ARCHIVED - Telecom - Commission Letter - 8652-B2-01/02 - Use of an after-taxweighted average cost of capital (AT-WACC) in Phase II cost studies - City ofCalgary's Deficiency Request

Letter

File No: 2002.8652.B2.01

Ottawa, 9 December 2002

BY TELECOPIER

To: Parties to Public Notice 2001-37 (attached list)

Re: Use of an after-tax weighted average cost of capital (AT-WACC) in Phase II cost studies - City of Calgary's Deficiency Request

Pursuant to the revised procedures set out by the Commission in its letter dated 20 November 2002, this letter deals with the deficiency request filed by the City of Calgary (Calgary) on 12 November 2002. In its letter, Calgary made several claims of deficiency related to the incumbent local exchange carriers' (ILECs') responses to its 18 October 2002 interrogatories regarding the underlying variables and assumptions associated with the ILECs' proposed after-tax weighted average cost of capital (AT-WACC) approach.

On 22 November 2002, Aliant Telecom Inc., Bell Canada, MTS Communications Inc., Saskatchewan Telecommunications, (collectively, the Companies) and TELUS Communications Inc. (TELUS) filed responses to Calgary's request. On 27 November, Calgary filed reply comments regarding this matter.

Calgary's Request for Further Information

Calgary submitted that in its letter of 24 September 2002 the Commission had stated that the merits of the ILECs' proposed methodological change would be considered. Calgary indicated that to that end, it submitted interrogatories to obtain information that would allow an understanding of the merits of the proposed change, the underlying variables and assumptions used in the AT-WACC methodology, and its application by the ILECs.

Calgary submitted that to date, the ILECs had not provided the details to permit public scrutiny of those variables and assumptions to test the methodology. Calgary noted that the ILECs had not provided any substantive evidence, including expert testimony, that would demonstrate the appropriateness of the use of AT-WACC for regulatory purposes. Calgary noted that the record consisted primarily of two letters from the Companies. Calgary submitted that the Companies had made numerous unsubstantiated claims that there would only be a minimal impact resulting from a change to the use of AT-WACC. Calgary argued that its interrogatories provided the ILECs with the opportunity to supply the details that would substantiate the claims, but that the ILECs chose not to use that opportunity to provide the requested evidentiary support.

Calgary submitted that to a large degree, the Companies had failed to provide the requested information that was aimed at uncovering the underlying variables and assumptions in the methodology. Inclusive of the various subparts, Calgary stated that it asked 70 questions, and noted that the Companies had argued that 57 (or 81%) of those questions related to information that was irrelevant and unnecessary. Calgary submitted that the failure of the ILECs to provide sufficient responses led to an evidentiary record that was inadequate.

As an example of deficient information, Calgary pointed to the response to The Companies(Calgary)18Oct02-1 AT-WACC where the Companies provided information on the methods used to determine the cost of debt. According to Calgary, the Companies did not provide the depth of response that would support the choices of measurement for debt cost, how the debt rate was determined, or how the debt ratio was determined.

Calgary further submitted that further confusing the record was the revelation that the cost of debt, as estimated by TELUS, reflected TELUS' estimate of the cost of new long-term debt for TELUS Corporation, based on information provided by various investment dealers. According to Calgary, TELUS indicated that: (1) it was not using its own debt to determine its debt costs; (2) it was using information from various investment dealers; (3) it was an estimate by TELUS; and (4) it was an estimate of the cost of new debt only. Calgary added that there was no information to properly compare the processes used by TELUS relative to those used by the Companies.

Calgary submitted that the foregoing were but examples of the inconsistencies and difficulties posed by the state of the record, to date. Calgary submitted that these were major deficiencies of the current record, and as such there was little, if any, evidence that could be used to justify AT-WACC methodology, or to assure the Commission that it and all parties had a common understanding of the inputs and application of the methodology. Calgary submitted that its questions had been directed at obtaining information that would provide a substantially improved record and which would allow an informed decision by the Commission.

Calgary requested that the Commission require the ILECs to provide detailed responses to the interrogatories it had posed. If the request were granted, Calgary submitted that additional time would be required to provide the responses, and for parties to review those responses. Calgary therefore requested that the Commission provide a date certain for responses together with a requirement for written submissions two weeks following that date, which would accord to the original schedule.

Overall arguments opposing Calgary's request for further responses

In response to Calgary's request, TELUS submitted that most of Calgary's 12 November 2002 letter was devoted to comments and did not directly identify the specific interrogatory responses that it believed to be deficient. TELUS claimed that in fact, the only direct citations referenced by Calgary were responses to interrogatories The Companies(Calgary)18Oct02-1 AT-WACC and TELUS(Calgary)18Oct02-2 AT-WACC.

With regard to interrogatory response TELUS(Calgary)18Oct02-2, TELUS submitted that Calgary was provided with a full and complete response. If Calgary found that it was not able to compare TELUS' processes to those of the Companies as it has asserted, it was not because TELUS had failed to provide the information requested by the City of Calgary in this interrogatory. In fact, Calgary itself acknowledged four distinct pieces of information from the response provided by TELUS.

TELUS noted that it had documented the reason why it was not providing more detailed responses to interrogatories 13 through 28 from Calgary in its covering letter dated 1 November 2002. TELUS reiterated that it was unable to provide more detailed responses to these interrogatories because these interrogatories were posed in the context of quotations from a manual that TELUS did not have. TELUS further submitted that its position in this regard had not changed.

The Companies submitted that the parameters applicable to economic studies conducted by Aliant Telecom, Bell Canada and MTS were determined in Decision 98-2. The Companies noted that in the proceeding leading to that decision, the subjects of capital structure and return on equity including risk premium methodology, risk-free rate, market risk premium and beta coefficient were thoroughly examined by the Commission and interveners (including Calgary) involved in the proceeding. The corresponding parameters for SaskTel were determined in Decision 2001-238.

The Companies noted that their Part VII application regarding Decision 2001-238 did not request a change to any of the parameters applicable to economic studies filed by the Companies, nor did the application request that the Commission affirm the parameters established in the decisions cited above.

The Companies submitted that where Calgary's interrogatories raised questions that were pertinent to the actual methodological issues regarding the appropriateness of AT-WACC methodology for use in Phase II costing studies, they did provide the information requested by Calgary. The Companies submitted that, however, in many instances Calgary chose to focus its questions on issues related to the actual determination of the values of the parameters that would be used to calculate an AT-WACC. The Companies argued that since the Companies were not proposing to alter the values or derivation of any of the parameters used in their Phase II costing studies and were not seeking an affirmation of the parameters already established by the Commission in the decisions cited earlier, these issues were not pertinent to their application to use an AT-WACC methodology in Phase II costing studies. Further, as the Companies noted in their responses to many of Calgary's interrogatories, issues related to the derivation of the elements used in the calculations under either the AT-WACC or the hybrid cost of capital approach would be more appropriately addressed in the upcoming Phase II methodology review, as per Decision 2002-34. Given the above, the Companies indicated that the issues raised by Calgary were irrelevant and unnecessary to a decision in this proceeding.

With respect to The Companies(Calgary)18Oct02-1 AT-WACC, the Companies reiterated that they were not proposing to change any methods and procedures related to the cost of debt or its calculation. The methods and procedures related to the cost of debt and its calculation were already known to the Commission and had been approved by the Commission. The selection of an AT-WACC or a hybrid cost of capital did not rest on any issues related to the measurement or value of the cost of debt. In the context of this proceeding these issues were irrelevant.

In conclusion, the Companies submitted that Calgary's comments and claims of deficiency were founded upon a misapprehension of the nature of the Companies' application. Indeed, as discussed above, the Companies had provided full and complete responses to Calgary's interrogatories wherein the information sought was relevant to the issues in this proceeding. On this basis, the Companies submitted that Calgary's claims should be rejected.

Factors in the assessment of requests for further responses

With regard to requests for further responses, the requirements of subsection 18(2) of the CRTC Telecommunications Rules of Procedure (the Rules) apply. The general principles enunciated by the Commission in past proceedings include the following considerations.

The major consideration is the relevance of the information requested to the matter at issue.

The availability of the information requested is also a factor, which is balanced against the relevance of the information. If the provision of the information sought would require an effort disproportionate to the probative value of the information itself, further responses will not be required.

Another factor considered is the extent to which an interrogatory answer is responsive to the interrogatory as it was originally asked. Generally, parties are not required to provide further responses to requests for further information from a party that did not ask the original interrogatory.

Conclusion

Many of Calgary's interrogatories focussed on issues related to the actual determination of the values of the parameters that would be used to calculate an AT-WACC. Commission staff agrees with the Companies that such issues are not pertinent to the application of an AT-WACC since the Companies are not proposing to alter the values or derivation of any of the parameters used in their Phase II costing studies. Commission staff considers that any issue related to the derivation of the parameters used in the calculations under either the AT-WACC or the hybrid cost of capital approach would be more appropriately addressed in the upcoming Phase II methodology review, as discussed in paragraph 1008 of Regulatory Framework for Second Price Cap Period, Telecom Decision CRTC 2002-34, 30 May 2002 (Decision 2002-34). Commission staff however considers that some of the information sought by Calgary's interrogatories is relevant to obtaining a better understanding of the merits of the proposed AT-WACC approach and should be answered. These have been identified in Attachment 1.

In interrogatory The Companies(CRTC)18Oct02-3 AT-WACC, the Companies were asked to "provide a complete discussion on the theoretical merits of the proposed AT-WACC approach considering the results obtained in (questions) 1 and 2 above". In response to this interrogatory, the Companies provided a one-paragraph answer and submitted that the AT-WACC approach recognized the principle that

all cash flows had an impact on financing requirements while the hybrid before-tax cost of capital approach did not. The Companies further submitted that although the hybrid approach could accommodate this principle, for practical reasons and to be consistent with internal business decision processes, the Companies had proposed the AT-WACC approach to adopt this principle. In response to the same question posed in TELUS(CRTC)18Oct02-3 AT-WACC, TELUS similarly submitted that it was of the view that financing requirements for expenses net of revenues should be treated in the same manner as capital.

Commission staff is of the view that such changes in financing assumptions may cause changes in the income tax treatment of the expense cash flows and lead to different calculations of Phase II income tax costs. Commission staff considers that the responses to the above interrogatories do not adequately document the changes in the income tax cost calculations, methods and procedures, and underlying assumptions that would occur as a result of the proposed change from the hybrid before-tax cost of capital approach to the AT-WACC approach.

The further responses to interrogatories to be provided pursuant to this letter will afford parties a more meaningful opportunity to understand the merits of the proposed changes to the AT-WACC methodology compared to the before-tax hybrid cost of capital approach.

Having regard to the considerations set out above, the information subject to a request for further response listed in Attachment 1 is to be placed on the public record of this proceeding. The ILECs are directed to provide in Attachment 1 a complete response to TELUS(CRTC)18Oct02-3 AT-WACC and to The Companies(CRTC)18Oct02-3 AT-WACC, such that each response provides detailed changes in the costing methods and procedures between the two approaches. The response should further provide rationale for the change in financing assumptions.

The ILECs are to file with the Commission all information to be provided pursuant to Attachment 1, by 6 January 2003, serving copies on interested parties by the same date. Interested parties may supplement their comments by filing them with the Commission, serving other parties, by 17 January 2003. The ILECs may file their reply comments, serving other parties, by 24 January 2003.

In the alternative, the ILECs may choose to defer the entire matter to the upcoming Phase II methodology review, referred to in paragraph 1008 of Decision 2002-34. If so, the ILECs are to advise the Commission, copying other parties, by 6 January 2003.

Yours sincerely,

Original signed by Shirley Soehn

Shirley Soehn
Executive Director,
Telecommunications

Attachment

c.c. Yvan Davidson, CRTC, (819) 953-5414

Attachment 1

The Companies(Calgary)18Oct02- AT-WACC
Provide complete responses to the following City of Calgary's interrogatories:

7, 22, 23, 25, 27, 28, 30, and 31.

TELUS(City of Calgary)18Oct02- (AT-WACC)
Provide complete responses to the following City of Calgary's interrogatories:

8, 15, 22, 24, 26, 27, 30, and 31.

The Companies(CRTC)18Oct02-3 AT-WACC
Provide a complete response to this interrogatory, describing the changes in the costing methods and calculations due to the proposed changes in financing assumptions.

TELUS(CRTC)18Oct02-3 AT-WACC
Provide a complete response to this interrogatory, describing the changes in the costing methods and calculations due to the proposed changes in financing assumptions.