Why BT is in the spotlight over Openreach - and how it could respond

An announcement from a regulator that satisfies no one is usually a sign that a compromise has been struck - but today's statement from Ofcom that it plans to force through a legal separation of Openreach from BT is not as drastic as it sounds.

It is certainly not as draconian on BT, either, as the alternative actions that Ofcom could have taken.

It is important to stress what Ofcom has NOT ordered today: a full-blown demerger of Openreach, the division of BT that owns and operates the UK's national broadband infrastructure.

That is what had been demanded by Vodafone, Sky (Amsterdam: BK8.AS - news) - the owner of Sky News - Three and Talk Talk Telecom, each of whom rely on Openreach to deliver broadband to their own customers, in competition with BT's own retail division.

They argue BT has failed to invest enough in Openreach, resulting in slow network speeds and patchy coverage, arguing that BT has sought to wring every last drop of capacity out of its existing copper wire network rather than invest in the more expensive but more efficient fibre alternative.

They also argue that, so long as Openreach remains part of BT, the business will have an incentive to favour BT's own retail arm over that of the company's rivals.

Another grievance - one denied by BT - is that cash which could have been invested in a roll-out of fibre has instead been diverted into bidding for sports rights and into buying the mobile operator EE.

:: Ofcom orders BT 'separation' from Openreach network

BT has argued, in response, that forced break-ups of incumbent telecoms operators, as in countries like Australia and New Zealand, have failed to improve the service noticeably while costing billions of dollars.

BT has also argued it is already investing some £6bn in the rollout of "ultrafast" broadband and pointed out that broadband coverage in the UK is wider than in a number of other advanced countries.

It has also argued that its exchanges, ducts and poles are now open to its competitors, like Sky (Frankfurt: 893517 - news) and Talk Talk, but that the latter have chosen not to invest in "fibre to the property" but instead left it to Openreach.

More recently, BT's lobbying efforts have highlighted the £9.9bn deficit in its company pension scheme, which have won support from the scheme trustees and the unions.

It has argued that, if forced to demerge, filling that deficit would be impossible.

This latter argument appears to have influenced Ofcom's decision.

The regulator has said today it accepts a forced demerger of Openreach would be likely to require a "more aggressive" pension deficit reduction plan from BT, as well as crystallising the pension deficit to such an extent that it would hit the value Openreach might attract, should BT try to sell it.

So the regulator's solution is to press ahead with a legal separation of Openreach.

This would involve Openreach having its own chairman and board and being able to take its own investment decisions independent of BT.

It would also mean the Openreach board having a majority of non-executive directors independent of BT.

That goes further than BT wants.

It has accepted the need for a legal separation of Openreach and has so far named a new chairman for the business, revealed by Sky News on Monday to be Mike McTighe, a former Ofcom board member.

But crucially, under BT's current proposals, Clive Selley, the Openreach chief executive, would continue to report to Gavin Patterson, the BT chief executive.

BT says that, were this not to be the case, it would be a breach of company law.

So there are still significant differences between the positions of BT and Ofcom and which is why the regulator has today said it plans to press ahead, formally, with plans to make BT legally separate Openreach.

Its announcement has also, though, left the way open for BT to come back with a compromise offer - although that will depend on BT satisfying the regulator that, under a new set-up, the Openreach board would be able to make decisions independently and "without undue influence" from BT.

It is also leaving the threat of a forced break-up of BT on the table if legal separation proves not to deliver sufficient benefits for the wider telecoms industry and its customers.

There is another dimension to Ofcom's announcement today.

It has said it is prepared to make a submission to the European Commission to require BT to make these changes.

The commission has jurisdiction in these matters and has, in the past, intervened in local telecoms markets, such as Italy, where it has identified a lack of competition.

Ironically, this may be in the interests of BT, whose biggest shareholder is now Deutsche Telekom (IOB: 0MPH.IL - news) .

BT may well take the view that, rather than try to do a deal with Ofcom, it will leave the regulator to refer the matter to Brussels.

It could then play for time, waiting for Britain to leave the EU, at which point the Commission's influence would be limited.

That would, though, run a political risk for BT.

The new minister of state for communications, Matt Hancock, is seen in Westminster and Whitehall as less sympathetic to BT than his predecessor, Ed Vaizey, while it was significant that, in his Autumn Statement last week, Philip Hammond, the Chancellor, earmarked £400m to invest specifically in fibre and spoke of stepping up investment in "fibre to the property" rather than in fibre to roadside cabinets - something BT's competitors have been urging.

Some kind of deal between BT and Ofcom, rather than a referral to Brussels, still looks the way to bet.