ARCHIVED -  Telecom Decision CRTC 91-21

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TELECOM DECISION
Ottawa, 19 December 1991
Telecom Decision CRTC 91-21
TELEGLOBE CANADA INC. - REGULATION AFTER THE TRANSITIONAL PERIOD
Table of Contents
I BACKGROUND
A. Transitional Period Regulation and the Initiation of the Proceeding
B. Other Issues Considered in the Proceeding
C. Filing of Evidence
D. The Public Hearing
II TRANSITIONAL MATTERS
A. Rate Stabilization Account
B. Capital Structure
C. Valuation of Net Fixed Assets
D. Excesses or Shortfalls in Earnings
III TERMS OF SERVICE
IV RESALE AND SHARING
A. Introduction
B. Conclusions
C. Impact on Revenue Requirement
D. Tariff Revisions
V FORBEARANCE FROM REGULATION
A. Introduction
B. Conclusions
VI FORM OF REGULATION
A. Background
B. Rolling Multi-Year Approach and Income Reserve Account
C. Alternatives to Rate Base/Rate of Return Regulation
VII ADVANCES TO MEMOTEC
A. Background
B. Teleglobe's Position
C. Conclusions
VIII REVENUE REQUIREMENT 1992
A. Construction Program
B. Intercorporate Transactions (Other than Advances to Memotec)
C. Operating Expenses
D. Operating Revenues
E. Financial Issues
F. Revenue Requirement
IX RATE REVISIONS
X QUALITY OF THE COMPANY'S EVIDENCE
I BACKGROUND
A. Transitional Period Regulation and the Initiation of the Proceeding
In February 1987, the Minister of State, Privatization, announced the acceptance of the bid of Memotec Data Inc. (Memotec) (now, Teleglobe Inc.) for the acquisition of Teleglobe Canada Inc. (Teleglobe). Subsequently, on 1 April 1987, the Teleglobe Canada Reorganization and Divestiture Act (the Teleglobe Act) received Royal assent, providing for the privatization of Teleglobe. The Act also brought Teleglobe under the jurisdiction of the Commission.
The Teleglobe Act sets out a number of provisions defining the scope of the Commission's powers with respect to Teleglobe. Among other things, the Commission has the jurisdiction to forebear from the regulation of Teleglobe's competitive activities in certain circumstances.
On 2 April 1987, pursuant to the Teleglobe Act, the Governor in Council issued the Direction to the CRTC on the Regulation of the New Corporation Resulting from the Reorganization of Teleglobe (the Direction). Among other things, the Direction established the range for Teleglobe's rate of return on common equity (ROE) during the transitional period (the period from 1 January 1988 to 31 December 1991).
During the transitional period, the Commission approved a number of international telephone rate reductions in order to ensure that Teleglobe's ROE would be within the prescribed range. Taken together, Teleglobe's rates for International Telephone Service (ITS) have been reduced by about 35% over the transitional period.
In Teleglobe Canada Inc. - Rate Stabilization Account and Rate of Return over the Transitional Period, Telecom Decision CRTC 89-1, 31 January 1989 (Decision 89-1), the Commission approved, with amendments, Teleglobe's application for the establishment of a Rate Stabilization Account (RSA). The RSA is intended to minimize rate changes associated with fluctuations in the company's ROE caused by swings in currency exchange rates. In Decision 89-1, the Commission expressed its intention to review and assess the operation of the RSA before the end of the transitional period.
On 20 December 1990, the Commission issued CRTC Public Notice 1990-102 (Public Notice 1990-102), establishing a proceeding, including a public hearing, to deal with the regulation of Teleglobe after the transitional period. The Commission invited comment on the following issues, as well as on other issues parties might consider relevant:
(1) how regulatory matters arising during the transitional period should be dealt with, such as (a) the RSA, (b) the appropriate capital structure, (c) the valuation of net fixed assets owned by Teleglobe at the beginning of the transitional period, and (d) excesses or shortfalls in earnings;
(2) to what extent does Teleglobe have market power in the business segments in which it offers products and services;
(3) what form of regulation should be applied to Teleglobe after the transitional period;
(4) what regulatory provisions should be put in place to ensure that Canadians will continue to have access to international telephone services of a high quality; and
(5) whether rules governing the resale and sharing of Teleglobe services should be further liberalized.
The Commission established a procedure whereby interveners wishing to participate in the public hearing could address interroga- tories to Teleglobe and file memoranda to be presented as evidence. That procedure also permitted interested parties who did not wish to participate in the public hearing to file comments. The Commission directed Teleglobe to file evidence and to respond to an initial set of Commission interrogatories by 26 March 1991. The Commission added that Teleglobe's evidence should address the company's revenue requirement, using 1992 as the test year.
B. Other Issues Considered in the Proceeding
1. Construction Program Review
In Teleglobe Canada Inc. - Construction Program Review, CRTC Telecom Public Notice 1991-12, 21 February 1991 (Public Notice 1991-12), the Commission announced that it would conduct a review of Teleglobe's construction program (CPR) for the forecast period 1991-1995.
In Public Notice 1991-12, the Commission stated that it considered a separate CPR review meeting unnecessary. Instead, the record of the 1991 CPR would be included in the record of the proceeding initiated by Public Notice 1990-102. The Commission stated that parties wishing to question Teleglobe with respect to its construction program could do so during the public hearing in that proceeding. In addition, parties would be given the opportunity to make final argument on the reasonableness of Teleglobe's 1991 construction program.
2. Advances to Memotec
After Memotec acquired Teleglobe in 1987, Teleglobe was included in Memotec's central cash management system. Under this system, funds in Teleglobe's bank accounts, except imprest and payroll accounts, are transferred to a Memotec bank account at the end of each day.
In February 1990, the Commission established a proceeding to examine various aspects of this arrangement. That proceeding led to the issuing of Teleglobe Canada Inc. - Advances to Memotec Data Inc., Telecom Decision CRTC 91-5, 19 April 1991 (Decision 91-5), dealing with Teleglobe's proposals to organize its cash management and short-term investment program. In that Decision, the Commission reiterated previously expressed concerns with respect to funds advanced to Memotec. The Commission established an interim regime whereby Teleglobe would be deemed for regulatory purposes to earn a return equal to the prime interest rate plus 3% on the first $60 million dollars of the advances, and a return equal to the 91-day Treasury bill rate on the balance of the advances. The Commission also stated that, in the proceeding announced in Public Notice 1990-102, it would make a final determination as to the portion of Teleglobe's advances to Memotec to be considered as long-term investment, and the rate(s) of return that Teleglobe would be required to earn on the advances for regulatory purposes. Teleglobe was directed to file a statement of its position on these issues in the proceeding established by Public Notice 1990-102.
In addition, the Commission concluded that Teleglobe had not been provided with adequate security for the funds it had advanced to Memotec. Teleglobe was directed to file, by 18 June 1991, details of an arrangement with Memotec whereby the latter would pledge, in a manner that complied with the Canada Business Corporations Act (CBCA), a portion of its shares in Teleglobe as security for the funds advanced. The Commission stated that it was prepared to consider an alternative proposal from Teleglobe for the securing of the advances, provided that the alternative afforded a level of security equivalent to a pledging of shares.
By letter dated 18 June 1991, Teleglobe advised the Commission that, in its opinion, it was not possible for Memotec to pledge its shares in Teleglobe to Teleglobe or otherwise to grant to Teleglobe a security interest in the shares in a manner that would comply with the CBCA. Teleglobe proposed an alternative arrangement for securing the advances.
In a letter to Teleglobe dated 26 July 1991, the Commission stated that, in view of the importance of adequate security arrangements to Teleglobe's financial situation, it would consider Teleglobe's proposals regarding the advances to Memotec in the proceeding announced in Public Notice 1990-102. In addition, the Commission stated that the record of the proceeding leading to Decision 91-5 would form part of the record of the proceeding announced in Public Notice 1990-102.
3. Interconnection and Settlement Agreement with Members of Telecom Canada
On 23 May 1991, Teleglobe filed an application seeking approval, by 1 July 1991, of proposed amendments to the Interconnection and Operating Agreement between itself and the member companies of Telecom Canada. In a letter to Teleglobe dated 4 June 1991, the Commission determined that the proposed amendments would be considered in the proceeding initiated by Public Notice 1990-102, in view of the potential impact of the proposed amendments on Teleglobe's financial performance and on the Commission's regulation of the company.
In a letter to the Commission dated 12 July 1991, Teleglobe stated that it appeared that a decision respecting the proposed amendments might not be expected until close to the end of 1991. Teleglobe was concerned that a material delay beyond 1 July 1991 in a decision on the 1991 settlement reductions contained in the proposed agreement would have negative repercussions for the company.
Accordingly, Teleglobe requested interim approval, on an expedited basis, of the proposed $0.045 per minute reduction in the settlement rates, effective 1 January 1991 for Canadian-billed traffic and 1 October 1991 for foreign-billed traffic. Teleglobe indicated that these reductions could be put in place on an interim basis without the adoption of other proposed amendments related to the settlement of revenues for Canadian-billed traffic.
In a letter to Teleglobe dated 12 August 1991, the Commission denied the request for interim approval of the proposed agreement, in whole or in part. The Commission was of the view that reductions in domestic settlement rates were appropriate. However, the Commission considered that, due to the significance of the proposed agreement and its potential relationship to other matters before the Commission in the proceeding initiated by Public Notice 1990-102, it would be inappropriate to grant interim approval to any part of it before considering related evidence and argument that might arise during the public hearing.
By letter dated 17 September 1991, after the public hearing was completed, Teleglobe requested that the proposed amendments be approved forthwith. In Teleglobe Canada Inc. - Proposed Amendments to the Interconnection and Operating Agreement with Telecom Canada, Telecom Decision CRTC 91-20, 29 November 1991, the Commission denied the proposed amendments to the Agreement. However, the Commission stated that it would be prepared to give expeditious approval to a revised agreement that addressed the concerns raised by the Commission in the Decision.
On 4 December 1991, Teleglobe filed a revised agreement for the Commission's approval. In Telecom Order CRTC 91-1599, 12 December 1991, the Commission approved the revised agreement.
C. Filing of Evidence
On 26 March 1991, as directed in Public Notice 1990-102, Teleglobe filed its evidence (the March View) and its responses to the Commis- sion's initial interrogatories.
By letter dated 12 April 1991, the Commission advised Teleglobe that it had received a letter from Unitel Communications Inc. (Unitel) submitting that the evidence filed by Teleglobe was deficient in certain respects. The Commission invited interveners to comment by 19 April 1991 on the issues raised by Unitel. Teleglobe filed its reply to these comments on 24 April 1991.
In a letter to Teleglobe dated 3 May 1991, the Commission ruled that the company's 26 March 1991 evidence was deficient. Specifically, Teleglobe had not commented on the form of regulation that it considered most appropriate in the post-transitional period. The Commission's letter was accompanied by a series of interrogatories. The Commission stated that it expected Teleglobe to elaborate, in response to those interrogatories, on its position regarding rate of return regulation and alternatives. In addition, Teleglobe was directed to file, by 27 May 1991, (1) any additional evidence that it might wish to submit regarding the form of regulation; and (2) a discussion paper on its Terms of Service referred to in the company's reply of 24 April 1991.
On 27 May 1991, in accordance with the Commission's letter, Teleglobe filed additional evidence and responses to the Commission's interrogatories. Teleglobe stated that there had been a number of developments since its initial evidence had been filed, including the negotiation of a revised agreement with Telecom Canada and the issuing of Decision 91-5 concerning its advances to Memotec. Accordingly, in addition to the requested discussion paper on Terms of Service, Teleglobe filed revisions to its March View evidence (the May View), supplemental evidence elaborating on its views on the post-transitional form of regulation, and a statement of its position on issues arising out of Decision 91-5.
In its supplemental evidence, Teleglobe noted that its revenue forecast for 1992 was $374.8 million, while its revenue requirement was $331.7 million. Teleglobe stated that the excess revenues (some $43.1 million) would be eliminated through rate reductions to be identified in the fall 1991 budget process.
D. The Public Hearing
The hearing was held in Hull, Quebec, from 12 August to 28 August 1991 before Commissioners Louis R. (Bud) Sherman (Chairman of the hearing), David Colville and Fernand Bélisle.
The following appeared or were represented at the public hearing: AGT Limited (AGT); Bell Canada (Bell); Cable & Wireless Telecommunications (CWT); The Canadian Bankers' Association; Canadian Broadcasting Corporation (CBC); Canadian Satellite Communications Inc. (Cancom); Competitive Telecommunications Association (CTA); Consumer and Corporate Affairs, Director of Investigation and Research (the Director); Government of Ontario (Ontario); Government of Quebec (Quebec); Sovcan Star Satellite Communications Inc. (Sovcan); and Unitel. Final and reply argument were made on 27 and 28 August 1991.
II TRANSITIONAL MATTERS
A. Rate Stabilization Account
1. Introduction
In Decision 89-1, the Commission capped the balance in the RSA at $15 million in order to ensure that the RSA was used as a regulatory tool for stabilizing rates and not simply to defer profits or to delay warranted rate changes. The company was directed to include any amount in excess of the cap in the current month's income statement.
In accordance with the procedures approved in Procedure to Approve Exchange Rates for Budgeting Purposes, Telecom Letter Decision CRTC 90-10, 22 June 1990 (Letter Decision 90-10), Teleglobe submits to the Commission in July of each year a list of sources it intends to use to determine the exchange rates it will use for budgeting purposes in connection with the RSA. In November, it submits the rates forecasted by those sources.
In this proceeding, the Commission considered whether the RSA should be continued beyond the transitional period, and, if so, whether modifications to the current procedures are required.
2. Positions of Parties
Teleglobe requested continuation of the RSA under the framework approved in Decision 89-1. The company submitted that the RSA has been in the interests of Teleglobe and its customers. In Teleglobe's view, the account contributes to its financial integrity by mitigating near-term exchange rate risk exposure on a month-to-month basis within the fiscal year. The company also submitted that hedging is not a cost effective substitute for the RSA (in this context, hedging refers to the purchase of contracts for the acquisition of special drawing rights (SDRs) and United States (U.S.) dollars to cover the amounts payable to foreign administrations in the future).
In support of its position, Teleglobe noted the cost of hedging, the difficulties of matching forward exchange contracts with the timing of settlements, and the fact that hedging contracts are available only for substantial amounts. Teleglobe stated that hedging does not reduce the overall uncertainty of anticipating currency movements, nor does it affect Teleglobe's primary foreign exchange risk arising from changes in outgoing and incoming traffic balances. Teleglobe submitted that the current blend of the RSA and hedging, where the latter is competitively priced, is appropriate. It argued that the RSA smooths the impact of short-term exchange rate swings that could otherwise seriously destabilize Teleglobe's financial results.
In general, interveners did not oppose the continuation of the account. Ontario expressed concern that the record is not clear on whether a study was done to determine the feasibility and cost of hedging all of Teleglobe's foreign exchange exposure. Further, Ontario requested that the Commission direct Teleglobe to use SDR hedging more extensively for reducing foreign exchange exposure.
Quebec submitted that it would be premature, based solely on the experience of the last three years, to modify the RSA. Quebec also urged the Commission to study developments in Teleglobe's hedging operations.
3. Conclusions
The Commission notes that, in the recent past, experts have tended to underestimate the value of the Canadian dollar in relation to the major foreign currencies reflected in SDRs. In the Commission's judgment, this confirms the view that forecasting foreign exchange rates is an inexact science at best and reinforces its finding in Decision 89-1 that Teleglobe's exposure to currency swings, which is considerable because of the nature of its business, is largely beyond its control. The Commission agrees with Teleglobe that, because of transaction costs and the difficulties of matching exchange contracts with the timing of foreign settlements, hedging alone is not a cost effective method of eliminating the company's foreign exchange risk exposure.
The Commission is of the view that the account, with the $15 million cap, has accomplished its stated objective of minimizing frequent tariff changes associated with fluctuations in foreign exchange rates, and has not served simply as a mechanism for deferring profits or delaying warranted rate changes. Therefore, the Commission approves the continuation of the RSA, in conjunction with hedging, as established by Decision 89-1. The procedures approved in Letter Decision 90-10 for the approval of budgeted exchange rates will also continue.
B. Capital Structure
Teleglobe's capital structure is considered in Part VIII, Section E, Financial Issues.
C. Valuation of Net Fixed Assets
1. Introduction
The Direction instructed the Commission to accept for the purpose of calculating Teleglobe's revenue requirement a new balance sheet on which the net fixed assets are 140% of the net historical book value.
In implementing this 40% "gross-up" over the net book value of its assets, Teleglobe excluded the INTELSAT/INMARSAT international satellite space segment and construction work in progress. As a result, its other assets were written up by about 53%. The 40% premium amounted to $119.8 million, $117.3 million for depreciable assets and $2.5 million for land. At the end of the transitional period, the undepreciated gross-up is estimated at $59 million.
Both the Teleglobe Act and the Direction are silent as to how the gross-up should be treated after the transitional period. In this proceeding, the Commission considered whether the value of the assets acquired at privatization should be adjusted to remove the remainder of the 40% gross-up. Based on the company's estimate of its value, disallowance of the unamortized balance of the gross-up would result in a further revenue requirement reduction of $21.3 million in 1992.
2. Positions of Parties
Teleglobe submitted that the unamortized balance of the gross-up should remain in its asset base and should be depreciated in accordance with the principles of Phase I of the Cost Inquiry. Teleglobe argued that it would be inappropriate and fundamentally unfair to reduce, for regulatory purposes, any part of the unamortized value of the gross-up.
In support of its position, Teleglobe stated that the acquisition of Teleglobe was not a private transaction; the vendor was the Government of Canada, and it was the Government that determined that it would be in the public interest to sell Teleglobe at a price that, at a minimum, included the 40% gross-up. That floor price was based on an independent appraisal commissioned by the seller, and it was confirmed by a second independent appraisal commissioned by the successful purchaser, Memotec. Teleglobe submitted that it was for the Government and Parliament to determine whether or not the gross-up was unreasonable.
Teleglobe also submitted that the bidders had an understanding that the grossed-up value would be the new value of the corporation. However, the company acknowledged that there was no guarantee, either in the Teleglobe Act or in the Direction, that the written-up value would be continued beyond the transitional period.
Teleglobe argued that, throughout the transitional period, the Commission determined Teleglobe's revenue requirement and approved depreciation charges for regulatory purposes based on the grossed-up asset value. Teleglobe submitted that there was no suggestion from any quarter that the entire value of the gross-up should have been recovered during the transitional period. Teleglobe also noted that the company was not subject to rate base/rate of return (RB/ROR) regulation prior to privatization.
A number of interveners commented on the issue of the valuation of fixed assets. Quebec, AGT and Canadian Business Telecommunications Alliance (in comments filed 16 August 1991) accepted the company's position. Cancom/Sovcan, however, submitted that the gross-up should not be continued beyond the transitional period. Ontario was prepared to accept the continued depreciation of the gross-up, but submitted that it would be appropriate for the Commission to allow a zero rate of return on that portion of the asset value.
3. Conclusions
The Commission regulates the companies under its jurisdiction by determining an appropriate revenue requirement, calculated by determining, among other things, appropriate depreciation expense, interest on long-term debt, the return on shareholders's equity, and associated income tax. Since the valuation of a company's assets is reflected in the calculations noted above, that valuation directly affects a company's revenue requirement. It is the revenue requirement that determines the level of rates to be paid by subscribers. Thus, proper valuation of fixed assets is critical to the process of ensuring that rates are just and reasonable.
In rate of return regulation, the regulator generally requires that the value of a company's assets be set at the historical net book value. When ownership of a company changes, the transaction may result in a valuation of the fixed assets that is in excess of net book value. In such circumstances, the regulator is concerned that the new shareholders not recover, through future rates, costs of assets already paid for by subscribers in the form of past rates. Hence, the regulator may disallow the difference between the historical net book value and the purchase value in determining the company's rate base, and thus its revenue requirement, on a going forward basis.
Prior to privatization, Teleglobe was not regulated. Its rates were set on the basis of Government policy objectives, rather than on a statutory requirement that they be just and reasonable. Teleglobe's rates did not necessarily reflect costs incurred in the provision of service. Accordingly, there is no framework within which to establish whether the inclusion of the gross-up in Teleglobe's rate base would result in customers paying in future rates for the cost of assets already paid for through past rates.
In light of (1) the special circumstances surrounding the transaction, (2) the regulatory considerations discussed above (3) the question of fairness to the shareholder, and (4) the benefits that have accrued to customers in the form of rate reductions since privatization, the Commission finds it appropriate to leave the remainder of the gross-up in Teleglobe's asset base for the purpose of determining its revenue requirement after the transitional period.
D. Excesses or Shortfalls in Earnings
In Decision 89-1, the Commission expressed the view that the Direction allows the company to exceed its allowed ROE range in any given year of the transitional period, provided that its average ROE over the full transitional period falls within the prescribed range.
In Part VIII, Section F, Revenue Requirement, the Commission determines that, over the transitional period, the company will earn an average ROE near the top of its allowed range. Accordingly, no further action is required with respect to Teleglobe's earnings over the transitional period.
III TERMS OF SERVICE
At present, Teleglobe's tariffs contain only service-specific terms and conditions. Unlike other federally regulated carriers, Teleglobe does not have a set of general regulations (Terms of Service) setting out its obligations to its customers; nor do its tariffs contain procedures relating to customer complaints and inquiries. In Public Notice 1990-102, the Commission invited comment on whether general Terms of Service and formal procedures to handle complaints and inquiries are required for Teleglobe.
In this proceeding, Teleglobe requested that the Commission forbear from regulating any of its services other than ITS. Teleglobe submitted that, if the Commission were to forbear from regulation, general Terms of Service and a formalized complaints procedure would not be necessary for the services in question. However, Teleglobe filed (in Teleglobe Exhibit 10) a draft of general Terms of Service to be incorporated into its tariffs should the Commission deny its request for forbearance. The draft adapts the relevant Terms of Service prescribed by the Commission for the terrestrial carriers and for Telesat Canada (Telesat).
Teleglobe proposed that, for those services where it has a direct relationship with the customer, there be general Terms of Service in addition to the service-specific terms contained in its individual tariffs. Teleglobe noted that the service-specific terms and the draft general terms would require review in order to ensure that they are clear and consistent. For those services where Teleglobe does not a have a direct relationship with the customer, the existing system would continue. Under this system, the customer's rights and duties with respect to matters such as non-discriminatory access, security deposits and payments are governed by the Terms of Service of the relevant domestic carrier. Teleglobe's tariffs deal only with such matters as Teleglobe's liability, service availability and rates.
In Part V of this Decision, the Commission denies Teleglobe's request that it forbear from regulating services other than ITS.
CBC was the only party to cross-examine Teleglobe on the issue of Terms of Service. In final argument, CBC submitted that Teleglobe's draft general Terms of Service should be filed as a general tariff for approval by the Commission. However, CBC also submitted that the existing tariffs for broadcast services (tariffs 9140, 9150 and 9900) contain deficiencies that are not addressed by Teleglobe's draft general terms.
CBC submitted that it would be consistent with Teleglobe's stated desire to be customer-oriented and market-driven to formalize (1) its internal processes for service ordering; (2) its computerized fault reporting system; (3) its standard for confirmation of service availability; and (4) its quality of service standards in relation to frequency and duration of service outages. CBC stated that it would be reasonable for Teleglobe to incorporate formalized standards and procedures related to the above into its tariffs for broadcast services.
CBC submitted that, when fully developed, Teleglobe's computerized fault reporting system should automatically credit broadcast customers with rebates. CBC noted that the general Terms of Service proposed by Teleglobe would require the customer to identify a service outage, report it, and then submit a written claim for a rebate. During cross-examination by CBC, Teleglobe stated that information on the cause and duration of service outages would be generated by an automated program booking system. Teleglobe stated its intention to work with broadcasters to derive the type of standard information that the latter would like to receive regarding their services. Teleglobe also stated that it intended to develop service standards as to the cause and duration of outages, and that it would work with the broadcasting industry to develop formal procedures for the ordering and confirmation of service for tariffs 9140 (International Audio Program Service) and 9150 (International Television Service). Teleglobe noted that these tariffs already contain descriptions of the way in which service can be obtained. Teleglobe stated that, if customers consider that those descriptions need to be adjusted, it would work with them to do so.
CBC also requested that Teleglobe be directed to discontinue a procedure known as the "self-matching order", until such time as it is provided for in Teleglobe's tariffs. As described by Teleglobe, this procedure could result in the customer being held liable for charges for downlinks at the far end, even in circumstances where the downlink is not actually provided to the customer. CBC also considered that this form of order should be placed only at the customer's request.
During cross-examination, Teleglobe stated that it knows of no instance in which a customer has been charged for a downlink that was not actually provided.
In the Commission's view, the resolution of CBC's concerns is most appropriately left to discussions between Teleglobe and its broadcasting customers, particularly in light of Teleglobe's undertaking to work with the broadcasting industry in order to develop standards and procedures related to the cause and duration of service outages and to the ordering and confirmation of services. However, the Commission directs Teleglobe to report to it on the standards and procedures once they are determined.
During cross-examination, Teleglobe agreed with CBC that the rules governing the preemption of satellite service should be included in the appropriate tariff (9900). Teleglobe is directed to file, by 15 January 1992, proposed tariff pages incorporating those rules. Copies of those proposed pages are to be served on CBC.
In its evidence, Teleglobe described the systems it has in place to resolve customer complaints and deal with customer inquiries. Teleglobe submitted that its customer complaint procedures are reasonable and that it would be inappropriate to incorporate them in the general Terms of Service tariff.
No intervener reported difficulties with Teleglobe's complaints and inquiries procedures and no specific changes were proposed. To the extent that the CBC's concerns relate to faults and fault reporting, Teleglobe has undertaken to work with the broadcasting industry, including CBC, to address those concerns.
In light of the above, the Commission is of the view that tariff provisions governing Teleglobe's complaints and inquiry procedures are not required.
The Commission finds reasonable Teleglobe's proposal as to the application of general and service-specific terms. The Commission also finds Teleglobe's draft general Terms of Service acceptable on the whole. However, some particular items in Teleglobe's draft terms require clarification or further explanation. In addition, as noted by Teleglobe, the general terms and the service-specific tariff provisions require comparison and review in order to ensure consistency and clarity. The Commission will, in the near future, address interrogatories to Teleglobe with respect to its draft terms. At the same time, Teleglobe will be directed to file, in the same format as Teleglobe Exhibit 10, proposed wording with respect to service-specific tariff provisions that may require amendment. Parties to this proceeding will be given an opportunity for further comment before final Terms of Service and service-specific tariff provisions are approved.
IV RESALE AND SHARING
A. Introduction
In Teleglobe Canada Inc. - Resale and Sharing of International Services, Telecom Decision CRTC 90-2, 23 February 1990 (Decision 90-2), the Commission permitted the resale and sharing of Teleglobe's services in accordance with the restrictions set out in Appendix A of Tariff Revisions Related to Resale and Sharing, Telecom Decision CRTC 87-2,12 February 1987 (Decision 87-2), but subject to the additional requirement that any resale and sharing arrangements between persons in Canada and persons in another country be conditional on such arrangements being allowed in both countries.
The restrictions set out in Appendix A of Decision 87-2 did not permit the resale on a joint-use basis of interexchange private line services to provide interconnected voice services. Public Notice 1990-102 invited comment on whether the rules governing the resale and sharing of Teleglobe's services should be further liberalized to permit such resale and sharing (liberalized resale).
At the outset of this proceeding, Teleglobe took the position that liberalized resale would be contrary to the best interests of the Canadian public. However, during the course of the hearing, Teleglobe stated that it supported liberalized resale under certain conditions. Teleglobe identified benefits that could result from resale, but stated that these benefits must be balanced against its ability to provide service to all its customers, the impact on users who do not benefit directly from resale, and the implications for the international telecommunications infrastructure. Teleglobe provided an analysis of the impact of liberalized resale under various terms and conditions. Teleglobe considered that the impact of resale for joint use would be manageable, provided that:
(1) intergovernmental agreements are in place between Canada and the countries concerned with respect to the terms and conditions of liberalized resale;
(2) domestic and foreign facilities-based carriers and their affiliates are not permitted to engage in liberalized resale; and
(3) unless otherwise agreed, private lines between Canada and an overseas destination are used to carry traffic between Canada and that overseas destination only.
Teleglobe also based its position on the continuation of the restrictions on bypass set out in Teleglobe Canada Inc. - Resale of Transborder Services, Telecom Decision CRTC 91-10, 26 June 1991 (Decision 91-10).
Twelve interveners commented on the resale issue. All, except Bell and AGT, favoured liberalized resale. AGT submitted that Teleglobe's resale proposal was incomplete because it did not include appropriate consideration of contribution payments. Bell submitted that the Commission should not liberalize resale until accounting rates, settlement rates and collection rates have moved closer to costs. The remaining interveners took various positions regarding Teleglobe's proposed conditions for liberalized resale.
A number of interveners identified benefits that, in their view, would flow from the liberalization of resale. They submitted that liberalized resale would maximize the use of Canadian facilities, in accordance with government policy, and increase pressure for reductions in accounting rates. It was further submitted that liberalized resale would be consistent with existing government policies to promote both competition in the Canadian marketplace and the international competitiveness of Canadian industry. In addition, certain interveners argued that liberalized resale would be consistent with developments in the international telecommunications market.
B. Conclusions
1. General
The Commission anticipates that liberalization of the rules governing the resale and sharing of Teleglobe's private line services would result in the benefits identified above. The Commission also anticipates that liberalization may result in some negative effects, but is satisfied that, under the conditions prescribed below, these would be outweighed by the benefits that would be achieved. Accordingly, the Commission concludes that the liberalization of the rules governing the resale and sharing of Teleglobe's private line services is in the public interest.
In formulating the conditions for the implementation of liberalized resale, the Commission has attempted to maximize the benefits to be derived, while minimizing any possible adverse consequences. Under these conditions, the Commission considers that the impact of liberalized resale will be manageable from Teleglobe's perspective, as well as from the perspective of the members of Telecom Canada.
The Commission also wishes to state that it has no objection to the resale of Teleglobe's private line services to provide interconnection to the public switched telephone network at the foreign end.
2. Intergovernmental Agreements
Teleglobe submitted that, prior to implementing liberalized resale, intergovernmental agreement with respect to the applicable terms and conditions should be required between Canada and the foreign country. Teleglobe argued that this approach would ensure that the national and policy interests of both countries are understood and respected.
Certain interveners expressed concern that Teleglobe's proposal for the conclusion of prior intergovernmental agreements could delay the implementation of liberalized resale and the achievement of its attendant benefits.
In Decision 90-2, the Commission concluded that intergovernmental agreements were not necessary in order to permit the resale and sharing of Teleglobe's services. The Commission determined that it was sufficient that Teleglobe's tariffs specify that any resale or sharing arrangements must be permitted in both countries. The Commission continues to consider this approach appropriate, and notes that it will permit the expeditious implementation of liberalized resale. This approach does not, of course, preclude the conclusion of intergovernmental agreements relating to liberalized resale.
3. Participation by Domestic Carriers and Affiliates
Teleglobe requested that domestic facilities-based carriers be prohibited from engaging in liberalized resale. Teleglobe argued that, if domestic carriers engaged in such resale, they could divert their ITS traffic to resold private lines. In Teleglobe's view, this would result in the effective takeover of Teleglobe's business by the domestic carriers, would render Teleglobe's switched plant redundant and would reduce the company's role to that of a facilities provider. In the worst case scenario provided in Teleglobe's analysis of the impact of liberalized resale, the bulk of the estimated traffic and revenue erosion arose from Telecom Canada members reselling Teleglobe's private lines.
The Commission agrees with Teleglobe that the diversion by domestic carriers of ITS traffic could have a significant impact on Teleglobe's position in the Canadian and international telecommunications industries. The Commission therefore concludes that domestic telecommunications carriers should be prohibited from engaging in liberalized resale. Moreover, in the Commission's view, the diversion of ITS traffic by the carriers to any reseller(s) could result in similar consequences. Accordingly, the Commission directs the carriers under its jurisdiction not to route their ITS traffic through a reseller of Teleglobe's private lines. In addition, Teleglobe is directed to file proposed tariff revisions prohibiting joint-use resellers of its private lines from carrying the ITS traffic of domestic carriers.
Should an agreement concluded between Canada and another country provide that Canadian telecommunications carriers may engage in liberalized resale of Teleglobe's private lines, the Commission would expect Teleglobe to file proposed tariff revisions to reflect the terms of that agreement.
Teleglobe also requested that persons affiliated with a domestic carrier be prohibited from engaging in liberalized resale. In light of the restriction on the ability of domestic carriers to deliver their overseas traffic to resellers, no carrier would be in a position to confer an undue preference on an affiliated reseller in this respect. Accordingly, the Commission does not consider it necessary to restrict the international resale activities of persons who may be affiliated with a domestic carrier.
4. Participation by Foreign Carriers and Affiliates
Teleglobe requested that foreign carriers and their affiliates be prohibited from engaging in liberalized resale.
Teleglobe advanced three main arguments in support of its proposed restrictions on the resale activities of persons affiliated with foreign carriers. First, Teleglobe argued that foreign carriers could route their Canadian ITS traffic using Canadian affiliates. Teleglobe submitted that foreign carriers might act to maximize traffic on their networks world-wide. Second, Teleglobe argued that, if such resale activity were allowed, foreign carriers would have less incentive to negotiate accounting rate reductions with Teleglobe.
CWT and CTA submitted that the routing over resold private lines of telephone traffic not originating with a resale customer would violate international and intercarrier agreements. CWT, supported by CTA, submitted that Teleglobe's first two arguments assume that carriers would engage in unauthorized traffic routing. Teleglobe did not disagree with CWT that such routing would violate inter-carrier agreements. However, Teleglobe suggested that there would be an economic incentive to route in this manner and that it could occur.
Teleglobe presented, as its third argument, the concern that foreign carrier-affiliate groups could cross-subsidize activities between countries. CWT submitted that Teleglobe had failed to establish that such groups would use the profits from operations in certain parts of the world to cross-subsidize an otherwise uneconomic entry in others.
The Commission must proceed on the assumption that carriers will respect their national and international obligations. Furthermore, federal government policy does not place ownership restrictions on persons acting as resellers in Canada. Finally, the Commission is not persuaded that carrier-affiliate groups would cross-subsidize operations in Canada. The Commission therefore concludes that restrictions on the resale activities of foreign carriers (that do not themselves operate as facilities-based carriers in Canada), or on the resale activities of persons affiliated with foreign carriers, are not warranted.
5. Traffic Routing
Teleglobe proposed that its resale and sharing tariff be revised to specify that, unless otherwise agreed, private lines between Canada and an overseas destination should be used to carry traffic between Canada and that overseas destination only. It submitted that resellers are not governed by the same international obligations as are carriers, and that the proposed provision would govern the routing of traffic by resellers over lines leased from Teleglobe.
In Decision 91-10, the Commission considered similar tariff restrictions concerning the bypass of Canadian facilities as a result of routing traffic through the United States. In that Decision, the Commission concluded that the tariffs of Telesat and of the terrestrial carriers under its jurisdiction should be amended to prohibit the routing of basic traffic through the United States when that traffic originates or terminates in Canada. The Commission determined that this prohibition would assist the carriers in ensuring that traffic originating or terminating in Canada makes maximum use of Canadian facilities.
The Commission considers reduced rates for Canada's international services the most effective long-term strategy for maximizing the use of Canada's international facilities. In the Commission's view, liberalized resale will contribute to the achievement of this goal. However, the Commission also considers that a tariff restriction governing the resale and sharing of Teleglobe's private lines to provide joint-use voice services will help ensure that such traffic makes maximum use of Canada's international facilities.
Accordingly, the Commission approves the inclusion in Teleglobe's tariff of a provision prohibiting the routing through a third country of joint-use private line voice traffic, when that traffic originates or terminates in Canada.
Teleglobe indicated during the hearing that it would not object to resold traffic being routed or hubbed through a third country if the countries or operating agencies involved agreed on this routing. The Commission considers such flexibility regarding the negotiation of traffic routings appropriate. Therefore, Teleglobe's tariffs should provide for an exception to the routing restriction where alternate routing has been negotiated.
6. Contribution Charges
Teleglobe did not request that it receive contribution payments for itself as a condition of liberalized resale. In the Commission's view, contribution payments to Teleglobe are not required.
With respect to contribution payments to Telecom Canada members, Bell submitted that, in its case, the average contribution derived from ITS is over twice that derived from domestic Message Toll Service. Similarly, AGT stated that it relies heavily on ITS traffic to keep local rates low. Bell submitted further that, even if resale is liberalized under the conditions proposed by Teleglobe, there will be further contribution loss beyond that due to Globedirect. Neither Bell nor AGT, however, presented evidence or argument on what they considered the appropriate level of contribution to be.
AGT and Ontario submitted that there is not enough information on the record to deal with the question of contribution to Telecom Canada members. CTA submitted that there is sufficient evidence to deal with this issue. CTA proposed a contribution charge of $200 per channel in recognition of the inferior service attributes of joint-use private lines and the restricted geographic scope of the access permitted under Resale and Sharing of Private Line Services, Telecom Decision CRTC 90-3, 1 March 1990 (Decision 90-3).
Teleglobe submitted that the Commission has already dealt with the question of contribution to Telecom Canada members in the proceeding leading to the approval of tariffs for Globedirect. It argued that users of Teleglobe's services presently pay a high level of contribution and that they should not continue to contribute more than other long distance users in Canada. Teleglobe submitted that, under the conditions it proposed, it would be Globedirect traffic, plus a percentage of inbound ITS traffic, that would migrate to resold private lines if resale was liberalized.
In the Commission's view, Public Notice 1990-102 provided ample notice of its intention to consider liberalization of the rules governing resale and sharing of Teleglobe's services beyond that approved in Decision 90-2 (in which the Commission did not consider and thus did not permit resale and sharing on a joint-use basis). The Commission notes that AGT and Bell, while providing no evidence or argument on the appropriate level of contribution, did address the impact of joint-use resale of Teleglobe's service on contribution to members of Telecom Canada. The Commission is satisfied that an adequate record exists upon which to base a determination regarding contribution to the members of Telecom Canada.
The Commission considers a contribution of $200 per channel appropriate at this time. The charge will apply to local and interexchange channels used to access Teleglobe's private lines for the purpose of providing joint-use interconnected voice services. This charge is the same as that approved for access to Teleglobe's Globedirect service, which in turn reflects the level of contribution approved in Decision 90-3 for resale of Bell's and B.C. Tel's private lines for joint use. The Commission considers that a contribution charge of $200 per channel will serve to reduce incentives to bypass the use of Canadian facilities and to repatriate traffic currently routed over the facilities of U.S. carriers.
The Commission recognizes that it may become necessary to review the level of this charge in the future, depending on the impact of factors such as reductions in rates for Canada's international services, stimulation and further repatriation of traffic resulting from the liberalization approved in this Decision, liberalization of the rules governing resale in foreign country markets, and any future adjustments made to the contribution rate established in Decision 90-3.
Teleglobe is to file proposed tariff revisions specifying that it will remit contribution charges to Telecom Canada members, consistent with the framework established for Globedirect service in Telecom Order CRTC 91-380, 19 March 1991.
In order to facilitate the proper functioning of the contribution mechanism, Teleglobe's proposed tariffs are also to specify that resellers and sharing groups are to register with Teleglobe and with the Commission, prior to receiving service.
C. Impact on Revenue Requirement
In view of the fact that Teleglobe put forward its current position on liberalized resale after it had submitted its May View, no adjustments for the impact of liberalized resale would have been incorporated in that view. The Commission has, therefore, made a revenue adjustment in determining Teleglobe's 1992 revenue requirement in order to reflect the impact of liberalized resale.
D. Tariff Revisions
Teleglobe is to file, by 15 February 1992, proposed tariff pages implementing the Commission's determinations in this Part.
V FORBEARANCE FROM REGULATION
A. Introduction
In Public Notice 1990-102, parties were requested to comment on the form of regulation that should be applied to Teleglobe after the transitional period. In particular, parties were asked to comment on the potential for Teleglobe to engage in price discrimination and cross-subsidization and to earn monopolistic profits.
The Commission also stated that, in deciding on a regulatory framework for Teleglobe after the transitional period, it considered it useful to determine the extent to which Teleglobe can dominate the market segments it serves. Parties were invited to comment on this matter with reference to rates for similar services provided by U.S. carriers and to the incentives for customers not to route Canadian telecommunications traffic destined for overseas locations on Canadian facilities to the maximum possible extent.
Section 16 of the Teleglobe Act allows the Commission to forbear from regulating any activity of the company where the Commission determines that the activity in question is subject to a degree of competition sufficient to ensure just and reasonable tolls, rates or charges and ensure against unjust discrimination or undue or unreasonable preference, advantage, prejudice or disadvantage. In particular, the Commission may permit Teleglobe to charge tolls without having first filed a tariff with the Commission for approval.
Teleglobe did not specifically address the issue of forbearance in its initial evidence filed in March. However, in its supplementary evidence filed in May, Teleglobe advanced a proposal requesting that the Commission exercise the power of forbearance set out in section 16 of the Teleglobe Act. The key elements of its proposal are: (1) for each of its competitive services, commencing January 1992, the Commission would no longer authorize, approve, or alter the rates and conditions of service for the designated services, nor would the Commission adjudicate customer or competitor complaints; (2) the effect of this decision would be detariffing of existing and future non-telephone services (i.e., services other than ITS), as well as the termination of any other regulatory activities associated with non-telephone services; (3) telephone services would continue to be offered to subscribers at just and reasonable rates approved by the Commission, and the Commission would continue to receive and monitor information sufficient to permit it to determine whether Teleglobe's telephone operations are cross-subsidizing its non-telephone operations; and (4) the Commission would have the ongoing responsibility of ensuring that the necessary conditions of forbearance continue to exist, and could review its forbearance decision.
With respect to the issue of safeguards against cross-subsidization, Teleglobe stated its intention to develop a broad service category costing methodology. However, it argued that the implementation of forbearance need not await that costing methodology.
Generally, Teleglobe's justification for its proposal is that the market for the services in question is sufficiently competitive to ensure that Teleglobe cannot (1) charge excessive rates; (2) engage in predatory pricing; (3) forestall service innovations; or (4) establish unreasonable conditions of service. Teleglobe bases this view on the overall competitiveness of its operating environment, which, in its view, is characterized by the presence of a number of competitive forces, namely: (1) the existence of direct rivals; (2) the availability of substitutes; (3) potential entry; (4) technological change; and (5) buyer and supplier power, in particular, the power of Telecom Canada members, who deliver virtually all of Teleglobe's outbound traffic to its gateways.
B. Conclusions
Neither section 16 of the Teleglobe Act nor past Commission decisions establish specific criteria for measuring competition. However, in the case of the various market segments served by Teleglobe, the Commission can identify a number of general criteria for assessing the degree of competition that exists. These general criteria are as follows: (1) the degree to which direct competition exists for a given service or the extent to which substitutes are available (this includes a consideration of barriers to entry); (2) where comparable services are available from other providers, the extent to which Teleglobe's rates exceed or are below the rates for those comparable services; and (3) the extent to which service changes or new technology are implemented relative to other international service providers.
A second area of concern is the extent to which the potential for cross-subsidization exists.
The Commission notes that the above criteria are consistent with its previous decisions concerning the detariffing of certain of Unitel's services and the regulation of cellular carriers, wherein the Commission emphasized the issues of "effective competition" and the potential for cross-subsidization.
Teleglobe's principal evidence on the extent of its market power, the study conducted by Monitor Company, does not analyze competition on a service-by-service basis but, rather, adopts a general approach to the issue of competition, relying on a review of market characteristics and forces.
In assessing Teleglobe's proposals for regulatory forbearance, the Commission examined first the question of the general environment in which the company operates and whether the company exercises, in a general sense, market power within that environment. At this level, the Commission accepts the proposition that Teleglobe's market power is somewhat mitigated by external factors. In particular, there are a number of factors which will pressure Teleglobe to reduce its rates, including increased competition in the provision of international telecommunications services, the move to liberalized resale and sharing rules internationally, the threat of international hubbing, and the fact that prices for overseas services are significantly above cost.
While acknowledging that Teleglobe's ability to set monopoly prices is partly constrained, the Commission shares the view of the Director that Teleglobe's market power is not solely related to its ability to set prices. As noted by interveners, Teleglobe clearly has a monopoly over earth station licences, cable landings and access to the INTELSAT space segment. By virtue of this monopoly status, Teleglobe is in a position to influence, if not control, the speed of innovation and the introduction of new technology and services.
Furthermore, the Commission is of the view, as submitted by various interveners, that Decision 91-10 and the introduction of Globedirect have reduced the potential for bypass of Teleglobe's facilities, thus enhancing its market power. Teleglobe itself expressed the view that Globedirect would repatriate traffic that currently bypasses or otherwise would have bypassed Teleglobe's facilities.
Teleglobe's proposal essentially calls for the Commission to forbear from regulating all "competitive" services, i.e., services other than ITS. These services, such as private lines and Globedat, are the sole source of supply for overseas transmission. The Commission notes, in particular, that Teleglobe's largest customers, the domestic facilities-based carriers, are not in a position to use the services of the "competitors" listed by Teleglobe because of restrictions imposed by tariffs, interconnection agreements and/or government policy. Therefore, on a prima facie basis, the Commission finds that the majority of these services, with the possible exception of services such as Globefax and Globetex, are not competitive, but rather are provided by Teleglobe on a monopoly basis.
In light of the above, the Commission finds that, in a general sense, Teleglobe is in a position to exercise market power within its operating environment.
As noted above, Teleglobe's principal evidence on the extent of its market power, the study conducted by Monitor Company, does not analyze competition on a service-by-service basis. When asked for any service-specific analyses, Teleglobe indicated that no such analyses had been completed.
In the absence of any analyses of the specific services in question, including an examination of factors such as relative price levels, substitutes, geographic reach and service availability, the Commission finds it impossible to assess the extent to which Teleglobe faces effective competition in the provision of any or all of those services. Accordingly, it is impossible for the Commission to find, on the basis of the evidence in this proceeding, that the necessary conditions exist for the exercise of its power to forbear from regulating any of the services in question. Accordingly, Teleglobe's application for forbearance is denied.
Since Teleglobe's proposal is denied, it is not necessary for the Commission to consider, at this time, the establishment of appropriate competitive safeguards, such as the broad service category costing methodology suggested by the company. However, the Commission considers that, as a monopoly provider of ITS, Teleglobe is in a position to cross-subsidize competitive activities from monopoly revenues. Accordingly, under current market conditions, were the Commission to approve a request from Teleglobe for forbearance with respect to its non-telephone services, competitive safeguards would be required.
As stated above, the Commission accepts, at a general level, that Teleglobe's market power is somewhat mitigated by external factors. Although Teleglobe maintains, at this time, a significant degree of market power, the situation may change in the future. In particular, if Teleglobe is subjected to a greater degree of competition in its domestic market through resale and sharing, and if a greater North American market for international telecommunications services develops, Teleglobe may face a degree of competition sufficient that the Commission could forbear from regulating many of its activities.
VI FORM OF REGULATION
A. Background
The Direction issued to the Commission prescribed an allowable ROE range for Teleglobe over the transitional period. The lower limit of that range was the weighted average mid-point of the allowed ROEs of Bell and B.C. Tel, and the upper limit was that mid-point plus 200 basis points. This resulted in an allowed ROE range over the transitional period of about 12.9% to 14.9%.
In Decision 89-1, the Commission expressed the view that the Direction permitted Teleglobe to exceed its allowed ROE in any year of the transitional period, provided that its average ROE over the full transitional period fell within the prescribed range. However, the Commission stated that Teleglobe's ROE should not deviate so substantially from the prescribed range that it might carry a significant earnings shortfall or excess into the last year of the transitional period. Teleglobe expressed its agreement with the Commission's approach.
As noted above, Public Notice 1990-102 requested that parties comment on the form of regulation that the Commission should apply to Teleglobe after the transitional period. The Commission noted that, although RB/ROR regulation has brought significant benefits to users of ITS, resulting in rate reductions of about 35% over the transitional period, the environment in which Teleglobe operates and the risks that it faces may have changed since privatization. The Commission therefore sought submissions on possible alternative forms of regulation. However, Public Notice 1990-102 also directed Teleglobe to file financial evidence for 1992 on a RB/ROR basis.
In its Memoranda of Support, filed on 26 March 1991, Teleglobe stated that the complex nature and the changing competitive dynamics of the international telecommunications environment call into question the appropriateness and adequacy of conventional RB/ROR regulation for the company. Teleglobe added, however, that the complex and dynamic nature of the environment makes it difficult for the company to reach definitive conclusions on better forms of regulation. It stated that it plans to further examine alternatives with a view to developing a specific proposal for the Commission's consideration in the short to medium term.
Teleglobe based its financial evidence on a single forward test year, 1992. The company noted that, under a single forward test year RB/ROR approach, profits are limited each year to a specific allowed ROE range. In order to mitigate its combined forecasting and operating leverage risk, Teleglobe proposed a 200 basis point ROE range, rather than the more usual 100 basis point range.
In its letter to Teleglobe of 3 May 1991, the Commission determined that the company's evidence of 26 March 1991 relating to form of regulation was deficient. Accordingly, Teleglobe was directed to file, by 27 May 1991, any supplemental evidence it might have on the matter, as well as responses to a series of supplementary Commission interrogatories (the 1900 series) dealing with form of regulation.
In its supplemental evidence, Teleglobe stated that conventional RB/ROR regulation presupposes a level of market power that it does not believe it has. The company submitted that it requires a regulatory framework that allows it to function effectively as a competitive business and that recognizes its role as the sole supplier of Canadian overseas telecommunications services. However, Teleglobe stated that it was not yet prepared to file a proposal on a specific alternative form of regulation. Instead, the company proposed, as an interim measure, a modified RB/ROR regime, with a rolling multi-year approach, effective 1 January 1992.
Teleglobe stated that it expected to present a concrete proposal for an alternative regulatory regime sometime in 1992, but no later than 1993. Teleglobe considered that any such alternative would itself constitute a transitional regime lasting about four to five years. The company expected that, after that time, market forces alone would be sufficient to ensure just and reasonable rates.
B. Rolling Multi-Year Approach and Income Reserve Account
1. Positions of Parties
In response to interrogatory Teleglobe(CRTC)25Apr91-1901, filed with its supplementary evidence, Teleglobe proposed that the practice of averaging its achieved ROE over a number of years be continued after the transitional period. However, rather than averaging its ROE over a fixed period, the company proposed that its ROE be averaged over a moving multi-year period (for example, four years) beginning in 1992. Teleglobe was of the view that the rolling multi-year approach is better suited to its circumstances because factors affecting its revenues and earnings are largely outside of its control. Teleglobe submitted that its proposal would provide a better structure within which to plan rate changes and would allow it to mitigate the impact of the cyclical nature of its asset acquisition profile.
Teleglobe proposed that any revenue excess or shortfall incurred in any one year be recorded in a deferred income reserve account (IRA), the balance of which would be amortized over the following three years. During examination by Commission counsel, Teleglobe added that an effective cap of plus or minus $15 million on the balance of the IRA would be reasonable. Teleglobe stated that it believed the company's external auditors would accept the IRA as conforming to Generally Accepted Accounting Principles (GAAP) and that the treatment of the IRA would be considered a part of the company's financial results on a book basis, rather than on a regulatory basis.
In final argument, Ontario generally took the view that a single forward test year RB/ROR form of regulation would be appropriate in the post-transitional period. However, Ontario submitted that, if the Commission determines that there is a need to account for volatility in Teleglobe's earnings, it should contemplate either continuation of the RSA or adoption of the IRA with a set cap and fixed amortization period, but that both mechanisms should not be approved.
2. Conclusions
The Commission notes that, until prompted to file supplementary evidence and directed to file responses to interrogatories dealing with form of regulation, Teleglobe gave every indication that a single forward test year RB/ROR regime with a 200 basis point ROE range would be appropriate until it filed a specific proposal. Indeed, Teleglobe's March evidence makes no mention of any alternative to a single forward test year approach.
In its letter of 3 May 1991 and in the 1900 series of interrogatories, the Commission sought to obtain further evidence with respect to Teleglobe's views on specific regulatory regimes such as price cap and incentive rate of return regulation. As noted above, Teleglobe's proposed multi-year approach, as outlined in its responses to the 1900 series of interrogatories, contemplated more than one interim regulatory regime in the post-transitional period. Teleglobe envisaged that its proposed rolling multi-year approach and IRA, for example, would be in effect for approximately one to two years, after which time an alternative regulatory framework would be in effect. Teleglobe acknowledged in response to a Commission interrogatory that it had not determined whether the IRA would form part of its eventual proposals for an alternative regulatory regime.
As a result of Teleglobe's failure to formulate a specific proposal as to how it should ultimately be regulated, the Commission finds that considerable uncertainty exists as to the future role of the IRA. Furthermore, the Commission is of the view that the IRA, as proposed, would, among other things, provide Teleglobe with less incentive to exercise cost containment procedures than a single forward test year RB/ROR regime. If the company were to earn below its ROE range in a particular year as a result of overspending, it would be able to recover the shortfall in future years through the use of the IRA. The Commission finds it inappropriate that the proposed IRA would enable Teleglobe to recover increases in expenses that are within the company's control and could reasonably be avoided.
In light of the above, the Commission denies Teleglobe's proposed rolling multi-year approach and its proposed IRA. Until a form of regulation is established, as contemplated by Public Notice 1990-102, the Commission considers the approach set out in Teleglobe's March 1991 evidence a more appropriate method of regulation. Therefore, Teleglobe will be regulated under a single forward test year RB/ROR regime with a 200 basis point range (as discussed in Part VIII, Section E, Financial Issues). As discussed in Part II, the RSA will continue.
Teleglobe has identified a number of expected changes in its operating environment (in particular, amendments to its agreement with Telecom Canada and the planned gateway access tariff) that may reduce variations in its revenues as a result of changes in domestic settlement rates. As discussed in Financial Issues, the Commission has taken Teleglobe's existing operating environment into account in establishing the 200 basis point range. However, should there be a substantial change in the circumstances foreseen in Teleglobe's 1992 budget estimate, indicating that the company's ROE for 1992 would fall outside of the approved range, the company or the Commission may undertake the appropriate action (as discussed in Part VIII, Section F, Revenue Requirement).
C. Alternatives to Rate Base/Rate of Return Regulation
1. Positions of Parties
The Commission contemplated that, in responding to Public Notice 1990-102, Teleglobe would put forward specific proposals as to how it wished to be regulated after the transitional period. However, in its evidence, Teleglobe limited itself to general comments regarding the applicability of possible alternative regulatory regimes, stating that further work would be required before it could file a specific proposal. In this context, Teleglobe expressed reservations about RB/ROR regulation and submitted that an incentive ROR approach would be the most attractive option. During cross-examination by Ontario, Teleglobe indicated that it is seeking more specific guidance from the Commission as to the direction it should take in investigating alternative methods.
In final argument, the Director stated that RB/ROR regulation, with or without a moving average return, is no longer an appropriate form of regulation for Teleglobe's services. The Director had serious reservations with respect to RB/ROR regulation, stating that this method fosters inefficient input choices, slows technological progress and provides incentives to cross-subsidize unregulated activities from regulated markets.
Despite its view that the appropriateness and applicability of other regulatory methodologies had not been adequately explored in this proceeding, the Director recommended that the Commission implement price cap regulation for Teleglobe as quickly as possible. The Director suggested that the Commission might wish to consider setting up one price index for residential and small business users of ITS and another for large business users of ITS.
In final argument, Quebec stated that Teleglobe appears to have ruled out traditional RB/ROR regulation in its analyses of alternative forms of regulation. Quebec was of the opinion that Teleglobe has not demonstrated why the current regulatory regime should be rejected. Quebec stated that the Commission should urge Teleglobe to consider modifications to RB/ROR regulation, such as the deferral account proposed by the company, to make it more flexible. Further, Quebec expressed doubts about the effectiveness of regulatory approaches requiring a price cap index, since Teleglobe currently lacks control over the majority of its costs. Quebec submitted that Teleglobe's financial situation might be jeopardized under such an approach if the company were unable to reduce accounting rates and/or settlement rates by as much as it assumes.
2. Conclusions
As noted above, Teleglobe requested that the Commission provide it with more specific guidance as to the form of regulation that should apply to it after the transitional period. In Public Notice 1990-102, the Commission set out the broad concerns that Teleglobe should consider in formulating its position as to form of regulation. The Commission considers it inappropriate to provide more specific guidance. Rather, it is for the company to come forward with proposals that will address the concerns identified by the Commission.
As noted earlier, Teleglobe expressed concerns as to the adequacy of RB/ROR regulation given its circumstances. However, the Commission agrees with Quebec that Teleglobe has failed to present sufficient evidence to warrant rejection of RB/ROR regulation. In the Commission's view, Teleglobe has not provided sufficient rigorous analysis or empirical evidence to support a finding that RB/ROR regulation is inadequate for the post-transitional period.
The Director suggested that the Commission proceed to implement price cap regulation. The Commission considers such a move premature, particularly in light of the inadequacy of the record concerning the appropriateness of alternative regulatory regimes. Indeed, based on its assessment to date, Teleglobe stated that price cap regulation might pose significant implementation problems because the company operates in an international environment. In addition, the Commission notes Quebec's submission that Teleglobe's financial situation could be jeopardized under a price cap regime.
In establishing an alternative form of regulation for Teleglobe, it will be necessary to assess in detail the relative merits of whatever approach Teleglobe may advance. Therefore, the company should be prepared to file, where possible, strong empirical evidence to substantiate its position. For example, if Teleglobe proposes an incentive rate of return regime, it should provide empirical evidence to support its productivity offset. The company's assessment should, among other things, include the criteria it used to formulate its preferred regulatory approach and a discussion of the economic benefits and savings that its approach would achieve, over and above what would be achieved under the current form of regulation.
In addition, any future submissions by Teleglobe regarding its preferred form of regulation should take into account the following areas, initially identified in Public Notice 1990-102:
(1) the company's financial integrity and its ability to attract capital on reasonable terms, including appropriate measures to assess this;
(2) the potential for Teleglobe to engage in price discrimination and cross-subsidization and to earn monopolistic profits, including any proposed safeguards to check such occurrences;
(3) incentives for the company to strive for greater efficiency improvements, as well as the measures to detect improvements in efficiency; and
(4) the requirement for fairness and the requirement that rates set, using a particular form of regulation, be just and reasonable.
Teleglobe stated that it expects to put a concrete proposal for an alternative regulatory regime before the Commission by 1993. Should the approach adopted in this Decision prove unsatisfactory to Teleglobe, the company is invited to file an alternative proposal before that time. Upon the filing of Teleglobe's proposal, with adequate supporting evidence as described above, the Commission will initiate a public proceeding to consider the form of regulation that should apply.
VII ADVANCES TO MEMOTEC
A. Background
1. Central Cash Management System
After Memotec acquired Teleglobe in 1987, Teleglobe was included in Memotec's central cash management (CCM) system. Under this system, funds in Teleglobe's bank accounts, except imprest and payroll accounts, are transferred to a Memotec bank account at the end of each day. These advances to Memotec are, in effect, loans made by Teleglobe to Memotec, although Teleglobe has never actually received any interest payments from Memotec on the amounts outstanding. Moreover, Teleglobe pays Memotec a corporate management services charge that includes a fee for cash management.
The funds that Teleglobe provides to Memotec are substantial. Teleglobe's ability to maintain such large cash balances results from its revenue settlement arrangements with foreign administrations and with domestic carriers. Under its current agreement with Telecom Canada, Teleglobe receives from Telecom Canada remittances for outgoing overseas telephone calls about one and a half months after the end of the month in which the calls are placed. However, under International Telecommunication Union regulations, settlements with foreign administrations of revenues derived from incoming and outgoing telephone calls do not have to be finalized until some six to eight months after the calls are made. Since Canadians make over 50% more telephone calls to overseas destinations than they receive, Teleglobe's accounts payable to foreign administrations are greater than its accounts receivable from those administrations. This fact, combined with the length of the international settlement process, means that Teleglobe has significant funds on hand.
Under the CCM system, the advances to Memotec are recorded in Teleglobe's books of account as accounts receivable from Memotec, and in Memotec's books of account as accounts payable to Teleglobe. The average daily balance of these advances increased steadily from about $60 million near the beginning of 1988 to about $100 million at the end of February 1990. On 28 February 1991, the balance stood at $133.8 million, accounting for some 40% of Teleglobe's net book value. Since then, the balance has declined. At the end of October 1991, it stood at $91.0 million, $30.7 million more than projected in the May View and $29.1 million more than projected in the revised forecast provided by Teleglobe in response to interrogatory Teleglobe(CRTC)26July91-3401.
Until December 1988, Teleglobe accrued an interest income on the advances on its books of account, presumably in anticipation of receiving actual interest income from Memotec. However, in December 1988, Teleglobe changed its accounting procedure. Since that time, Teleglobe has imputed an interest income on the advances only for regulatory purposes. As noted above, Teleglobe has never actually received any interest payments from Memotec. Prior to Decision 91-5, the imputed interest was based on 91-day Treasury bill rates.
2. Letter Decision 89-23
The Commission has had serious concerns with aspects of the CCM arrangements since it first assumed jurisdiction over Teleglobe. The Commission first expressed its concerns publicly in Reduction in International Telephone Service Rates, Advances to Memotec Data Inc., Telecom Letter Decision CRTC 89-23, 9 November 1989 (Letter Decision 89-23). Specifically, the Commission noted that Memotec furnished no security for funds advanced by Teleglobe, that the advances were substantial, and that there was no written agreement formalizing any aspect of the CCM arrangements. The Commission was also concerned that no interest was actually paid to Teleglobe, and that significant differences would develop between financial indicators based on Teleglobe's books of account (used by bond rating agencies in assessing Teleglobe's creditworthiness) and those derived for regulatory purposes. The latter indicators take into account interest income imputed on the advances, while the former do not.
In Letter Decision 89-23, the Commission expressed the view that, since a float of funds of at least $60 million would likely exist for the foreseeable future, it would be more cost effective for Teleglobe to use some of that float to lower its invested capital. The Commission noted that this would require the removal of a covenant in Teleglobe's loan agreement with the National Bank of Canada (National Bank) requiring that a ratio of current assets to current liabilities (current ratio) of at least 1:1 be maintained.
In Letter Decision 89-23, the Commission concluded that the CCM system was not consistent with Teleglobe's obligation as a regulated company to ensure that its customers' interests are protected, or with the company's own best interests. The Commission directed Teleglobe to file, by 8 December 1989, proposals to organize its cash management and short-term investment program in a way that would address the Commission's concerns. The Commission stated that acceptable alternatives would include: (1) that Teleglobe maintain its own short- term investment program; (2) that Teleglobe enter into a written agreement with Memotec formalizing the cash management arrangements in such a way as to protect Teleglobe's financial interests and to ensure that Memotec pays it a market interest rate on the advances; (3) that Teleglobe contract out its cash management and short-term investment program to an unrelated party.
Teleglobe filed its proposals on 8 December 1989. The company undertook to enter into a written agreement with Memotec formalizing the imputation of interest at 91-day Treasury bill rates. Under the proposed agreement, Teleglobe was to have the right to repayment of a portion of the advances on seven days notice. The balance would be repayable on 90 days notice. Teleglobe also stated that the National Bank had undertaken to provide Memotec with a comfort letter indicating that funds would be made available to Memotec to meet its obligation to repay Teleglobe. Teleglobe also offered to deem, for regulatory purposes, the payment to Memotec of a monthly dividend equal to the after-tax value of the imputed interest and to make a one-time deemed dividend adjustment equal to the after-tax value of the imputed interest for the years 1988 and 1989.
3. Decision 91-5
After reviewing Teleglobe's proposals, the Commission remained concerned that no interest would be paid on the advances, that funds on deposit with Memotec might not be sufficiently secure, and that Teleglobe's key financial ratios would continue to be adversely affected, with a possible negative impact on the company's credit rating and borrowing costs. In Teleglobe Canada Inc. - Advances to Memotec Data Inc., CRTC Telecom Public Notice 1990-21, 23 February 1990 (Public Notice 1990-21), the Commission initiated a public proceeding to address these concerns.
During the proceeding established in Public Notice 1990-21, Teleglobe filed (on 6 April 1990) a copy of an agreement with Memotec dated 27 March 1990 with respect to the CCM arrangements. This agreement (the loan agreement) sets out the terms and conditions under which Teleglobe advances funds to Memotec. Under that agreement, Teleglobe transfers to Memotec all funds that are surplus to Teleglobe's daily business requirements. Memotec's obligation to repay is evidenced by two revolving promissory notes, one for advances in Canadian funds and the other for advances in American funds. These promissory notes are annexed as schedules to the loan agreement. The loan agreement can be terminated on 90 days notice, and outstanding advances are due and payable on 90 days notice or on demand by Teleglobe following the occurrence of an "event of default". The outstanding amount does not bear interest prior to its due date (pursuant to the notice provisions) or prior to demand following an event of default. Events of default are defined in the loan agreement and include: (1) default by Memotec on its loans; (2) the appointment of a receiver for Memotec's properties; and (3) the initiation of a petition in bankruptcy by or against Memotec.
Teleglobe also filed an abridged version of a line of credit (LOC) agreement between Memotec and the Royal Bank of Canada. This $150 million credit facility is for general corporate purposes, including repayment of payables and loans owing to Teleglobe and non-hostile acquisitions by Memotec. The LOC agreement contains a number of conditions precedent to any disbursement of funds to Memotec, including requirements that Memotec shall have maintained certain financial performance standards and that no event of default shall have occurred. In a letter to Teleglobe dated 27 April 1990, which Teleglobe filed with the LOC agreement, Memotec stated that its current intention was to maintain an amount of unused credit not less than the outstanding advances from Teleglobe.
Teleglobe stated that the loan agreement, coupled with the LOC agreement, was intended to satisfy the Commission's concern by removing the perceived risk of non-payment.
Teleglobe submitted that the imputing of interest at 91-day Treasury bill rates is advantageous to it and to its subscribers, since no minimum balance or minimum placement period is required in order to obtain the 91-day Treasury bill rate, as would be the case with commercial cash management arrangements. As well, the imputed interest is applied to the whole amount of the advances. Teleglobe also stated that its expenses are lower with the CCM arrangements, since its own staff are not required to manage the funds in question. (As noted earlier, Teleglobe pays Memotec a corporate management services charge that includes a fee for cash management.)
Teleglobe took the position that actual interest need not be paid on the advances, because the 91-day Treasury bill rate is a market interest rate and because its customers' interests are protected by the inclusion of the imputed interest for revenue requirement purposes. Teleglobe characterized the funds on deposit with Memotec as intercorporate advances between a parent company and its wholly-owned subsidiary. Teleglobe stated that such intercorporate advances are generally made at no interest, because the financial statements of a parent company and its subsidiaries are prepared on a consolidated basis. In the consolidation process, intercorporate receivables and payables (such as the advances) and intercorporate interest expense and income are eliminated.
Teleglobe submitted that the question of applying a portion of the advances to reduce invested capital should be deferred to the present proceeding. However, Teleglobe offered to negotiate with the National Bank to relax the covenant requiring a current ratio of 1:1 and to apply about $40 million to $45 million of the advances towards reducing its invested capital.
In Decision 91-5, the Commission concluded that Teleglobe had made a number of improvements in its arrangements with Memotec, as evidenced by the loan agreement and the LOC agreement. These instruments were considered, respectively, to at least set out the terms and conditions of the CCM system in writing and to provide Teleglobe with some assurance that Memotec would have funds available to meet its repayment obligation. However, the Commission noted that that assurance was subject to three provisos, specifically (1) that Memotec would comply with the representations, warranties, covenants and other conditions in the LOC agreement; (2) that the funds that Teleglobe advances to Memotec would not exceed the total amount available under the LOC agreement; and (3) that an amount of credit sufficient to cover the advances would remain unused.
Further, the Commission noted that, although the deeming of dividends to Memotec corresponding to the imputed interest payments resulted in common equity on a books-of-account basis becoming the same as that on a regulated basis, Teleglobe's regulated income and its regulated ROE would continue to differ from its income and its rate of return on a books-of-account basis.
The Commission concluded in Decision 91-5 that the steps proposed by Teleglobe were not sufficient to secure the funds advanced to Memotec or to ensure Teleglobe an adequate return on those funds. The Commission's conclusion on the question of the security provided by the proposal was based on a number of specific concerns.
First, the Commission found that, under the loan agreement between Teleglobe and Memotec, advances to Memotec were supported by promissory notes that were no more than evidence of indebtedness. No real security was provided, such as a pledge of property. The Commission also found that, although the funds loaned to Memotec were to be due and payable to Teleglobe on 90 days notice, a significant portion of these funds was tied up in Memotec's investments in subsidiaries and would likely not be readily available to meet Teleglobe's funding and liquidity needs.
The Commission concluded that the cash advances to Memotec were no longer a liquid asset on the basis of an examination of the published financial statements of Memotec. Memotec's audited consolidated financial statements showed that, while its cash and short-term deposits (accounts that would contain the cash advances from Teleglobe) were $113.8 million at year-end 1988, they were reduced to $17.2 million at year-end 1989. Memotec's consolidated statement of changes in financial position for the year ended 31 December 1989 showed that the cash balance of the consolidated entity, which includes Teleglobe, was $113.8 million at the beginning of the year and negative $2.8 million at the end of the year, a decrease of $116.6 million. On Teleglobe's books of account, the balance of the funds advanced to Memotec stood at about $91.4 million at year-end 1988. This balance had increased to about $107.9 million by year-end 1989. Further, the Commission noted that, during 1989, Memotec acquired three subsidiaries, including ISI Systems Inc., a U.S.-based company engaged in the mainframe processing of insurance policies, the development of rating automation and the provision and maintenance of insurance application software for personal computers. The purchase price (paid in cash, common shares and debentures) was $154.4 million, $111.1 million of which was for goodwill. Memotec also acquired two other American companies, Equifax Insurance Systems and Concord Data Systems Inc., for total cash consideration of $35.3 million. Of that $35.3 million, $21.6 million was for goodwill.
The second specific concern noted in Decision 91-5 was that, while the loan agreement provided that advances are due and payable immediately upon an event of default, the advances from Teleglobe ranked only as unsecured debt. Therefore, it appeared unlikely that Teleglobe would recover the full amount of the advances in an event of default.
Finally, the LOC agreement between Memotec and the Royal Bank was found not to be solely for the repayment of funds owing to Teleglobe. The only assurance that Teleglobe would have had with respect to the availability of funds pursuant to the LOC agreement was Memotec's statement, in its letter of 27 April 1990, that its "current" intention was to maintain unused credit not less than the amount of the outstanding advances. There was, however, no guarantee that this would occur. Moreover, there was no assurance that the conditions precedent set out in the LOC agreement for the disbursement of funds to Memotec would be satisfied.
The Commission concluded that further safeguards were necessary in order to ensure the provision by Teleglobe of international telephone service at just and reasonable rates, as required by section 340(1) of the Railway Act. In order to provide for adequate security for the advances, Teleglobe was directed to file, by 18 June 1991, details of an arrangement with Memotec whereby the latter would pledge, in a manner that complied with the CBCA, a portion of its shares in Teleglobe to secure the funds advanced. The Commission advised that it was prepared to consider an alternative proposal from Teleglobe for the securing of its advances to Memotec. However, any such alternative was to provide for a level of security equivalent to a pledging of shares.
The Commission also found in Decision 91-5 that a substantial portion of the cash advanced by Teleglobe was used by Memotec for investments bearing higher risk than that associated with Teleglobe. The Commission's view was that Teleglobe's required return on the advances should be commensurate with the risk associated with Memotec's use of the funds. Accordingly, the Commission concluded, on an interim basis, that, as of 1 May 1991, Teleglobe would be required, for regulatory purposes, to earn on the first $60 million of its advances to Memotec a return equal to the prime rate plus 3%. The return on the rest of the outstanding advances was allowed to remain at 91-day Treasury bill rates. The Commission noted that Teleglobe's book financial indicators would continue to be significantly weaker than they would be if Teleglobe were actually receiving interest payments on its loans to Memotec. Further, on the matter of an appropriate return on the advances, the Commission advised that it intended, in the present proceeding, to determine on a final basis (1) the portion of Teleglobe's advances to Memotec to be considered long-term investment; and (2) the rate(s) of return that Teleglobe would be required to earn on the advances for regulatory purposes.
B. Teleglobe's Position
1. The Proposed Security Arrangements
In a submission dated 18 June 1991 filed pursuant to Decision 91-5, Teleglobe stated its understanding that Memotec cannot, in compliance with the CBCA, pledge its shares in Teleglobe to Teleglobe. Consequently, it proposed alternative security arrangements, embodied in three documents: a Deed of Trust, a Demand Debenture and a third party Escrow Agreement.
A draft of an Escrow Agreement, which Teleglobe characterized as a working document, was filed on 28 June 1991. On 31 July 1991, Teleglobe filed a draft Deed of Trust associated with its proposed security arrangements. On 9 August 1991, an amended Deed of Trust and the related draft Demand Debenture were filed in response to Commission interrogatories.
Under Teleglobe's proposed alternative arrangements, the Deed of Trust would be the underlying document that, in its view, would create the security for the Teleglobe indebtedness. Under the Deed of Trust, between Memotec and a trustee acting for Teleglobe, Memotec would provide a floating charge on all of its property, assets and undertakings, excluding the Teleglobe shares themselves, but including all accounts receivable and proceeds arising from the sale or other disposition of any of Memotec's assets, including its shares in Teleglobe.
Teleglobe proposed that the Deed of Trust contain a covenant placing monetary limits on Memotec's ability to further encumber its assets, so that the Teleglobe shares would always maintain an unencumbered residual value sufficient to satisfy the Memotec-Teleglobe intercorporate debt, after taking into account prior secured claims. In Teleglobe's submission, the unencumbered residual value should be determined using a market-to-book ratio of 1.2 to 1; that is, by multiplying the book value by 1.2. Teleglobe submitted that this valuation corresponds to the prevailing market-to-book value relationship of Canadian telecommunications carriers.
The Demand Debenture would be issued under the Deed of Trust. It would contain, among other things, a promise to pay on demand. Under the Debenture, demand could be made on Memotec following an event of default. An event of default would include, among other things, Memotec defaulting in payment of any indebtedness or liability to Teleglobe.
The proposed Escrow Agreement would be between Memotec, the Commission, and a third party Escrow Agent. Under the Escrow Agreement, the Escrow Agent would have the right to require that the Teleglobe share certificates be delivered to it, if and when the prior secured creditors, together with any permitted future creditors, were paid or were otherwise prepared to release the shares. Once the Escrow Agent took possession of the Teleglobe share certificates, it would hold them in accordance with the terms of the Agreement, which would require it to sell the shares on an order from the Commission upon a default by Memotec.
2. Imputed Interest
Teleglobe submitted that it would be inappropriate to regard any portion of the cash advances as a long-term investment for regulatory purposes. Teleglobe based its submission largely on its view that, under its alternative security arrangements, the advances would be adequately secured and demonstrably liquid. Accordingly, they should be regarded as a short-term investment. Teleglobe submitted that, as a short-term investment, the advances should bear the imputed return originally proposed, i.e., the 91-day Treasury bill rate.
Teleglobe pointed out in its May View forecast that sufficient cash advances would shortly be repaid to bring Teleglobe's current ratio down to a level of 0.75. (Teleglobe's financial results as at the end of October 1991, however, show cash advances of $91.0 million resulting in a current ratio of 0.87.) In Teleglobe's submission, the use of these funds to lower the current ratio is noteworthy, since it entails Teleglobe reinvesting the funds in fixed assets.
Further, Teleglobe submitted that the repayment of advances will lead to the elimination of virtually all of the first $60 million of the advances. Accordingly, in its view, the basis for the Commission's interim decision to require an imputed interest rate of prime plus 3% on the first $60 million of advances will have been removed.
3. Impact on Teleglobe's Cost of Borrowing
In Teleglobe's view, the earning of deemed rather than real interest does not affect Teleglobe's creditworthiness. Teleglobe argued that, with or without imputed interest, its interest coverage ratio remains above three times, under any scenario. Teleglobe acknowledged that any interest coverage increase would improve investors' views of a company, but contended that the absence of real interest does not hurt Teleglobe's creditworthiness.
Teleglobe's position on this matter was supported by its expert witness, Mr. D. A. Carmichael. Mr. Carmichael advised that Teleglobe's financial performance would improve if interest were received, but felt that the improvement would not be significant. At the level of advances to Memotec forecast for 1992, he judged that the payment of actual interest would increase the planned interest coverage ratio only by approximately 30 basis points.
4. Cost of Administering Security Arrangements
Under the proposed Escrow Agreement, Deed of Trust and Demand Debenture, any fees and charges payable, together with counsel fees and other reasonable expenses incurred, would be to the account of Memotec. Teleglobe was questioned on whether any thought had been given to procedures to ensure that these charges would, in fact, be borne by Memotec and not ultimately be charged back to Teleglobe. Teleglobe advised that costs of this nature would not be charged back to Teleglobe and that, if the Commission so wished, the Escrow Agreement could be amended to include a covenant by Memotec not to charge back to Teleglobe any fees, charges or other costs paid by Memotec to the Escrow Agent.
C. Conclusions
1. The Proposed Security Arrangements
In considering the alternative security arrangements proposed by Teleglobe, the Commission has taken into account the adequacy of the security and the liquidity that the proposed arrangements would provide.
Teleglobe submitted that the issue is not whether there remain any Memotec assets that are unencumbered, but rather whether Teleglobe would actually receive any proceeds upon the realization of Memotec's property after a distribution to the prior-ranking creditors. In this regard, the Commission notes that the Teleglobe shares are currently subject to two prior pledges totalling $315 million. These pledges consist of:
(1) a first ranking pledge in favour of Montreal Trust Company in the amount of $75 million; and
(2) a pledge with respect to a $240 million bond in favour of the Royal Bank of Canada as agent for several lenders.
The $240 million bond secures three debts:
(1) a $150 million revolving term credit facility that had not, at the time of the proceeding, been utilized, and that Teleglobe advised will no longer be necessary if the Commission approves the proposed security arrangements (during the proceeding, Teleglobe advised that, following the Commission's approval of the proposed security arrangements, Memotec intends to have the secured creditors discharge and release their security interest in the Teleglobe shares in respect of this facility);
(2) a U.S. $80 million medium-term loan facility; and
(3) a U.S. $44.7 million letter of credit.
In addition to these pledges, Memotec's inventory and receivables are charged to secure repayment of a $20 million National Bank operating line of credit. Further, specific pieces of leased equipment are charged to lessors and suppliers.
An indication of the value and security of the proposed arrangements can be obtained by comparing the value of the Teleglobe shares to the pledges, excluding from the latter the $150 million revolving term credit facility (on the assumption that Memotec has the secured creditors discharge and release their interest in the Teleglobe shares with respect to this facility). However, the dollar amount that might be considered unencumbered in such a comparison depends on the basis used to value the shares. As noted above, Teleglobe proposes using a market-to-book ratio of 1.2 to 1 for the valuation. Using that valuation would result in a nominal unencumbered value of about $230 million.
During the period 1982 to 1990, the market-to-book value ratios of Canadian public telephone companies ranged from a low of 0.9 in 1982 to highs of 1.4 in 1985 and 1986. If, for example, one were to compare the value of the existing pledges, excluding the $150 million referred to above, to a share valuation derived using a market-to-book value ratio of 0.9, the nominal unencumbered value would drop to about $130 million.
Under the share valuation scenarios outlined above, a substantial nominal unencumbered value would appear to be available to secure the cash advances. Teleglobe argued that the unencumbered value could be considered to be even higher, given that prior secured creditors would likely first satisfy their claim against Memotec's liquid assets, such as inventory and receivables. However, with respect to this particular argument, it is important to note that Memotec's inventory and receivables are charged to secure repayment of a $20 million operating line of credit with the National Bank.
The Commission continues to have serious concerns regarding the level of security that would be provided by the proposed security arrangements. The Commission notes that the market-to-book ratios cited by Teleglobe for Canadian public telephone companies from 1982 to 1990 are for companies operating without a significant level of exposure to default on the part of a single debtor. There is no evidence as to what the actual market value of the Teleglobe shares might be in the event that Memotec were to default, either to a third party creditor or with respect to the repayment of the advances, and the advances were viewed as uncollectible by parties interested in acquiring the shares. In such circumstances, the likelihood of recovery of the advances would undoubtedly affect an investor's decision to purchase the shares. As noted above, the 31 October 1991 balance of the advances stood at $91.0 million, some 27% of Teleglobe's net book value. Accordingly, if there is a default, the market value of the shares may be significantly below the level indicated by historic market-to-book ratios.
The concerns described above with respect to the security of the proposed arrangements are not eased when the Commission looks at Memotec's non-regulated assets. The Commission notes that a substantial portion of these assets is for Goodwill and Other. The 27 July 1990 Dominion Bond Rating Service (DBRS) report provided by Teleglobe in response to interrogatory Teleglobe(CRTC)21June91-2425 (which requested the "most recent" bond rating reports on Memotec) noted that Memotec has goodwill amounting to about $271 million, and that 60% of this goodwill relates to computer and software operations where goodwill can disappear quickly if key personnel leave. This matter was raised again in a more recent DBRS report, dated 26 April 1991, wherein Memotec was said to have a large level of intangibles (close to $260 million).
In light of the above, the Commission is not persuaded that, under the proposed security arrangements, Teleglobe would actually receive sufficient proceeds to cover the advances should there be a realization of Memotec's property and a distribution to prior-ranking creditors.
Furthermore, the Commission does not accept Teleglobe's view that the advances would be demonstrably liquid under the proposed security arrangements. The foundation of these arrangements is based on a trustee realizing on the assets of Memotec in an event of default. Even if Teleglobe were the highest ranking secured lender (and, as outlined above, it would not be), the process of realizing on the assets would in all likelihood require considerable time.
Moreover, under the loan agreement with respect to the cash advances, Teleglobe must, in the normal course, give 90 days notice prior to demanding the repayment of all or any portion of the advances, while under the proposed Demand Debenture, Memotec would have to be in default for 10 consecutive days before the Demand Debenture is enforceable. Thus, in the normal course, 100 days could pass between the time that Teleglobe demanded payment and the time that the Trustee could commence the process of realizing on Memotec's assets. There is no evidence as to the amount of time that could elapse between a default on the loan agreement and Teleglobe recovering the advances through the realization of Memotec's assets, in the event that sufficient funds remained to satisfy the debt after prior creditors had made their claims. (The Commission recognizes, of course, that the advances are due immediately in certain specific instances such as (1) in an event of default of Memotec, which is not cured or waived, with any bank, financial institution, or other lender; or (2) if a receiver or a trustee of Memotec's properties is appointed).
On the basis of the fundamental problems described above, the Commission concludes that Teleglobe's proposed alternative security arrangements are not acceptable. The Commission notes in addition that there are other problems with the proposed alternative arrange- ments, the most serious relating to the proposed Escrow Agreement.
Although the Escrow Agreement is one of the documents underlying the proposed security arrangements, it contains two readily apparent flaws. First, it inappropriately calls for the Commission, Teleglobe's regulator, to be a party to the Agreement, with the ability to order the Escrow Agent to sell Teleglobe's shares. Second, the Teleglobe share certificates cannot be delivered to the Escrow Agent until the two prior secured lenders are paid or are otherwise prepared to release the shares. In fact, future lenders may secure a pledge on the shares and, in that event, those lenders would also have to be paid before the shares could be delivered to the Escrow Agent.
In addition, under the proposed Demand Debenture, Memotec is to furnish to Teleglobe, within 30 days of the end of each fiscal quarter, a certificate of an officer of Memotec stating that the officer has reviewed this Debenture and has no knowledge of any default by Memotec. Under this notice provision, as much as four months could pass between the time such a default occurred and the time Memotec would be obligated to advise Teleglobe. The Commission finds this unacceptable.
As noted above, the Commission has had serious concerns with respect to the CCM system since it first assumed jurisdiction over Teleglobe. Those concerns were identified first in Letter Decision 89-23 and again in Decision 91-5. On three separate occasions since November 1989, the Commission has provided Teleglobe with an opportunity to satisfy its concerns with respect to the advances. None of the proposals submitted by Teleglobe has adequately addressed the concerns identified by the Commission.
The Commission repeats that it must be assured that these substantial cash advances are adequately safeguarded in order to ensure the provision of international telephone service at just and reasonable rates, as is its mandate under the Railway Act.
Specifically, the Commission must ensure that Teleglobe is able to recover the funds, and recover them on a timely basis, in the event of a default with respect to the advances. Should Teleglobe be unable to recover the funds on a timely basis, it may be necessary to increase its revenue requirement to compensate for the uncollectible or overdue advances to enable the company to meet its foreign settlement obligations. An increase in Teleglobe's revenue requirement would result in an increase in the rates paid by Teleglobe's customers.
Similarly, the Commission wishes to ensure that Teleglobe's creditworthiness would not be impaired and its cost of borrowing increased as a result of a default. Again, in such an event, an increase in Teleglobe's cost of borrowing might have to be reflected in Teleglobe's revenue requirement, and thus in the rates paid by Teleglobe's customers.
The Commission would consider the advances adequately secured if Memotec were to provide Teleglobe with an irrevocable third party letter of credit, with any associated covenants acceptable to the Commission, authorizing Teleglobe to draw money up to the total outstanding balance of the cash advances to Memotec at the time those advances are due. Should Teleglobe not be provided with such a letter of credit, the Commission directs that the advances are to be retrieved and that no further advances are to be made to Memotec.
As noted above, in its consideration of this issue since 1989, the Commission has explored a number of alternatives. Teleglobe's most recent proposals are not acceptable to the Commission for the reasons discussed above. The Commission notes that a letter of credit is a commonly used financial instrument that is both secure, in that it is guaranteed by a third party financial institution, and liquid, in that payment can be demanded from the issuer when it is due. Thus, a letter of credit would adquately address the need to protect the interests of Teleglobe's customers.
The risk to a financial institution of providing such a letter would, of course, be reflected in the associated cost to Memotec. However, the provision of a letter of credit would appropriately shift the risk of default on the part of Memotec from Teleglobe and its customers to a financial institution that, by the nature of its business, has the expertise necessary to assess that risk.
Should Teleglobe be provided with a letter of credit, it is directed to file it with the Commission by 17 February 1992. The Commission will consider the proposed letter and provide Teleglobe with an opportunity to address any concerns the Commission may have. In the event that the Commission finds it unacceptable, it will issue a ruling as to the timing of the return of the advances.
Should Teleglobe not be provided with a proposed letter of credit, it is directed to notify the Commission by 17 February 1992 and recover all advances made to Memotec by 19 June 1992.
2. Impact on Accounting Rates
In the course of this proceeding, the Commission has also considered whether, with the CCM system, Teleglobe adequately takes into account the interests of customers in the payment of foreign administrations. During the proceeding, Teleglobe advised that it is aware that some administrations would be willing to negotiate more favourable accounting rates if payments were expedited. However, there is no evidence to indicate that Teleglobe is pursuing this matter in order to obtain such a benefit for its customers. Should Teleglobe secure an irrevocable letter of credit from Memotec, and consequently continue to advance funds to Memotec, the Commission will monitor the settlement process in order to ensure that it takes into account the interests of Teleglobe's customers. In this regard, the Commission will be monitoring whether the loans to Memotec appear to be inhibiting Teleglobe's ability to negotiate lower accounting rates.
3. Imputed Interest
As discussed above, the Commission is of the view that the alternative security arrangements proposed by Teleglobe would not provide adequate security or liquidity. However, the Commission accepts Teleglobe's submission that the advances would appropriately be regarded as a short-term investment if the conditions of adequate security and liquidity were satisfied. In the Commission's view, an irrevocable third party letter of credit, as described above, would meet both these criteria.
Accordingly, in the event that Teleglobe acquires a letter of credit satisfactory to the Commission, the Commission would accept, from that time forward, the use of 91-day Treasury bill rates to calculate Teleglobe's return on the cash advances for regulatory purposes. Thus, an adjustment to Teleglobe's revenue requirement would be necessary in order to reflect the lower imputed interest rate on the first $60 million of the advances. Should the advances be returned to Teleglobe, the issue of an appropriate rate for an imputed return will disappear. In this event, the Commission must estimate an actual return on the retrieved funds for the purpose of establishing Teleglobe's revenue requirement for 1992. In the absence of evidence on this point, the Commission considers a forecast return equal to 91-day Treasury bill rates to be reasonable.
Teleglobe's 1992 revenue requirement has been adjusted with respect to interest to reflect this ruling.
4. Impact on Teleglobe's Cost of Borrowing
There is no evidence on the record of this proceeding to indicate that, at the level of the advances forecasted by Teleglobe, the earning of imputed rather than real interest affects Teleglobe's creditworthiness and its cost of borrowing. However, should Teleglobe continue to participate in the CCM system, the Commission will monitor any effect that the earning of imputed rather than actual interest may have on Teleglobe's cost of borrowing. As previously expressed by the Commission in Decision 91-5, in determining Teleglobe's revenue requirement, the Commission will allow Teleglobe to recover only those financing costs that it would incur if it were receiving actual interest payments from Memotec.
5. Cost of Administering Security Arrangements
As indicated above, the Commission considers that the risk of default on the part of Memotec should not be borne by Teleglobe and its customers. Accordingly, the Commission expects that any costs of acquiring an irrevocable third party letter of credit will be borne by Memotec. The Commission will not accept for inclusion in Teleglobe's future revenue requirement any costs of this nature.
VIII REVENUE REQUIREMENT 1992
A. Construction Program
1. Introduction
On 5 April 1991, Teleglobe filed the 1991 View of its construction program for the years 1991 to 1995, inclusive (the five-year capital plan). Ontario, Quebec, and CBC participated in the review.
2. Capital Plan 1991-1995
a. Usage Categories
The five-year capital plan is divided into five basic usage categories: (1) Demand, accounting for 78.7% of the five-year total; (2) Operations, Maintenance and Betterments, 4.2%; (3) Support, 11.0%; (4) Research and Development, 6.0%; and (5) Management Adjustments, net 0%.
Total expenditures for all categories were projected to be, in millions of dollars, (1) 196.3 in 1991; (2) 186.2 in 1992; (3) 160.2 in 1993; (4) 137.0 in 1994; and (5) 151.1 in 1995, for a cumulative total of 830.9 over the five years.
The Demand category includes expenditures for telephone switch expansion, new earth station facilities and participation in INTELSAT, INMARSAT and submarine cable system ventures. The Operations, Maintenance and Betterments category includes expenditures to maintain service quality, improve operating efficiency, and replace facilities. The Support category includes expenditures for test equipment, general administrative computer facilities and office equipment and furnishings and expenditures to modify and improve existing buildings and other facilities.
The Research and Development category and the Management Adjustments category are described below.
b. Capacity and Demand
Teleglobe's 1991 View showed a disproportionate increase in network capacity relative to demand. The company attributed this to four factors: (1) the "total circuits in service" forecast was made in July 1990, while the "paid telephone minutes" forecast was made in March 1991; (2) circuits to India had been increased in order to improve the grade of service (GOS)(GOS to a destination country is measured as the percentage of call attempts for which the required international connecting circuit is not obtained); (3) the emergence of competitive carriers in several countries; and (4) the rapid growth of non-voice services.
The Commission accepts Teleglobe's explanation for the divergence of capacity and demand. However, the Commission directs the company to provide, in future five-year capital plans, time consistent forecasts of "paid telephone minutes" and "total circuits in service" in order to portray more accurately the relationship between capacity and demand.
The Commission notes Teleglobe's undertaking to study alternative indicators of network efficiency and provide the Commission with a report of the results by 28 February 1992. Teleglobe is to serve copies of the report on all parties to this CPR.
c. Cost and Source of Switches
In light of cost information filed by Teleglobe in confidence, the Commission sought assurances from the company that its switching equipment is being obtained economically. Teleglobe stated that, in 1982, it negotiated an exclusive five-year contract with Northern Telecom Canada Limited (NTCL) for the purchase of DMS switches. Three switches were acquired pursuant to this agreement, which was subsequently extended for another five years on a non-exclusive basis. Recently, Teleglobe obtained a fourth DMS-300 switch under the contract extension. Teleglobe cited network compatibility as its reason for choosing to acquire this switch from NTCL. However, Teleglobe stated that it is not committed to the DMS-300 switch and that it will, in the future, consider the equipment of other manufacturers, in order to ensure that switching equipment is obtained on the most cost-effective basis.
The Commission is concerned that Teleglobe did not seek tenders for a purchase as substantial as the recently acquired DMS-300 switch. Teleglobe has undertaken to file a study of the costs of competitive gateway switches by 28 February 1992. The Commission will assess the reasonableness of Teleglobe's projected switch expenditures after the filing of this study.
d. Switch Utilization
In its 1991 View, Teleglobe projected lower switch utilization in 1992 and 1993. Teleglobe stated that the lower utilization projected arises from the duplication of facilities to ensure a smooth transition to CCITT Signalling System 7. Teleglobe further stated that long provisioning intervals for common equipment are necessary to avoid shortfalls associated with rapid growth.
Teleglobe pointed out several reasons for decreased line efficiency: (1) more than one international carrier serving a particular country; (2) delays in the Montréal 2 gateway installation and its effects on signalling requirements; and (3) the introduction domestically of Globedirect and other services.
Ontario expressed the opinion that the capacity of Teleglobe's telephone switches bears little relationship to the number of lines in service. Ontario suggested that Teleglobe describe, in future CPR presentations, the factors in addition to demand used in determining its provisioning policy. Ontario was of the view that the very large spare switching capacity is due, among other things, to Teleglobe provisioning on the basis of the highest peak day of the year. Ontario stated that, in other areas, the company uses GOS considerations for provisioning, employing weekday traffic data rather than absolute peak data.
In addition, Ontario noted that Teleglobe presented switch utilization data based on actual peak traffic and on forecasted non-peak traffic. Ontario submitted that the results could therefore be misinterpreted. Ontario suggested that the format be modified.
Based on the record of this proceeding, the Commission is not persuaded that Teleglobe has provisioned its circuits to achieve optimum utilization. The Commission directs Teleglobe to modify its presentation format for switch utilization in future filings in order to report results on a uniform basis. The Commission also notes that a certain ambiguity exists with respect to Teleglobe's provisioning interval. During cross-examination by counsel for Ontario, Teleglobe indicated that its provisioning policy is based on three years of growth plus two years extra, while it indicated in response to an interrogatory that its policy is based on a three-year interval.
Accordingly, the Commission directs Teleglobe to file, by 28 February 1992, the following: (1) a clarification of its basis for provisioning; (2) an explanation of the meaning of three years growth plus two years extra; and (3) studies that demonstrate that the company is employing the most economic engineering interval. Copies are to be served on parties to this CPR.
e. Mix of Submarine Cable and Satellite Circuits
In its five-year capital plan, Teleglobe projected that the proportion of cable circuits in relation to total circuits would increase from 38% in 1991 to 56% in 1995.
Teleglobe stated that it intends eventually to achieve a cable-to-satellite ratio of 85:15 for heavily utilized routes with one satellite backup path, and a ratio of 80:20 for a few heavily utilized routes with two satellite backup paths. Teleglobe claimed that cable is very attractive on high traffic routes between cable landing points, but that it is better to use satellite circuits for locations that are far from a cable landing point. The cross-over point depends on the cost of cable extensions and the transit arrangements, and varies from country to country. Thus, the per-path cost for satellite is not readily comparable to the per-path cost for cable.
Teleglobe stated that it envisaged a graceful migration to cable, rather than a large scale turn-down of satellite circuits in the short term. This would be achieved by putting all growth on cable.
The Commission notes Teleglobe's plan to migrate smoothly from satellite to cable on the heavily utilized routes. In the next CPR, the Commission will expect further details of Teleglobe's plans to meet its announced goals with respect to cable-to-satellite ratios for heavily utilized routes.
f. Long Range Submarine Cable Plans
Ontario observed that the installed plant capacity is growing faster than the in-service plant, apparently due to the extended planning process required for submarine cables (up to 10 years). Ontario submitted that there is not enough information to determine whether projected cable circuit capacity is reasonable. It argued that traffic data and information on the number of circuits in service are not sufficient, since they cannot be related to the installed circuit capacity. Ontario submitted that additional justification is also necessary because historical growth rates and cost ratios cannot be used to assess the reasonableness of the plan.
The Commission considers that it would be helpful to have information as to the current status of Teleglobe's long-range submarine cable plans. Accordingly, the Commission directs Teleglobe to include those plans in the material filed for future CPRs.
g. 10% Sunday Grade of Service
Teleglobe Canada Inc. - 1989 Construction Program Review, Telecom Decision CRTC 89-15, 19 December 1989, the Commission directed Teleglobe to file, by 19 March 1990, information with respect to routes provisioned on the basis of the Sunday GOS standard of 10% and the effect on the existing number of circuits if the normal 1% GOS standard were applied instead. Teleglobe reported that six major routes (to Greece, Israel, Italy, Netherlands, Portugal and the United Kingdom) are currently provisioned on the basis of the Sunday 10% GOS standard. These routes experience extremely heavy Sunday traffic. Teleglobe stated that application of the usual 1% GOS standard (based on the peak traffic day of the week, weekend included) would require additional circuits from both Toronto and Montreal in order to meet the demand.
In a letter to Teleglobe dated 10 October 1990, the Commission stated that, since no price discounts apply on Sundays on these routes to compensate for design blocking higher than on other routes on weekdays, the policy might be viewed as discriminatory. The Commission asked Teleglobe to explain its rationale for the use of a less stringent GOS standard on these routes. In letters to the Commission dated 11 January 1991 and 13 May 1991, Teleglobe set out the factors inhibiting a change from a Sunday GOS of 10% to the usual 1% GOS standard. These factors include (1) reluctance of overseas partners to increase circuits by up to 15%; (2) additional circuits would lower weekday circuit utilization; and (3) the adverse effect on the net revenues of Teleglobe and its overseas partners. Teleglobe submitted that its circuit provisioning policy reflects internationally accepted practices and is not discriminatory.
Teleglobe also stated that use of a Sunday 10% GOS standard, instead of a 1% GOS standard based only on weekday traffic, results in a higher percentage of successful Sunday calls.
During this proceeding, Teleglobe repeated the position expressed in the above-noted correspondence.
The Commission accepts Teleglobe's provisioning policy for the six routes with 10% Sunday GOS.
h. CBC TV Feeds
During cross-examination, CBC raised a number of questions on the planned closure of the Mill Village antenna site currently used by Teleglobe as a link between its terrestrial and satellite facilities. CBC stated that this closure would reduce the interconnecting capability of all users with both international and domestic satellites carriers for broadcast services, producing an access bottleneck for television service.
Teleglobe undertook to involve the CBC and domestic carriers in the Mill Village antenna relocation. Teleglobe agreed that negotiations should start now to meet the 1993 closure date.
The Commission expects that concerns such as CBC's can be satisfactorily addressed through negotiations between Teleglobe and its broadcasting customers. Should that prove not to be the case, the matter can be brought to the Commission's attention in a separate application or through the complaints process.
i. Capital Expenditures for Research and Development
Teleglobe stated that it has decided to open a new category for Research and Development (R&D) to reflect the emphasis it is placing on R&D expenditures. Teleglobe's expenditures on R&D amounted to 1.8% of its revenues in 1988, 3.5% in 1989 and 2.0% in 1990. Teleglobe proposes to devote 6.0% of its five-year capital plan to identified R&D projects. The Commission finds this percentage reasonable.
j. Reporting of Management Adjustments in the Construction Management Process
Teleglobe stated that it instituted the Management Adjustments category to accommodate expenditure delays attributable to changes in project schedules in the early years of the construction program, and to account for unforeseen projects in the latter years.
The Commission considers the Management Adjustment category unnecessary. The Commission realizes that the construction program is based on a snapshot of future expenditures, and that projected expenditures change from year to year as plans become firm. However, an explanation of the variances between budgeted and actual expenditures, currently provided by the company, is sufficient to permit the Commission to assess the capital plan.
3. Conclusions
Having considered the evidence before it, the Commission finds Teleglobe's 1991-1995 capital plan reasonable, with the exception of switch expenditures and switch utilization. These will be reviewed further following the submission of the information requested from the company.
B. Intercorporate Transactions (Other than Advances to Memotec)
1. Memotec Management Fees
a. Teleglobe's Position
In response to a Commission interrogatory, Teleglobe stated that, during 1990, Memotec charged it $1.7 million in management fees. In its May View, Teleglobe forecasted the management fees to be approximately $1.8 million in each of 1991 and 1992.
The management fee charged by Memotec is a global fee for all management services, including, among other things (1) centralized executive management; (2) centralized cash management; (3) shareholder and investor relations; (4) management of the Employee Share Purchase plan; and (5) representation and promotion to maintain Teleglobe's monopoly.
Teleglobe was unable to quantify costs related to individual services, stating that Memotec's accounting records do not permit the identification of costs, other than per Memotec's chart of accounts.
In 1990, 63.7% of the management fee charged by Memotec was based on equity allocation and 32.0% on time allocation, while only 4.3% of the fee was charged on a specific allocation basis.
During the hearing, Teleglobe filed a report entitled Review of Principles to be Applied in Allocating Charges Incurred at the Holding Company Level Between Regulated and Unregulated Subsidiaries, which had been prepared for the company by Touche Ross in 1988 (the Touche Ross report). The purpose of this report was to advise Teleglobe on a policy relating to the calculation of intercorporate charges from Memotec, and to compare the recommended policy to the existing method of allocating corporate costs to Teleglobe, identifying any changes necessary in the latter.
During final argument, Teleglobe stated that the Memotec management fees, as a whole, are entirely reasonable given the services provided. It contended that Memotec's principles for identifying charge components and allocating shares of Memotec's headquarters group to affiliates are consistent with the Touche Ross report.
In addition, Teleglobe indicated that it intended "to arrange with Memotec for a refocused cost recording system that permits affiliate confirmation of fees charged within the context of a parent/affiliate management services agreement which identifies and defines the activities to be charged and the basis for allocation of common costs which cannot be charged directly by reference to specific accounting entries".
b. Conclusions
The Commission notes that the Touche Ross report determined, with reference to Memotec's then existing methodology, that the relationship between the majority of the costs incurred and causality or beneficiality did not appear to have been established. The Touche Ross report judged that many of the charges should be allocated on a specific or usage basis, as the charges could be identified with the specific entity for which they were incurred. Most importantly, the Touche Ross report recommended the following allocators:
(1) Travel - specific allocation, otherwise time allocation;
(2) Liability Insurance - specific allocation; and
(3) Consulting - specific allocation where possible, balance may be composite allocation or excluded from allocation.
Contrary to Teleglobe's assertions that Memotec's charges are consistent with the recommendations in the Touche Ross report, Memotec is, in fact, charging each of the above costs on the basis of equity allocation. The Commission is therefore not persuaded that there is indeed a relationship between the allocation of these costs to Teleglobe, and causality or beneficiality. In particular, the Commission is not persuaded of the benefits accruing to Teleglobe from Memotec's travelling expenses. In the Commission's view, travelling expense, by its very nature, lends itself to allocation on a specific basis.
In addition to the above, the Commission finds Teleglobe's method of forecasting the 1991 and 1992 management fees inappropriate. The 1991 and 1992 management fees were estimated by simple extrapolation from the 1990 charge. However, the 1990 charge included a large one-time consulting fee relating to the Memotec Strategic Plan. By Teleglobe's own admission, it is unlikely that a similar charge will occur in either 1991 or 1992.
In light of the above, the Commission has reduced Teleglobe's 1992 operating expense forecast by $750,000. This amount comprises that portion of the forecasted 1992 management fee related to travelling expenses, liability insurance and consulting fees.
Teleglobe stated that it intends to arrange with Memotec for a refocused cost recording system within the context of a management services agreement. Teleglobe is directed to file a copy of any agreement reached with Memotec within 28 days of its execution.
In addition, Teleglobe is directed to file with the Commission a report from its external auditors certifying that the new cost recording system and management services agreement fully comply with the recommendations of the 1988 Touche Ross report. The external auditor's report is to be filed with the Commission within 90 days of the execution of the agreement.
2. Intercorporate Transactions Policy and Procedures
a. General
Teleglobe has established general principles, policies and procedures applicable to transactions between itself and its affiliates. In response to a Commission interrogatory, Teleglobe provided details of these principles, policies and procedures in a document entitled Teleglobe Canada Inc. Intercorporate Transactions Policy and Procedures, dated January 1991 (the Intercorporate Transactions Policy).
The Intercorporate Transactions Policy defines an affiliate as any subsidiary of Memotec in which Memotec has "an ownership voting control of 50% or more." The document deals with intercorporate transactions such as Acquisition of Goods and Specific Services, Acquisition of Shared Services, Transfer of Assets, Provision of Services, Loan of Personnel, Temporary Transfer of Employees, Affiliate Start-Up Costs, and Leasing to Affiliates.
Issues relating to the Intercorporate Transactions Policy on which the Commission wishes to comment are discussed below.
b. Acquisition of Goods and Specific Services
Section 2.11 of the Intercorporate Transactions Policy states that the purchase of goods and services by Teleglobe from outside suppliers, including affiliates, should, when feasible and desirable, be subject to competitive requisitioning or tendering. Section 2.11 also states that, under certain circumstances, the seeking of competitive bids may be neither appropriate nor desirable. In material cases, written documentation is to be prepared, demonstrating that such action is in the interest of Teleglobe and to the advantage of the customers of its regulated services.
In interrogatory Teleglobe(CRTC)21June91-2414, the Commission asked Teleglobe to provide information with respect to Contract 2025 with Memotec Datacom Inc., providing for the development of software products and the supply of data equipment related to the management control and supervisory system for the Montréal International Centre (the Montréal MCS system). Teleglobe responded that this contract was not awarded as a result of a competitive bidding process. Teleglobe stated that no written justification for not seeking competitive bidding had been prepared with respect to this contract, since the Intercorporate Transactions Policy took effect in January 1991, while the Montréal MCS system project had started in May 1989.
During examination, Commission counsel pointed out to Teleglobe that its provisional policy on intercorporate transactions of July 1988 (the provisional policy) required the same written justification as the Intercorporate Transactions Policy. Therefore, in not preparing written justification, the company had not followed the provisional policy. Commission counsel pointed out that Teleglobe, when it filed its provisional policy in July 1988, had stated that, although the policy was provisional, the company would be guided by it in its dealings with affiliates.
Teleglobe argued that not all purchases can or should be tendered or otherwise open to competitive bidding. The company stated that it intended to ensure that the supporting documentation contemplated by the policy is generated in all future significant purchases involving an affiliated supplier.
The Commission finds Teleglobe's policy with respect to the Acquisition of Goods and Specific Services to be appropriate. However, the Commission is concerned that Teleglobe may not be complying fully with that policy. The Commission notes that only one of the intercorporate agreements filed with the Commission in this proceeding was awarded as a result of a competitive process. As previously noted, no written justification was generated with respect to the non-competitive awarding of Contract 2025.
The Commission therefore directs Teleglobe to provide the Commission with a copy of the written documentation required by Section 2.11 of the Intercorporate Transactions Policy, justifying why competitive bids were neither appropriate not desirable, when filing any intercorporate agreements or amendments to agreements that are not the result of a competitive process.
The Commission also has concerns with the dollar value of Amendment 2 to Contract 2025, and is particularly troubled with the timing of the filing of this Amendment with the Commission. These concerns are discussed further in Part X of this Decision, Quality of the Company's Evidence.
c. Temporary Transfer of Personnel
Section 2.6 of the Intercorporate Transactions Policy states that, when Teleglobe employees are temporarily transferred to an affiliate with a guarantee of re-employment, "Teleglobe will be compensated for all direct and appropriate indirect costs associated with the transfer."
During examination by Commission counsel, Teleglobe indicated that the temporary transfer of an employee to an affiliate had never actually occurred. However, it agreed in principle that, in addition to all direct and indirect costs associated with such a transfer, an appropriate level of contribution should be charged. Teleglobe also agreed, in principle, that an annual disruption fee should be charged.
The Commission directs Teleglobe to amend Section 2.6 of its Intercorporate Transactions Policy to add the words "plus an appropriate level of contribution. Teleglobe will also charge an annual disruption fee as appropriate."
d. Contribution
Section 2 of Annex I to the Intercorporate Transactions Policy states that contribution is a mark-up applied to the sum of all costs. The percentage applied is that felt to be fair and reasonable, depending on existing circumstances.
During examination by Commission counsel, Teleglobe stated that 25% is the contribution level that it believes to be reasonable, and that generally it adheres to this level.
The Commission directs Teleglobe to amend Section 2 of Annex I to specify a target contribution level of 25%.
3. IDB Aeronautical Communications, Inc.
Teleglobe is party to a contract (the SITA contract) establishing a consortium for the provision of Mobile Aeronautical Satellite voice and data communications. Teleglobe entered into a contract with IDB Aeronautical Communications, Inc. (IDB-A), whereby Teleglobe subcontracted to IDB-A some of its rights and obligations under the SITA contract. Under the terms of this contract (the IDB-A contract), IDB-A was responsible for supplying and constructing an earth station in the region of San Francisco to access the INMARSAT Pacific Ocean region operational satellite. IDB-A was to purchase certain equipment, which had previously been ordered by Teleglobe, directly from EB NERA of Norway. The IDB-A contract stipulated that the parties would complete, as expeditiously as possible, the assignment to IDB-A of Teleglobe's rights and obligations under the EB NERA contract.
In fact, the EB NERA contract was never assigned to IDB-A, and Teleglobe remained responsible for its administration. Teleglobe continues to receive and pay invoices from EB NERA. Teleglobe then rebills IDB-A for the actual amount invoiced by EB NERA. No charges are added by Teleglobe to reflect the actual costs incurred by Teleglobe for contract administra- tion carried out on behalf of IDB-A.
Teleglobe stated that the transaction in question constitutes a Transfer of Assets, for which no contribution charge applies under its Intercorporate Transactions Policy.
The Commission notes that, in its Quarterly Report of Intercorporate Transactions for the first quarter of 1990, Teleglobe states that the total costs of $1,115,915 transferred to IDB-A represent the book value of aeronautical communications equipment for construction of the Niles Canyon earth station.
In the company's 2nd quarter 1990 Report, additional charges of $12,245 are explained as engineering efforts related to the assets under construction transferred to IDB-A in the last quarter. Similarly, charges of $17,756 noted in the 3rd quarter 1990 Report are said to represent engineering efforts related to the assets under construction transferred in a previous quarter.
However, in the 4th quarter 1990 Report, the explanation appears that Teleglobe is engineering and procuring an aeronautical communications earth station for operation by IDB-A. This explanation refers to 4th quarter 1990 charges to IDB-A of $2,412,403. It is repeated for charges totalling $1,169,077 in the reports for the 1st and 2nd quarters 1991.
In the Commission's view, the charges reported in the first three quarters of 1990 are correctly identified as Transfer of Assets. However, the Commission considers that the transactions commencing in the 4th quarter of 1990, which total $3,581,480 as of the 2nd quarter of 1991, are more appropriately categorized as Provision of Goods.
The Commission notes that Section 2.43 of the Intercorporate Transactions Policy, which deals with Provision of Goods, states that the price charged by Teleglobe to its affiliates should consist of the cost of the goods purchased, the costs caused by the acquisition of these goods, plus an appropriate contribution.
The Commission directs Teleglobe to treat future dealings with IDB-A, and any similar situations that may arise in the future, as Provision of Goods.
C. Operating Expenses
1. 1991 and 1992 Forecasts
In its Memoranda of Support of 26 March 1991, Teleglobe estimated, based on its March View, that its operating expenses (including depreciation expense) would total $215.0 million in 1991 and $245.9 million in 1992, representing annual increases of 11.1% and 14.4%, respectively. On 27 May 1991, Teleglobe submitted its May View, which reduced its forecast of operating expenses to $205.3 million for 1991 and to $237.9 million for 1992. These revised estimates of operating expenses represent annual increases of 6.1% and 15.9%, respectively. In its Supplemental Evidence, Teleglobe stated that the downward revisions are due mainly to (1) changes in Canadian dollar currency rates vis-à-vis the U.S. dollar, affecting expenses for satellite circuit rentals; (2) lower cable maintenance expenses as a result of lower cable ship costs; (3) a reduction in staff costs as a result of a corporate reorganization; and (4) cost containment measures with respect to some discretionary expenses.
Excluding depreciation expense, the revised operating expenses total $141.1 million in 1991 and $154.0 million in 1992, representing annual increases of 4.8% and 9.1%, respectively.
2. Rentals Expense - Terrestrial & Satellite Circuits in Canada
Teleglobe's forecast for 1991 for this expense is $19.3 million, a 29.8% increase over 1990. For 1992, the forecast is $26.5 million, representing an increase of 37.3% over 1991.
Much of the evidence provided by Teleglobe with respect to this expense is incomplete or contradictory. As an example, interrogatory Teleglobe(CRTC)21June91-2616 requested the company to provide the basis for the calculation of the values of eight specified rental agreements. The interrogatory specifically asked the company to provide, for each agreement, the relevant General or Special Facilities Tariff Item number, capacity leased, mileage, unit price, currency conversion rate, effective date, and any other factors relevant to calculating the values of the agreements in question. However, Teleglobe's response did not provide mileage or any applicable customer discounts, and noted only one tariff item.
During examination by Commission counsel, Teleglobe amended one piece of information contained in its response to interrogatory Teleglobe(CRTC)21June91-2616, then stated that it had no additional information that would change the numbers provided in that response. However, in response to a request from Commission counsel, Teleglobe filed Teleglobe Exhibit 73, providing some of the information originally requested in the interrogatory. Despite Teleglobe's earlier disclaimer, Exhibit 73 contained a revised forecast for 1992 for digital facilities between Montréal and Pennant Point. Specifically, the figure of $2.3 million in the interrogatory response had been revised to $3.9 million, an increase of $1.6 million. Teleglobe offered no explanation for this difference.
The Commission has particular difficulty with the rental agreement for Inter-Gateway Digital Connections (Globedirect service, Montréal-Vancouver), forecasted to account for $1.3 million in 1991 and $3.6 million in 1992. In interrogatory Teleglobe(CRTC)26Feb91-625, the Commission requested, for each of the years 1990 to 1992, a list showing the annual expense and a brief description of each rental agreement with a dollar value greater than $100,000 per annum. The Inter-Gateway Digital Connections agreement is not included in either the initial response to the interrogatory, filed 26 March 1991, or in the updated interrogatory response, filed 27 May 1991.
The first time this facility is mentioned is in response to interrogatory Teleglobe(CRTC)25Apr91-1614, also filed on 27 May 1991, which requested a listing of all rental agreements for each of the years 1990 to 1992. When interrogatory Teleglobe(CRTC)21June91-2618 subsequently asked for a reconciliation between Teleglobe(CRTC)26Feb91-625 and Teleglobe(CRTC)25Apr91-1614, the company simply replied that Teleglobe(CRTC)26Feb91-625 was in error, and offered no further explanation. It then revised Teleglobe(CRTC)26Feb91-625 to agree with Teleglobe(CRTC)25Apr91-1614, adding Inter-Gateway Digital Connections to the list of agreements greater than $100,000 per annum.
In response to interrogatory Teleglobe(CRTC)26Feb91-623, which deals with the company's expense budgeting process, Teleglobe stated that its network costs are estimated on a zero-based build-up, based on the Marketing and Network Plans. However, the Commission notes that no provision was made for the Inter-Gateway facility in Teleglobe's Systems and Facilities Development Plan (the "Network Plan"), approved by the company in December 1990.
In response to interrogatory Teleglobe(CRTC)21June91-2616, Teleglobe stated that capacity for both 1991 and 1992 was "not determined at budget time", but that the 1991 utilization period for the Inter-Gateway facility was estimated to be 4 to 5 months. This response was filed on 2 July 1991. The Commission questions how the capacity for a major facility, scheduled to be installed as early as the beginning of August 1991, could fail to have been determined by the time of the filing of this interrogatory response. Furthermore, the Commission questions how Teleglobe could reasonably make any estimate of the rental expenses for this facility in the absence of any estimate of the required capacity.
In addition to the above, the Commission notes that there are several discrepancies with respect to the Inter-Gateway facility between Exhibit 73 and the response to interrogatory Teleglobe(CRTC)21June91-2616. While the interrogatory response estimated monthly rental charges at $296,000, the Exhibit states that rental charges would be $174,018 per month. Although the estimate of monthly rental charges in Exhibit 73 is over 40% lower than the estimate in the interrogatory response, the total forecast rental charges for this facility is the same in both the Exhibit and the interrogatory response. In addition, instead of the 4 to 5 month utilization period originally estimated for 1991, the Exhibit indicates the "estimated" utilization period for 1991 to be 7 months. Exhibit 73 was filed in late August. The Commission concludes that Teleglobe's utilization period estimates for 1991 are clearly overestimated.
In response to interrogatory Teleglobe(CRTC)21June91-2616, the company estimated that, in 1992, the Inter-Gateway facility would be in place for 12 months at $296,000 per month, the same monthly rental assumed for 1991. This suggests that the same capacity required for 1991 would also be required for 1992. However, when Exhibit 73 was filed and the capacity requirements were finally provided, Teleglobe stated that one DS-3 circuit had been budgeted for seven months of 1991 and 12 months of 1992, with a second DS-3 circuit being added for eight months of 1992.
In light of the inconsistencies in Teleglobe's evidence, and in light of Teleglobe's statement (in Exhibit 73) that the Inter-Gateway facility was being "reevaluated presently", the Commission cannot fully accept Teleglobe's expense estimates for Canadian terrestrial and satellite circuit rentals. Based on the record, the Commission concludes that the expense associated with the second DS-3 circuit in 1992 should be disallowed. Accordingly, the Commission has reduced Teleglobe's 1992 expense forecast by $1.4 million.
3. Maintenance & Repairs Expense - Cable Maintenance
In its evidence of 26 March 1991, Teleglobe estimated, based on its March View, that its cable maintenance expense would be $8.7 million in 1991, a decrease of 6.1% from 1990. Teleglobe estimated the 1992 expense at $10.2 million, an increase of 18.1% over 1991. When it filed its May View on 27 May 1991, Teleglobe revised its cable maintenance forecast for 1991 downwards to $7.9 million, a decrease from 1990 of 14.7%. However, Teleglobe did not amend its 1992 forecast of $10.2 million, which consequently represents a 30.1% increase over 1991.
In Exhibit TCI 91-800 included in its Supplemental Evidence, Teleglobe explained that lower cable maintenance expenses in the May View of 1991 are the result of lower cable ship costs. During examination by Commission counsel, Teleglobe confirmed that the main reason for the $800,000 difference between the March and May Views of 1991 is the timing of the coming into service of a new cable ship, the "Global Sentinel".
In response to interrogatory Teleglobe(CRTC)21June91-2420, the company indicated that the cost of the Global Sentinel included in the March View was $670,000, while the cost of the ship in the May View was $410,000, a difference of only $260,000. At the hearing, Teleglobe informed the Commission that the remainder of the $800,000 difference, i.e., $540,000, was accounted for by its actual experience with cable breaks throughout 1991.
The Commission considers it unlikely that $540,000 of the $800,000 reduction in 1991 expenses is due to actual cable break experience. Teleglobe did not include this explanation in its Supplemental Evidence and, prior to being presented with the figures set out in response to interrogatory Teleglobe(CRTC)21June91-2420, the company contended that the main reason for the decrease was the delay of the coming into service of the Global Sentinel.
In light of Teleglobe's failure to explain $540,000 of the decrease in forecasted 1991 cable maintenance expenses between the March and May Views, the Commission concludes that the May View, for the most part, simply represents a more accurate estimate of these expenses for 1991. Furthermore, even if $540,000 of the decrease can be attributed to Teleglobe's actual experience with cable breaks throughout the year, the Commission is not persuaded that the company's experience in 1992 should differ materially from that in 1991.
The Commission therefore concludes that the May View of 1992, being unchanged from the March View of 1992, is likely overestimated.
In interrogatory Teleglobe(CRTC)21June91-2602, the Commission asked Teleglobe to provide a detailed explanation, with supporting calculations and the assumptions on which those calculations were based, for the 1992 increase in cable maintenance expense of $2.4 million or 30.1%. Teleglobe did not provide a full response to the Commission's interrogatory. Rather, it provided detailed calculations only for the ANZCAN C budget, thereby accounting for only $221,000 of the total increase of $2.4 million. In response to a request from Commission counsel during examination, the company provided more complete calculations in Teleglobe Exhibit 65. Attachment 2 of this Exhibit shows the 1992 cost of the Global Sentinel to be approximately $1.5 million. However, response to interrogatory Teleglobe(CRTC)21June91-2420 shows the cost of the Global Sentinel included in the May View of 1992 as $900,000, a difference of approx-imately $600,000 from Exhibit 65.
In light of this inconsistency, and in light of its conclusion that the May View of 1992 is likely overestimated, the Commission finds that a $600,000 reduction to Teleglobe's 1992 forecast of cable maintenance expense is appropriate.
4. Cable Restoration Costs
Teleglobe's 1991 forecast for this expense is $1.4 million, a decrease of 53.1% from 1990. For 1992, the forecast is $2.9 million, representing an increase of 107.1% over 1991.
Teleglobe submitted that the large increase in 1992 is due to the coming into service of the TAT-9 and TPC-4 cable systems. However, Teleglobe offered no persuasive evidence as to why the coming into service of these systems would result in an increase of such magnitude.
The Commission is of the view that the forecasting of cable restoration costs is, for the most part, a judgmental exercise. However, the Commission also notes that year-to-date results indicate that actual cable restoration costs for 1991 are underrunning the May View.
In light of the above, the Commission finds it appropriate to reduce the 1992 expense forecast by $500,000. Even after this disallowance, the Commission notes that forecasted 1992 cable restoration costs represent a considerable increase over the forecasted 1991 expense.
5. Publicity & Advertising Expense - Promotional Advertising
Teleglobe forecasts $2.7 million for this expense for 1991, representing a 41.3% decrease from 1990. However, for 1992, Teleglobe's forecast is $4.7 million, an increase of 74.8% over 1991.
In response to interrogatory Teleglobe(CRTC)21June91-2601, Teleglobe stated that the 1991 decrease was the result of a cost containment program implemented by management with respect to Teleglobe's discretionary expenses. It stated that 1992 expenses are forecasted to return to their 1990 levels, but added that this would be reviewed in the preparation of the upcoming fall budget.
At the hearing, Teleglobe was asked whether this last statement suggests that there would be a downward adjustment in the 1992 Publicity & Advertising expense. Teleglobe replied that, at that time, it was unable to say whether the "real budget number for 1992" would be higher or lower. The company also stated that, in 1992, it would place a greater focus on the promotion of its telecommunications services to business users. Teleglobe did not, however, provide any specific details regarding the content or cost of any proposed advertising programs.
In the Commission's view, Teleglobe provided no persuasive evidence to justify an increase in 1992 of 75% over the expense for 1991. Furthermore, Teleglobe's testimony (noted above) tends to cast doubt on the reasonableness of its 1992 forecast of advertising expense, which is a discretionary expense. Noting that the relatively low 1991 forecast resulted from a cost containment program, and also that the company intends to shift the focus of its advertising program in 1992, the Commission considers a 20% increase over 1991 promotional advertising expenses to be appropriate in 1992. The Commission has therefore reduced the 1992 forecast for these expenses to $3.2 million (a reduction of $1.5 million). Any promotional advertising expenses in excess of that amount will have to be offset by a corresponding decrease in some other expense category.
6. Conclusions
The Commission is satisfied that Teleglobe's forecast of its operating expenses for 1991 is, on the whole, reasonable. The Commission notes that actual total operating expenses to date closely track the company's May View. In addition, the Commission finds a 4.8% increase in 1991 in total operating expenses, excluding depreciation, to represent a reasonable annual increase under current economic conditions and in light of the scope of Teleglobe's operations.
However, the Commission finds Teleglobe's May View of 1992 to be unreasonable. This View estimated a 15.9% increase over forecasted 1991 total operating expenses, including depreciation, and a 9.1% increase over 1991 forecasted operating expenses, excluding depreciation.
As discussed in Section F below, Teleglobe stated in final argument that the May View of 1992 cannot be regarded as providing reliable information as to its expected financial performance in 1992. At the hearing, Teleglobe had an opportunity to substantiate any changes to its May View of 1992 in order to reflect more recent information. Teleglobe chose not to do so.
As noted in the foregoing pages of this Section, the Commission finds it appropriate to reduce Teleglobe's 1992 expense forecast in the operating categories and amounts summarized below:


Memotec Management Fees
Rentals Expense - Terrestrial & Satellite Circuits in Canada
Maintenance & Repairs Expense - Cable Maintenance
Cable Restoration Costs
Publicity & Advertising Expense - Promotional Advertising
Total

Thousands
of Dollars
750

1,400

600
500

1,500
4,750

After the above-noted adjustments, Teleglobe's operating expense forecast for 1992 is approximately $149.3 million, excluding depreciation, representing an annual increase of 5.8% over the 1991 forecast. The Commission considers this a more reasonable estimate for 1992 than that forecasted by Teleglobe in its May View.
D. Operating Revenues
1. Introduction
Based on its May View, Teleglobe estimated that, at existing rates, its net operating revenues would be $265.2 million in 1991 and $374.8 million in 1992. Teleglobe also estimated that, with a 4% reduction in collection rates effective 1 January 1992, its net operating revenues for 1992 would be $331.7 million.
2. Accounting Rates
a. Disclosure of Accounting Rates
In final argument, Bell submitted that the Commission should direct Teleglobe to place its external interconnection agreements, including accounting rates by country, on the public record. Bell noted that, in the United States, the Federal Communications Commission requires that accounting rates between U.S. carriers and overseas administrations be placed on the public record. Bell submitted that, given the need to reduce Teleglobe's costs and the incentive for bypass of Canadian facilities through the United States, it is imperative that information such as accounting rates be publicly available in order to assess the progress of Teleglobe's negotiations with foreign administrations. Bell argued that the members of Telecom Canada, as purchasers of Teleglobe's facilities and services and as domestic service providers, are interested in the reasonableness of the price they pay relative to Teleglobe's accounting rates.
Bell also noted that, in 1983, the Commission expressly denied the company's claim for confidentiality with respect to settlement arrangements with MCI. Bell stated that, since 1983, it has placed all of its external interconnection agreements, including settlement rates, on the public record.
In reply, Teleglobe submitted that the confidentiality of the accounting rate process has allowed it to negotiate lower accounting rates. Teleglobe noted that the Commission has knowledge of the accounting rates, from which it can judge the reasonableness of Teleglobe's rates. Teleglobe also stated that all of Bell's settlement arrangements are not on the public record.
The Commission notes that the CRTC Telecommunications Rules of Procedure provide for the disclosure of information filed in confidence either when there would be no specific direct harm from disclosure or when the public interest in disclosure would outweigh the specific direct harm.
The Commission notes that the instance cited by Bell, in which the Commission ordered disclosure of Bell's settlement arrangements with MCI, occurred during and in the context of an ongoing proceeding. In that instance, the Commission considered that the information in question would assist parties in formulating submissions that would be of value to the Commission in examining the appropriateness of the trial Canada-U.S. long distance service at issue in the proceeding. The granting of Bell's request in this instance, given that it was raised only in final argument, would be of no such value.
The Commission notes that, under current arrangements, most administrations' accounting rates are not on the public record. Although disclosure is required in the United States, in the Commission's view, this requirement is not particularly helpful in assessing a specific case in Canada, given the differences between Canada and the U.S. in terms of industry structure and environment. For example, in the United States, multiple carriers operate international facilities.
While, the Commission acknowledges that there may be some benefit in permitting public scrutiny of the information sought by Bell, the Commission considers that the disclosure of Teleglobe's interconnection agreements with foreign administrations, including accounting rates, could result in specific direct harm to Teleglobe by affecting its ability to negotiate lower or preferential accounting rates. The Commission therefore denies Bell's request for disclosure.
b. 1991/1992 Accounting Rates
Teleglobe estimated, based on its May View, that reductions in accounting rates in 1991 would increase its net operating revenues for that year by $9.0 million, and that further reductions in 1992 would increase net operating revenues by an additional $9.0 million.
In its evidence for 1991, Teleglobe indicated that negotiations accounting for $8.2 million of the estimated $9.0 million had already been finalized. Teleglobe estimated that negotiations accounting for the remaining $0.8 million would be finalized by year-end. In response to a Commission interrogatory, Teleglobe estimated the 1992 accounting rate reductions for the top 15 country markets, specifying effective dates and the impact on revenues.
The Commission accepts Teleglobe's evidence with respect to 1991 accounting rate reductions, since Teleglobe has provided detailed information accounting for $8.2 million of the estimated impact on revenues of $9.0 million. However, the Commission considers Teleglobe's estimates of accounting rate reductions for 1992 to be conservative.
The Commission notes that Teleglobe's forecast for 1992 assumes that the majority of the accounting rate reductions would not become effective until mid-year or later in 1992. However, there is nothing on the record to explain why, in 1992, reductions would occur primarily in the latter part of the year.
Furthermore, the March 1991 report on Teleglobe's operating environment, filed as CRTC Exhibit 13, estimated that accounting rates for two of Teleglobe's major trading partners, the United States and the United Kingdom, would decrease by 62% over the three-year period 1990 to 1992. Teleglobe assumed no reduction in accounting rates with the United Kingdom in 1991 and, in the Commission's view, was overly conservative in its forecast reduction for 1992.
In light of the above, the Commission finds that the May View forecast of Teleglobe's 1992 net operating revenues should be increased by $2.0 million. The Commission has taken into account this additional $2.0 million in net operating revenues in calculating Teleglobe's 1992 revenue requirement.
In its comments of 16 August 1991, CBTA argued that the Commission should have input into accounting rate agreements between Teleglobe and foreign carriers, to ensure that those agreements are in the public interest. The Commission notes that, under section 17 the Teleglobe Act, accounting rate agreements between Teleglobe and the foreign administrations are to be submitted to the Commission, if required, but are not subject to the Commission's approval.
However, the Commission would find it useful in monitoring Teleglobe's revenues to have more information with respect to the company's expectations as to changes in accounting rates. The Commission therefore directs Teleglobe to provide, in confidence, more detailed information than is currently provided concerning possible changes in accounting rates with foreign administrations. Specifically, when Teleglobe submits its annual budget to the Commission, it is to provide details of its expectations with respect to accounting rate reductions with the major countries, including the timing of the reductions and their estimated impact on the company's revenues. In addition, in order to substantiate its accounting rate estimates, the company is required to provide information as to its ongoing negotiations with the top 15 country markets, including the positions of the other countries.
3. Foreign Exchange Rates
a. Foreign Exchange Rate Approval Procedure
In Letter Decision 90-10, the Commission set up procedures for the approval of Teleglobe's budgeted foreign exchange rates. Under these procedures, Teleglobe submits, on or about 1 July each year, (1) a list of sources of the external forecasts that it will use to calculate the annual budgeted exchange rates; (2) a calculation of the preliminary exchange rate forecasts, using the data then available from the sources noted above; and (3) the expected publication dates of the data to be used in the final forecast. Teleglobe is also required to file, by 1 November of each year, a written report setting out the forecasted foreign exchange rates that it will use in its budget view for the coming year.
b. 1991 Exchange Rates
In December 1990, the Commission approved foreign exchange rates for use in Teleglobe's 1991 budget. The 1991 actual foreign exchange rates to date have been consistently more favourable than the budgeted rates.
Experts relied on by Teleglobe in July 1991 in conformity with the procedures established in Letter Decision 90-10, anticipated that, for the remainder of 1991, foreign exchange rates would continue to be more favourable than those incorporated in the May View. In its updated response to interrogatory Teleglobe(CRTC)25Apr91-1407, filed 22 August 1991, Teleglobe estimated that these more favourable rates would affect the 1991 financial results by increasing RSA amortization by approximately $5.8 million over the amount assumed in the May View. During the hearing, Teleglobe submitted that it would experience traffic declines during the second half of 1991, which would likely offset the gains from foreign exchange rates.
The Commission acknowledges that telecommunications traffic in and out of Canada has been declining from the levels estimated in the May View. The Commission agrees with Teleglobe that for 1991 the gains from favourable foreign exchange rates will likely be offset by traffic declines. However, given that the foreign exchange rates are significantly more favourable than anticipated in the May View, the Commission finds it appropriate, in assessing Teleglobe's 1992 revenue requirement, to calculate the 1992 opening balance for the RSA using the more favourable 1991 foreign exchange rates provided by the company in response to interrogatory Teleglobe(CRTC)25Apr 91-1407, Attachment 1 (updated 22 August 1991).
c. 1992 Exchange Rates
In preparing its May View, Teleglobe used the 1992 foreign exchange rate forecasts available at the time. In July 1991, as required by Letter Decision 90-10, Teleglobe submitted its preliminary 1992 foreign exchange rate forecast, along with its methodology and sources. The preliminary 1992 foreign exchange forecast was more favourable than the May View. In its updated response to interrogatory Teleglobe(CRTC)21June91-2423, filed 23 August 1991, the company estimated that the more favourable foreign exchange rates would increase net operating revenues by $5.9 million and increase RSA amortization by $0.62 million over the amounts forecast for 1992 in the May View.
On 1 November 1991, Teleglobe filed its foreign exchange rate forecast, for use in its 1992 budget, for the Commission's approval. Teleglobe filed an amended forecast on 14 November 1991.
The Commission finds Teleglobe's 14 November forecast reasonable. The Commission directs Teleglobe to use these forecasted foreign exchange rates in its 1992 budget. Use of these foreign exchange rate forecasts increases the May View projection of Teleglobe's 1992 net operating revenues by $7.5 million and the projection of RSA amortization by $1.1 million. The Commission has taken these revised estimates into account in calculating Teleglobe's 1992 revenue requirement.
4. Traffic Growth
In its May View, Teleglobe assumed that, in 1991, telecommunications traffic in and out of Canada would grow by 13% over 1990. Year-to-date information indicates that traffic is below that forecast in the May View. During the hearing, Teleglobe stated that, although it did not wish to revise its forecast, it expected traffic over the second half of 1991 to be lower than that assumed in the May View. As stated above, the Commission acknowledges that, in 1991, telecommunications traffic in and out of Canada has been declining from the levels estimated in the May View.
Despite traffic declines for 1991, the Commission accepts that the 1992 traffic forecast presented in Teleglobe's May View is reasonable. Many of the latest economic forecasts suggest improved growth, over that assumed in the May View, in Gross Domestic Product for the Canadian and other national economies. Furthermore, the Commission notes that Teleglobe's 1992 forecast of traffic growth of 17% over 1991 is significantly less than the growth levels experienced prior to the 1991 recession, when traffic growth averaged 25% per year.
E. Financial Issues
1. Introduction
Teleglobe retained two external consultants, Dr. C. S. Patterson and Mr. D. A. Carmichael, to provide evidence on the appropriate rate of return for the company. Based on the recommendations of these witnesses, and on its own qualitative assessment of its risk, Teleglobe proposed an allowed ROE range of 14.5% to 16.5%, with rates set to achieve the mid-point of that range (15.5%) in 1992. In final argument, Teleglobe stated that, if its proposed IRA were approved, it would find an allowable ROE range of 100 basis points acceptable. In Part VI, above, the Commission denied the company's proposed IRA and rolling multi-year approach.
Dr. Patterson estimated a fair rate of return for Teleglobe using a method that does not rely on data from other regulated utilities or carriers. Dr. Patterson submitted that Teleglobe's risk characteristics differ substantially from such firms. In his reply evidence, Dr. Patterson emphasized that this assumption is critical to his approach to estimating Teleglobe's fair rate of return.
Using an assumed risk-free rate of 10%, a market risk premium of 7%, and a derived beta coefficient of 0.87, Dr. Patterson estimated a fair rate of return of 16% for Teleglobe. He stated that, given the nature of the data and the analytical techniques used to arrive at this estimate, the lower limit on Teleglobe's rate of return would be approximately 15% and the upper limit would be approximately 17%.
In his updated evidence, using the comparable earnings method, Mr. Carmichael obtained an ROE range of 14% to 14.5%, with a mid-point of 14.25%. Using an equity risk premium approach, Mr. Carmichael obtained a range of 14.32% to 14.68%, with a mid-point of 14.5%. He then assigned equal weight to the results from each method and obtained an ROE of 14.375%, with an allowable range of plus or minus 50 basis points (i.e., 13.875% to 14.875%).
During examination by Commission counsel, Teleglobe stated that it places greater weight on Dr. Patterson's results, because Mr. Carmichael assumed that there is no perceived risk of the company losing its sole provider status and because he relied on only one study in developing his market risk premium estimate.
Bell, Ontario and Cancom/SovCan commented on a fair and reasonable ROE for Teleglobe. Of these, only Ontario provided evidence.
Ontario retained Dr. L. D. Booth to provide an estimate of Teleglobe's cost of equity capital and to comment on the evidence of Dr. Patterson and Mr. Carmichael. Dr. Booth used various discounted cash flow (DCF) and equity risk premium techniques to estimate a fair rate of return for Teleglobe. Although Dr. Booth calculated an overall average of 11.52% from these techniques, he recommended 12% as a fair rate of return for Teleglobe for 1992.
The Commission wishes to comment on the following issues: Teleglobe's market beta, market risk premium, flotation cost allowance, financial structure and the allowable ROE range. Although it has chosen to restrict its comments to certain key issues, the Commission found all of the approaches used in the proceeding to be of assistance in assessing a fair and reasonable rate of return for Teleglobe.
2. Teleglobe's Market Beta
a. Positions of Parties
In calculating a market beta for Teleglobe, Dr. Patterson first estimated the relationship between observed levels of systematic market risk and the accounting variables that appear to determine that risk, using data from 61 firms. He applied this relationship to the corresponding accounting variables for Teleglobe in order to determine what its market beta would be if it were publicly traded. His calculated market beta for Teleglobe was about 0.87.
Mr. Carmichael was of the opinion that the market risk associated with an investment in the major publicly-traded telecommunications companies is underestimated by their stock market betas, which averaged 0.38 over the last business cycle. Given this conclusion and his view that Teleglobe is riskier than other telephone companies, Mr. Carmichael arrived at a risk adjustment of about 0.65 to his market risk premium of 5%.
Ontario was of the opinion that there are a number of problems with the model used by Dr. Patterson to derive Teleglobe's market beta, the most important of which is its tendency to overestimate, by an average of approximately 20 basis points, the market betas of the ten regulated companies in his sample. In addition, Ontario was of the opinion that Mr. Carmichael provided insufficient justification for his risk adjustment of 0.65.
In Ontario's view, a market beta for Teleglobe of 0.53, as estimated by Dr. Booth, is more reasonable. In calculating his estimate, Dr. Booth relied on a beta value of 0.44 for Teleglobe, emanating from a modification of Dr. Patterson's model, and on a market beta of about 0.55, produced by an additional model (the Myers model). He noted, however, that the results from the latter model might be slightly biased upwards.
b. Conclusions
In reply to Ontario, Dr. Patterson stated that the overestimated values derived from his model by Dr. Booth are likely the result of measurement errors associated with data for companies at the low-risk end of his sample (i.e., the regulated utilities). Dr. Patterson contended that this is a statistical artifact and not indicative of a shortcoming in his model. During examination by Commission counsel, however, Dr. Patterson acknowledged that he did not know whether the differences between Dr. Booth's predicted beta values and actual market betas are the result of measurement errors. More importantly, however, Dr. Patterson did not consider that his estimated market beta for Teleglobe should be adjusted to take into account the tendency for his model to overestimate market betas for companies at the low-risk end of his sample, because he did not consider Teleglobe to be of comparable risk to these companies.
The Commission notes that all the companies at the low-risk end of Dr. Patterson's sample are, like Teleglobe, regulated utilities. As discussed below, although the Commission considers Teleglobe to be of somewhat higher risk than the regulated telephone companies in Dr. Patterson's sample, it nonetheless considers that Teleglobe would be in the low-risk end of his sample. In the Commission's opinion, Dr. Patterson's failure to account for the tendency of his model to overestimate the market betas of firms at the low-risk end of his sample may result in an overestimate of Teleglobe's market beta.
The Commission concurs with Ontario that Mr. Carmichael's assumption of a risk adjustment of 0.65 does not appear to be supported by his evidence. Mr. Carmichael concluded that the low R2s (i.e., the proportion of the security's total risk attributable to market risk) associated with stock market betas for the major publicly-traded telephone companies are indicative of the general lack of stability of these betas. During cross-examination by Ontario, however, Mr. Carmichael agreed that it is not unusual for utility stock market betas to have low R2s since there are a significant number of other, non-market, factors that affect utility stock prices.
In the Commission's view, Dr. Booth's beta models produced useful evidence that supports his conclusion that Teleglobe is of marginally higher risk than the other telephone companies. However, the Commission agrees with certain of Dr. Patterson's comments regarding problems in Dr. Booth's application of the Myers model and the theoretical and empirical shortcomings of Dr. Booth's adjustments to Dr. Patterson's model. For example, Dr. Booth included an asset growth term in his application of the Myers model, from which he derived his overall mean estimate of 0.55 for Teleglobe's beta. As Dr. Patterson correctly pointed out, the theoretical relationship between growth and duration for stocks is a positive one, while the coefficient of asset growth in Dr. Booth's model is consistently negative.
Based on the record of the proceeding, the Commission concludes that the risk associated with an investment in Teleglobe's common equity may be slightly higher than the average risk of common equity investments in the other regulated telephone companies studied in this proceeding.
In light of the above, the Commission is of the opinion that Dr. Booth's beta estimate (0.53) may not be entirely reflective of Teleglobe's risks. Similarly, for the reasons identified above, the Commission is of the view that a market beta lower than that used by Dr. Patterson (0.87) and, to some extent, lower than that used by Mr. Carmichael (0.65), would be appropriate for Teleglobe.
3. Market Risk Premium
a. Positions of Parties
Dr. Patterson relied on a market risk premium of approximately 7%, based on a review of several historical market risk premium studies. By contrast, Mr. Carmichael placed greatest weight on the observed three and five-year holding period returns from a single study (Hatch and White (1987)), arriving at a market risk premium of between 5.5% and 6%. Mr. Carmichael submitted, however, that more recent data from a ScotiaMcLeod study supported a downward adjustment of his market risk premium to 5%.
Ontario stated that Dr. Patterson presented no independent evidence, but instead relied on market risk premium evidence from a subjective sampling of other studies. Ontario argued, among other things, that three of Dr. Patterson's studies used U.S. data and should not be used as a basis for determining Canadian risk premiums because of differences in tax and regulatory environments.
Ontario submitted that Mr. Carmichael had disregarded market risk premium evidence based on ScotiaMcleod data and that, in so doing, arrived at a market risk premium that is not entirely supported by his evidence.
Dr. Booth relied on market risk premium estimates based on the same ScotiaMcleod study referred to by Mr. Carmichael. Dr. Booth concluded that a market risk premium of 2% to 3% is reasonable.
b. Conclusions
The Commission notes that there is a fair amount of judgment involved in estimating market risk premiums, as evidenced by the range of estimates submitted by the expert witnesses in this proceeding.
The Commission accepts the view of Dr. Patterson, that primary weight should be given to the Canadian studies, and that the U.S. studies should only be used as a check on the reasonableness of the market risk premium derived from the Canadian studies.
The Commission notes that the results of the studies relied upon by Dr. Patterson and Mr. Carmichael were derived using arithmetic averaging of realized returns. As noted by both Drs. Patterson and Booth, for an investor with a multi-period investment horizon, it is more appropriate to rely on the geometric mean of the historical risk premium. The Commission is of the view that the use of arithmetically averaged risk premiums would, on its own, tend to overestimate a market risk premium for Teleglobe. On the other hand, the Commission is not persuaded that a market risk premium in the order of 2% to 3%, as estimated by Dr. Booth, would be entirely reasonable, given the range of estimates produced by the market risk premium studies relied upon by the expert witnesses in this proceeding.
Based on the record of the proceeding, the Commission finds a reasonable market risk premium to be considerably higher than that recommended by Dr. Booth, but lower than the 7% used by Dr. Patterson.
4. Flotation Cost Allowance
a. Teleglobe's Position
In arriving at his recommended flotation cost allowance of 6% to 7%, Mr. Carmichael relied on commission costs (3.1%) and other costs (0.4%) as estimated by an expert witness at the hearing in the proceeding leading to Maritime Telegraph and Telephone Company Limited - Revenue Requirement for 1990 and 1991, Telecom Decision CRTC 90-30, 20 December 1990 (Decision 90-30). However, Mr. Carmichael did not rely on the offering spread estimate of 0.8% advanced by the same expert witness at that hearing. Rather, he believed an offering spread estimate of 2.5% to 3.5% to be more indicative of the true cost of issuing common equity since the market collapse of 1987. In his updated evidence, Mr. Carmichael stated that, since his original evidence was submitted, certain firms have had to offer spreads of up to 5%. On this basis, he submitted that an offering spread of 5% would be appropriate.
b. Conclusions
The Teleglobe Act limits the amount of Memotec's share equity that can be held by BCE Inc. (BCE).During examination by Commission counsel, Mr. Carmichael stated that he made no adjustment to his estimate of flotation costs for the percentage of Memotec's equity that was placed with BCE, since he had no guarantee that BCE would maintain that percentage in future common equity issues for Memotec.
The Commission considers it reasonable to assume that BCE will maintain a significant share equity investment in Memotec. The Commission estimates that this factor alone would reduce Mr. Carmichael's sum of commission costs and other costs.
In previous decisions, the Commission has determined that any estimate of flotation costs should reflect the accumulated sources of common equity in the company's rate base. Mr. Carmichael's recommended flotation cost allowance is based solely on the cost of new public issues of common equity. As stated in Decision 90-30and elsewhere, the Commission is of the opinion that an approach for estimating flotation costs that recognizes only the most expensive method of issuing equity tends to overestimate those costs. A consideration of other, less expensive, methods of issuing equity would tend to further reduce Mr. Carmichael's estimated flotation cost allowance.
The Commission notes that the offering spread estimate of 5% submitted by Mr. Carmichael was based solely on 1991 data. In the Commission's opinion, a reliance on only very recent market events may produce an unrepresentative and inappropriate estimate of offering spread for the purposes of determining flotation costs. In this context, the Commission notes that, in response to interrogatory Teleglobe(CRTC)21June91-2428, Teleglobe reported that Memotec has had only one common equity share issue since 1987 and that there was no offering spread associated with that issue.
For these reasons, the Commission is of the view that an offering spread lower than that assumed by Mr. Carmichael would be more appropriate.
Taking the above into consideration, the Commission considers a flotation cost allowance considerably lower than Mr. Carmichael's recommended 6% to 7% to be appropriate for Teleglobe.
Finally, as noted above, Mr. Carmichael's estimates of commission and other costs were derived from a generic study presented by an expert witness in the proceeding leading to Decision 90-30. In the Commission's view, these estimates should have been supported by evidence of their applicability to Teleglobe.
5. Capital Structure and Interest Coverage Ratios
a. Positions of Parties
The Direction to the CRTC prescribed an initial capital structure for Teleglobe of 45% debt and 55% equity. In its March View, Teleglobe proposed a capital structure for 1992 consisting of 42% debt, 7.2% preferred equity and 50.8% common equity. The company also requested a 14.5% to 16.5% ROE range for 1992. In its May View, Teleglobe revised its evidence, stating that additional infusions of common equity are required in 1991 and 1992, since it was unable to float a $50 million preferred share issue in 1991. The company stated that these equity infusions, coupled with a concurrent reduction in its current ratio, would increase the common equity component of its invested capital to 60% and reduce its debt to 40% in 1992. Teleglobe did not, however, adjust its proposed ROE to reflect this shift to a more conservative capital structure.
In final argument, Teleglobe stated that its proposed financial structure consists of three interrelated parts, none of which should be considered in isolation:
(1) a 40/60 debt to equity ratio;
(2) an interest coverage ratio of at least 3 times; and
(3) a 0.75 current ratio.
Teleglobe considered that this overall financial structure would support the bond rating necessary to ensure continued access to bond markets at reasonable rates, while providing the company with the lowest overall cost of capital.
In final argument, Ontario stated that Teleglobe's more conservative debt/equity ratio is a result of the company's strategy for the management of its current assets and liabilities, rather than a result of its intrinsic business risk. Ontario believed that an appropriate capital structure for Teleglobe would be similar to that of the other telecommunications carriers. It was of the opinion that a higher proportion of equity in the company's capital structure would tend to inflate Teleglobe's revenue requirement. It did not, however, specify what it considered an appropriate target structure.
b. Conclusions
Teleglobe's move towards a more conservative capital structure would, in itself, tend to reduce the company's financial risk. All other things being equal, this would result in a reduction in the company's overall level of risk. However, the reduction in financial risk due to a more conservative capital structure may be offset to some extent by an increase in business risk due to changes in Teleglobe's operating environment since 1987. On balance, the Commission considers that Teleglobe's level of overall risk may be lower than assumed by the company.
During cross-examination by Ontario, Teleglobe noted that as part of the terms of its renegotiated loan agreement with the National Bank of Canada, its current ratio had been reduced from 0.9 to 0.75. However, Teleglobe stated that, at the same time, it was required to increase its common equity ratio to 60%. Teleglobe argued that any reduction in financial risk as a result of reducing the proportion of debt in its capital structure would tend to be offset by an increase in its financial risk resulting from the reduction in its current ratio. Teleglobe submitted that, as a result of the changes to its financial structure, there would be a net reduction in its 1992 revenue requirement.
All other things being equal, the reduction in Teleglobe's current ratio may represent an increase in short-term risk. This factor, however, should be tempered by a consideration of whether a reduction in the company's current ratio from 0.9 to 0.75 would be regarded as significant by investors in regulated telecommunications companies.
In light of the above, the Commission considers that Teleglobe's move to a more financially conservative capital structure of 40% debt and 60% equity (estimated for 1992) results in a reduction in its level of financial risk since 1987.
Teleglobe estimated, based on its May View, that its interest coverage would be about 4.6 in 1992, with the proposed revenue reduction. This compares with actual interest coverage ratios of 3.1 in 1989, 2.1 in 1990 and an estimated ratio of 3.4 in 1991. Teleglobe also noted in its updated evidence that its credit rating had been reduced by DBRS from AA (Low) to A (High), in a report dated 27 July 1990.
The Commission notes that the DBRS report dated 27 July 1990 noted, among other things, that Teleglobe's balance sheet remained positive with the proportion of debt in the company's capital structure near 43%. DBRS stated that this fact would assure that interest coverage ratios would be in the 2.5 to 3 times range. During examination by Commission counsel, Mr. Carmichael stated that agencies such as Canadian Bond Rating Service (CBRS) would look for interest coverage in excess of 3 times to support a bond rating of A. On the basis of its findings with respect to Teleglobe's revenue requirement, discussed below, the Commission estimates that the company's interest coverage will be 3.4 times in 1991 and 4.0 times in 1992.
In prescribing a 1992 ROE range for Teleglobe, the Commission has taken into account Teleglobe's conservative estimated capital structure, its other financial ratios, its external financial requirements and its credit quality. The Commission would be concerned if, under current conditions, Teleglobe were to attempt to move towards a more conservative capital structure than that currently estimated in 1992.
6. Allowable ROE Range
In its Memoranda of Support, Teleglobe proposed an allowable ROE range of 200 basis points in the framework of a single forward test year. Teleglobe stated that the continuation of a 200 basis point range would mitigate some of the risk associated with the fact that its business volatility is higher than that of the other telephone companies. In final argument, Teleglobe stated that, if its proposed IRA were approved, it would find an allowable ROE range of 100 basis points acceptable, since the IRA would reduce some of the volatility in the company's earnings.
In final argument, Ontario took the position that a single forward test year RB/ROR form of regulation would be appropriate for Teleglobe, and that the allowable ROE range should be 100 basis points, as is the case with the other federally regulated telecommunications carriers.
In Part VI, above, the Commission denied Teleglobe's proposed IRA.
The Commission notes that Teleglobe's revenues over the transitional period have exhibited a pattern of volatility. Future developments, including possible changes to Teleglobe's agreement with Telecom Canada and the establishment of a gateway access tariff may reduce some of that volatility and the risk associated with it. In the present circumstances, the Commission is of the view that the wider ROE range may be of assistance in mitigating the risk associated with fluctuations in the company's revenues.
In light of the above, and taking into account its denial of the proposed IRA, the Commission finds an ROE range of 200 basis points reasonable in this case.
7. Conclusions
In arriving at an appropriate ROE for Teleglobe for 1992, the Commission has considered, in addition to factors previously discussed, developments in capital market conditions subsequent to the hearing. In this context, the Commission notes that, since the end of August 1991, yields on long-term Government of Canada bonds have declined somewhat. The Commission notes, however, that current forecasts of long-term interest rates for 1992 remain at or near the average level of expected long-term interest rates relied upon by the expert witnesses in this proceeding. As a result, the impact of recent developments on the forecast 1992 long-term interest rates used in this proceeding has been relatively minor.
Having weighed all of the considerations discussed above, the Commission determines that a fair and reasonable ROE for Teleglobe for the test year 1992 is 13.75%, with an allowable range of 12.75% to 14.75%. In the Commission's view, this range is fair to both the company's customers and its shareholder.
F. Revenue Requirement
1. General
In final argument, Teleglobe stated that its 1992 May View did not provide "reliable information on expected 1992 financial performance", since the company had not completed its 1992 budget process and would not do so until the fall of 1991. Teleglobe submitted that it would therefore be inappropriate to establish its 1992 revenue requirement on the basis of the evidence presented in this proceeding.
The Commission notes that this proceeding, like any proceeding in which a carrier's revenue requirement is being established, involved the examination of much evidence and a consideration of many complex issues. In the Commission's view, this process is greatly enhanced by the holding of a public hearing and the participation of interveners. It would not have been possible to base this proceeding on information filed in the fall of 1991, while providing for a public process and for the issuing of a decision in time for implementation in early 1992.
The Commission also notes that the schedule established for this proceeding is similar to that of major proceedings with respect to other regulated carriers. Furthermore, like any regulated carrier, Teleglobe had the opportunity at the hearing to substantiate any changes to its forecast for the test year, but chose not to do so.
The May View represents the most complete, up-to-date information placed before the Commission during this proceeding. The Commission therefore finds it appropriate to establish Teleglobe's 1992 revenue requirement on the basis of the May View.
Teleglobe has various options if it appears that will be its 1992 earnings below the lower limit of its ROE range. First, Teleglobe can undertake cost containment measures to achieve an ROE within the approved ROE range. Second, the company can accept a lower ROE. Third, it can request the Commission to take the appropriate action to increase its earnings to a level within the approved range.
Similarly, if Teleglobe's 1992 earnings are likely to be above the upper limit of its approved ROE range, it is open to the Commission to take action to bring Teleglobe's earnings for 1992 down to a level within the allowed ROE range.
2. 1991 ROE and Earnings Over Transitional Period
In its May View, Teleglobe estimated an ROE of 13.4% for 1991 and an average ROE over the transitional period of 14.8%.
The Commission finds Teleglobe's May View forecast of 1991 to be reasonable. The Commission estimates that, over the transitional period, the company will have earned, on average, an ROE near the top of the allowed range of 12.9% to 14.9%.
3. 1992 Revenue Requirement
In its May View, Teleglobe estimated, at existing rates, an ROE of 22.3% for 1992. Teleglobe estimated that a revenue reduction of $43.1 million would be necessary in 1992 in order for it to achieve an ROE of 15.5%, the mid-point of its proposed range of 14.5% to 16.5%.
The Commission's calculations indicate that Teleglobe's 1992 pending and planned tariff filings, not reflected in the May View, will increase 1992 net operating revenues by about $0.6 million over the May View forecast. The Commission estimates that, after incorporating this adjustment and the various other adjustments for 1992 identified in this Decision, Teleglobe's regulated 1992 ROE would be approximately 24.4% at existing rates.
In order to provide the company with a regulated ROE of 13.75% (the mid-point of the approved range of 12.75% to 14.75%), the Commission finds that a revenue reduction of approximately $70 million is necessary. In calculating Teleglobe's revenue requirement, the Commission has taken into account any additional financing costs that the company may incur as a result of the fact that the Commission has ordered rate reductions higher than those anticipated in the May View.
X QUALITY OF THE COMPANY'S EVIDENCE
At various stages during this proceeding, the Commission found it extremely difficult to obtain from Teleglobe the information required to establish a proper record on which to base a decision. Similarly, interveners found it difficult to obtain the information they needed to prepare their positions properly.
Teleglobe's failure to provide sufficient, clear and accurate information in a timely manner required the Commission and interveners to expend additional time and effort in an attempt to lay an appropriate basis for the hearing. It also necessitated additional work for Teleglobe, obliging it to respond to supplementary interrogatories and other requests for information that would have been unnecessary had the company provided adequate information in the first place. Notwithstanding the supplementary rounds of interrogatories, the Commission and interveners found it necessary to expend additional time and effort in examination and cross-examination at the hearing in order to deal with matters that remained incomplete or vague.
At the outset of the proceeding, Unitel and several other interveners complained about the adequacy of Teleglobe's 26 March 1991 evidence relating to form of regulation. In Public Notice 1990-102, the Commission had specifically sought comment on the most appropriate form of regulation for Teleglobe in the post-transitional period. Teleglobe's failure to file evidence on this issue, together with its stated intention not to file a specific proposal on an alternative method of regulation in this proceeding, led the Commission to find Teleglobe's evidence in this area to be deficient. As a result, the Commission found it necessary to depart substantially from the procedures set out in the Public Notice in order to ensure that matters related to form of regulation could be adequately addressed during this proceeding. In particular, the Commission was obliged to accelerate a deficiency and confidentiality process, seek additional evidence from the company, add a supplementary round of interrogatories (including a separate deficiency and confidentiality process) and delay the date for the filing of interveners' evidence.
In several instances, Teleglobe's responses to interrogatories were incomplete, inaccurate or contradictory. In Part VIII, Section C, above, dealing with the company's operating expenses, the Commission describes the difficulties it experienced attempting to obtain information with respect to Teleglobe's rental expenses for terrestrial and satellite circuits in Canada. In addition to these difficulties, Teleglobe's responses to eight of the Commission's 600 series of interrogatories (which dealt with operating expenses) were deficient and had to be re-addressed in the first supplementary round of interrogatories.
In interrogatory Teleglobe(CRTC)12June91-2425, the Commission asked Teleglobe to provide, among other things, the most recent bond rating reports on Memotec by Canadian and American bond rating agencies. Teleglobe's response to this interrogatory was filed on 2 July 1991. With its response, Teleglobe provided copies of a CBRS report dated 28 May 1990 and a DBRS report dated 27 July 1990. The latter, however, was not the most recent report available. In fact, DBRS issued a report on Memotec on 26 April 1991, more than two months before the filing of Teleglobe's response to interrogatory Teleglobe(CRTC)12June91-2425.
Teleglobe set out its position on resale and sharing in evidence and in interrogatory responses prior to the commencement of the hearing. Many parties considered that Teleglobe changed that position at the hearing. In reply argument, Teleglobe stated that the essence of its position had not changed, and that the parties in question had obviously failed to understand that position.
If it is indeed true that Teleglobe's position on resale and sharing did not change in the course of this proceeding, then the company clearly failed to set out its position adequately in its initial evidence. In the Commission's view, any confusion as to Teleglobe's position is attributable to Teleglobe and to the quality of its evidence, and not to the other parties to this proceeding.
Of particular concern to the Commission is the timing of Teleglobe's filing of Amendment 2 to Contract 2025, discussed in Part VIII, Section B, above. Among other things, this Amendment had the effect of significantly increasing the total amount payable by Teleglobe to its affiliate, Memotec Datacom, pursuant to the contract. Although dated 8 May 1991 and executed by representatives of Teleglobe and Memotec Datacom on 6 July and 19 July 1991, respectively, the existence of Amendment 2 was not brought to the Commission's attention during the hearing. Rather, it was not filed with the Commission until 5 September 1991, more than one week after the completion of the hearing, at which the company's witnesses were questioned extensively about Contract 2025.
Contract 2025 was initially filed in this proceeding on 16 March 1991 in response to interrogatory Teleglobe(CRTC)26Feb91-408 (CRTC- 408), which requested details relating to actual or estimated payments made or received for goods or services received or rendered by Teleglobe under contracts between it and affiliated companies for the years 1989, 1990 and 1991. In interrogatory Teleglobe (CRTC)25Apr91-1441 (CRTC-1441), the company was asked to update the data for 1991 provided in response to CRTC-408 and to include information for the months of March to June 1991. Amendment 2 was not mentioned in Teleglobe's response to CRTC- 1441, dated 27 May 1991, nor was it mentioned when the response was further updated on 2 July 1991. As noted above, the Amendment is dated 8 May 1991.
It is clear from the foregoing that information relating to Amendment 2 to Contract 2025, and the Amendment itself, was available and should have been provided to the Commission in the context of this proceeding, either as a draft amendment in response to CRTC-1441 or, subsequent to 19 July 1991, as an executed amendment to Contract 2025. Had Amendment 2 been filed before or during the hearing, the Commission would have been in a position to investigate the Amendment and the circumstances surrounding it.
The Commission recognizes that this proceeding provided Teleglobe's first experience with an oral public hearing before the Commission since coming under federal regulatory jurisdiction. It also notes that several of Teleglobe's senior officers attempted to be as helpful as possible in their participation as witnesses to the company's evidence during that hearing. Nevertheless, the Commission considers Teleglobe's inability or unwillingness at various stages of this proceeding to provide adequate and timely information to be unacceptable. The Commission expects Teleglobe to take whatever steps are necessary to ensure that these problems do not occur in the future.
Allan J. Darling
Secretary General
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