Document 2'2 The economic regulation tools : Financial and technical audits, modelling

1
ITU/EC Project  Capacity building Regional
Workshop  Regulatory Practices
Doc. N2.2 The economic regulation
tools Financial and technical audits, modelling
Mohamadou A. SAIBOU ITU Consultant
2
Content of the Presentation

• Objective of the presentation
• Audit
• Modelling

3
Objective of the Presentation

• The objective of this presentation is to give an
  overall view of some economic regulation tools,
  such as audit and modelling

4

• Introduction
• The regulator must have a certain number of tools
  allowing him to fulfil his mandate. The main
  tools are
• Modelling
• Audit
• surveys
• Monitoring of technological development
• Market monitoring watchdog
• Monitoring of operators
• This presentation is about AUDIT and MODELLING

5
I- AUDIT
6

• Regulators missions
• In the field of telecommunications, the regulator
  is entrusted with the mission of
• Guaranteeing the users interests
• Creating the condition of an effective and fair
  competition on the whole market
• Ensure national coverage at reasonable prices
• So as to reach these objectives, reference to
  costs proves to be of utmost importance, they
  have therefore to be measured correctly which is
  the purpose of audit.

7
Definition and purpose of Audit
General definition of Audit Inspection made by
an independent and competent specialist in order
to give a justified opinion on the sincerity and
integrity of the financial accounts and
statements. Source OECF
8

• Definition and Purpose of
  Audit
• Definition
• An audit is a methodological examination of a
  situation by a structured, independant and
  competent team which
• Ensures the materiel authentication of the
  elements it has to check ,
• Checks whether the processing of facts are in
  compliance with the rules, standards and control
  procedures.
• With the aim of showing the strenghts, weaknesses
  and risks associated with this situation in
  comparison with standards and procedures.

9

• Definition and Purpose of
  Audit
• Why conducting an audit ?
• All the costs and proceeds generated by the
  provision of services  offered  by operators
  must be known.
• The regulator can allocate the costs in a
  consistent way
• It is important that the signals given are as
  clear as possible, so that investments
  decisions are based on reliable informations.

10

• Regulatory framework The case of
  Morocco
•  The operators of public telecommunications
  networks must hold a cost accounting system
  allowing to determine the costs, products and
  results of each network operated or service
  provided.
• The summary statements published, at the latest
  within the three (3) months subsequent to the
  closure date of the fiscal year, by the cost
  accounting departmentmust be reported yearly for
  audit to an organization selected by the ANRT.
• The purpose of the audit is to particularly
  ensure that the summary statements reflect both
  regularly and faithfully the costs, products and
  results of each network operated or service
  provided. 
• Article 4 of decree 2-97-1026 on general
  conditions of operation.

11
The Case of Burkina Faso
 Operators shall establish a cost accounting
system allowing to identify the costs of general
network, the interconnection service specific
costs and the operators services specific costs
other than interconnection. 
12

• The case of Burkina Faso
• The ARTEL, in accordance with the legislative
  and regulatory provisions, was able to audit
  with the help of a consultant (at startpoint) the
  final costs on all telecommunications networks
  (fixed and mobile).
• Objectives Collect and ascertain a certain
  number of information elements typical of
  telecommunication networkrs in order to feed the
  interconnection tariff setting model.

13

• The case of France
• The Decree of march 12, 1998 authorizing the
  company France Télécom to establish and operate a
  telephone network acessible to the public and to
  provide telephony service to the public states
  that
• The audit particularly checks the coherence of
  the seperate accounts compared to the operators
  general and cost accounts. The auditors must be
  different from the operators auditors. They
  issue a certificate of compliance. This audit can
  be the same as that provided for in article 18 on
  the terms of reference attached to the
  abovementioned decree no 96-1225 of december 27,
  1996.
• As for article 18 on the terms of reference
  attached to the above mentionned decree no
  96-1225 of December 27, 1996, it enacts that
  France Télécom shall hold a system of information
  as well as a system to account the services and
  activities, which must particularly allow to
  check compliance with the cost orientation
  principle when applicable .

14

• The role of audit as a regulation tool
• Audit is a decision making, negociation and
  monitoring tool, and helps
• Confirm that the returns on costs and earnings
  recorded are exactly the same as those resulting
  from the allocation and disbursement rules
  presented to the regulator.
• Ensure that costs and earnings forecasts are
  based on the best informations available at
  the level of the operator.
• Give a point of view on allocation and
  disbursement rules used by the operator and
  ensure these comply with his regulatory
  obligations.
• Advise if necessary the regulatory authority on
  the evolution of allocation and disbursement
  rules to be used in order to enforce the
  regulatory framework.

15

• Audit and Pricing
• The audit helps the regulator
• To prove the accuracy of connection and
  subscription costs used to calculate the maximum
  tariffs, that can allow to access telephone
  service at an affordable price.
• To check whether the tariffs reflect the costs
  of some services, such as voice telephony for
  instance
• To ensure that tariffs are cost-oriented it
  consists in approving the interconnection
  catalogue and to ensure that the tariffs pay for
  the effective use of the networks.
• Ensure that accounting seperation is applied by
  the operator because it is an information tool
  for the regulator.

16

• Audit and Interconnection
• Audit allow to check whether interconnection
  tariffs are really based on the following
  principles
• The costs taken into account must be relevant
• Costs must aim at increasing economic efficiency
  in the long term
• Tariffs include an equitable contribution.
• Tariffs include a correct interest on
  investments made.

17

• The stages of the audit
• A preparation stage
• A control stage
• A conclusion stage

18

• The preparation stage
• Establish contact with the organisation to be
  audited
• Identify and inventory the main internal and
  external risks
• Formalise the main control objectives
• Write an orientation report of the study that
  will serve as a guideline since it states all the
  objectives whose achievement level are to be
  checked.

19

• The preparation stage (cont/end)
• Draw up the list of all action controls to be
  performed to allow the auditor commit himself on
  the achievement level of the previously defined
  objectives.
• All control actions as well as the identification
  of stakeholders who will be involved represent
  the control programme.
• Kick off meeting where the preparation stage
  works are officially approved, which is also an
  opportunity to plan the control stage
  appointments.

20

• 2.The control stage
• The auditor checks and studies all the necessary
  proof elements that can allow commit himself and
  give a final point of view on the achievement
  level of the objectives listed in the orientation
  report.
• The sequence of this stage is done in compliance
  with the control programme presented during the
  kick off meeting.
• When the auditor discovers irregularities, he
  documents and formalizes them using a specific
  document the Finding and Problem Analysis
  sheet. (FPAS)
• The auditor must permanently have his findings
  and recommendations validated by the concerned
  stakeholders, all along the control stage.

21

• 3. The conclusion stage
• The auditor writes a draft audit report, that
  will be officially presented and submitted to
  the managers during the closing meeting, that
  should at least be attended by the same
  participants who were present at the opening
  meeting.
• During that meeting, the auditor presents the
  findings and comments the conclusions of his
  survey and have them officially validated.
• The audited organisation can make some comments,
  express some reservations, that can either be
  taken into account in order to change the
  document or be reported as such in the final
  report.

22

• Example Audit of interconnection costs
• The data to be collected
• The sources of information

23

• The information to be collected must concern data
  related to the following aspects
• The traffic by destination (local, national,
  international), incoming, outgoing (national,
  international), at off peak or peak hours
• The typology of the operators network and the
  different network components (switch,
  transmission, access network..)
• Investments costs (CAPEX ) and operating costs
  (OPEX) , by network element.
• Other miscellaneous costs (common, joint capital
  costs)

24

• The main sources of information

• Financial Statements
• Balance sheet, Profit and Loss Account, Cash Flow
  Statement
• Market Situation and commitments
• Human resources status
• Human resources file
• Reports and trade information system
• Tariffs
• Time range Modulations
• Traffic
• Subscriber base and segments
• Technical and network planning reports
• Structure of switch component
• Structure of transmission component
• Structure of local loop
• Capacities (installed and interconnected )

25

• Audit of Human Resources

26

• Audit of Human Resources

• Objective Identify the staff assigned to network
  and services
• On the basis of a list of all staff employed by
  the operator, a distibution will be made within
  the following areas of activity
• Switching
• Transmission
• Infrastructure
• Access network
• Added value services (internet, data transmission
  )
• Retail sales
• Common staff (Head office, etc)
• Not relevant (staff sent on secondement to other
  organisations)

27
Example of HR distribution Source ARTEL
(fictitious data)
28

• Commercial and Technical Audit

29

• Audit of business data on the traffic

• The different time ranges (PH, SH, Week-end
  H,etc)
• The distribuution of the traffic in on the
  basis of time range
• The tariff levels corresponding to time ranges
  (PH tariff selected equals 100)
• These data will be used to calculate the
  time gradient that will allow dicriminate
  interconnection tariffs according to the
  different time ranges.
• Traffic handling matrix
• Routing factors (Number of times an inrush call
  uses a switch node or a transmission link)

30

• Audit of planning and technical data

• The audit will apply to
• The traffic handling matrix
• Measurement of efficient and inefficient calls
• Traffic measurement
• At the most busy hours of the year (traffic
  curve)
• Within the same network (local and national)
• Towards and from the other national operators
• On the International (incoming and outgoing)
• In the case when these traffic volumes (local and
  national) are not available, a solution could be
  to act on the representative terminals of the
  network and further make some extrapolation.
• These traffic asessments, once available must be
  validated through crosscheking.

31

• Audit of planning and technical data

• Measurement of the average duration of each call
  expressed in minutes.
• Progression expected in for each type of
  communication. We can take into account the
  traffic increase in the current year. These
  variables are important because they will help in
  the sizing of the network (nodes and arteries).
• Average answer time for efficient and
  inefficient calls expressed in seconds.
• Percentage of efficient calls.

32

• Audit of the switch component

• The audit task must consist in
  inventoring the total number of switching nodes
  (CAA, URAD, CT, CTI), according to the following
  classification
• Number of CAA connected with their URAD
• Number of CAA connected by satellite ( Domsat
  Systems)
• Number of nodes connected by SDH loop
• Number of CAA with transit role
• Number of CAA serving as points of
  interconnection (POI)
• Installed and connected capacity
• Replacement project ( prospective approach study
  the best technologies with current costs)

33

• Audit of the Transmission component

The different transmission carriers will be
audited

• Optical network
• Inventory all optical fiber connections precising
  their lenght and also according to
• The routes type (segments located between two
  concrete CAA-CAA and CAA-URAD connected nodes,
  international connections)
• The mix of STM line termination system (STM1,
  STM4, STM16, STM64)
• And by type of connection, distribute the network
  trenches in according to
• Coated line (urban)
• Light line (suburban)
• In the open ground line (rural)
• And determine their level of mutualisation
  (sharing with other types of networks)
• Radio relay system
• Inventory of all radio beam connections precising
  their lenght and according to
• The number and type of routes (segments located
  between two concrete CAA-CAA and CAA-URAD
  connected nodes, international connections)
• SDH closure (in 155 Mbps)
• Non SDH by radio termination system with a
  capacity of 34, 8 and 2 Mbps
• The satellite network ( Domsat network)
• Inventory of all Domsat connections Domsat and
  precise the route type.

34
Summary table of connected CAA-URAD links
Summary table of CAA-CAA connection
Summary table of links towards CTI
35

• The data collected both for switch and
  transmission can be summarized in the below chart
  

Rural telephony The number of terminal stations
have to be counted including their installed and
connected capacity, the number of terminal
stations and the number of relays corresponding
to central stations.
36

• The pylons
• Make an inventory of all transmission network
  pylons by
• Number
• Size
• Light pylons (lt40 meters)
• Average Pylons (between 40and 60 meters)
• Heavy pylons (over 60 meters)

37

• Financial Audit

38

• Audit of costs accounts and of Fixed Assets

• We shall make a Top-down allocation of cost and
  fixed assets accounts
• Objective Recover the shared costs and also the
  reconciliation between top-down and bottom-up
• The approach to be adopted is as follows
• Create an allocation key matrix of expenditure
  and investment items according to the following
  activities
• General networkl (Switching, Transmission,
  Infrastructures)
• Access network
• Retail sales
• Added value services
• Shared costs
• Non relevant costs

39

• Allocation of cost accounts
• From the general balance sheet, extract
  the costs accounts of common activities out of
  which we shall withdraw
• The allowance for depreciation and charges to
  provisions, since the model takes account of the
  investments (accounts 68 and 69)
• The shares and other capacity purchases which
  account for purchase of services from other
  operators
• Interest charges, (taken into account in the
  capital cost)
• The fees paid to the regulator (universal
  service)
• Allocation of investments (same procedure as with
  the costs).

40
Example of allocation
41

• Other financial elements to be audited

• Cost of the capital borne by the operator
• Make an inventory of year end loan stock as well
  as the corresponding interest rates Take account
  of short term loans trade debts if they are
  interest bearing.
• Determine the amount of shareholders equity
• Record the zero risk rate (interest rate of the
  of Treasury bonds)
• Determine the rate of return on shares (See
  regional Stock exchange for stocks and shares)
• Determine the beta coefficient which measures
  the volatility of the shares or of the sector of
  activity on the financial market (lt1)
• Record the profit tax rate.

Summary table of shareholders equity and debts
42

• Unit costs of equipments
• Generally, the cost of a network element is
  subdivided into 3 categories
• Fixed cost of the equipment
• Variable costs with the capacity
• By lines
• By subscribers (subscribers card)
• By BPN (MIC)
• Cost of site (real estate cost, cost of buildings
  and landscaping, cost of fixtures and fittings,
  cost of energy)

43

• (Costs of rural telephony
• Study the supply and installation markets of AMRT
  systems and markets.
• Study the civil engineering opportunities
  (construction of rural telephony site) in order
  to extract the following elements
• 
  
  
  
  
  
  
  
  
• Costs of optical transmission
• Study the markets for the supply and installation
  of optical cables and of interconnection
  equipments in order to extract the following
  elements
• Cost of optical fiber cables by meter
  (6,12,24,36,48,96 fibers)
• Cost of laying cables by meter (on the ground,
  lighted, coated)
• Cost of line termination systems and of STM
  cards (1,4,16,64)

44

• Costs of satellite transmission
• Stdy the markets for the supply and installation
  of Domsat systems in order to extract the
  following elements
• 
  
  
• 
  
  
• 
  
  
• Costs of radio relay transmission
• Study the markets for the supply and installation
  of radio termination systems, the construction of
  radio relay sites, and the supply and
  installation of pylons in order to extract the
  below mentionned elements
• The Cost of radio termination systems (155 Mbps,
  34 Mbps, 8 Mbps, 2 Mbps)

45

• Audit report
• Notes and discussions on the conclusions of the
  report.

46
Example Audit of France Telecom

• The audit carried out by the consultancy firm
  Mazars Guérard includes four batches Batch I
  audit of the cost accounting system (audit of
  completeness and of accounting and relevance
  analysis) Batch II audit of the elements
  that have a part in the determination of the
  final universal service net cost for the year
  2002 (Cost and earnings assessment for 2002 and
  audit of the year 2002 accounts per product or
  per service included in the calculation of the
  final universal service net cost for the same
  year). Batch III audit of the year 2002
  statutory accounts audit of the six seperate
  accounts of France Télécom licence for the year
  2002 including its operational accounts by
  product or by service as part of the seperate
  accounts for year 2002Batch IV Study of the
  interconnection related costs offer in terms of
  average incremental long term costs (AILTC)
  (control of replacement, cost calculations for
  France Télécom for the year 2004, cost
  calculation and allocation of partially leased
  connections for the same year).
• Source ARCEP, Decision n 2005-0027 of january
  18, 2005 that issues the year 2002 certificate
  of compliance for the costs booked in the
  seperate and operational accounts per product or
  service drawn up by France Télécom in the
  framework of its statutory obligations.

47
II- MODELLING
48
Definition of Modelling

• An economic model is a schematic representation
  of a phenomenon provided by the behaviour of one
  or many variables interconnected between
  themselves by a system of mathematical
  relationships.
• Models are used because all the economic
  behaviours form a highly complex system and there
  is a need for simplification.

49
Modelling as a regulation tool

• Designing a cost calculation model is one of the
  core elements used by the regulator to enable
  effective competition.
• It is an important tool if we consider cost
  aspects in the telecommunications sector.

50
Cost aspects in the telecommunications sector

• The telecommunications sector generates special
  costs which are
• partly fixed ones
• geographically variable
• shared between various activities
• irreversible

51
Major constraints to modelling

• A model requires large access to information
• Asymmetry of the information An ubiquitus
  characteristics in the telecommunications sector.
• Consultation with operators on computation
  methods is indispensable in order to reduce this
  incertainty.

52
The foundations for the selection of a cost
calculation model

• Various cost calculation models are possible. The
  methodologic choice made is determinated by the
  following
• Regulation and regulatory objectives
• The market structure
• The type of operators or the level of
  competition.
• The strategic and tactic behaviour innovation,
  investment and the tarrifs applied by the
  traditional operator.

53
Modelling and cost oriented tariffs

• Cost orientated tariffs are a universally
  recognised principle, both
• for the services provided to customers and for
  interconnections charges.
• Intense discussions are currently ongoing on the
  method used to model  costs
• Which costs to take ?
• How to allocate indirect costs, common costs?
• How to take account of the time factor?
• The basic principle is to provide acceptable
  advantage to the main operator, without
  transferring unjustified costs (planning
  mistakes, oversizing, unecessary activities to
  the production of the concerned segment )

54
Main interconnection costs calculation methods

55
Conclusion

• There is no miracle method/model
• There is no perfect method find out a method
  that is closer to the economic decision
  and use it in order to
• Better anderstand the costs
• Fix the acceptable brackets
• Help in the negotiations
• Lead this approach in a recurent manner in order
  to
• Improve the knowledge of costs
• React quickly to the market and to technico
  economic evolution.

56
Conclusion (end)

• The three essential aspects for the success of an
  efficient economic regulation are
• The setting up of a legal and regulatory
  framework that can allow the emergence of
  competition..
• A strong an free regulatory authority that can
  impose the respect of good conduct rules.
• An accounting and management control system for
  all operators that can help justify
  interconnection costs and revenues set in the
  general interest.

57
Thank you for your attention

• Mohamadou A. SAIBOU
• Tel [phone]
• Tel [phone]
• Tel [phone]
• Fax [phone]
• mohamadou.saibou_at_esmt.sn
• mohamadou.saibou_at_ties.itu.int