200 countries and territories
participating in international telecommunications and
thus, in principle, up to 20,000 distinct traffic flows between them that need to be
administered. The traditional arrangements have produced a substantial, continuing, and
growing international transfer of resources between telecommunications operators. These
transfers have helped telecoms operators in some developing countries to expand and
upgrade their networks and make progress towards universal service goals. Nevertheless,
many critics object to the traditional arrangements on the grounds that they conflict with
competitive market principles. Critics often argue that there are alternative and better
ways of generating funds to pay for rapid progress towards goals of network expansion and
universal service. They also often object that in some developing or newly industrialising
countries the flows of hard currency from international settlements are retained by
national Finance Ministries and not necessarily used for such investments in the telecoms
The importance of this issue to developing countries (especially those which are
relatively small, or have relatively "open", export-oriented economies) should
not be under-estimated. In the case of Jamaica, where settlement payments have in most
years flowed directly to the telecommunications operator, 46% of telecoms revenue in 1995
was attributable to the total of net settlements received for international traffic. The
average for the small island countries of the Caribbean basin is between 30% and 50%. On
the other hand, in India total funds received from net settlements though substantial
(estimated at US$254 million in 1994), accounted for only 9% the combined total of
reported domestic and international telecommunications revenue in 1994, reflecting the
large scale of Indias domestic telecoms market.
The impact on developing countries of changes in the international settlement system
should be of concern to governments and telecommunications operators in industrialised
countries, since (as is often the case) the interests of developed and developing
countries are more closely aligned than is generally believed. Notwithstanding their
dissatisfaction with todays level of settlement rates, telecoms operators in
advanced industrial countries (and their customers) are beneficiaries of the expansion and
upgrading of public networks in developing countries that is to some degree paid for by
settlement payments. Telecoms operators in industrialised and developing countries alike
almost invariably find that international calls represent one of their most profitable
The traffic that provides the basis of this profitable business is growing rapidly:
annual growth of the top five international routes is on the order of 15%, with some
routes such as US/Mexico growing by over 20% per year. This does not necessarily mean that
revenues are also growing rapidly in every case, because prices are generally falling.
On routes where open competition prevails; they are falling very rapidly, as our
UK-US example illustrates.
Future growth prospects are, however, constrained by the low telephone penetration in
developing countries and by congestion and other service problems. Congestion results in
numerous failed call attempts that incur costs for the telecoms operator trying to
originate the call, as well as the operator in the developing country, and generate no
revenues. It is very much in the interests of telecoms operators and users (and thus the
whole national economy) in advanced industrial countries that operators in developing
countries should continue to be able to finance programmes of network expansion and
upgrading which are reducing these constraints on worldwide growth in traffic and
Of course, there are many ways in which the capital investments required by such
programmes can be financed. In the case of operators which are privately owned or being
privatised, these include foreign direct equity investment; local equity investment;
project finance (for example, Build-Operate-Transfer schemes or leveraged leases); and
borrowing. But the feasibility of all of these in turn depends on the operators
profitability, which in many developing countries is closely linked to the flow of net
Shortcomings of the Traditional Arrangements
The shortcomings of the traditional arrangements have become more apparent with the
passage of time, as the telecommunications marketplace has become more competitive and
more open to entry and to new modes of operation. In particular:
- The structure of these arrangements tends to limit the degree of effective competition
on a route. Using the same accounting rate and settlement rate for all operators on a
route (sometimes called "parallel accounting") prevents operators competing on
price to attract terminating traffic. Proportionate return requirements (which we
emphasise are not called for by the ITU Recommendations) obviously also have this
effect. Proportionate return puts additional traffic and revenue in the hands of
established operators with large outgoing traffic flows, and disadvantages new competitive
entrants which might otherwise have been able to bid to carry the terminating traffic.
Thus the traditional structure is not very consistent with an overall policy favouring
- Since settlement rates are intended (according to ITU-T Recommendation D140) to be
cost-based, and since telecoms operators costs per minute of traffic are much higher
in some countries (especially developing countries) than others, using the same accounting
rate for both directions of traffic seems inappropriate. An "asymmetric" system
with different per-minute rates of payment between operators in the two directions would
correspond more closely to the economic realities.
- Todays settlement rates, for calls to a particular country can vary by a ratio of
5:1 or more (sometimes much more) depending on what country the traffic came from. This
seems illogical. Settlement rates are intended to be cost based, and yet the charge for
terminating an international call in a particular country is largely independent of what
other country the call is coming from. The structure of settlement rates should reflect
this. This logic has given rise to a proposal for uniform "termination charges"
for each country, regardless of the country of origin of the traffic: this approach was,
for example, advocated by the Australian delegation to the recent WTO telecommunications
negotiations, and is also under intensive consideration in ITU-T Study Group 3. As
opportunities grow for operators to re-route traffic around the world in search of the
cheapest alternative routing, some such levelling of settlement rates is inescapable.
Technological change and relaxation of regulatory barriers is increasing such re-routing
opportunities very rapidly. If levelling of settlement rates does not occur, the routes
where higher settlement rates apply will simply be bypassed, a phenomenon akin to
"arbitrage" in financial markets. Market forces will ensure an outcome not far
from the Australian proposal, though not necessarily in the specific form that was
- While accounting rates and hence settlements have fallen significantly (for example,
settlement rates for traffic to and from the US fell from a weighted average of
51.5 cents per minute in 1992 to 36.5 cents in 1996 and 35 cents in August
1997), it is widely accepted that this fall was insufficient to bring them into line with
the true costs of terminating international calls, or to reflect the large cost reductions
arising from technological change and economies of scale. The Informal Group of Experts
convened by the ITUs Secretary General to advise on the reform of the settlement
system noted in its report of April 1997 that studies carried out by the ITU Secretariat
suggested that "in all but a few cases, settlement rates should be priced below
25 cents per minute".
- The structure of the traditional settlement arrangements, combined with the high level
of settlement rates, creates economically inefficient incentives for telecoms operators.
limits (though by no means eliminates) the incentive for operators that are net
payers of settlements to reduce end-user prices (collection charges) since the settlement
rate is an uncontrollable cost representing a substantial percentage of the collection
restricts the incentive for operators that are net recipients of settlements to
reduce their collection rates and generally promote the growth of outgoing calls
through marketing and service improvements (since doing so would increase their outgoing
traffic relative to incoming traffic, and thus reduce their net settlement receipts).
- Consequently, the traditional settlement arrangements impede the growth of international
traffic, though traffic growth has nevertheless been very rapid.
The incentive structure inherent in the traditional system, to some degree inhibiting
the growth of outgoing international traffic from operators that are net recipients of
settlements, is one (but only one) cause of the large and fast-growing flows of net
settlement payments paid by operators in some industrialised countries.
The United States and Germany have by far the largest net out-payments of settlements,
as the "top 10" summary in Exhibit ES.3 shows. In 1995 net payments from
the US were US$4.9 billion. The FCC's interim estimate for 1996 is US$5.6 billion.
Estimated net payments from Germany in 1994 (the most recent year for which extensive data
are available for countries other than the US) were US$0.8 billion; no other net payer
country paid more than US$160 million in that year. While settlement payments contribute
to the ability of telecoms operators in developing countries to finance their network
expansion, the operators paying the settlement payments generally argue that these
payments are far larger than what can be economically justified. This is, of course, at
the heart of the current controversies about the international payments system. But are
the large out-payments for settlements demonstrably inappropriate and harmful, when judged
against objective criteria?
It is important to remember that the size of the settlement payments depends on the
size of the traffic imbalance as well as the settlement rate. If outgoing and incoming
traffic were roughly in balance, the level of the settlement rate would be much less of an
issue. The traffic imbalances partly exist for fundamental reasons beyond the control of
telecoms operators and regulators: for example, high per capita incomes in advanced
industrialised countries; habits of telephone usage in those countries; and the existence
of large overseas emigrant communities.
The size and growth of traffic imbalances also reflects other factors that are, to a
degree, controllable. Traffic imbalances have grown because competition has reduced
collection rates in countries with a competitive telecoms market, despite the constraining
effect of settlement payments on reductions in end-user prices. They have also grown
because of the phenomenon known as "turnaround". "Country
Direct" services such as BTs "UK Direct" or AT&T "USA
Direct" represent one important form of turnaround. If a caller in Country B calls
Country A by means of "country direct" services using a telephone credit
card/calling card, the call is billed to the customer in Country A, not Country B. The
call is counted for settlement purposes as a call from A to B, not from B to A. The same
happens for a call from Country B to Country A using a callback operator in Country A. The
use of "country direct" service, calling card services or callback in effect
increases the measured traffic imbalance that is the starting point for calculating the
TOP TEN PAYERS AND RECIPIENTS OF NET SETTLEMENTS FOR 1994
* FCC "Trends
in Telephone Service", March 1997
*** ITU estimate, private communication
Source: updated from ITU/TeleGeography "Direction of Traffic, 1996" available
from ITU website at <http://www.itu.int/ti>
The overall effect of the different forms of turnaround, taken together, can be
sizeable. In the United States, the ratio of outgoing to incoming international minutes
rose from 1.84:1 in 1990 to 2.14:1 in 1995 and 2.29:1 in 1996. In Hong Kong, which has
been on the opposite end of this process, the ratio of calls incoming from the US
(where a great deal of turnaround activity is based) to calls outgoing to the US
was 1.2:1 in 1992. By 1995, this had increased to 3.1, and by the end of 1996 it was 7:1.
Since the period 1992-96 is exactly the period during which callback activity, and
turnaround in general, burgeoned on this route, it is reasonable to assume that the very
large growth in the traffic imbalance is mainly to this.
Such effects, with turnaround leading to increased traffic imbalances, are particularly
pronounced for traffic between developed and developing countries. It would plainly be
wrong to assume that the traffic imbalances that result in the large and controversial
outflows of settlement payments from some industrialised countries are caused solely by
the structural defects and inappropriate incentives built into the traditional settlement
system. Much of the imbalance is the result of normal competitive market activity,
including the creation of service innovations like "country direct" services;
though the scale of turnaround activity is of course motivated to a sizeable extent by
customers desire to avoid the high end-user prices ("collection rates") in
The mere fact that innovations such as those just described increase traffic imbalances
does not mean they are undesirable: in fact, traffic imbalances and resulting flows of
settlement payments would not be (or certainly should not be) an issue if the level
of the settlement rate represented a fair market price for the service of completing one
minute of international calling.
A Verdict on the Traditional Arrangements
and the Case for Change
How should the merits and demerits of the traditional settlement system, be judged
overall? Any such overall "verdict" must answer four questions:
- Are the economically inefficient incentives built into the traditional arrangements
sufficiently harmful to justify making it a goal of public policy to abolish those
- Quite apart from the public interest point of view taken by governments, legislators and
regulators, is the structure of the traditional arrangements in any case sustainable in
the new, increasingly competitive environment?
- Is the level of settlement rates in the traditional system, as distinct from the
structure of the system, acceptable from a public policy point of view?
- Is the level of settlement rates sustainable?
This section discusses these questions in turn, giving the authors personal view.
Question 1: Inappropriate Incentives:
Do they Warrant Abolition of the Traditional Arrangements?
This reports answer is "no". The adverse incentives involved in the
traditional arrangements, such as discouraging the growth of outgoing traffic from
countries that are net recipients of settlement payments, are only economically
significant if the settlement rates are above cost-justified levels. But while settlement
rates are high, governments and regulators even in countries that are net recipients of
settlement payments (mainly developing countries) should be concerned about such
disincentives. The way the traditional system constrains the growth of outgoing traffic is
bad for the national economies of these countries. Enterprises in these countries should
enjoy the same opportunities that companies in other countries have to use
telecommunications to explore and pursue their economic opportunities throughout the
world. If not, the balance of international competitive advantage in the business
environment generally is tilted against telecoms users in the countries that are
net recipients of settlements.
The solution is to reduce the settlement rates and not necessarily to abandon the
entire structure of the traditional arrangements. Desirable structural reforms
include, however, the "levelling" of settlement rates already discussed, and the
abolition of proportionate return requirements at least for service to Single Market
Should governments and regulators also allow alternative "modes of operation"
such as leased line (private line) resale or foreign-operator PoPs ("self-termination")
to grow up alongside the traditional arrangements, or perhaps even direct traffic away
from the traditional arrangements? Governments of countries that are net recipients of
settlements may be reluctant to allow the use of the new modes of operation, for fear of
reducing the settlements payments flowing in. The Federal Communications Commission (FCC)
in the United States has also shown itself reluctant in a wide range of situations to
allow leased-line resale by foreign operators, and foreign-operator PoPs.
Governments or regulators in other net-payer countries, however have not taken this
view: in Japan, New Zealand, Sweden and the UK, for example, use of the "new modes of
operation" such as leased-line resale or foreign-operator PoPs is generally permitted
regardless of the correspondent country involved. This policy reflects the view, shared by
the author of this report, that there is more to gain from the benefits of increased
competition than there is to lose from the risk (as yet only hypothetical) that a monopoly
correspondent in another country will abuse this liberalisation to gain additional
bargaining power and profits.
Question 2: Is the Structure of the Traditional Arrangements Sustainable?
Regardless of what governments or regulators decide about the merits or demerits of the
traditional arrangements, are they sustainable? This report's answer is "yes, but
only with significant modification". The reasons are:
Question 2: Is the Structure of the Traditional
Regardless of what governments or regulators decide about the merits or demerits of the
traditional arrangements, are they sustainable? This report's answer is "yes, but
only with significant modification". The reasons are:
- In a wide variety of situations the traditional arrangements can continue to be an
attractive mode of operation for both of the operators making up a "relation".
However, this is only the case when the cost of settlement payments (per minute of
traffic) to the operator that is the net payer is comparable to the equivalent per-minute
cost under new modes of operation such as leased-line resale or foreign-operator PoPs.
Sustainability depends mainly on the level of settlement rates, rather than the structure
- Nevertheless, certain modifications are essential for sustainability:
differences in settlement rates in the same country for different correspondent
countries will have to be greatly reduced or even eliminated; otherwise refile and
arbitrage will simply divert all the traffic to where the settlement rate is lowest.
Anomalies give rise to large arbitrage opportunities for operators other than the
traditional operators to capture part of the value of the traffic by re-routing it.
as a fully competitive environment approaches, it may become impossible to
maintain a symmetrical system where the same accounting rate applies to both directions of
traffic. The settlement system must provide for lower charges for terminating calls in
low-cost countries (this is already provided for within the traditional arrangements in
the case of the Europe/Mediterranean region, under the terms of ITU-T Recommendation
Overall, reform of the structure of the settlement system is a quite distinct
question from the level of the settlement rates. There is no logical reason why the
broad structure of the existing settlement system (that is, correspondent relations in
which operators exchange traffic and a net settlement is paid) should not remain in being
if the settlement rates come down sufficiently and the necessary structural changes also
take place. The indispensable structural change is the reduction or elimination of
differences in settlement rates to the same country based on where the traffic originated;
and the use of asymmetric settlement rates where the costs of termination (or origination)
of calls are substantially different in the two countries concerned. In this scenario, a
modified form of the traditional arrangement continues in use as one mode of operation
used for international traffic, coexisting with the various "new modes of operation".
All the complexities of the issue therefore reduce ultimately to three simple
questions: when is a settlement rate "too high", and according to what criteria?
Who decides that? And how?
Question 3: Is the Level of Settlement Rates Acceptable?
The relatively slow rate of reduction of settlement rates, contrasted with the rapid
rate of reduction in network costs for international links, has led to a widespread
"common sense" view that settlement rates are now too high. Despite the fact
that the cost of international transmission links represents only a small part of the
total cost of an international call, most independent specialists in
this field (including this author) would still support the "common sense"
But how, more objectively and analytically, should levels of settlement rates be
judged? This is by no means obvious: it is not at all self-evidently valid, for example,
to use the text-book microeconomic criteria often employed to argue that settlement rates
should equal some measures of a correspondent operators Long Run Incremental Costs,
as the FCC did in the Notice of Proposed Rulemaking (NPRM) for its International
Settlement Rates Proceeding.
It is not realistic to expect a high degree of consensus about this. Not only are there
obvious divergences of view between governments, regulators and operators in different
countries (especially as between net-payer countries and net recipient countries). Even in
theory, it is problematic to ascertain exactly what the "correct" level is.
There are good reasons (discussed in detail in Chapter 8 of the main report) to view
sceptically even the principle of prescriptions such as the FCCs proposal for
settlement rates based on Total Service Long Run Incremental Cost (TSLRIC), derived from
microeconomic theory, let alone the feasibility of applying such prescriptions in
This authors conclusions are as follows:
- Even from the point of view of economic theory, a pure incremental cost approach (as in
the FCCs assertion in the NPRM that reducing settlement rates to "an
incremental cost level... would maximise consumer welfare") is not warranted. Indeed,
the FCC itself partially recognised this in its very next sentence, where it added that:
"In addition, we believe that it may be appropriate for international services to
provide a reasonable contribution to the common costs of foreign carriers".
- In the authors view, it not only may be, but is, appropriate for settlement
rates to provide a contribution to the joint and common costs incurred by an operator to
enable its whole network and business to function. Domestic interconnect charges already
do just this, in the United States and elsewhere.
- Similarly, since governments and regulators typically impose Universal Service
Obligations (USOs) on operators, it is equally appropriate that the international
settlement rate should include a contribution to the cost of meeting these obligations:
again, this is done in the United States and many other countries in setting domestic
interconnect charges. (It is well known, though, that USOs can be an excuse for the costs
of monopoly inefficiencies, and that in many areas rural services, operated efficiently,
can be profitable and therefore incur no USO costs: any USO contribution should therefore
be set at "reasonable", economically justified levels. Agreeing what these are
will obviously not be easy, but will be necessary).
- The contribution to joint and common costs and USO costs from international settlements,
per minute or as a percentage of the total payment, in general need not necessarily be the
same as it is for domestic calls. For routes entirely within a Single Market however, it
is not feasible to collect a higher per-minute contribution for international calls than
for domestic long-distance calls, since both types of calls can use the same
The best that can be hoped for in practice is a series of pragmatic negotiations in
which the parties involved eventually find themselves able to agree on:
(a) broadly what elements can legitimately be included in a settlement rate;
(b) what range of numerical values can be arrived at for these elements, under a wide
variety of different but logically defensible cost-related doctrines;
(c) what level of settlement rates in any case is sustainable in practice, given
the reality that the traditional settlement system is increasingly subject to competitive
pressures. Most net recipients of settlements will want to retain the existing system,
sufficiently reformed to keep the net payers in the system and thus to achieve
sustainability in the face of the emergence of new modes of operation.
The gradual leakage of traffic out of the traditional payment system is steadily
compressing the range of settlement rates that will be sustainable in the longer term (say
beyond 5 years). It should therefore be possible to get agreement on this pragmatic basis
that the great majority of todays settlement rates are indeed "too high",
and to secure faster reductions than have occurred in recent years.
This also seemed to be the view of the ITU Secretary Generals "Informal
Expert Group" when it reported in April this year.
Question 4: Is The Level and Structure of Settlement Rates
No. This does not mean that the more established operators are abandoning the
traditional system wholesale, because they must think at least twice before disturbing the
existing correspondent relationships upon which so much long-established business relies.
But newer players have fewer such concerns. Even many of the traditional players use tools
such as refile, or agreements to terminate one-way traffic without a linkage to return
traffic, far more often than is generally supposed.
Consequently, traffic is increasingly flowing outside the traditional arrangements as a
joint result of the high settlement rates and the evolution towards a new industry
structure in which operators have many "new modes of operation" available to
Thus there is little practical doubt that todays levels of settlement rates are
not sustainable. Where there is a monopoly operator at one end of a "relation",
and "new modes of operation" such as leased-line resale are not allowed at that
end, these high levels of settlement rates might in theory be maintained for some years,
but even in this case, the arrangement will come under pressure:
- Refile and hubbing will direct traffic to those routes where the settlement rate is
- If (as usual) collection rates as well as settlement rates are high in the monopoly
country, callback and other forms of "turnaround" will tend to inflate the
traffic imbalance. This, together with the high settlement rates,may rise the flow of
settlement payments to such a high level that the operators (and possibly the regulator)
in the net payer country apply very strong pressures for change.
- Major telecommunications users may also press for change, increasingly making
unfavourable comparisons between prices and other conditions for telecommunications to the
country concerned, compared to other countries.
It follows that substantial reductions in settlement rates are inescapable and that the
structure of settlement rates must move towards a uniform charge ("termination
charge") for each country, rather than differing settlement rates depending on the
country of origin of the call. This will be the case even in most of the countries where a
telecoms monopoly still prevails.
In the previous section we discussed the case for change based on fundamental
considerations about the desirability and sustainability of international payment
arrangements. In this section, we discuss the forces which are likely to challenge the
The traditional settlement system and the current level of settlement rates are under
challenge from five distinct directions:
- The emergence of "new modes of operation" in which both the operational
arrangements and the payment arrangements differ from the traditional correspondent
relationship and settlement system.
- Commercial pressures from net payers of settlements. Accounting rates/settlement
rates are negotiated between pairs of correspondents, and net payers are becoming more and
more reluctant to pay according to todays (and potentially tomorrows) scale of
- Pressure from regulators in net payer countries. Some regulators, notably the
FCC, have aligned themselves with the operators based in their countries who are net
payers, and are pressing for the reduction of settlement rates. Interestingly, however,
regulators in several other countries that are net payers of settlements (notably in
Germany, with estimated net settlement out-payments of US$800 million in 1994, and the UK,
where 1994 out-payments were estimated at US$158 million) have chosen not to do so.
- The rethinking of international settlement practices that is taking place
multilaterally through the ITU and other international forums such as the OECD.
- The WTO Basic Telecoms Agreement. For the thirty-two Group A and Group B
countries, whose WTO commitments are in conflict with the traditional settlement system as
it is operated today (though not necessarily with a reformed version).
Commercial negotiations still represent the main avenue for reform in the structure of
the settlement system. Notwithstanding the frustrations often expressed in net payer
countries, such negotiations (assisted in the case of the US by pressure from the FCC as
regulator) have produced sizeable reductions in settlement rates. According to AT&T
these "negotiations resulted in a reduction of ...18% in the average accounting rate
paid by AT&T from 1992 to 1995. This number is controversial. FCC estimates show
larger increases. The FCC has published its estimate (for US international service
carriers as a group). It shows a 29% decrease in the weighted-average settlement rate for
US operators from 1992 to 1996, and a 32% decrease from 1992 to 1997.However, these
reductions certainly still leave settlement rates in most cases well above any level that
is likely to have a reasonable cost justification, and for some "relations"
there has been little change.
Some major operators, especially AT&T, MCI and others in the US, frustrated with
this situation, have been increasingly forceful (and successful) in urging their
regulator, the FCC, to intervene.
Pressure from Regulators in Net Payer Countries
Increasingly, as telecommunications operators in those industrialised countries that
are net payers of settlements have become concerned by the continuing rapid growth and
large scale of settlement payments, they have pressed regulators in those countries
to become more active in pursuing reform of the settlement systems. Depending on the
country concerned, such regulatory activism has included:
(1) Requiring disclosure of accounting rates (which were traditionally kept
confidential). This has been done in the US, the UK and New Zealand, and has helped
highlight exceptionally high settlement rates and increased the pressure to change them.
(2) In some countries (notably the US), regulators have sought to protect operators in
a competitive market against excessive bargaining power at the monopoly end of a
"relation" by imposing a mandatory requirement on the operators they regulate to
establish proportionate return arrangements with their correspondents in monopoly
countries. The FCC in the US does this through its International Settlement Policy (ISP).
However, in Australia, New Zealand and Sweden (among other countries) the regulatory rules
do not require proportionate return. The rules in the UK do not require
proportionate return as such, but do contain some other safeguards. The FCC also
requires uniform accounting rates for all operators to the same correspondent country (a
policy sometimes referred to as "parallel accounting"). Here again, regulators
in other countries are often less restrictive: UK policy, for example, generally does not
require parallel accounting. Policies requiring proportionate return and uniform
settlement rates, which arguably could be a safeguard against anti-competitive behaviour
by monopoly correspondents, also have their own anti-competitive effects. They raise
barriers to entry and favour incumbent operators.
(3) Controlling practices thought to contribute to excessive settlements payments. If
there is a competitive market at one end of a "relation" ("Country A"),
and a monopoly at the other ("Country B") this may result mainly in the
diversion of traffic from B to A (rather than in the reverse direction) out of the
traditional settlement system to the "new modes of operation". If this happened,
it would further increase the flow of settlements payments in B's favour . Until recently,
the UK government for this reason allowed international traffic to be carried via the
resale of leased-line capacity ("International Simple Resale" or ISR) only to or
from countries that allowed ISR operations by UK operators. This restriction (sometimes
referred to as a "reciprocity" policy) was abolished in 1996, through the UK
government retained certain safeguards, including regulatory powers to intervene
subsequently if anti-competitive behaviour occurs. The Japanese Ministry of Posts and
Telecommunications has abolished its ISR restrictions on a similar basis with effect from
January 1998. The FCC in the United States used to operate a reciprocity policy (broadly
similar to that followed by the UK before 1996), under the name of the "equivalent
competitive opportunities" test, or "ECO test". Recently, policies have
increasingly diverged. While the UK (like Japan and several other countries) has abolished
reciprocity restrictions on resale, the FCC while abolishing the ECO test for traffic
between the US and other WTO members as required by the 1997 Basic Telecommunications
Agreement has imposed new restrictions (discussed later in this summary) which still
greatly restrict leased-line resale
(4) Setting indicative targets for reduction of accounting rates.
(5) Making these targets ("benchmarks") mandatory.
A striking divergence of philosophies seems to be emerging between the FCC on the one
hand, and regulators in other countries with competitive telecommunications environments
(such as Australia or the UK) on the other. The UK government abolished its ISR
restrictions in June 1996, well before the 1997 WTO agreement (which, when it comes into
force, will limit national governments ability to maintain such restrictions). In
abandoning its restrictions, the UK government in effect took the position that gains from
an unconditionally open competitive market (expanding the total "size of the
pie") outweighed the theoretical risk that such radical deregulation might give too
much bargaining power in international telecommunications to monopolies in other countries
(enabling them to take too large a "slice" of the expanded pie).
As we describe below the FCC has tended to take the contrary view. It has focused on
issues of bargaining power and hence who gets what "slice of the pie". To that
end it has maintained strong restrictions on the use of "new modes of operation"
for international traffic, except to countries that have already complied with the
FCCs unilateral decisions about how far settlement rates should be reduced. Even for
fraffic to or from those countries, significant FCC regulatory constraints and
encumbrances still apply. The FCC, through several related but separate regulatory
proceedings, has made three key decisions in this field:
- It has indicated that it may waive its International Settlements Policy (ISP), which
requires proportionate return and uniform accounting rates for all US operators for any
given country. ISP waivers would allow new services, variants of the traditional
settlement arrangements, and "new modes of operation" in those cases where it
believes this favours the operation of a competitive market. It seems clear, however, that
the FCC does not intend to use this flexibility in the sphere of basic fixed telephone
services, except in two particular ways:
(1) to follow a "hands off" policy towards the emergence of Internet
(2) to waive restrictions on other "new modes of operation" such as
leased-line resale or foreign PoPs (which require FCC approval under Section 214 of the
1934 Communications Act) only under specified conditions linked to the FCCs policy
on settlement rates, as described below.
- It has adopted "benchmark" settlement rates, defined for each of four groups
of countries classified by income level. It has in effect given US international operators
an ultimatum that they must start applying these benchmark rates by a stated deadline.
(The benchmark rates are compared with current settlement rates for a range of countries
in Exhibit ES.4.) Since the US operators have operating agreements with their foreign
"correspondents", the decision puts them in an interesting position: to comply
with the FCC Order, they must renegotiate their settlement rate with the correspondent if
they can, and unilaterally breach their agreement if they cannot. Later in this summary
(in Section 7 under the heading "Possible Outcomes") we discuss what might
happen in practice.
SELECTED BENCHMARKS FOR US CARRIERS (US$/MIN.)
* Rate offered by largest carrier:
* Rate offered by largest carrier
Source: FCC, In the Matter of International Settlement Rates, IB Docket
N¡ 96-261, released August 18th, 1997; TeleGeography 1997/98, TeleGeography Inc.,
Washington DC, 1997.
- It has made its consent to the use of several of the "new modes of operation"
under which traffic is carried outside the traditional settlement systems (specifically,
leased-line resale and foreign-carrier PoPs: see below) conditional to varying degrees on
the foreign correspondent carrier complying with the FCC-mandated benchmark settlement
rate for the traffic that does continue to be carried under the traditional
arrangements. While introducing these new restrictions, the FCC abolished old ones based
on a reciprocity principle ("Equal Competitive Opportunities" or ECO test), as
required by the commitments to market access and National Treatment made by the US to
other WTO countries in the February 1997 WTO agreement.
- It has imposed several new restrictions on the activities of foreign operators using
leased-line resale or foreign-operator PoPs in the US; for foreign operators which are
considered "dominant" (according to a very all-inclusive definition of "dominant")
in their home country.
The FCC's policies undoubtedly represent strong pressure for reducing the settlement
rates in the traditional settlement systems. On the other hand, they do not attack the structure
of the settlement systems per se. If anything, they tend to do the opposite: they
restrict the use of some of the new "modes of operation" through which traffic
can be carried outside the traditional settlement systems -- though not, interestingly,
the use of Internet telephony.
These FCC decisions raise some major questions about the proper governance of
international activities that involve the jurisdiction of both the FCC and regulators in
other countries: we discuss the issues involved below in Section 6 of this summary. The
decision to link FCC consent for the use of "new modes of operation" (with the
exception of Internet telephony) to foreign correspondents acceptance of the
benchmark settlement rates unilaterally declared by the FCC seems to violate the
commitments to market access for foreign operators made by the US in the 1997 WTO
telecommunications trade agreement.
New Modes of Operation
We noted earlier how service innovations such as country-direct service or callback
result in "turnaround". These particular types of innovations do not take
traffic out of the traditional settlement systems: they reverse the effective
direction of traffic for purposes of calculating settlements, in such a way as to increase
measured traffic imbalances, and flows of settlement payments. Consequently, they also
tend to increase the pressures from net payers to curb the growth of settlement payments.
Another distinct set of service innovations, which we refer to generically as the
"new modes of operation", have a quite different effect. They either remove
traffic from the settlement systems entirely or (as in the case of refile and
"hubbing") they involve routing traffic in such a way as to "mix and
match" old and new modes of operation to maximum commercial advantage (as an
alternative to the term "new modes of operation", the expression
"full-circuit regime" has also been used).
The five "new modes of operation" are:
- Resale of leased-line ("private line") capacity to provide public
switched international telephone service. In this mode of operation (sometimes called
International Simple Resale: ISR) calls originate on the public switched telephone network
(PSTN), move to the destination country via leased lines or similar bulk transmission
arrangements, and then terminate in the destination country via the PSTN. Freedom to use
leased-line resale is incresing rapidly in many countries: in Japan, for example,
restrictions on ISR were essentially abolished in January 1998.
- Foreign Points of Presence (PoPs)/Points of Interconnection (PoIs). If an
operator from Country A is permitted to extend its own physical network infrastructure,
including transmission links, into another Country B and interconnect to the PSTN there in
order to terminate international calls, the locations where such interconnection takes
place are known as PoPs or (with exactly the same meaning) PoIs. This type of arrangement
contrasts with the traditional mode of operation where the operator from Country A
possessed only "half circuits" to a notional mid-point between Country A and
Country B, not transmission capacity all the way from A to B. This mode of operation is
also referred to as "self-termination".
- Refile, hubbing or re-origination, in which an operator takes its international
traffic to a country where an open competitive market and low charges apply for forwarding
of traffic to its ultimate destination in a "third" country. The traffic may get
to the country where this "refiling" occurs either via a conventional
correspondent arrangement, via a leased line, or via a foreign-operator PoP. The
unconventional routing is selected in order to minimise the originating operators
cost for terminating international calls. From the point of view of the telecommunications
operator where the call terminates, the call appears to have originated from the country
where the refiling or hubbing took place: for this reason, refiling or hubbing is
sometimes called "anonymous" refile. Such unconventional routings are less and
less constrained by technical considerations, because digital signals undergo relatively
little impairment even if they traverse very indirect routings: this was not true for the
analogue signals that prevailed at the time todays settlement systems was created.
Refile, hubbing and re-origination are quite distinct from the "transit"
arrangements that form part of the traditional settlement systems.
- International alliances of operators. Operators may decide to combine their
activities in certain lines of business internationally, as in alliances like Concert (led
by BT), World Partners (led by AT&T) or Unisource (led by KPN of the Netherlands,
Telia of Sweden and Swiss PTT Telecom) that service large multinational business
customers. (Proposed transnational mergers take the same trend a stage further.) Such
alliances provide end-to-end service. The alliance purchases and pools transmission
capacity (either as half circuits or in other forms) provided by the parent company or
other telecommunications operators. It uses this capacity to build global networks through
which data and value added services, and increasingly voice services as well, are
provided.Traffic is not accounted for within the traditional arrangements. The alternative
revenue-sharing and cost-sharing arrangements used by the international alliances are
complex and diverse.
- Internet Telephony. Recent technological developments, together with the
beginnings of gateway arrangements allowing telephone calls to flow between the Internet
and the PSTN, opens up a realistic possibility that the carriage of international
telephone calls via the Internet ("Internet telephony") will soon move from its
original more or less prototype or hobbyist status to become a major "mode of
operation" for carrying commercial traffic. It seems so far that this may happen
entirely outside the conventional regulatory framework; it is certainly happening outside
the traditional settlement systems.
The Rethinking of International Settlements Practices
Through Multilateral Bodies
Just as operators and governments collaborated multilaterally to shape the traditional
settlement arrangements, multilateral consultations in recent years have focused on how to
adapt international settlement arrangements to the changing environment. Essentially all
the players are committed to this multilateral consultative process. Even the FCC, which
has chosen to act unilaterally on the question of benchmark settlement rates, has stated
that "we should continue to work vigorously with these (multilateral) organisations
to pursue accounting rate reform".
The three main multilateral entities active in this field have been:
- the OECD seeking to develop a consensus among governments in advanced market-economy
- Study Group 3 of the ITUs telecommunications standardisation sector (ITU-T), the
source of the ITUs highly influential formal Recommendations in this field.
- the Informal Expert Group appointed in early 1997 by the ITUs Secretary General,
Dr. Pekka Tarjanne.
The Secretary General himself has played a vital catalytic role as advocate for fresh
thinking in this field, pressing the case for rapid reform of the settlement systems along
market-oriented lines. Work by the ITU Secretariat, the activities of the OECD, and the
ITU-T Study Group 3 have helped clarify the issues and provided useful data and analysis.
In addition, the World Bank and various regional bodies including APT in Asia and CITEL in
the Americas have been active in stimulating reconsideration of the settlement
arrangements. Within the European Union, the European Commission, working with national
governments and regulators, has been the architect of the EU Single Market for telecoms
The Informal Expert Group (IEG) contributed an independent view on the adapting of
international economic relationships and settlement arrangements to an increasingly
competitive environment. It puts forward a set of "guiding principles" which:
- favour increased competition and "the move to transparent, non-discriminatory,
cost-oriented settlement arrangements";
- advocate "new co-operative relationships" among organisations concerned with
the issues, including national regulators, on a multilateral basis;
- emphasise the informational role of the ITU and its contribution to developing costing
methodologies and pricing principles;
- propose that the ITU should "help articulate the general range of settlement rates
to which current rates are likely to evolve";
- propose a role for the ITU to "mobilise support from other international
institutions to help countries make the inevitable adjustments".
In addition, the IEG advocated "an immediate, global reduction in settlement rates
of the order of 5 to 10% during 1997, followed by a similar reduction in the first half of
1998". It proposed that "international carriers should guarantee certainty over
the transition period for those countries likely to be hardest hit ( e.g. total settlement
payments maintained at some predetermined level in exchange for shared risk and staged
reductions in the unit settlement rate from current levels to those consistent with
Following the IEG recommendation, ITU in co-operation with the Commonwealth
Telecommunications Organisation has since commissioned eight Case Study analyses of the
likely impact of reduced settlement revenues on a range of telecoms operators in specific
The Effects of the 1997
WTO Basic Telecommunications
The 1997 WTO telecoms agreement outlined in Section 1 of this summary will
undermine the traditional settlement system, or at least force a radical restructuring and
reduction of settlement rates. This will not be the case for all traffic among WTO member
countries, but will be the case for traffic originating or terminating in WTO countries
that allow the "new modes of operation". As we've explained, allowing the new
modes of operation and granting non-discriminatory interconnection rights to foreign
operators forces a transition to an open-market environment where charges for originating
or terminating international calls via incumbent operators' networks are dramatically
The vital remaining question, therefore, is just which traffic flows
regulators will allow the telecoms operators to interconnect in this way. This is a
complex and difficult question, turning on how far some national regulators will try to
maintain restrictions, and how far the treaty obligations in the GATS and the 1997
agreement turn out to permit or prevent such restrictions. Over the three or four years,
however, we believe the effect of the WTO agreement will be to allow the new modes of
operation and thus revolutionise the arrangements for international traffic along Single
Market lines, at least for traffic among most (perhaps all) of the Group A countries.
Considering what might happen next is inevitably speculative in such a fast-changing
situation. Still, its useful to consider in broad terms the kinds of changes that
may come about, and also how they may come about.
There are essentially four ways that the international economic relationships involved
in the carriage of international traffic may change:
(1) The traditional arrangements might remain in use for a large amount of
international traffic, but with the level of settlement rates, at least for the great
majority of "relations", being substantially reduced.
(2) The traditional arrangements may be restructured. This might include cost-based
"termination charges" which would be the same for all international calls to a
given country, regardless of the country where the call originates; or at least would
involve settlement rates which vary relatively little for each destination country. It
might also include asymmetric settlement rates which are lower for high-volume, low cost
operators in advanced industrialised countries than for operators with lower volume and
higher costs, predominantly in developing countries.
(3) Transferring traffic to "new modes of operation" outside the settlement
(4) The distinction between international service and domestic long distance may
be abolished, so that domestic interconnect charges replace settlement payments.
In practice, it is unlikely that any one of these four possibilities will prevail
everywhere. There will be a mix, different for different pairs of countries:
- Options (1) or (2) may predominate for traffic to and from many developing countries,
although it is also likely that an increasing number of developing countries may make a
radical step towards an open-market, pro-competition policy by joining a "Single
Market", in which case options (3) or (4) also come into play. Option (2) is
currently the focus of Intense consultative activity in ITU-T Study Group 3.
- For traffic between countries that have pro-competitive regulatory rules, to varying
degrees, the various "new modes of operation" (Option 3) are likely to become
more and important: large amounts of traffic will be handled in those ways outside the
framework of the traditional settlement arrangements.
- For pairs or groups of such countries already forming, or committed to form a Single
Market (US/UK for example, or EU/EEA), it is already clear that option (4) or at least
something very close to it, will eventually predominate. This does not necessarily mean,
however, that the traditional settlement arrangements will vanish for all international
traffic within a Single Market. Operators will sometimes find it convenient managerially
and perhaps also the most economic solution, especially for lower-volume traffic flows, to
continue using the traditional system, as long as they can do so at settlement rates which
are not far above the level of domestic interconnect charges.
Policy Choices: Regulatory Options and Governance
The developments and issues described in this report require government decision-makers
(Ministers, executive officials, legislators, regulators, and even courts of law,
depending on the structure of government in each particular country) to make choices about
two distinct kinds of questions: process questions concerning how regulatory
decisions should be made and, if necessary, enforced; and substantive questions
about the regulatory decisions themselves.
National decision-makers will increasingly need to choose...:
- How far to leave settlement issues to be decided by the telecommunications operators
through commercial negotiations, and how far to intervene.
- If the decision is to intervene, whether to act:
Unilaterally, telling telecommunications operators carrying traffic to or from
particular countries what they must do or may not do concerning settlement payments,
without reference to the views of the regulator (or other relevant government authority)
in the other country concerned.
Bilaterally, through decisions concerning individual "relations" with
particular correspondent countries, arrived at through agreements or understandings with
each of those countries National Regulatory Authorities (NRAs).
Multilaterally, through agreements or understandings (e.g. voluntary compliance
with new or revised ITU-T Recommendations) reached among NRAs and operators from numerous
countries, through the ITU or otherwise.
On the first question, the stances of each of the NRAs in different countries fall
fairly clearly into three categories:
- Interventionist: actively intervening, and specifically seeking to impose levels
of settlement rates well below todays levels. So far the FCC in the United States is
the only regulator in this category.
- Pro-competitive but non-interventionist: NRAs in most of the countries with a
pro-competitive telecommunications policy are in this category. They are aware of the
issues concerning settlements and have adopted some regulatory measures in this field
(usually concerning disclosure), but have chosen not to seek to impose a solution on the
operators or on regulators in other countries. It is striking that in several countries
other than the US that now have pro-competitive regulatory regimes and are net payers of
settlements including Australia, Germany, Hong Kong and the UK, the national regulators
have so far (despite active consideration of the issues) chosen not to intervene.
- Regulators in countries with a monopoly industry structure for telecommunications:
So far these NRAs, where they exist, have either not addressed the subject of
international settlements at all, or have favoured the status quo.
Until recently, settlement matters were handled almost exclusively by telecoms
operators themselves. The operators defined the broad framework of the settlement systems
by creating a consensus for particular ITU-T Recommendations. They negotiated the
specifics, such as levels of accounting rates, through commercial negotiations between
themselves, separately for each pair of operators (i.e. each "relation"). As the
US, followed by other countries, made the transition from monopoly to competition in
telecommunications, the pressures for change began to escalate. So far, however, the FCC
remains the only NRA in the world to have taken a highly activist stance about the
settlement system. Some other NRAs have taken cautious steps in such areas as transparency
(e.g. Oftel in the UK has published all UK accounting rates) and have retained reserve
powers to intervene in future if necessary, especially to ensure that new operators are
fairly treated. None has yet undertaken a radical intervention comparable to the
FCCs benchmarks decision of August 1997.
On the matter of "unilateral", "bilateral", or
"multilateral" action, two essential questions are inescapable:
- Does an NRAs jurisdiction extend to unilaterally deciding the terms of an
international collaboration between telecoms operators in different countries to provide
international service? (In such a collaboration, each of the participating telecoms
operators should be a "willing buyer" and "willing seller" of
services, and the sovereignity of the correspondent country and the jurisdiction of its
NRA should be respected.)
- Even if the answer to the first question is "yes", is it wise to seek to
dictate such decisions unilaterally?
The answer to the first of these two questions depends on complex issues of both
domestic and international law. It is clearly beyond the scope of this report, and its
authors expertise, to give a view on the legal issues involved. It is however
relevant to note that, over the years, a body of legal principles and precedents has grown
up concerning the handling of international commercial and operational issues that involve
two or more national jurisdictions. One of the key principles is that of
"comity": the obligation of courts and other public bodies in one country to
give due weight to the jurisdiction and laws of the other country or countries involved.
The FCC, in taking the unilateral route, stated (in its "Benchmark" Report
and Order of August 1997) that:
- "...we will require that US carriers negotiate with their foreign correspondents
settlement rates at or below the appropriate benchmark... If US carriers fail to achieve
progress... we will take... enforcement action..."
- it will only grant foreign or foreign-affiliated operator authority to establish PoPs in
the United States ("certain types of Section 214 authorisations") on condition
that the "foreign affiliate offer US international carriers a settlement rate at or
below the relevant benchmark".
Startlingly, the FCC claims that the first of these provisions (among others) does
"not constitute an exercise of jurisdiction over foreign carriers" since the
decision and any related enforcement actions "will apply to US carriers within our
jurisdiction, not their foreign correspondents", and the decisions will only have an
"indirect" effect on operators outside the US. It also argues that its position
on the granting of Section 214 authorisations does not conflict with the commitments of
the United States to market access and National Treatment of foreign operators under the
1997 WTO agreement, even though the US Schedule to that agreement says nothing about the
commitments being conditional upon reduced settlement rates.The General Agreement on Trade
in Services (GATS) and the 1997 agreement allow for measures by national regulators to
combat anti-competitive behaviour by companies with market power. The GATS requires,
however, that these measures must not be such as to "nullify or impair" the
country's commitments to open their national markets to competition.
No doubt these issues will be very fully dissected in the US District Court for the
District of Columbia. As of October 23rd, 1997, six non-US telecoms operators and two
international bodies had submitted "Petitions to Review" the FCCs August
decisions in the "Benchmark" proceeding, typically arguing that (to quote Cable
& Wireless plc of the UK), these decisions establish "without... jurisdictional
authority the rate that foreign common carriers... must charge US common carriers for
terminating their traffic in the foreign market...". Separately, the Philippine
regulator (the National Telecommunications Commission), and the largest Philippine
operating company (the Philippines Long Distance Telephone Company) have filed
"Petitions for Reconsideration" with the FCC.
But aside from the question of the lawfulness of initiatives to impose an
outcome unilaterally, there is also the question of whether such an approach is wise. The
entire fabric of international telecommunications has been built up based on a very high
degree of mutual and voluntary co-operation between operators and governments in widely
varying societies around the world. This co-operative process has become successful beyond
the wildest dreams of its founders in fields ranging from numbering and standards for technical
and operational compatibility. Any user of computers can testify that such seamless
connectivity and universal compatibility was not guaranteed to happen, does not in
fact happen in large areas of computer applications, and should not be taken for granted.
Unilateral action on key issues does not enhance the atmosphere for such voluntary
co-operation in the future.
To the extent that national regulators (individually, or collectively through a
multilateral process) do decide to intervene in the international settlement systems (as
the FCC clearly has decided to do, but other NRAs apparently have not), the agenda
for the regulator in this field includes:
- What levels of settlement rates to insist upon, based on what economic or regulatory
- Whether to regulate the non-price terms of operating agreements, e.g. requiring uniform
settlement rates for all operators serving a particular country, or requiring
- Whether to attempt to restrict the "new modes of operation", tolerate them, or
positively encourage them.
In developing countries, the agenda also should include:
- Steps to ensure that operators exploit the advantages to them of the "new modes of
operation" (e.g. foreign-operator PoPs) to generate additional outbound traffic to
industrialised countries, outside the settlement systems, wherever regulatory rules and
operational practicalities permit. Such measures could, for example, include bilateral
agreements with industrialised countries, or negotiated entry into multilateral Single
Market groupings for purposes such as that emerging from the 1997 WTO agreement.
- Measures to minimise the adverse effect of reduced settlement in-payments on
telecommunications network development and on progress towards universal service goals:
for example rebalancing of prices to make activities other than inbound international
traffic more profitable.
Even where these possibilities are energetically pursued, however, it is likely that
the forthcoming reductions in settlement rates will cause significant disruptions to the
financial management of many telecoms operators in developing countries.
7. POSSIBLE OUTCOMES
Stepping back from the intricacy of the issues and possibilities discussed so far, is
it possible to discern broadly how events might develop? This section suggests a range of
possibilities, in the form of three scenarios.
Scenario 1: The "Soft Landing" Scenario
This scenario broadly corresponds to the changes envisaged by the Informal Experts
Group (IEG) appointed by the Secretary General of the ITU, which reported in April, 1997.
It involves a degree of "give and take" on the part of all the players involved:
- For high-income countries, which also are becoming (with few exceptions) countries with
open competitive telecoms markets as well, changes that are naturally taking place as a
result of the transition to a Single Market lead to rapid reductions in settlement rates.
This ensures that there is no significant or lasting conflict with the FCC's "benchmarks".
In any case, for traffic between the various Single Market countries, large amounts of
traffic flowing via the "new modes of operation" begin to be terminated at
domestic interconnect rates, at termination rates close to domestic interconnect rates, or
at end-user prices. These are far below the benchmarks, and settlement rates are
commercially negotiated down to the benchmark levels or below in order to ensure
- For other countries, including major net recipients of settlement, negotiations lead to
staged but accelerated reductions in settlement rates, but not in all cases rather than
the very rapid reductions called for by the FCCs benchmarks and associated
- Developing countries which are adversely affected are able to obtain significant
transitional assistance from the World Bank, the ITU and other international agencies.
Scenario 2: The Conflict Scenario
In this scenario, the "irresistible force meets the immovable object". Net
recipients of settlements refuse to lower settlement rates fast enough to satisfy the
demands of the telecommunications operators who are large net payers (AT&T, for
example), and the FCC. Jurisdictional issues escalate (starting from the District Court
proceedings that began in September 1997), as the FCC and the major net payers based in
the US seek to force the issue.
The likely outcome would be a protracted stalemate while the jurisdictional issues are
fought out in the courts or through other dispute-resolution mechanisms, possibly even
high-level international diplomacy.
As this scenario proceeds (if it does), international relationships between operators,
governments and regulators would be likely to deteriorate, possibly culminating in a
variety of adversarial acts, which might include:
- One or more operators in a net-payer country unilaterally reducing settlement payments.
- A regulator in a net-payer country (probably the FCC) ordering a carrier to do this.
- An operator in the correspondent country, either spontaneously or under the direction of
its regulator, inactivating certain international circuits in retaliation, or at
least refusing to authorise additional circuits; or alternatively sending all its return
traffic indirectly via an operator in a third country.
- The operator in the net payer country routing all its traffic to the net-payer
country by indirect routings.
Lest this scenario seem alarmist, it is worth noting that events along exactly these
lines occurred in the case of the "relation" between AT&T in the US and
Telintar in Argentina in 1996, though the
dispute apparently has been settled subsequently. Past experiences with previous
attempts to unilaterally decide international issues are also not encouraging as
precedents in the orderly management of international telecommunications.
The case for maximum effort to avoid the Conflict Scenario is compelling.
Scenario 3: The Competitive Response Scenario
The essential distinguishing feature of this Scenario is that in it, countries which
are currently major net recipients of settlements, especially developing countries, would
positively embrace the opportunities offered by a competitive international environment.
They would seek to maximise these opportunities rather than simply accepting reduced
settlement rates and seeking to minimise their adverse impacts (as in Scenario 1), or
seeking to delay change and defend the status quo (as in Scenario 2). In doing so, an
essential element of the strategy of developing countries would be to hold governments and
regulators in the industrialised "net payer" countries fully to their own
expressed commitments to open competition.
In this scenario, as in Scenario 1, operators who are net recipients of settlements
today agree to accelerated reductions of settlement rates, but do so on condition that
they are granted the right to carry traffic into the net-payer countries such as the UK or
the US using "new modes of operation", with no further regulatory obstacles or
encumbrances. Such initiatives could involve Internet telephony, leased line resale or
their own PoPs established in those countries. Of course, relatively few operators in
developing countries will have the resources to implement such a strategy on their own. It
is nevertheless entirely practical to do so through an alliance or through an arrangement
in which a strong operator from one developing country carries traffic for other
developing country operators. Alternatively, some third party, which might well be a
telecoms operator based in an industrialised country, could perform the necessary
aggregation of traffic and operate the necessary network arrangements under contract to
several developing-country operators.
In effect, governments and telecoms operators from developing countries would (in the
US case) be turning around the FCCs position of refusing to authorise new modes of
operation such as leased-line resale or foreign-operator PoPs until the correspondent
countrys settlement rate is reduced to (or below) the benchmark rate promulgated by
the FCC. The correspondent would pursue the converse proposition: agreeing to accelerated
reductions in settlement rates, on condition that it receives the right to utilise
"new modes of operation": in the US, for example, it would petition the FCC to
grant Section 214 authority, and full interconnection rights, for such an extension of the
correspondents operations into the United States (for example via a foreign-operator
PoP), with no further conditions or restrictions other than the reduction of settlement
rates to the agreed levels. For correspondents from countries that are WTO members, this
is a matter of holding the industrialised, net-payer countries to the letter of their
market-opening commitments in the 1997 WTO telecommunications agreement.
In the new Single Market situation thus created, the operator from the developing
country would compensate for its reduced settlement rate from incoming international calls
by a large expansion of its profits on two new other lines of business. The first of these
is international traffic to each major country that is a net payer of settlements,
carried outside the traditional settlement system and using one or more of the "new
modes of operation". The second is carriage of traffic from such countries
under turnaround arrangements such as card calling or "country direct" services.
The increased profits would arise from:
- Increased volume, due to reduced collection rates and increased marketing and
product/service innovations and enhancements, for which there would now be a much greater
incentive. (Provision of card-calling and "country direct" services to overseas
emigrant communities is an important example.)
- Low unit costs, due to the use of end-to-end transmission links and domestic
interconnect at the distant end of the call in the "net payer" country.
To fully exploit the Scenario 3 opportunity in practice, groups of developing countries
would need to find ways to aggregate their outgoing traffic to achieve economies of scale.
The scenario indicated several ways this can be done. Likely candidates to launch such an
initiative are operators that have emerged or are emerging as major "hubbing"
players in developing or newly-industrialised countries: for example, Singapore Telecom
arguably is such a player already, and VSNL in India apparently intends to become one.
Contemplating the relatively unpromising prospects offered for some developing
countries by the "Soft Landing" scenario, and the unconstructive nature of the
Conflict Scenario, it seems worthwhile to seriously investigate the possibilities of
Scenario 3, the Competitive Response Scenario. Above all, every effort should be made to
avert the Conflict Scenario. At worst, it might disrupt the orderly management of
international services, or conceivably even interrupt service between certain countries at
certain times. Even on the most optimistic view, it would surely undermine the excellent
working relationships that have so far made international telecommunications work so well.
The best opportunity for developing countries is not to concentrate exclusively on
seeking to minimise the damage caused by reductions in incoming settlements (though this
is obviously necessary), but to re-examine the entire configuration of their business to
obtain the best economic results achievable in the new environment. In particular,
operators in developing countries should:
- Respond to the increased incentive to cut collection rates and expanding outgoing
traffic, through a major effort to:
- Increase outgoing volume not only by greatly reducing collection rates but also by
extending and enhancing services; by improved marketing and service innovations (for
example, through innovations such as pre-paid telephone cards, and other kinds of card
services); and by attracting private capital into what can certainly be very profitable
investments in expanded international operations andinternational capacity.
- Increase margins for outgoing traffic through aggregation of traffic from
multiple countries; acquiring end-to-end transmission capacity instead of half circuits;
and establishing PoPs in industrialised countries. This of course must involve governments
in a major effort to negotiate away remaining regulatory barriers.
- Make full use of the "new modes of operation", including Internet
- Use reverse call-back from developing countries to industrialised countries where
- Develop a negotiating approach for bargaining with regulators and operators in the
industrialised countries to ensure that regulatory barriers in those countries which could
block implementation of such a strategy are removed. A key issue is the acceptance of
asymmetrical interconnection or termination charge, in which the overall level of charge
is reduced but the legitimate cost-based case for setting such rates higher in developing
countries than in industrialised countries is recognized.
- Recognise that achieving this in practice is likely to require concessions to the
concerns of industrialised countries where the telecoms market is competitive. Such
concessions might include agreement to reduced settlement rates matching, or reasonably
close to, what is being sought by the FCC, or new commitments (through the WTO process,
for example) to a phased timetable for increased opening of the national market to
- Develop strong "country direct", card calling and callback services of their
own. These were less attractive in the past because they would have reduced the incoming
traffic imbalance and hence the level of settlement payments, but become more and more
attractive as settlement rates within the traditional correspondent system move down
The new environment, while highly challenging for almost every participant, need not be
a "zero sum game". Gains for one participant do not necessarily mean setbacks
for another. The key to managing the new situation successfully is to recognise this
fully, and seek out so-called "win-win" solutions where as many participants as
possible can achieve a positive outcome.