International economic relationships in telecommunications: A painful transformation

¹elecommunications Policy, Vol. 22, No. 10, pp. 797—816, 1998( 1998 Elsevier Science Ltd. All rights reserved

Printed in Great Britain0308-5961/98 $19.00#0.00

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International economicrelationships intelecommunications

A painful transformation

Michael Tyler and Susan Bednarczyk

In the international telecommunications marketplace, intense controversysurrounds the changing nature of economic relationships among telecomsoperators and the large flows of funds generated by international traffic.Telecoms operators receiving settlement payments under the traditionalarrangements are acutely aware that they risk losing significant revenue.As competitive telecoms market structures evolve, traffic that might other-wise yield settlement payments via traditional arrangements is increasing-ly handled in other ways. Moreover, some telecoms operators in advancedindustrial countries that are large net payers of settlements have provedincreasingly unwilling to make growing settlement out-payments and arepressing for large and rapid reductions in settlement rates.

The discussion below describes two radically different kinds of eco-nomic relationships for international telecommunications: a new ap-proach based on open competitive markets, with little distinction betweeninternational and domestic operations; and the traditional approachbased on the exchange of traffic between operators in different countries.Possible outcomes are summarised in the form of three scenarios, withdiscussion of policy issues faced by governments and regulators.

Economic relationships and payments for international calls:new arrangements in an open market

Until the mid-1990s, the telecommunications sector’s transition frommonopoly to competition typically meant a transition to competition ina national market.1 Since that time, an increasing number of countrieshave adopted pro-competitive policies, and a growing number have begunto extend to foreign telecoms operators the rights of competitive entryand the regulatory protections2 formerly enjoyed only by national

This article concerns the internationaleconomic relationships between thetelecommunications operators whichenable them to connect internationalcalls. It focuses on how these rela-tionships are evolving, and on theregulatory policies affecting them. Itsummarises the existing arrangementsconcerning accounting rates and settle-ments; analyses the intense pressuresfor change; and suggests the kinds ofchanges that could result. It also pres-ents views of which outcomes shouldbe preferred, and what choices by na-tional policy makers and regulators willmake such outcomes probable. 1998Elsevier Science Ltd. All rights reserved

Michael Tyler and Susan Bednarczyk arewith Tyler & Company, 17 Gledhow Gar-dens, London SW5 OAY, UK. Tel.: #44(0) 171 565 1500; fax: #44 (0) 171 5651501; e-mail: [email protected].

This article is based upon the Briefing Re-port by Michael Tyler, entitled Transform-ing Economic Relationships in InternationalTelecommunications, prepared in conjunc-tion with the ITU’s Seventh Regulatory Col-loquium held in Geneva in December 1997.We are indebted to many individuals ininternational institutions, national govern-ments and telecommunications operatorswho we are not free to name for reasons ofconfidentiality. We would, however, like totake this opportunity to thank them. This

continued on page 798

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competitors. Within most of the 15-country European Union(EU), sucha policy has applied to competitive entry by operators from any EUcountry since 1 January 1998.

Open competition and interconnection across frontiers: the idea of a singlemarket

Extending pro-competitive policies to foreign telecoms operators hasfar-reaching implications for the way international calls are carried, andassociated financial arrangements. Within any group of countries allowingforeign (or foreign-owned) operators unrestricted market entry and inter-connection rights, there need be little distinction between internationaland domestic calls. Regulators should promote fair and nondiscriminatorycompetition by allowing international calls to be carried via the publicnetwork in the destination country under arrangements just like those thatapply to domestic long-distance calls. For many countries, the WTOtelecommunications trade agreement of 1997, discussed later in this article,explicitly requires this. In such an environment, interconnect charges forinternational calls are the same as (or similar to) those for domesticlong-distance calls, since the interconnect service is the same. For callswithin the EU, differences will disappear as a result of EU legislation.3

Such situations exist today, although many regulatory and commercialbattles will be fought before the details of the new landscape are seenclearly.

The term ‘Single Market’ is used here to refer to a group of two or morecountries in which telecoms operators can:

f Sell international services in any other country in the group.f Extend their networks into any other country in the group, establish

network Points of Presence (PoPs)4 there, and further extend theirnetworks to the destination customer’s premises (assuming there isenough traffic for this to be commercially viable).

f Interconnect their PoPs to the public switched network of the incum-bent telecoms operator in any other country in the group, and terminateinternational calls (or originate them) on the same interconnect termsand at the same interconnect prices that domestic operators pay forsimilar traffic.

Single markets in practice

Until 1998, Single Markets consisted only of a few pairs of countries. Eachof these Single Markets was (and is) characterised by relatively lowend-user prices (‘collection rates’), high and fast-growing traffic volumes,and diverse and fast-changing industry structures and arrangements forinternational traffic. The US and the UK form a rough approximation ofa Single Market, although UK-based operators still face significant regula-tory obstacles and constraints in the US. Other existing Single Marketscomprising pairs of countries include Canada—UK, Sweden—UK, NewZealand—US, and Canada—US.5

The domain of Single Markets is expanding dramatically, to includelarge multilateral groups of countries. Since 1 January 1998, telecomsoperators from any EU country are entitled to build network plant andconduct operations anywhere within this Single Market. They can termin-ate their international calls via the incumbent operators’ networks. Theinterconnect charge payable for international traffic within the EU will be

continued from page 797work has drawn extensively on the pub-lished work of Dr Peter Stern, Dr Tim Kellyand colleagues in the ITU Secretariat. Re-sponsibility both for statements of fact andfor interpretative judgments neverthelesslie with the authors alone.

1Until the mid-1990s, only Australia, Chile,Finland, Japan, New Zealand, Sweden, theUnited Kingdom, and the United States hadmade such a change.2For example, regulatory rules concerningthe rights of competitors to interconnecttheir networks to the Public Switched Net-work (PSTN) operated by the old-estab-lished incumbent telecoms operator.3International calls will no doubt continue tobe priced to end-users somewhat higherthan domestic long-distance calls, al-though the difference is likely to be relative-ly modest.4Also called Points of Interconnection(PoIs).5Canada has retained some foreign-ownership restrictions, but this does not sub-stantially impede open competition asdescribed here.

International payments and economic relationships: M Tyler and S Bednarczyk

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the same as for terminating domestic long-distance calls6. Although therewill doubtless be the usual delays and difficulties in implementing the newrules, the direction of change is clear.

An even more extensive Single Market is beginning to emerge. Twentyof 69 countries7 participating in the World Trade Organisation (WTO)Basic Telecommunications Agreement of 15 February 1997 (includingnine of the 15 EU countries) agreed to terms which, when fully imple-mented, will effectively make these countries into a Single Market. Al-though full implementation of the agreement may not be easy, fast oruncontentious, there is nevertheless a strong trend towards a SingleMarket among these countries within the next few years.

Of course, even with the EU Single Market for telecommunications inplace and the WTO telecoms agreement fully implemented, the majority ofcountries in the world will still not yet be members of a Single Market.Most of the world’s international telecoms traffic, however, will flowwithin one or more of the Single Market groups, enabling the SingleMarket environment to shape the way such traffic is carried.

Unrestricted competitive carriage of international traffic in a Single Marketis very different from the environment in which the traditional arrangementswere developed. The traditional relationships for handling traffic (which theITU calls ‘jointly provided service’) were established between pairs of oper-ators, one in each country. Operators were typically authorised to operateonly in their ‘home’ country. The traditional financial arrangement, deter-mined by bilateral negotiation, was well adapted to this situation.

A Single Market opens up many new alternatives for how telecomsoperators carry international traffic, the role of other operators in theprocess, and how (and how much) other operators are paid. These ‘newmodes of operation’ include resale; refile, hubbing or re-origination; Inter-net telephony; international alliances of telecoms operators; and facilities-based cross-border market entry (also called ‘self-termination’).8

These ‘new modes of operation’ may not replace traditional arrange-ments entirely, but will exist as alternatives for significant amounts oftraffic between Single Market countries. Settlement rates will have to fallto levels that are competitive (from the point of view of net payers ofsettlement payments) with these new alternatives. Rates will be lowered tothe point where paying settlements is comparable to the cost of termina-ting a call...

f via leased-line resale, or2f using the foreign operator’s trans-national network all the way to a PoP

in the destination country, plus interconnect charges between the PoPand the customer, or2

f via the foreign operator’s network all the way to the customer’s premisesin the destination country, if the foreign operator has a local network inthe distant city (as WorldCom now has in several European cities).

For large operators on major routes between Single Market countries,foreign-operator PoPs (‘self-termination’) may become the predominantmode of operation.

Traditional arrangements

Most international traffic is still carried today under traditional bilateralrelationships between pairs of nationally based telecommunications

6The Interconnection Directive does not ex-plicitly say that the same interconnectcharges must apply for domestic and inter-national calls. However, the provisionsconcerning cost-orientation of charges andnon-discrimination seem to the authors toclearly imply this outcome, and thereseems to be wide agreement that this is thecorrect interpretation.7We arrived at the number of 20 countriesby counting only those countries whichhave: (a) made commitments in their WTOschedules to open their national market forbasic fixed telecommunications; (b) incorp-orated in their commitments all or essen-tially all of the provisions of the ReferencePaper on regulatory affairs, which inter aliaallow the new entrants to interconnect tothe incumbent operator’s network on inter-connect terms which are cost-based, andthe same as those provided to domesticcompetitors; and (c) committed to abolishforeign ownership restrictions.8The extension of foreign operators’ net-works to PoPs that they have establishedin the destination countries; or in somecases, the extension of these networks allthe way to customers’ premises in thosecountries.


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operators (‘correspondents’). The essential features are simple:

f If the number of minutes of traffic flowing from Country A to CountryB exceeds the flow in the reverse direction, the operator in Country Amakes a net payment (or ‘settlement’) to the operator in Country Bbased on the net flow of traffic from A to B.

f The net payment is calculated from the net flow of traffic (measured inminutes) multiplied by an amount per minute agreed upon between thetwo operators.9 This amount is based on the ‘accounting rate’, a negoti-ated price that is usually the same in both directions. The amount paidper minute from one operator to its correspondent (the ‘settlement rate’)is usually half the accounting rate. Modified arrangements apply whenthe traffic flows indirectly from A to B via a third country (the ‘transitcountry’). The accounting rate and settlement rate are not necessarilyrelated to the prices charged to end-users for international calls (‘collec-tion charges’ or ‘collection rates’).

f Where there are multiple operators at one end or both ends of the‘relation’, operating agreements between pairs of correspondents maystipulate ‘proportionate return’. For example, if an operator in CountryA originates 35% of the total traffic flowing from Country A to a par-ticular telecoms operator in Country B, that operator in CountryB must send back 35% of its return traffic to the same operator inCountry A. Regulators in Country A may insist on proportionatereturn, especially if a telecoms monopoly exists in Country B. A propor-tionate return requirement is a major feature of the InternationalSettlements Policy (ISP) of the Federal Communications Commission(FCC) in the United States, although regulatory authorities in mostother countries with competitive telecoms markets (e.g. Australia) donot require it. Proportionate return tends to favour established oper-ators by raising barriers to entry.

Aspects of traditional arrangements that are codified in the ITU-T Recom-mendations have been very influential. Although they are not legallybinding, their main structural features were developed by industry consen-sus and are widely followed. The Recommendations also allow foralternative arrangements, such as ‘Sender Keeps All’ where no settlementspayments are made.10

For and against the traditional arrangements

Merits of the traditional arrangements

The traditional arrangements have some virtues. They are simple toadminister. They have produced a substantial, growing internationaltransfer of resources between telecommunications operators, which havehelped some developing countries to upgrade their networks and makeprogress towards universal service goals. Critics argue, however, that thisconflicts with competitive market principles, and that in some developingor newly industrialising countries, the flows of hard currency from settle-ments are not invested in the telecoms infrastructure but retained bynational Finance Ministries.

Telecoms operators in industrialised and developing countries find thatinternational calls represent a highly profitable revenue stream. The trafficdriving this profitable business is growing rapidly: annual growth of the

9For accounting and financial-reportingpurposes, it is common for telecoms oper-ators to show out-payments and receiptsunder the settlement systems on a grossbasis, although no money actually flowsbetween operators except on the net basis.The effect is to keep reported revenueshigher than would otherwise be the case.10In practice, the most important exampleof SKA is the Internet, which carries inter-national traffic without any form of settle-ment payment. Its international links, how-ever, which predominantly run to and fromthe US, are paid for by the non-US InternetService Providers.


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top five international routes is approximately 15%, with some routes suchas US/Mexico growing by over 20% per year. Revenue growth is not asfast, since prices are rapidly falling on routes where open competitionprevails.

Future growth prospects are constrained by the low telephone penetra-tion, congestion, and other service problems in developing countries.It is very much in the interests of telecoms operators and users (andthus the whole national economy) in advanced industrial countries thattelecoms operators in developing countries continue to be able to financetheir network expansions and upgrades, to reduce these constraints.The required capital investments can be financed in many ways, butall are dependent upon the operator’s profitability, which is closelylinked to the flow of net settlement payments in many developingcountries.

Shortcomings of the traditional arrangements

As the telecoms marketplace has embraced competition and become moreopen to new entrants and new modes of operation, the shortcomings of thetraditional arrangements have become more apparent:

f The structure of the traditional arrangements is inconsistent with anoverall policy favouring competition, because it limits the degree ofeffective competition on a route. Using the same accounting rate andsettlement rate for all operators on a route (i.e. parallel accounting)prevents price competition among operators. Proportionate returnrequirements put additional traffic and revenue in the hands of estab-lished operators with large outgoing traffic flows, and disadvantagenew competitive entrants that otherwise might have bid to carry thereturn traffic.

f Using the same accounting rate for both directions of traffic seemsinappropriate, since settlement rates are intended to be cost-based andsince telecoms operators’ costs per minute of traffic are much higher insome countries than others. An asymmetric system with different per-minute rates of payment between operators in the two directions wouldcorrespond more closely to the economic realities.11

f Today’s settlement rates for calls to a particular country can vary bya ratio of 5 : 1 or more depending on the country from which trafficoriginates. This seems illogical. The cost for terminating an interna-tional call in a particular country is largely independent of the countryfrom which the call originates.12 A system of uniform ‘terminationcharges’ for each country, regardless of the country origin of traffic hasbeen advocated.13 Market forces will prevail as technological changeand deregulation increase operators’ abilities to re-route traffic aroundthe world to find the cheapest alternative routing. As this occurs, someleveling of settlement rates is likely to occur; otherwise, the routes wherehigher settlement rates apply will simply be bypassed, a phenomenonakin to ‘arbitrage’ in financial markets.

f Although accounting rates, and hence settlements, have fallen signifi-cantly (for example, settlement rates for traffic to and from the US fellfrom a weighted average of 51.5c/ per minute in 1992 to 36.5c/ in 1996and to 35c/ in August 1997)14, it is widely accepted that this reductionwas insufficient to bring them fully into line with costs,15 reflecting thelarge cost reductions arising from technological change and scale econ-omies.16

11Such a system has applied for someyears in the Europe/Mediterranean (TEU-REM) region, in accordance with ITU-TRecommendation D300R.12Strictly true only for direct routes betweenthe countries concerned. Where transit ar-rangements are used, the costs incurred bythe transit operator, and the transit settle-ments, may vary for the same destinationcountry, depending on the country wherethe traffic originated.13This approach was, for example, ad-vocated by the Australian delegation to therecent WTO telecommunications negoti-ations, drawing on work by ProfessorHenry Ergas, and is also under intensiveconsideration in ITU-T Study Group 3.14FCC estimates.15Deciding what indicator is most appropri-ate to measure costs is difficult, but thisstatement is likely true on most interna-tional routes for almost any reasonablecost-analysis concept.16The Informal Group of Experts convenedby the ITU’s Secretary General to adviseon the reform of the settlement systemnoted in its report of April 1997 that studiescarried out by the ITU Secretariat indicatedthat ‘in all but a few cases, settlement ratesshould be priced below 25c/ per minute’.See ITU, Report of the Informal ExpertGroup on International TelecommunicationsSettlements’, Geneva, April 1997. (http://www.itu.int/intset/expert/issuesp2.htm'.


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Table 1. Top ten payers and recipients of net settlements for 1994.

Country Total out-payments(in millions)US$

Country Total in-payments(in millions)US$

US 4289* China 480Germany 800s Mexico 444UK 158s India 254Japan 151s Philippines 235UAE 148s Russia 185Saudi Arabia 135s Turkey 173Switzerland 135s Israel 162Australia 100t Portugal 148Iran 87s Morocco 145Hong Kong (SAR) 78s Colombia 136

* FCC ‘Trends in Telephone Service’, March 1997.-Estimated.‡ITU estimate, private communication.Source: updated from ITU/TeleGeography ‘Direction of Traffic, 1996’ available from ITUwebsite at (http://www.itu.int/ti'.

f The structure of the traditional settlement arrangements, combinedwith the high level of settlement rates, creates economically inefficientincentives. This structure:s limits the incentive for operators that are net payers of settlements to

reduce end-user prices (‘collection charges’), since the settlement rateis an uncontrollable cost representing a substantial percentage of thecollection charge.17

s restricts the incentive for operators that are net recipients of settle-ments to reduce their collection rates and promote outgoing callgrowth through marketing and service improvements (since doing sowould increase their outgoing traffic relative to incoming traffic, andreduce their net settlements receipts).

f Consequently, the traditional settlement arrangements impede thegrowth of international traffic, although traffic growth has been veryrapid nevertheless.

The incentives inherent in the traditional system, to some degree inhibitingthe growth of outgoing international traffic from operators that are netrecipients of settlements, is one (but only one) cause of the large andfast-growing flows of net settlement payments paid by operators in someindustrialised countries. The United States and Germany have by farthe largest net out-payments of settlements, as the ‘‘top 10’’ summary inTable 1 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.18 Estimated netpayments from Germany in 1994 (the most recent year for which extensivedata are available) were US$0.8 billion; no other net payer country paidmore than US$160 million in that year.

Although settlement payments enable telecoms operators in some devel-oping countries to finance network expansion, the operators paying thesettlements generally argue that these payments are beyond what can beeconomically justified. When judged against objective criteria, are theselarge out-payments demonstrably inappropriate and harmful?

The size of the settlement payments depends on the size of the trafficimbalance and the settlement rate. If outgoing and incoming traffic werein balance, the level of the settlement rate would be less of an issue.The traffic imbalances partly exist for reasons beyond the control oftelecoms operators and regulators: for example, high per capita

17The higher the settlement rate, the largerthe percentage reduction of profit causedby a 1% reduction in the collection rate.(This reduction of profit is partially offset ifsuch a price cut generates, through propor-tionate return, additional return traffic forthe operator that has cut its price.)18Preliminary estimate by Industry AnalysisDivision, FCC Common Carrier Bureau asof January 1998. Final 1996 numbers werenot available at that time.


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incomes in advanced industrialised countries; habits of telephoneusage in those countries; and the existence of large overseas emigrantcommunities.

The size and growth of traffic imbalances also reflect other, morecontrollable factors—reductions in collection rates in certain countriesdue to competitive telecoms market structures and the phenomenonknown as ‘turnaround’. The use of ‘country direct’ services,19 calling cardservices or ‘callback’ increases the measured traffic imbalance upon whichthe settlement payments are calculated.

The overall effect of the turnaround can be sizable. In the US, theratio of outgoing to incoming international minutes rose from 1.84:1in 1990 to 2.23:1 in 199520 and 2.29:1 in 1996.21 In Hong Kong, theratio of calls incoming from the US (where a great deal of turnaroundactivity 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 7:1.22Since the period 1992-96 is exactly the period during which callbackactivity and turnaround in general burgeoned on this route, it is reason-able to assume that these activities generated the large growth in the trafficimbalance.

Such effects are particularly pronounced for traffic between developedand developing countries; thus, it is wrong to assume that the trafficimbalances that result in the large outflows of settlements payments fromindustrialised countries are caused solely by the structural defects andinappropriate incentives built into the traditional settlements system.Much of the imbalance results from normal competitive market activity,including the creation of service innovations like ‘country direct’ services.The mere fact that these innovations increase traffic imbalances does notmean they are undesirable: in fact, traffic imbalances and resulting flows ofsettlements payments should not be an issue (according to economicprinciples) if the level of the settlement rate represented a fair market pricefor completing one minute of international calling.

Reaching a verdict on the traditional arrangements and the case for change

To seek a verdict on the merits and demerits of the traditional settlementsystem, four questions are posed and answered below:

Question 1: Economically inefficient incentives: do they warrant abolition ofthe traditional arrangements?

No. The adverse incentives involved in the traditional arrangements(e.g. discouraging growth of outgoing traffic from countries that are netrecipients of settlements) are only economically significant if the settlementrates are above cost-justified levels. Governments and regulators in coun-tries that are net recipients (mainly developing countries) should be con-cerned about the disincentives, because constraints on growth of outgoingtraffic are bad for their national economies. Enterprises in these countriesshould be encouraged to use telecommunications to pursue economicopportunities throughout the world; otherwise, the balance of interna-tional competitive advantage will be tilted against business telecoms usersin these countries.

The solution is to reduce the settlement rates but not to abandoncompletely the entire structure of the traditional arrangements. Desirablestructural reforms include the ‘leveling’ of settlement rates towards a uni-form termination charge and the abolition of proportionate return re-quirements, at least for service to Single Market countries.

19BT’s ‘UK Direct’ or AT&T’s ‘USA Direct’represent one important form of tur-naround. If a caller in Country B calls Coun-try A by means of ‘country direct’ servicesusing a telephone credit card or callingcard, the call is billed to the customer inCountry A, not Country B. The call iscounted for settlement purposes as a callfrom A to B, not from B to A, since theoperator in Country A has receivedthe caller’s payment, and is required by thesettlement arrangements to settle with theoperator in Country B.20Derived by AT&T from FCC 43.61 Inter-national Traffic Reports and FCC TrendsReport-Canada 1990 (AT&T SupplementalComments in CC Docket No 90-337,Phase II, February 26th, 1996).21Derived from TeleGeography 1997/98,Washington, DC, 1997.22Lam, P.-L. ‘Erosion of monopoly powerby callback: lessons from Hong Kong’,Telecommunications Policy, 1997, 12(8),693—695.


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Should new modes of operation23 be allowed to evolve alongside andpossible even direct traffic away from traditional arrangements?24Governments of countries that are net recipients of settlements may bereluctant to allow the new modes for fear of reducing their inflow ofsettlement payments. In the US, the FCC has also shown reluctance toallow leased-line resale by foreign operators and foreign-operator PoPs.Governments and regulators in other net-payer countries (e.g. Japan, NewZealand, and the UK), however, generally permit the new modes ofoperation.

In our view, there is more to gain from the benefits of increasedcompetition than there is to lose from the risk (as yet only hypothetical)that a monopoly correspondent in another country will abuse this liberal-isation to gain additional bargaining power and profits.

Question 2: is the structure of the traditional arrangements sustainable?Yes, but only with significant modification. Traditional arrangements

can continue to be an attractive mode of operation for both of theoperators in a relationship, but only when the cost of settlement payments(per minute of traffic) to the operator making the net payment is compara-ble to the equivalent per-minute cost under new modes of operation(e.g. leased-line resale or foreign-operator PoPs).

Sustainability depends mainly on the level of settlement rates, ratherthan the structure itself; certain modifications are essential:

f Differences in settlement rates in the same country for different corre-spondent countries must be greatly reduced or eliminated; otherwiserefile and arbitrage will simply divert all the traffic to where the settle-ment rate is lowest.

f In a competitive environment, it may become impossible to maintaina symmetrical system where the same accounting rate applies to bothdirections of traffic where the costs of termination (or origination) ofcalls are substantially different in the two countries concerned. Thesettlement system must provide for lower charges for terminating callsin low-cost countries.25

Overall, reform of the structure of the settlement system is a quite distinctquestion from the level of the settlement rates. There is no logical reasonwhy the broad structure of the existing settlement system should notremain in use if the settlement rates come down sufficiently and thenecessary detailed structural changes occur. Indispensable structural cha-nges include the reduction or elimination of differences in settlement ratesto the same country based on where the traffic originated, and the use ofasymmetric settlement rates. In this scenario, a modified form of thetraditional arrangement continues as one mode of operation used forinternational traffic, coexisting with the ‘new modes of operation’.

All the complexities of the issue are ultimately reduced to three simplequestions: When is a settlement rate ‘too high’, and according to whatcriteria? Who decides? How do they decide?

Question 3: Is the current level of settlement rates acceptable?The slow rate of settlement rate reduction, contrasted with the rapid

rate of network cost reduction for international links, has led to a wide-spread view that settlement rates are now too high. But how should levelsof settlement rates be judged analytically?

The answer is by no means obvious: even from the point of view ofeconomic theory, a pure incremental cost approach is not warranted.26

23Such as leased line (private line) resale orforeign-operator PoPs (‘self-termination’).24Allowing leased-line resale (also calledprivate-line resale or International SimpleResale) is generally only effective if oper-ators are allowed to interconnect theirleased lines to the PSTN at both ends andpay for their PSTN use at either domesticend-user prices or domestic interconnectrates.25Traditional arrangements already providefor this in the case of the Europe/ Mediter-ranean region, under the terms of ITU-TRecommendation D300R.26The FCC took this view in its Notice ofProposed Rulemaking (NPRM) for its inter-national settlement rates proceeding,saying that ‘‘2 it may be appropriate forinternational services to provide a reason-able contribution to the common costs offoreign carriers’’, NPRM in IB Docket No.96-261, 19 December 1996.


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Even in theory, it is problematic to ascertain exactly what the ‘correct’level is. Relevant considerations include:

f Settlement rates should provide a contribution to the joint and commoncosts incurred by an operator to enable its whole network and businessto function. Domestic interconnect charges already do this in theUnited States and elsewhere.

f Since governments and regulators typically impose Universal ServiceObligations (USOs) on operators, it is equally appropriate that theinternational settlement rate also include a contribution to these. This isdone in setting domestic interconnect charges in the United States andmany other countries.

f The contribution to joint and common costs and USO costs frominternational settlements, per minute or as a percentage of the totalpayment, need not be the same as for domestic calls. For routes entirelywithin a Single Market, however, it is not feasible to collect a higherper-minute contribution for international calls than for domestic long-distance calls, since both types of calls can use the same interconnectarrangements.

The best hope is for a series of pragmatic negotiations in which the partiesinvolved eventually agree upon the:

(a) elements that can legitimately be included in a settlement rate;(b) range of numerical values for these elements, under a wide variety of

different but logically defensible cost-related doctrines;(c) level of settlement rates that is sustainable, given the competitive

pressures27 upon the traditional system. Most net recipients of settle-ments will want to retain the existing system with reforms that aresufficient to keep the net payers in the system as ‘new modes ofoperation’ emerge in the competitive environment.

The gradual leakage of traffic out of the traditional system is steadilycompressing the range of settlement rates that will be sustainable inthe longer term (say beyond five years). It should therefore be possibleto get agreement on this pragmatic basis that the great majority oftoday’s settlement rates are indeed too high, and to secure fasterreductions.

Question 4: Is the level and structure of settlement rates sustainable?No. This does not mean that the more established operators are com-

pletely abandoning the traditional system, but that newer players have fewsuch concerns. Many traditional players use tools such as refile or agree-ments to terminate one-way traffic without linking it to return traffic;consequently, traffic is increasingly flowing outside the traditional ar-rangements.

There is little doubt that today’s levels of settlement rates are notsustainable. Where there is a monopoly operator at one end of a ‘relation’that does not allow new modes of operation (e.g. leased-line resale), highlevels of settlement rates might be maintained for some years, but event-ually the arrangement will come under pressure:

f Refile and hubbing will direct traffic to those routes where the settle-ment rate is lowest.

f If collection rates and settlement rates are high in the monopoly coun-try, callback and other forms of ‘turnaround’ will inflate the trafficimbalance. Together with the high per-minute settlement rates, this may

27If uniform termination charges are ad-opted to reform the traditional system,some of this pressure will be alleviated,since refile and hubbing will now removeless traffic from the traditional system.However, unless operators using the ‘newmodes of operation’ were also required topay the termination charge rather than do-mestic interconnect or end-user prices, the‘new modes’ will continue to exert pressureto lower the termination charge to cost-based levels.


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raise the total flow of settlement payments to such a high level thatmajor pressures for change will build.

f Major telecommunications users may also press for change to obtainlower calling charges.

It follows that substantial reductions in settlement rates are inescapableand that the structure of settlement rates must move towards a uniformcharge (‘termination charge’) for each country.

Pressure for change: the challenge to the traditional system

The traditional system and the current levels of settlement rates are underchallenge from five distinct directions, each of which is discussed below.

Commercial negotiations

Commercial negotiations still represent the main avenue for change.Notwithstanding the frustrations often expressed in net payer countries,such negotiations (assisted in the case of the US by pressure from the FCCas regulator) have produced sizable reductions in settlement rates.

According to AT&T, these ‘‘negotiations resulted in a reductionof ... 18% in the average accounting rate paid by AT&T from 1992 to1995’’.28 Published FCC estimates show larger decreases for US interna-tional service carriers as a group, showing a 29% decrease in the weighted-average settlement rate for US operators from 1992 to 1996, and a 32%decrease from 1992 to 1997.29 These reductions nevertheless still leavemost settlement rates above any cost-justifiable level. Major operators inthe US, especially AT&T, MCI and others, have been increasingly forceful(and successful) in urging their regulator, the FCC, to intervene.

Pressure from regulators in net payer countries

Regulatory activism has included:

(1) Requiring disclosure of accounting rates that were traditionallyconfidential. This practice in the US, the UK and New Zealand hashighlighted exceptionally high settlement rates, and increased thepressure for change.

(2) Regulatory protection of operators in a competitive market againstexcessive bargaining power at the monopoly end of a ‘relation’. Inthe US, for example, the FCC has imposed a mandatory require-ment through its International Settlements Policy (ISP) on theoperators to establish proportionate return arrangements with theircorrespondents in monopoly countries. The FCC also requires uni-form accounting rates for all operators to the same correspondentcountry (‘parallel accounting’). The rules in the UK do not requireproportionate return, but license conditions do contain other safe-guards—for example, licence conditions forbidding ‘‘one way by-pass’’ using the new modes of operation. UK policy, for example,generally does not require parallel accounting.30

(3) Controlling practices thought to contribute to excessive settlementspayments. Until recently, the UK government for this reason al-lowed international traffic to be carried via the resale of leased-linecapacity (‘International Simple Resale’ or ISR) only to or fromcountries that allowed ISR operations by UK operators. This

28Comments of AT&T Corp. ‘In the Matterof International Settlement Rates’, File No.IB 96-261, 7 February 1997.29FCC Notice of Proposed Rulemaking, Inthe Matter of International SettlementRates, IB Docket No. 96-261, released 19December 1996; FCC Report and Order, Inthe Matter of International SettlementRates in IB Docket No. 96-261, released 18August 1997.30‘‘There is no requirement on operators tomaintain a system of parallel accounting.’’This statement (in Oftel’s terminology)means that operators need not maintainthe same accounting rate as others operat-ing on the same route. Source: ‘‘Interna-tional Facilities Licenses, Guidelines onWell Established International OperatorDeterminations and Arrangements forAccounting in Respect of InternationalConveyance Services,’’ Oftel, July 1997.


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restriction (sometimes referred to as a ‘reciprocity’ policy) was abol-ished in 1996, through the UK government retained certain safe-guards to intervene if anti-competitive behaviour occurs. Similarly,the Japanese Ministry of Posts and Telecommunications has abol-ished its ISR restrictions since January 1998. In the US, the FCCused to operate a reciprocity policy under the name of the ‘equiva-lent competitive opportunities’ test, or ‘ECO test’. The FCC abol-ished the ECO test for traffic between the US and other WTOmembers under the 1997 Basic Telecommunications Agreement, buthas imposed new restrictions that restrict leased-line resale.

(4) The FCC’s setting indicative targets for reduction of accountingrates.

(5) The FCC’s 1997 decision to make these targets (‘benchmarks’)mandatory.

A striking divergence seems to be emerging between the FCC and regula-tors in other countries with competitive telecoms environments (such asAustralia or the UK). The UK government abolished its reciprocityrestrictions on ISR in June 1996, taking the position that gains from anopen competitive market in international telecommunications (expandingthe total ‘size of the pie’) outweigh the risk that such radical deregulationmight give too much bargaining power to monopolies in other countries.31

The FCC has taken the contrary view, focusing on issues of bargainingpower and who gets what ‘slice of the pie’. The FCC has maintained strongrestrictions on the use of ‘new modes of operation’ for international traffic,except to or from countries that have already complied with the FCC’sunilateral decisions about how far settlement rates should be reduced.Even for traffic to or from those countries, significant FCC regulatoryconstraints still apply (except in the case of Internet telephony).

The FCC, through several related but separate regulatory proceedings,has made five key decisions in this field. The FCC has:

f Indicated that it may waive its International Settlements Policy (ISP),32which requires proportionate return and uniform accounting rates forall US operators for any given country. ISP waivers would allow newservices, variants of the traditional settlement arrangements, and ‘newmodes of operation’33 in those cases where it believes this would favourthe operation of a competitive market.34 Clearly, however, the FCCdoes not intend to use this flexibility in the sphere of basic fixedtelephone services, except to follow a ‘hands off ’ policy towards theemergence of Internet telephony.

f Adopted ‘benchmark’ settlement rates, defined for each of four groupsof countries classified by income level, forcing US international oper-ators to adhere to a deadline in applying these benchmark rates.35 (Thebenchmark rates are compared with current settlement rates in Table 2.)Since US operators have operating agreements with their foreign ‘corre-spondents’, the FCC is forcing them either to renegotiate their settle-ment rates or to breach their agreements.

f Made its consent for several ‘new modes of operation’36 conditional tovarying degrees of compliance with the FCC-mandated benchmarksettlement rate for the traffic that continues to be carried under thetraditional arrangements.37

f Imposed several new restrictions upon foreign operators considered‘dominant’ in their home country regarding leased-line resale orforeign-operator PoPs in the US.38

31In this case, the agency responsible is theDepartment of Trade (DTI). Oftel retainspowers, under certain ‘conditions’ in thelicenses granted to UK-licensed operators,to intervene subsequently if it finds thatanti-competitive behaviour is occurring.32Regulation of International AccountingRates, CC Docket No. 90-337.33Author’s term: see detailed explanationon the next page of this summary.34Regulation of International AccountingRates, Fourth Report and Order (Phase II),11 FCC Rcd 20063, 1996.35Report and Order, In the Matter of Inter-national Settlement Rates, IB Docket No.96-261; FCC 97-280, 18 August 1997. Thedetails are explained in Chapter 13 of thisreport.36Specifically, leased-line resale and foreign-carrier PoPs.37Op. cit. paras 232—259. The FCC decidedthat is ‘will authorise carriers to provideswitched services over... private lines ... onthe condition that settlement rates for atleast 50% of the ... traffic on the route are ator below the... benchmark’ (paras 244—245).38‘Foreign Participation’ order, para. 257.


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Table 2. Selected FCC Benchmarks for US carriers (US$/Min).

Country Settlement rate (8/97) New Benchmark Effective date

Australia 0.21 0.15 1/1/1999Brazil 0.45 0.19 1/1/2000China 0.84 0.23 1/1/2002Colombia 0.58 0.19 1/1/2001France 0.13 0.15 1/1/1999Germany 0.10 0.15 1/1/1999India 0.79 0.23 1/1/2002Japan 0.43 0.15 1/1/1999Kenya 0.65 0.23 1/1/2002Malaysiaa 0.45 0.19 1/1/2000Russiaa 1.06 0.19 1/1/2001Switzerland 0.17 0.15 1/1/1999Thailand 0.75 0.19 1/1/2001

aRate offered by largest carrier.Source: FCC, In the Matter of International Settlement Rates, IB Docket No. 96-261,released August 18th, 1997; TeleGeography 1997/98, TeleGeography Inc., WashingtonDC, 1997.

The FCC’s policies represent strong pressure to reduce settlement rates inthe traditional settlements system, but they do not attack the structure ofthe settlement system per se. On the contrary, these policies tend toconserve both the structure and some of its anti-competitive effects.

These FCC decisions raise some major questions about the propergovernance of international activities that involve the jurisdiction of boththe FCC and regulators in other countries. The decision to link FCCconsent for the use of ‘new modes of operation’ (except Internet telephony)to foreign correspondents’ acceptance of the benchmark settlement ratesunilaterally declared by the FCC seems to violate the commitments tomarket access for foreign operators made by the US in the 1997 WTOtelecommunications agreement.39

New modes of operation

‘Turnaround’ service innovations, such as country-direct service or call-back, do not take traffic out of the traditional settlement system, but theyreverse the direction of traffic for purposes of calculating settlements. Thisincreases the measured traffic imbalances and the flows of settlementpayments, thus increasing the pressures from net payers to curb thegrowth of settlement payments.

The ‘new modes of operation’, another distinct set of service innovations,have a very different effect. Either they remove traffic from the settlementsystem entirely, or (as in the case of refile and ‘hubbing’) they route trafficin such a way as to ‘mix and match’ old and new modes of operation tomaximum commercial advantage. The five ‘new modes of operation’ are:

f Resale of leased-line (‘private line’) capacity to provide public switchedinternational telephone service. Calls originate on the public switchedtelephone network (PSTN), move to the destination country via leasedlines or similar bulk transmission arrangements, and terminate in thedestination country via the PSTN.

f Foreign points of presence (PoPs)/points of interconnection (PoIs). Thismode of operation is also referred to as ‘self-termination’.40 In this case,an operator from Country A is permitted to extend its physical networkinfrastructure, including transmission links, into Country B and tointerconnect to the PSTN for call termination. The locations wheresuch interconnection takes place are known as PoPs or PoIs.

39The correct interpretation of the GATSand the 1997 WTO Basic Telecommunica-tions Agreement appears to be that theFCC restrictions are a violation of the 1997agreement if they are such as to ‘nullify orimpair’ the market-opening commitmentsmade by the US in the 1997 agreementand thus create new trade barriers, whileseeking to achieve their declared aim ofpreventing anticipated anti-competitive be-haviour. This test is specified in Article VI ofthe GATS. Ultimately, whether the FCC’srestrictions do or do not ‘nullify or impair’under the GATS could only be definitelydecided by a WTO dispute settlementpanel.40Thus, the foreign operator may have itsown plant all the way to the customer’spremises at both ends, even though inter-connect services must still be used be-tween the PoP and the called party formost calls. WorldCom, for example, is inthis situation for traffic between the US andGermany, or the US and the UK (forexample) because it owns local networksat both ends of these routes.


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f Refile, hubbing or re-origination are quite distinct from the ‘transit’arrangements that form part of the traditional settlement system.41 Inthis case, an operator routes its international traffic to a country with anopen competitive market and with low charges for traffic forwarding,and sends traffic on to its ultimate destination in a ‘third’ country. Thetraffic may be sent via either a conventional correspondent arrange-ment, leased line, or foreign-operator PoP.42 Unconventional routingminimises the originating operator’s cost for terminating internationalcalls. From the point of view of the telecoms operator where the callterminates, the call appears to have originated from the country wherethe refiling or hubbing took place.43 thus, refiling or hubbing is some-times called ‘anonymous’ refile.44

f International alliances of operators. Operators may decide to combinetheir activities in certain lines of business in international allianceslike Concert (led by BT), the AT&T/BT alliance, or Unisource (led byKPN of the Netherlands, Telia of Sweden and Swisscom)that provide end-to-end service for large multinational businesscustomers. These alliances build global networks by purchasingand pooling transmission capacity (either as half-circuits or inother forms) provided by the parent company or other telecomsoperators. Instead of traditional arrangements to account for traffic,they use other complex, diverse revenue-sharing and cost-sharingarrangements.

f Internet telephony. As a result of recent developments, including gate-way arrangements between the Internet and the PSTN, the carriage ofinternational telephone calls via the Internet is quickly becoming a ma-jor ‘new mode of operation’ for commercial traffic. So far, Internettelephony has occurred entirely outside the conventional regulatoryframework and the traditional settlement system.

The rethinking of international settlements practices through multilateralbodies

The three main multilateral entities active in this field have been:

f the OECD, seeking to develop a consensus among governments inadvanced market-economy countries.

f Study Group 3 of the ITU’s telecommunications standardisation sector(ITU-T), the source of the ITU’s highly influential Recommendations inthis field.

f the Informal Expert Group appointed in early 1997 by the ITU’sSecretary General, Dr Pekka Tarjanne.45

This work has helped to clarify the issues and to provide useful data andanalysis. The World Bank and various regional bodies, including APT inAsia and CITEL in the America, have also been active in stimulatingreconsideration of settlement arrangements. Working with national gov-ernments and regulators, the European Commission has been the architectof the EU Single Market for telecoms services.

The Informal Expert Group (IEG) contributed an independent view onhow best to adapt international settlement arrangements to an increasing-ly competitive environment. IEG put forward a set of ‘guiding principles’that:

f Favour increased competition and ‘the move to transparent, non-dis-criminatory, cost-oriented settlement arrangements’.

41In transit arrangements, the routings areapproved by the destination operator, andthe settlement payments are constrainedby a rule, embodied in ITU-T Recommen-dations, that the shares of the accountingrate paid to the destination operator, andretained by the originating operator, mustbe the same. By taking certain traffic out-bound from the originating country out ofthe settlement system, refile (unlike transit)may also cause or exacerbate an imbal-ance of inbound traffic over outbound, inthe ‘relation’ between the originating andterminating countries. This would providethe originating operator with additionalsettlements revenue from the traffic thatremains within the traditional settlementssystem.42Internet telephony is beginning to beused in this way as well.43Technically, this is accomplished by strip-ping out the signaling data which identifieswhere the call originated, and substitutingthe corresponding data for the locationwhere the call is re-originated.44Such unconventional routings are lessand less constrained by technical consider-ations, because digital signals undergorelatively little impairment even if they tra-verse very indirect routings: this was nottrue for the analog signals that prevailed atthe time today’s settlement system wascreated.45The Secretary General himself hasplayed a catalytic role as advocate for freshthinking in this field, pressing the case forrapid reform of the settlement systemalong market-oriented lines.


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f Advocate ‘new cooperative relationships’ among organisations concernedwith the issues, including national regulators, on a multilateral basis.

f Emphasise the informational role of the ITU and its contribution todeveloping costing methodologies and pricing principles.

f Propose that the ITU should ‘help articulate the general range ofsettlement rates to which current rates are likely to evolve’.

f Propose a role for the ITU to ‘mobilise support from other interna-tional institutions to help countries make the inevitable adjustments’.

In addition, the IEG advocated ‘‘an immediate, global reduction in settle-ment rates of the order of 5—10% during 1997, followed by a similarreduction in the first half of 1998’’.

Following an IEG recommendation, the ITU in cooperation with theCommonwealth Telecommunications Organisation has commissionedeight Case Study analyses of the likely impact of reduced settlementsrevenues on telecoms operators in specific low-income countries.

The effects of the 1997 WTO Basic Telecommunications Agreement

The 1997 WTO telecoms agreement will undermine the traditional settle-ment system, or at least force a radical restructuring and reduction ofsettlement rates, particularly for traffic originating or terminating in WTOcountries that allow the ‘new modes of operation’ and grant non-discrimi-natory interconnection rights to foreign operators.

The vital remaining question, therefore, is just which traffic flows be-tween WTO countries will be allowed by regulators to interconnect in thisway. The answer to this complex, difficult question depends on how farsome national regulators will try to maintain restrictions, and how far thetreaty obligations in the GATS and the 1997 agreement will permit orprevent such restrictions.

What happens next?

In such a fast-changing situation, it is useful to speculate about what kindsof changes may come about and how they may come about. The interna-tional economic relationships involved in the carriage of internationaltraffic may change in four ways:

(1) The traditional arrangements may remain in use for a large amountof international traffic, but with a substantial reduction in settlementrates.

(2) The traditional arrangements may be restructured to include cost-based ‘termination charges’ that either would be identical for allcalls to a given country, regardless of the origination country, orwould involve settlement rates that vary little for each destinationcountry. Restructured arrangements might also include asymmetricsettlement rates that are lower for high-volume, low-cost operatorsin advanced industrialised countries than for low-volume, high-costoperators in developing countries.46

(3) Traffic may be transferred to ‘new modes of operation’ outside thesettlement system.

(4) The distinction between international service and domestic longdistance may be abolished, enabling settlement payments to bereplaced by domestic interconnect charges.47

46As already provided for in the case of theEurope/Mediterranean region by ITU-TRecommendations D300 and D150R.47In this case, there could be a substantialdegree of asymmetry, with cost-based in-terconnect rates in developing countriesbeing substantially higher than thoseprevailing.


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In practice, there will likely be a mix of these possibilities for different pairsof countries:

f Options (1) or (2) may predominate for traffic to and from manydeveloping countries. Some developing countries, however, may takeradical steps towards open-market, pro-competition policy by joininga ‘Single Market’48 where options (3) or (4) also come into play; a fewhave already done so.

f For traffic between countries that have pro-competitive regulatoryrules, the various ‘new modes of operation’ (Option 3) are likely toincrease in importance.

f For countries forming a Single Market (US/UK for example, orEU/EEA), something resembling option (4)49 is likely to predominate.Traditional settlement arrangements will not vanish within a SingleMarket, since operators may find it convenient and economic, especiallyfor lower-volume traffic flows, to continue using the traditional system,as long as settlement rates are not far above the level of domesticinterconnect charges.50

Handling the transition: issues of policy and governance

Government decision-makers need to make choices about both processquestions concerning how regulatory decisions should be made and enfor-ced, and substantive questions about the regulatory decisions themselves.

*Process+ questions

National decision-makers will increasingly need to choose ... :

f How far to leave settlements issues to be decided through commercialnegotiations, and how far to intervene.

f If the decision is to intervene, whether to act in a unilateral, bilateral, ormultilateral manner.

On the first question, the stances of each of the National RegulatoryAuthorities (NRAs) in different countries fall fairly clearly into threecategories:

f Interventionist: The FCC is currently the only regulator actively seek-ing to impose settlement rates.

f Pro-competitive but non-interventionist: NRAs in most countries withpro-competitive telecommunications policies are in this category. Na-tional regulators in several countries51 that are net payers of settlementshave considered the issues, but are choosing not to intervene.

f Regulators in countries with a monopoly industry structure for telecommu-nications: These NRAs have either not addressed the subject of interna-tional settlements or have favoured the status quo.

Until recently, settlements matters were handled almost exclusively by thetelecoms operators themselves. The operators defined the broad frame-work of the settlements system by creating a consensus for particularITU-T Recommendations. They negotiated the specifics, such as levels ofaccounting rates, through commercial negotiations between themselves,separately for each pair of operators (i.e. each ‘relation’). As countriesmade the transition toward telecommunications competition, the pressurefor change has escalated, although the FCC remains the only NRA to takea highly activist stance about the settlement system.

48If the country is a WTO Member (or iswilling to join the WTO and accept its traderules), it can do this by adopting a newnational Schedule to the 1997 WTO tele-communications agreement that effectivelymakes it part of the WTO ‘Single Market’.49In some Single Market countries it is pos-sible that a non-discriminatory cost-basedcharge for terminating international callsmay apply to all international calls, whethercarried by domestically based or foreignoperators, as required by the rules ofa Single Market, but this charge may besomewhat higher than the interconnectcharge for domestic calls.50The settlement rate should not exceedthe (local) interconnect rate plus the costsof domestic long-distance carriage of thecall, international gateway switching andan international half-circuit.51Including Australia, Germany, Hong Kongand the UK.


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Two essential questions emerge regarding the issue of unilateral, bilat-eral, or multilateral decision-making:

f Does an NRA’s jurisdiction extend unilaterally to deciding the terms ofan international collaboration between telecoms operators in differentcountries for international service?

f Even if the answer to the first question is ‘yes’, is it wise to seek to dictatesuch decisions unilaterally?

The answer to the first question depends on interpretation of complexdomestic and international law. Over the years, legal principles andprecedents have been developed concerning issues of international com-mercial and operational issues involving two or more national jurisdic-tions.52 A key principles is ‘comity’—the obligation of courts and otherpublic bodies in one country to give weight to the jurisdiction and laws ofthe other country or countries involved.

In its ‘Benchmark’ Report and Order of August 1997,53 the FCC statedthat it will:

f ‘‘... require that US carriers negotiate with their foreign corres-pondents settlement rates at or below the appropriate benchmark ...If US carriers fail to achieve progress ... we will take ... enforcementaction ...’’

f only grant foreign or foreign-affiliated operator authority to establishPoPs in the United States (‘‘certain types of Section 214 authorisations’’)on condition that the ‘‘foreign affiliate offer US international carriersa settlement rate at or below the relevant benchmark’’.

Startlingly, the FCC claims that the first of these provisions does ‘‘notconstitute an exercise of jurisdiction over foreign carriers’’ since the deci-sion ‘‘will apply to US carriers within our jurisdiction, not their foreigncorrespondents’’,54 and the decisions will only have an ‘‘indirect’’ effect onoperators outside the US. The FCC also argues that its position does notconflict with the commitments of the US to market access and nationaltreatment of foreign operators under the 1997 WTO agreement, eventhough the US Schedule to that agreement says nothing about the com-mitments being conditional upon reduced settlement rates. The GeneralAgreement on Trade in Services (GATS) and the 1997 agreement allownational regulators to combat anti-competitive behaviour as long asmeasures do not ‘nullify or impair’55 the country’s commitments to opentheir national markets to competition.

No doubt these issues will be very fully dissected in the US DistrictCourt for the District of Columbia. As of October 1997, six non-UStelecoms operators and two international bodies had submitted ‘‘Petitionsto Review’’ the FCC’s August decisions in the ‘Benchmark’ proceeding,typically arguing that (to quote Cable and Wireless plc of the UK), thesedecisions establish ‘‘without ... jurisdictional authority the rate that foreigncommon carriers ... must charge US common carriers for terminating theirtraffic in the foreign market...’’56.

Beside the question of the lawfulness of imposing an outcome unilat-erally, there is also the question of whether such an approach is wise. Theentire fabric of international telecommunications has been constructedupon a very high degree of mutual and voluntary cooperation betweenoperators and governments. This cooperative process has become success-ful beyond the wildest dreams of its founders, in fields ranging fromnumbering to standards for technical and operational compatibility.

52Since the issue is a commercial one, andmany of the players involved have monop-olies or substantial market power, competi-tion law as well as the administrative law oftelecoms regulation must be considered.53Report and Order ‘In the Matter of Inter-national Settlement Rates’, in IB DocketNo. 96-261, released 18 August 1997, para20.54Report and Order in IB Docket No. 96-261, op. cit., para 279.55The relevant provisions are in the Refer-ence Paper of the 1997 WTO Basic Tele-communications Agreement, clause 1.1and in the GATS, Article VI, DomesticRegulation.56United States Court of Appeals for theDistrict of Columbia, Cable and Wirelessplc vs. FCC, No. 97-1612, Petition for Re-view, 26 September 1997.


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Unilateral action on key issues does not enhance the atmosphere for suchvoluntary cooperation in the future.

Substantive questions

To the extent that national regulators decide to intervene in the interna-tional settlements system, the regulatory agenda to be addressed includesdetermining:

f What levels of settlements rates to insist upon and the economic orregulatory principles upon which this is based.

f Whether to regulate the non-price terms of operating agreements, e.g.requiring uniform settlement rates for all operators serving a particularcountry, or requiring proportionate return.

f Whether to restrict, tolerate, or positively encourage the ‘‘new modes ofoperation’’.

In developing countries, the agenda should also include:

f Steps to ensure that operators exploit the advantages of the ‘‘new modesof operation’’ (e.g. foreign-operator PoPs) to generate additionaloutbound traffic to industrialised countries outside the settlementsystem, wherever regulatory rules and operational practicalitiespermit. Such steps could, for example, include bilateral agreementswith industrialised countries, or negotiated entry into multilateralSingle Market groupings, such as those emerging from the 1997 WTOagreement.

f Measures to minimise the adverse effect of reduced settlement in-pay-ments on telecommunications network development and on progresstowards universal service goals: for example, rebalancing prices toincrease profitability of activities other than inbound internationaltraffic.

Even where these possibilities are energetically pursued, however, reduc-tions in settlement rates will likely cause significant disruptions to thefinances of many telecoms operators in developing countries.

Possible outcomes

Three scenarios serve to indicate a range of possible ways that eventsmight develop:

Scenario 1: the *soft landing+ scenario

This scenario involves a degree of ‘give and take’ among all the players:

f For high-income countries, changes that are naturally taking place asa result of the transition to a Single Market lead to rapid reductions insettlement rates. This ensures that there is no significant or lastingconflict with the FCC’s ‘benchmarks’. In any case, for traffic between thevarious Single Market countries, large amounts of traffic flowing via the‘new modes of operation’ begin to be terminated either at domesticinterconnect rates, at termination rates close to domestic interconnectrates, or at end-user prices. These are far below the FCC benchmarks,and settlement rates are commercially negotiated either down to orbelow the benchmark levels to ensure sustainability.


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f For other countries, including major net recipients of settlements, nego-tiations lead to staged but accelerated reductions in settlement rates,although not necessarily 100% of the rapid reductions required by theFCC’s benchmarks and deadlines.

f Developing countries that are adversely affected are able to obtainsignificant transitional assistance.

Scenario 2: the conflict scenario

In this scenario, the ‘irresistible force meets the immovable object’. Netrecipients of settlements refuse to lower settlement rates fast enough tosatisfy the demands of the telecoms operators who are large net payers andthe FCC. Jurisdictional issues escalate, as the FCC and the major netpayers in the US force the issue.

A protracted stalemate occurs while the jurisdictional issues are foughtout either in the courts or through high-level international diplomacy.

International relationships between operators, governments and regula-tors would be likely deteriorate, possibly culminating in:

f One or more operators in a net-payer country unilaterally reducingsettlement payments.

f A regulator in a net-payer country (probably the FCC) ordering anoperator to do this.

f An operator in the correspondent country either retaliating by deac-tivating of certain international circuits, refusing to authorise additionalcircuits, or sending all its return traffic indirectly via an operator ina third country.

f The operator in the net payer country routing all its traffic to thenet-payer country by indirect routings.

Note that although the dispute was settled,57 this scenario already occur-red in the case of the ‘‘relation’’ between AT&T in the US and Telintar inArgentina in 1996. Past experience in managing international telecommu-nications via unilateral decisions does not yield encouraging precedents.58Thus, the case for taking maximum effort to avoid the Conflict Scenario iscompelling.

Scenario 3: the competitive response scenario

In this Scenario, countries that are major net recipients of settlements,especially developing countries, would positively embrace the opportuni-ties offered by a competitive international environment, holding govern-ments and regulators in the industrialised ‘net payer’ countries to theirexpressed commitments to open competition.

As in Scenario 1, operators who are net recipients of settlements agree toaccelerated reductions of settlement rates on the condition that they aregranted the right to carry traffic into the net-payer countries using ‘newmodes of operation’. Operators in developing countries might enter intoan alliance with a strong operator from a developing country to carrytraffic for operators from other developing countries. Alternatively, a thirdparty might aggregate traffic and operate the network under contract toseveral developing-country operators.

Using this approach would in effect put into a new context the FCC’sposition of refusing to authorise new modes of operation, such as leased-line resale or foreign-operator PoPs,59 until the correspondent country’ssettlement rate is reduced to (or below) the benchmark rate promulgated

57Telecommunications Reports Interna-tional (TRI), 25 October 1996. According toTRI, normally considered a reliable source,at one stage in 1996 AT&T unilaterally lim-ited its settlement payments to 80 cents perminute. Telintar ‘unidirectionalised’ certaincircuits (i.e. stopped accepting traffic onthem from AT&T) on the grounds thatAT&T had failed to make past-due pay-ments. According to TelecommunicationsReports, the FCC International Bureauthen ordered all US operators to stopsettlements payments to Telintar. Againaccording to Telecommunications Reports,a subsequent understanding, approved bythe FCC earlier this year, called for AT&Tto pay 92c/ per minute for the period to 30September 1997 and then 85c/ per minutefor the rest of 1997.58The issue, highly controversial in the1970s, of whether to proceed with newsubmarine cables across the Atlantic pro-vides a telling example.59Strictly, refusing to grant Section 214authorisation.


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by the FCC. The ‘correspondent’ operator from a developing countrywould agree to accelerated reductions in settlement rates, on conditionthat it receives the right to utilise new modes of operation. For correspon-dents from countries that are WTO members, this is a matter of holdingthe industrialised, net-payer countries to the letter of their market-openingcommitments in the 1997 WTO telecommunications agreement.

In the new Single Market situation thus created, the operator from thedeveloping country would compensate for its reduced settlement rate fromincoming international calls by a large expansion of its profits on two newother lines of business. The first of these is international traffic to eachmajor country that is a net payer of settlements, carried outside thetraditional settlement system and using one or more of the ‘new modes ofoperation’. The second is carriage of traffic from such countries underturnaround arrangements such as card calling or ‘country direct’ services.The increased profits would arise from:

f Increased volume, due to reduced collection rates and increased mar-keting and product/service innovations, for which there would now bea much greater incentive.60

f Low unit costs, due to the use of end-to-end transmission links anddomestic interconnect at the distant end of the call in the ‘net payer’country.

To fully exploit the Scenario 3 opportunity, groups of developing coun-tries would need to find ways to aggregate their outgoing traffic to achieveeconomies of scale. Likely candidates to launch such an initiative areoperators that have emerged or are emerging as major ‘hubbing’ players indeveloping or newly industrialised countries: for example, Singapore Tele-com is such a player already, and VSNL in India intends to become one.

The way forward

Contemplating the relatively unpromising prospects offered for somedeveloping countries by the ‘soft landing’ scenario, and the unconstructivenature of the Conflict Scenario, it seems worthwhile to seriously investi-gate the possibilities of Scenario 3, the Competitive Response Scenario.Every effort should be made to avert the Conflict Scenario, since it mightdisrupt the orderly management of international services and surelyundermine the excellent working relationships that have so far madeinternational telecommunications work so well.

Operators in developing countries should re-examine the entire config-uration of their business to obtain the best economic results achievable inthe new environment. Options worth investigating include:

f Responding to the increased incentive to cut collection rates and ex-panding outgoing traffic, through a major effort to:s Increase outgoing volume not only by greatly reducing collection

rates but also by extending and enhancing services; by improvedmarketing and service innovations (for example, pre-paid telephonecards); and by attracting private capital into profitable investments inexpanded international operations and international capacity.

s Increase margins for outgoing traffic through aggregation of trafficfrom multiple countries; acquiring end-to-end transmission capacityinstead of half circuits; and establishing PoPs in industrialised countries.

60Provision of card-calling and ‘country di-rect’ services to overseas emigrant com-munities is an important example.


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s Make full use of the ‘new modes of operation’, including Internettelephony.

s Use reverse call-back from developing countries to industrialisedcountries where appropriate.

f Developing a negotiating approach for bargaining with regulators andoperators in the industrialised countries to ensure removal of regulatorybarriers in countries that could block implementation of such a strategy.A key issue is the acceptance of asymmetrical interconnection or termi-nation charge, in which the overall level of charge is reduced but thelegitimate cost-based case for setting such rates higher in developingcountries than in industrialised countries is recognised.

f Recognising that achieving this is likely to require concessions to theconcerns of industrialised countries that might include agreement toreduced settlement rates matching what is being sought by the FCC, ornew commitments to a phased timetable for increased opening of thenational market to international competition.

f Developing strong ‘country direct’, card calling and callback services oftheir own. These become more attractive as settlement rates within thetraditional correspondent system move down towards cost.

The new environment, while highly challenging for almost every partici-pant, need not be a ‘zero sum game’. Gains for one participant do notnecessarily mean setbacks for another. The key to managing the newsituation successfully is to recognise this fully, and seek out so-called‘win-win’ solutions where as many participants as possible can achievea positive outcome.


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Documents

International economic relationships in telecommunications: A painful transformation