Client Alert: August 1998: FCC Proposes New International Settlement Rate Rules For Telecommunications Carriers To Promote Competition And Lower Regulatory Barriers

Comments by interested parties in this rulemaking proceeding are due by September 16, 1998 and reply comments by October 16, 1998. The FCC likely will issue its final rule by early 1999.

The FCC's Proposal is the agency's third major settlement rate (See Footnote 1) initiative in the last two-and-a-half years intended to reduce the cost of international telephone calls. (See Table 1 reflecting the drop in accounting rates (See Footnote 2) since 1992.) The first initiative was the FCC's Flexibility Order (See Footnote 3) which provided a revised regulatory structure to allow U.S. carriers to negotiate flexible settlement arrangements (i.e., deviate from the uniform settlement rate and proportionate return requirements) with countries whose telecommunications markets meet the FCC's equivalency standard for providing effective competitive opportunities to U.S. carriers operating in that foreign market. The second step was the Benchmarks Order, (See Footnote 4) which set up a four-tiered system of target accounting rate ranges to be negotiated with foreign carriers based upon a country's level of development as determined by its Gross Domestic Product.

While the FCC's settlement regime remained unchanged until recently, the global communications market has evolved dramatically as long distance competition has grown in the United States and abroad. In particular, the 1997 World Trade Organization Agreement on Basic Telecommunications has increased competition in the 72 signatory countries as new entrants are challenging the position of the incumbent state-run (or formerly state-run) carriers. (See Footnote 5.)

How The Old System Worked

The FCC's settlement rate regime is referred to as the International Settlements Policy ("ISP"). This policy requires: (i) an equal division of accounting rates between the carrier originating a call and the carrier terminating a call; (ii) the nondiscriminatory treatment of U.S. carriers; and (iii) the proportionate return of traffic from a foreign market. Thus, under the ISP all arrangements between U.S. carriers and a foreign carrier must be under identical terms (including all conditions and settlement rates) and the foreign carrier must commit to providing proportionate return traffic (i.e., calls originating in the foreign country and terminating in the United States). The ISP was designed to prevent monopoly foreign carriers from taking advantage of the competitive marketplace in the United States by playing one carrier off another -- a practice known as "whipsawing" -- in order to extract higher rates for the completion of international calls originating from the United States.

The requirements of the ISP are still in place except where FCC initiatives (as mentioned above) have modified that policy. The FCC requires that all accounting rate agreements between U.S. and foreign carriers and all settlement rate modifications be filed with the FCC to ensure compliance with the ISP.

Rationale For Proposed Modifications to ISP

The proposed changes to the FCC's settlement rate policy in the Proposal extend beyond the FCC's initiatives over the last two years and the U.S. commitments contained in the WTO agreement. This newest initiative is consistent with the International Bureau's overall settlement rate strategy during the last several years, which is to be pro-active in attacking the settlement rate regime where barriers to greater competition and lower rates are still in place.

In its current Proposal, the FCC recognizes that while the ISP served its purpose in protecting U.S. carriers and consumers, its impact may now be counterproductive vis-a-vis certain countries that have competitive telecommunications markets, or are moving rapidly in that direction. The FCC notes in this Proposal that the ISP may, in fact, inhibit the negotiation of lower and more flexible settlement rate arrangements in several ways, including:

• The incentive to negotiate more aggressive settlement arrangements is hindered because the ISP requires equal terms (including settlement rates) for all U.S. carriers providing service on a particular route.

• Since settlement rates are publicly available, each carrier knows a large portion of its competitors' costs, which may have a chilling effect on competition along certain routes.

The proposed modifications to the ISP should alleviate some of these effects on competition. In addition, the proposal may prevent foreign carriers from shielding themselves from competitive pressures since U.S. carriers under the present system can only pursue the same terms as other U.S. carriers when bargaining with foreign carriers.

The FCC's Proposed Changes

The ultimate result of the FCC's Proposal (if adopted) will be to allow U.S. carriers to negotiate and enter into arrangements with foreign carriers in liberalized telecommunications markets with minimal or possibly no regulatory oversight.

The scope of the proposal will eliminate application of the ISP to two broad categories of carriers, which encompass a majority of telecommunications traffic with the United States.

• Carriers from WTO Member countries that lack market power would be exempt from the ISP. The FCC will consider carriers to "lack market power" where carriers possess less than 50% market share in the relevant market. It will be obvious in most countries which carriers "lack market power" since many markets currently have one large incumbent carrier (usually the former monopoly) with over 50% market share and several smaller new entrants. In other markets where the "market power" determination is less clear, the FCC may consider requiring carriers to certify that they lack market power, or carriers may petition the FCC for a declaratory ruling.

• Carriers from WTO Member countries that are authorized to provide International Simple Resale ("ISR") (See Footnote 6) also are proposed to be exempt from the ISP. These countries are generally considered to be "liberalized markets," because in order to be authorized to provide ISR the FCC must have found (i) that country to offer equivalent resale opportunities to U.S. carriers or (ii) that 50% of traffic with that country is settled at or below the benchmark settlement rate. (See Table 2 noting countries at or below Benchmark Settlement Rates.) The FCC believes that where either of these tests is satisfied, the danger of foreign carriers discriminating against U.S. carriers is greatly diminished. Moreover, the benefits of allowing U.S. carriers to enter into innovative settlement arrangements should outweigh any possible anti-competitive harm.

In addition to not applying the ISP to certain arrangements with WTO Member countries, the FCC's Proposal also seeks to remove several settlement rate-related filing requirements. In particular, the FCC proposes to simplify the process of filing settlement rate reductions or modifications by eliminating the current distinction between "modification requests" and "notification letters" in favor of a simplified modification filing requirement. The requirement of serving notice of such modification filings on all other carriers providing service along a route also will be replaced by a planned electronic filing system, and the current requirement of filing all contracts concerning settlement rates will be eliminated under the Proposal.

The Proposal does not remove the application of the ISP to carriers from non-WTO countries. Thus, U.S. carriers negotiating settlement arrangements with foreign carriers in those markets still will need to adhere to the ISP and make the required filings with the FCC.

Proposal Likely To Be Supported By U.S. Carriers And Face Limited Foreign Opposition

U.S. carriers are likely to support the FCC's Proposal, which will increase their ability to negotiate lower settlement rates with foreign carriers and reduce the regulatory burdens of entering into settlement arrangements. In particular, smaller U.S. carriers are likely to benefit from the removal of the ISP on routes that already are crowded by larger U.S. carriers, as the new entrants now may be able to push their way into these markets with aggressive proposals.

Some foreign carriers, particularly in markets that are still dominated by a single carrier or minimal competition, will see the FCC's latest Proposal as an additional attack on the lucrative settlement payment inflow to their countries. While protests might be heard from such carriers, most foreign governments and carriers in competitive markets likely will not raise significant objection to the FCC's action.

In contrast to the Benchmarks Order, which foreign governments strongly protested as "U.S. unilateralism" that imposed a cost structure on foreign carriers, the current Proposal seeks to change the ISP through actions more readily accepted as within the scope of the FCC's authority. This Proposal is more similar in character to the Flexibility Order that received much less attention from abroad.

Seth C. Silber is an associate practicing in the international trade and telecommunications field in our Washington, D.C. office. He formerly clerked with the FCC's International Bureau and the U.S. Trade Representative's Office while attending law school and is the author of "The FCC's Call-Back Order: Proper Respect for International Comity?" published in the George Washington Journal of International Law and Economics (1997).

Client Alert is published solely for the interest of friends and clients of Paul, Hastings, Janofsky & Walker LLP and should in no way be relied upon or construed as legal advice. For specific information on recent developments or particular factual situations, the opinion of legal counsel should be sought. PHJ&W is a partnership, including professional corporations