SPEECH OF FEDERAL COMMUNICATIONS COMMISSION CHAIRMAN REED HUNDT TO THE NATIONAL ASSOCIATION OF REGULATORY UTILITY COMMISSIONERS San Francisco, California November 20, 1996 Good morning. I want to express my enormous gratitude to your outgoing President, Cheryl Parrino, for her help and assistance during the past year. Cheryl has provided superb leadership for and advocacy on behalf of NARUC in the most significant single year in telecommunications policy since the breakup of AT&T. Cheryl's advice has always been sound -- especially when I made the mistake of not taking it. Cheryl, I know I can continue to call on you for wise guidance in the year to come. I congratulate your incoming President, Bruce Ellsworth. Brace yourself, Bruce, it's going to be a wild ride, but all of us commissioners should take it together. In the next several months we have many common challenges. The states must complete the hundreds of arbitrations, and then do the rulemakings to finalize inter-carrier pricing issues. The FCC needs your help as we build on the excellent Universal Service Joint Board success and actually write the follow-on rules. This needs to be carefully coordinated with our access reform Notice this December and Order next spring. The separations Joint Board has to take much of our attention. And in 49 jurisdictions we will at some point in time deal with the momentous and unprecedented Bell petitions for entry into long distance. 1996 is the most significant year for telecommunications regulation since the breakup of AT&T, but 1997 will probably surpass it for challenge, complexity and achievement. As 1996 approaches Thanksgiving, let me acknowledge my gratitude to the leaders of the Communications Committee -- Ken McClure, Bob Rowe and Lynn Butler. Each of you has provided much guidance, counsel, leadership and advice over the past year. I particularly take my hat off to Ken McClure, who worked tirelessly as the Chair of the state members of the Universal Service Joint Board and who was instrumental in achieving Joint Board recommendations with such a high level of agreement. I cannot commend enough the great effort and contribution that each member of the Joint Board -- state, federal, and consumer advocate -- made to the Joint Board process. The Joint Board's recommendations are the product of eight months of deliberation over a 40,000 page record, in a proceeding marked by unprecedented participation by industry, education, consumer, health care, and individual commenters. The Recommended Decision is strong in many places because of the contributions of each of the Joint Board members, and because of the countless hours put in by the staffs, drawn from the FCC, state commissions, and state public counsel offices around the country. I would like to thank in particular Martha Hogerty, Public Counsel from Missouri. Martha brought a public counsel's unique perspective to our Joint Board, and made a great contribution. I am very, very sad to report that in the week prior to our final vote, Martha's mother died and then her husband, Mike, was mortally stricken by a heart attack. He died last week. This double tragedy reminds us again of the preciousness of life and of its sometimes nearly unendurable course. Martha, our thoughts, sympathies and prayers are with you. Ken's leadership was crucial to the success of the Joint Board. I can't thank Sharon Nelson enough for her advice and leadership. Sharon and I started, I think, with nearly opposite experiences and perceptions about telecommunications. To summarize our relationship -- she had a lot of experience and insight and I had a little. Fortunately, she managed a fair bit of transfusion of expertise and I think the Joint Board results reveal that success. Julia Johnson brought intelligence, compassion and a talent for compromise to the Board. Florida is blessed to have her as the new PSC chair. Laska Schoenfelder kept us focused on the fact that universal service funds must come from the ratepayer, and therefore, we must be very prudent in our choice of the amount and means of distributing these funds. On a personal level, it was a great pleasure to get to know Laska, although I think she still believes we've let her cable bill go too high. When she introduced me to the Great Lakes and Mid Atlantic Conference of Regulatory Utility Commissioners, Cheryl Parrino likened the federal-state relationship under the 1996 Telecommunications Act to an arranged marriage. Our federal-state marriage, like any marriage, has had its highs and its lows over the past year, and like some rocky relationships we've got our lawyers going at each other on a few issues. So far the state lawyers are cleaning our clock, so I'm even more motivated to figure out ways to reconcile our competing views instead of resorting to judicial review. I'd like a happy marriage, and I'd like to invent new ways to make it happy. After all, divorce is not an option. For the sake of our country, our job growth, our children's opportunities, and our national commitment to high quality education and fair equality of education and health care, we just have to find successful ways to work together. So you will find me ever more willing, as we move forward, to explore compromise solutions to our federal-state jurisdictional conflicts. I can't make the legal issues in the Act disappear. Private parties will take all of the Act's dozens of interpretation issues to court. But there's no competitive necessity for the states and the FCC to disagree. If we can agree to compromise our policy and jurisdictional disputes and you can agree in return to support the compromise rules that the FCC must write, then the communications industries, the country and our relationship will be far better off. The alternative is that the FCC and the states will be doomed to repeat our jurisdictional debates in the litigation equivalent of the Bill Murray movie Groundhog Day -- we will go over and over the same issues until years from now, with the help of the courts, we finally learn how to work together. There is a better way -- let's try it on access reform, universal service, Bell entry into long distance and all other issues. Universal Service Proving that we can work together, the Universal Service Joint Board was unanimous or almost unanimous on almost all issues. Some highlights: Only communications services to an initial primary residence connection will be fully supported by universal service support mechanisms; Service to single-connection businesses will be supported at a reduced rate; We will end subsidies for second or third or fourth lines to homes or business and to all lines at vacation homes and ski chalets. This is a major step forward to reduce total subsidies. (In the future I'd like the states and the FCC together to consider whether the first line ought to be subsidized in a residence that takes a second line.) Eligible low-income consumers in every state and territory will receive support. In an information economy, the disadvantaged especially need to be on the network. Low income customers must have the option of selecting toll blocking or toll limitation, subject to technical feasibility, in order to keep them on the network. Here we're copying New York and Minnesota. Telecommunications carriers are going to be prohibited from disconnecting a Lifeline customer's local service for non-payment of toll charges, subject to a limited waiver for technical infeasibility. Here we're following the lead of Pennsylvania and Montana. And we agreed that affordable, high-quality telecommunications services should be available to all children and teachers in every classroom and library. The Joint Board's recommendations would create in every school district a federal-state, country-county, public-private partnership. A school district will put out for bid a contract to build to every classroom a cutting-edge network with the capabilities designed by the district -- not by Washington. The contract can include usage rates, distance learning, internal networking costs, and Internet access. The low bidder of course will win -- but the money to pay for the contract will come in part from the school district and in part from universal service funds. Poor schools will contribute 10% toward covered services, better off schools up to 80%. We believed that a matching grant system will guarantee local commitment to the construction of the communications lane of the bridge to the future. We agreed to lower the SLC as part of a transition to a high cost and low income universal service system funded from all telecommunications revenues, whether interstate or intrastate on classification. And we also agreed that the current per minute CCL is inefficient and should, if possible, be restructured to recover loop costs on a flat-rated basis. Of course, by far the greatest portion of universal service will go to guaranteeing affordable phone service in high cost areas. The crucial decision of the Joint Board was that all universal service support for high cost areas should be competitively neutral. For the first time everywhere in our country anyone can compete to provide even subsidized phone service. For the first time we've broken the bars that used to lock the laudable goal of universal service inside the jail of monopoly. This incarceration is what has created the hyper-regulation of the telephone network. But liberation is close at hand. The era of phone regulation is beginning at last to end. To decouple universal service from monopoly means that contributions to the universal service fund, and disbursements from it, must not be biased either in favor of or against the incumbent, not in favor of one kind of competition or another. The fund must be explicit, in contrast to the implicit cross-subsidies of yesterday. And states will exercise their discretion in declaring carriers "eligible" in a way that is consistent with competition. If an incumbent is the only carrier allowed to be eligible in a high-cost area, it will be difficult or impossible -- depending partly on the level of the subsidies -- for entrants to compete effectively. In effect, the high-cost area will have been abandoned to regulated monopoly. That can't be right. All carriers willing to provide supported services and to serve all customers within the universal service serving area must be able to become "eligible" carriers. Furthermore, the Board voted unanimously to base subsidies in high cost areas on the forward looking economic cost of providing universal service. This shows that regardless of jurisdictional disputes, we can and do agree on policy. The test of whether the states and the FCC can compromise jurisdictional issues -- instead of turning our problems over to courts to solve -- is the method of funding universal service. Six members of the joint board want to tap all interstate and intrastate revenue of telcom providers in order to create at least a part of the federal pool. Similarly, states could tap all interstate and intrastate revenue paid by state business and residential consumers. The federal fund would pay for subsidizing high cost service down to a certain level of customer revenue (including access) -- whether $20, $30, $40, or some other level that hasn't been decided yet. Then the state would generate additional subsidies from interstate and intrastate revenues it if wanted to lower the local dialtone price further. But two members of the Joint Board want to limit the federal fund to a portion of exclusively interstate revenue. States would correspondingly be limited to funding state universal service funds from intrastate payments by consumers in the relevant state. This option will mean a much, much smaller federal fund and therefore will force us to pick a much higher retail price for basic service as the full extent of federal subsidy. To lower that price to today's levels states will have to resort to a combination of substantial reductions in local service revenues or very high charges to end users in the state. Whether the first option or the second option is right, I will put aside for the moment. My plea to you is this: Let's have a joint NARUC-FCC solution as to which we will agree not to sue each other. Let's try for that. Interstate Access Charge Reform The next challenge for the states and the FCC is interstate access reform. I think we all recognize that the interstate access charge system cannot last in its current form. Some might have debated that point before passage of the 1996 Act. But today, no one reasonably contends that our current system of interstate access charges can survive in the competitive local markets that Congress mandated and that we together are committed to establishing. Access charges are an artifact of the era of local monopolies; both in terms of structure and level, they need to be changed to accommodate competition. Interstate access charges need reform. If we make incumbent LECs charge per minute switching rates to recover fixed costs when the competition can charge a flat rate that translates into a lower per minute charge for large users, we will doom incumbent LECs to losing high volume customers. The most frequently cited example of this problem is the local loop: per minute recovery of fixed loop costs cannot be sustained if competitors can build or lease loops at what are effectively flat rates. This problem may also apply to ports and other non-traffic sensitive parts of the switch. The Joint Board recognized as much when it recommended pursuing a flat rate alternative to the per minute CCL. Access charges also can no longer be a source of universal service subsidies. The Act forbids implicit subsidies. And in any event, implicit subsidies won't work. If we price up incumbent LEC-provided access to fund the provision of other services, customers will turn to competitor LECs solely to avoid the subsidy payment. Some parties contend that we must also examine the effect of our current access charge structures and pricing levels on competition in other markets, especially the long distance marketplace. IXCs all argue that, in order to preserve and enhance competition in the interexchange marketplace, access charges must be reduced to economic cost. They argue that unless they can obtain access at economic costs -- from the incumbent LECs or an alternative -- they can be subject to a price squeeze by a vertically integrated incumbent LEC that charges access rates above economic cost to its long distance competitors, while lowering the retail long distance rates of its long distance affiliate. Presumably the IXC can respond by competing to offer local and long distance service to the customers that are getting the cheap, price-squeezed long distance rate from the incumbent LEC. But that response is going to occur only if a state creates the correct pricing rules for local exchange competition and if the IXC has sufficient time to enter the market. Local competition, where states write the right rules, will eventually bring access charges closer to more economically rational levels. But is intervention needed to achieve this result more quickly? Most people agree at least that we should create some type of an interstate access transition plan moving today's high charges and inefficient structure to lower charges and an efficient structure. So what access transition should we craft? Can we rely on marketplace forces to move access prices and rate structures to economically efficient levels when a state has, through arbitration decisions and rules, created the conditions necessary for effective competition to take hold? Should we require incumbent LECs to lower their interstate access charges in any states that have not yet completed the pro-competition rulemakings necessary for full and fair competition to develop? These might be the two alternative tracks we could follow for a transition. Given the broad agreement among virtually all parts of the industry on the need for reform, the debate in our access reform proceeding, which will be launched in mid- December, will not be about whether we need to change our rules; rather, it will be about how we should change them so that they advance our pro-competition policy. The Order will be voted in the spring. We need your help on this issue. We need your ideas. We need your support. I've been in close touch with Ken McClure on these issues and I'm looking forward to working with him and the Communications Committee more in the near future. Separations Reform It is also clear that we will have to make changes to separations to account for purchases of unbundled elements, which (subject to the 8th Circuit's thinking on the subject) are jurisdictionally neither entirely interstate or intrastate in character. Once we decide how to raise money to fund the federal and state universal service pools, it will also be necessary to account for the universal service revenues correctly through separations. Suppose the federal universal service support for a particular customer loop is $50. How should that support be divided between the interstate and intrastate revenue requirements for incumbent local exchange carriers? A more fundamental question, as we move to economic cost- based regimes for interconnection and universal service: do we still need separations? After all, separations is a regulatory or jurisdictional system imposed on an industry that we hope is moving into regional, national, international and cross-jurisdictional markets, with bundled offerings combining together what today is intrastate and interstate, regulated and lightly regulated and deregulated. How can we reconcile these trends? Of course, there are many other changes in separations that various parties have suggested create the need for a comprehensive review of separations. I look forward to working on all of these hard issues with David Rolka and the members of the Separations Joint Board. I hope we can get that Joint Board more heavily at work in the near future. I might add here that the huge volume of work we all face tells us all that federal and state appropriators should give us the resources we truly need to write the rules that will give every state competition and ultimately deregulation in all telephone markets. Bell Entry into Long Distance The Bell Companies' petitions for entry into long distance will be a crucible that could unite or divide federal and state officials. The unprecedented, momentous entry decision in each of 49 jurisdictions must be made by the FCC. We never sought the role of deciding whether Bell Companies can enter long distance, but Congress gave it to us and we'll do our best to make the right call -- whether yes, no, or a conditional approval. I hope the process of the entry decisions will help the states and the FCC form common policies, respect each other's views and do the right thing for the public interest. As you know, we will ask each state to give us its views about compliance with the "checklist". We will also ask each state to tell us whether Bell entry into long distance would serve the public interest in that state and in the national long distance market. We have today the most competitive long distance market of any country in the world. Under the right circumstances, Bell entry can enhance that competition. That's why Congress made it clear that the Bells are not necessarily to be barred from the long distance market. Although each petition for entry will present its own facts and issues, at least one question will be common to all petitions: Do the conditions established, through arbitration agreements and other rules, give all parties a fair opportunity to compete in the local market? Congress wants the IXCs to be able to respond to Bell entry in the long distance market by competing against the Bells in the local exchange market. So whether that opportunity actually or potentially exists in a particular state will be a key question in thinking about any Bell entry petition. Without a doubt, parties will raise that question with us. In order to compete in the local exchange market, entrants must be able to exercise fairly the three basic rights given by Congress. They must be able to get a fair wholesale price so as to compete as resellers of an incumbent local exchange carrier's service. They must pay no more than a fair price to lease and combine elements of the incumbent carrier's network to create some or all of a new wired network. And they must be given a fair price for interconnecting their own facilities to those of the incumbent. These are the three basic rights that the Act gives to new entrants, and they are the centerpiece of a pro-competition (rather than pro-competitor) policy for local exchange competition. The private parties will make us study implementation of these rights by a state. What are the signs of a square deal that should address the IXC and other concerns about competing against the Bells in the Bells' own markets? We will need a full record on this subject in each state. But let me mention today some of the likely signs and symbols of a pro-competition policy -- certainly ones that parties will argue about -- that might be created by a state's arbitration and rulemaking decisions. 1. Are unbundled elements available at forward looking economic cost? Whether a state makes the elements of the incumbent LECs network available at forward looking economic costs (that's what TELRIC plus common cost means) is critical to any debate about competition policy in a state. What are the consequences of failing to set unbundled element prices at forward looking economic cost? If prices are set below economic cost, the incumbent LEC will lose incentive to invest in the network, and to innovate. If prices are set above forward looking economic cost -- whether to serve universal service goals or to recover so-called legacy costs -- new entrants will be unfairly excluded from some segment of the marketplace until new facilities can be built to bypass the incumbent's network and its inflated prices. These by-pass facilities won't necessarily be as efficient as the incumbent's facilities because of the incumbent's scale and scope advantages. And if the inflated prices are for elements that are extremely costly to bypass (like an extensive network of loops), then competition may never come at all. Economists agree that network elements need to be priced on a basis that reflects their true forward looking costs. These costs may vary across geographic areas based on the density of the area served, topography or other characteristics of the area. That is one of the reasons states advance in support of their claims that they have the right to set these prices. When elements that vary materially in price are averaged, then elements are underpriced in the high cost areas and overpriced in the low cost areas. An averaged element price is fair nowhere. Underpricing creates an artificial barrier to facilities-based entry -- such as wireless alternatives. Overpricing creates an implicit subsidy for the incumbent. Universal service concerns should be addressed expressly through universal service funds. Private parties will also say it's not fair to set traffic sensitive prices for non-traffic sensitive elements and vice versa. In a competitive environment, such pricing is not sustainable and threatens the viability of both the incumbents and of competition. Again, universal service concerns should be addressed expressly through universal service funds. 2. Are transport and termination available at cost-based rates? Competition requires clear, precise and fair rules regarding transport and termination of traffic. Without such rules, the operator of the largest network could set prices that are so high that its competitors have little incentive or ability to compete for customers, thus denying customers the benefits of the new competitive marketplace. One of the Act's three core rights is that new entrants should be able to obtain reciprocal compensation agreements with incumbents that are priced at levels that do not exceed the incumbent LEC's additional cost of terminating traffic that originates on the new entrant's network. 3. Is resale available at avoided cost? Congress provided that incumbent LECs should make their retail services available to new entrants at the retail rate less costs that are or reasonably could be avoided. This policy is straightforward and will provide new entrants with a vehicle for rapid entry into the retail marketplace. In this way, entrants can benefit from the scale and scope economies of the incumbent, without making the incumbent sacrifice its efficiency. I should point out that in the World Trade Organization negotiations we seek to obtain for all carries the right of resale of international services, because it will introduce competition and undermine the international cartel supported by the accounting rate system. We can't logically be arguing for an efficient resale policy in the Czech Republic without having it in California. 4. Is universal service needs to be competitively neutral? The Joint Board's recommended decision reflected two principles that are critical to competition policy. First, the collection mechanism must be competitively neutral. Second, the disbursement mechanism must be competitively neutral. 5. Have artificial barriers to competition been removed? Rules that inhibit a competitor from being able to compete effectively in any geographic or product market are inconsistent with the Act. Such rules include overly large minimum service areas, payments of special fees by some but not all competitors, and excessive performance requirements. A state adopting a pro-competitive policy can't leave these vestiges of the monopoly era on its rule books. 6. Are elements and services truly available? We can all agree that competitors must be able actually to order and receive elements and services in a commercially reasonable manner. Provisioning limits and provisioning delays must not materially limit the flow of customers from the BOC to its rivals. So incumbents must create well-functioning and adequately sized provisioning systems, both for resale and for unbundled elements. 7. A host of miscellaneous issues are vitally important to competition, including dialing parity, number portability, standards, access to rights-of-way There are a large number of other possible issues which may be important to an entry strategy. For example, dialing parity must be provided, so that CLECs' customers do not have to dial needless and annoying extra digits. Number portability must be established, so that customers' desire to keep their phone numbers does not amount to a barrier to competition. Network standards and protocols must be open and non-discriminatory. 8. Is enforcement credible and timely? I suppose that writing down pro-competitive rules and having them followed may be two very different processes. But any state or federal rules or rights must be enforced vigorously and swiftly so that consumers enjoy the benefits of the promised competition. States and the FCC have a duty to create forums for fast, fair and efficient dispute resolution. That's a summary of at least some of the rules and policies that will be debated in the 271 process. As markets in the telephone business become competitive, at the state and federal level we will be able to begin withdrawing from the regulation that otherwise protects ratepayers and sets pro-competitive inter-carrier pricing. In short, competition is supposed to permit us to deregulate. One reason is to achieve the smaller government that competition makes possible. Another reason is that rules requiring the incumbent to share certain advantages of incumbency may unintentionally detract from the incumbent's incentives to innovate. The sunny uplands of competition and true deregulation are today over the horizon for the LEC market. I don't know how long it will take to get there. But it's not too early to start thinking about how we will know when we have arrived. I think the answer must be based on the logic of what I've said about competition policy. Complete deregulation will make sense when carriers, rather than hoping to weaken their rivals through the withdrawal of cooperation, instead feel they should cooperate fully with other carriers or else lose them as customers to an alternative carrier. And complete deregulation will be timely if and when carriers no longer depend on one another's cooperation in order to compete for customers. In most or all of today's markets entrants such as MFS and MCI Metro would be severely disadvantaged by the incumbents' non-cooperation. But in the competitive world we're hoping to reach, rivals would not refuse to interconnect at a fair price because it would affect their business adversely. As and when and where competition is achieved -- and the timing will vary depending on what aspect of cooperation we're talking about -- we can have a red hot rule-burning party at the state and federal level. If we agree to make this state-federal marriage work, we will of course be doing it for our children -- for the sake of their future, education and the economy. There is no doubt that the Congressional competition policy is the right thing to do in every state; there's no disagreement about that. The proof of the success of competition policy is in the wireless and long distance markets. Regulation is minimal and fading. Investment is up and prices are down. Fueled by the fire of competition, the information and communications sector of the economy as a whole has experienced explosive growth in the last few years, growing at a compounded rate of at least 10% a year. Based on trends of the last several years, by next year this will be a trillion dollar sector of our economy. And another opportunity and challenge for competition policy lies on other shores. The World Trade Organization talks on telecommunications services offer the world an historic opportunity to take the leap of faith into the new world together. The U.S. has offered to open its markets if other countries do so as well. We hope that countries around the world will abandon the old model and embrace competition and liberalization. We hope that other countries will join us in declaring that the age of monopoly in telecommunications is finally over and that a new age -- of competition, innovation, and worldwide universal access -- has begun. But we can only hope to achieve this worthy goal on the world stage if we have first set the stage here at home. -FCC-