Audit of the Telefonica’s regulatory accounting model and the calculation of the net cost of the universal service

Project executed on behalf of Spanish Commisión Nacional de los Mercados y la Competencia (CNMC)

Project Objective

Every year, Telefonica, the incumbent fixed operator in Spain, must present a top-down regulatory accounting model, prepared following the FDC-HCA/CCA standards, to CNMC (Comisión Nacional de los Mercados y la Competencia), the national regulatory authority. The main regulatory goal of this model is to separate revenues, costs and margins of all segments and services provided by Telefonica during the relevant year.

CNMC needs an independent expert review of the models prepared by Telefónica to ensure its compliance with the existing regulations, the correctness of the information used and the reasonability of the model’s technical and economic calculations. This work is critical for the regulator as the results of Telefonica’s model are relied on as a basis for a diverse set of regulatory measures (wholesale services pricing, replicability assessments, identification of cross subsidies and margin squeeze practices, etc.).

Additionally, an independent audit is required for the calculation of the Net Cost of Universal Service Obligations. This is a highly complex and sensitive process since such net costs will determine the compensation that major operators in Spain must pay to Telefonica as the Universal Service Provider. The calculation establishes the revenues, costs and margins (or losses) associated with the provision of telecommunications services (mainly voice and broadband) with a high granularity, so as to identify remote rural any other areas of the country where an operator following solely economic reasons would never deploy its network.

Project Description

In this and other similar projects, the audit of the regulatory accounting model requires:

  • Review of the methodology applied by the operator concerned.
  • Review of the operational, technical and accounting information used to populate the system and ensure it reasonably reflects the telco’s structure and operations.
  • Review of the assets’ valuation considering the current costs an alternative operator would incur to build the same network nowadays (Current Costs standard).
  • Assessment of the revenues and cost allocation criteria to ensure they reasonably measure the usage of resources (technical and non-technical) and the required activities for the provision of each service (both retail and wholesale).
  • Provision of clear and actionable recommendations for the resolution of any issues or suitable action in any areas of improvement identified, and assessment of the impact of such issues or areas of improvement.

In order to successfully carry out the above activities, Axon Consulting’s approach includes:

  • Numerical analysis: We produce a replica of the operator’s calculations to ensure that the results submitted by the operator are correct and in order to allow the calculation of the impact of any particular issue or area of improvement identified without requiring a complete re-calculation of the results by the operator.
  • Technical expertise: Even if it is an accounting model, the complexity of the technical allocations of network assets as well as the revaluation of assets to current costs require in-depth understanding of the technology involved, as well as the network operations. Therefore, we appoint a team of engineers to review the relevant technical elements of the system.
  • Understanding of the market: The relevance of the system’s outputs for many regulatory measures requires our work to be based on a full understanding of the market realities as well as the regulatory framework and its history of implementation. Our consultants carefully review all services’ results and assess historical trends to identify any relevant change that could affect market evolution, so as to focus our efforts and ensure the results are fit for regulatory use.
  • Engagement with stakeholders: Our team dedicates significant efforts to engage with the CNMC and the operators. Such engagement is of high importance to understand the regulatory priorities and the calculations used in the system. When issues are identified, we coordinate the solution with the operator to ensure it is reasonable, implementable and accurate enough to maximise the accuracy of the results.

The main output of the audit is a detailed report providing a detailed assessment of the results, their evolution over the past years and a description of all the issues identified, with recommended amendments and improvements.

In parallel, we audit the calculation of the Net Cost of the Universal Service Obligations. The methodology for the calculation of the universal service relies on inputs from the regulatory accounting part of the project, for the following stages:

  • Identification of services subject to compensation (e.g., telephony, broadband, public phones, directories)
  • Identification of the relevant costs and revenues of the services that are subject to compensation
  • Allocation of costs and revenues attributable to different geographical areas, based on causal drivers
  • Calculation of intangible benefits
  • Evaluation of the margins in each area

The following map shows the most non-profitable areas in Spain:

Key Takeaways

The benefits of this project go beyond ensuring the correctness of the top-down regulatory cost accounting of the operator, as the final results will also affect several other processes and activities of the regulator.

Figure 1: Typical usages of regulatory accounting or accounting separation systems’ results

The revised results, after the implementation of our recommendations, are relied upon by regulators for regulated tariff setting, replicability analysis and evaluation of anticompetitive practices (e.g., margin squeeze), updating bottom-up models, etc.