EUROPEAN COMMISSION. The Right Hon Jack STRAW MP Secretary of State for Foreign and Commonwealth Affairs Downing Street London SW1A 2AL United Kingdom

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1 EUROPEAN COMMISSION Brussels, 05.X.2005 C(2005)3660 final Subject: State aid N 267/2005 United Kingdom Rural Broadband Access Project Sir, I. PROCEDURE 1. By letter registered on 31 May 2005, pursuant to Article 88 (3) of the EC Treaty, the authorities of the United Kingdom (hereafter UK ) notified the planned Rural Broadband Access Project (hereafter RBAP or the measure ) promoting the rollout of broadband services in specific areas of England. By letter of 26 July 2005, the Commission requested additional information on the proposed measure to which the UK authorities replied by letter registered on 23 August II. CONTEXT 2. Advantage West Midlands ( AWM ), the Regional Development Agency for the West Midlands, has identified the development of a better information and communications technology infrastructure as a key tactic in achieving its strategy of creating the conditions for sustainable economic growth for the West Midlands. To achieve this target, AWM has decided to encourage the universal availability of affordable broadband throughout the West Midlands region. In a similar vein, the Regional Development Agencies of the South West of England Region ( SWRDA ) and the East Midlands Region ( EMDA ) joined forces with AWM to develop synergies for broadband development in their respective regions. 3. The rural nature and geographical remoteness of the concerned areas currently make them an unattractive investment for private broadband service providers, and, based on predictions and geographical coverage analysis, they will not receive service in the foreseeable future. 4. British Telecommunications (BT) announced that twenty-four remaining local telephone exchanges in the West Midlands region, that do not currently offer broadband, are commercially unviable for ADSL broadband services. These The Right Hon Jack STRAW MP Secretary of State for Foreign and Commonwealth Affairs Downing Street London SW1A 2AL United Kingdom Commission européenne/europese Commissie, B-1049 Brussels Belgium - Telephone: (0)

2 exchanges are in remote and rural areas and the capital investment necessary to upgrade these exchanges to offer broadband services makes the business case for these exchanges unviable. Equally, according to the UK authorities, other major suppliers have also expressed their unwillingness to invest in alternative broadband services in these areas due to the low population density,, which makes service provision commercially unviable. The same conditions apply as regards the target areas of the project located in the East Midlands region (Thorpe Cloud area) and in the South West of England (23 areas). 5. To achieve its strategy of universal broadband availability for the region, AWM and its partner agencies have devised the RBAP. The project identified the remaining post code areas in the region that do not currently have access to broadband and offers a financial incentive to suppliers to make wholesale broadband services available. It will be a mandatory requirement of the tender that suppliers will offer use of their network to ISPs on an open wholesale basis. Existing and emerging technology suppliers operating in the region were invited to bid for the tender on an open wholesale network basis. 6. Regional Development Agencies that neighbour the West Midlands Region joined the project adding post codes from their respective regions to AWM s RBAP Procurement where they would also like to make broadband available. Suppliers have also stated there that they are unwilling to make the necessary capital investment without aid. The South West of England Regional Development Agency (SWRDA) and the East Midlands Development Agency (EMDA) will add post codes for their own areas to AWM s list. 7. Implementing the eeurope Action Plan 2005 and the i2010 initiative 1, most Member States have put comprehensive national broadband strategies in place 2. The notified measure is linked to the UK s National Broadband Strategy which aims at boosting investments in broadband access to improve the availability of connectivity for end users at adequate prices and to bridge the digital divide between communities and businesses that can get broadband access and those that cannot. III. DESCRIPTION OF THE MEASURE 8. General objective: The measure aims at providing an open broadband wholesale service in specific geographic areas of the West Midlands, East Midlands, and South West of England which are currently not served and where there are no plans for coverage in the near future. The selected wholesale suppliers will offer their services to Internet service providers (ISPs) who in turn will provide retail services to end users at conditions and prices similar to urban areas 3. The measure thereby aims to prevent the creation of a broadband digital divide between communities and businesses that can get access to broadband services at a competitive market price and those that cannot Commission Communication COM(2004) 369 of , Connecting Europe at High Speed National Broadband Strategies Asymmetric broadband at about 512kbps to 2Mbps downstream and 256kbps to 512kbps upstream speed. 2

3 9. Legal basis: The measure is based on UK Government Policy implemented under the Regional Development Act 1998, Section 5 (1). 10. Beneficiaries: Direct recipients of the aid will be a single, or a consortium of, provider(s) of electronic communications services, in particular licensed telecommunications operators, service providers and system integrators. Indirect recipients will be third party providers who may gain access to the provided wholesale service and households as well as businesses in the targeted areas. 11. Service definition: The project seeks to procure access to an open wholesale infrastructure to enable ISPs to offer retail broadband services to end users. The successful suppliers will be required to establish contracts with ISPs who will provide services to end users to include a minimum asymmetric broadband service of 512kbps downstream and 256kbps upstream speed. The tender specifications stipulate that the selected providers will have to offer wholesale access on a non-discriminatory basis to other operators and service providers wishing to connect customers. The successful supplier may or may not offer its own ISP services over the network. It will, in any event, establish contracts with all ISPs requesting access that will provide services to end users. 12. Technology and infrastructure: The project aims at wholesale service provision and does not specify any technology. It is up to the service providers to build, buy or lease the infrastructure necessary and to provide the necessary equipment to provide the required service. The funding authorities do not seek to procure or take ownership of any infrastructure or telecommunications equipment. 13. Funding instrument: The aid will be in the form of a one-off fee, invoiced by the infrastructure suppliers to the managing authority, to off-set the initial installation costs. 14. Budget and aid intensity: [ ] *. The funding has been provided by AWM for the West Midlands post codes, SWRDA for the South West England post codes and EMDA for the East Midlands post codes. The aid intensities will only be known after the selection of the service providers, but the aid granted will be limited to the strict minimum necessary to enable the provision of the wholesale service. 15. Procurement: The selection of the service providers will be conducted in accordance with EU procurement rules. A prior information notice in the Official Journal of the European Union was published on 17 th February 2005 (2005/S , SIMAP reference ) and a full notice on 27 th April 2005 (2005/S ) and suppliers had until 1st June 2005 to express interest. Interested suppliers have been invited to attend a suppliers day on 19th May 2005 at which the project was presented. Suppliers who made submissions in line with the Contract Notice have been invited to tender 4. It is expected that the final contract, subject to a State aid standstill clause, will be signed in October The designated supplier will invoice the managing authority for the agreed price of enabling each target post code once this has been done successfully. * 4 Covered by the obligation of professional secrecy. See 3

4 16. Eligible costs: Eligible capital costs such as investments in communications networks and equipment necessary to provide the requested broadband services have to be directly attributable to the project and incurred during the period of the Broadband Service Agreement. No operating costs will be financed. 17. Duration of the measure: The duration of the roll-out phase will be dependent upon the winning suppliers but all target post codes are anticipated to be broadband enabled within twelve months of the contract becoming active. The service agreement will require the services to be provided for a period of 3 years, subject to a possible extension of up to 2 years for each enabled post code area. It is anticipated that, at the end of the measure, the selected suppliers will have secured sufficient clients to ensure break-even on the operating costs of the network and will continue to operate the network thereafter. 18. Monitoring: The selected suppliers will be required to provide a timetable for service delivery and details of the annual cost of the service provision and will be required to provide annual reports to the contracting authority covering various data, pricing information and a financial summary relating to the reverse payment mechanism. All requirements for monitoring will end on the submission of the final reports for the period ending 31 st March IV. ASSESSMENT OF THE MEASURE: PRESENCE OF AID 19. According to the EC Treaty and consolidated case-law there is State aid within the meaning of Article 87(1) when: there is an intervention by the State or through State resources; it confers an economic advantage on the recipient; it distorts or threatens to distort competition; the intervention is liable to affect trade between Member States; State resources 20. The Regional Development Agencies are funded by the central UK government and tasked with improving the sustainable economic performance of their respective regions. Hence their resources, which are used to finance the Rural Broadband Access Project, are to be considered as State resources. 4

5 Economic advantage 21. Selected service providers: A tender tends to minimise potential advantages to the service provider in terms of excessive returns. However, even if a service provider would not receive an excessive return on its overall investment, it receives financial support which provides the possibility of entering the market for wholesale broadband services and establishing its business on conditions not otherwise available on the market. 22. Resellers: Notwithstanding the wholesale character of the measure, third party providers of broadband services will also benefit from the State resources, as they will be customers of the selected service providers. In some of the areas covered by the project, there is no broadband infrastructure and therefore no wholesale offer at all, preventing market entry of third parties such as resellers without their own infrastructures. 23. End users: The objective of the State subsidy is to provide a wholesale service to enable retail broadband services to residential users and businesses at conditions which are currently not available in the areas eligible for funding. Whereas residential users are not subject to State aid rules, businesses in the targeted geography will benefit from service coverage beyond and prices below what would be provided purely on a commercial basis like, in some areas, currently offered leased line offers or satellite connections. Considering the number of users to be connected to the service, it seems that the advantage for each individual end-user beneficiary will be below the de minimis threshold. However, the UK authorities did not provide any assurance relating to the respect of Article 3(1) of the de minimis Regulation regarding cumulation and monitoring. Therefore it cannot be excluded that aid granted to end-users could exceed the limits set out in the aforementioned de minimis Regulation. 5 Distortion of competition 24. The intervention of the State alters the existing market conditions by allowing the provision of wholesale broadband services by the selected service providers, thereby enabling the provision of retail services by ISPs. A number of SMEs may be subscribing to these retail services instead of more expensive market-based solutions (for instance satellite or leased line offerings). Therefore, the fact that a new broadband service becomes available at a much lower price than existing albeit expensive solutions has the effect of distorting competition. 25. In addition, while the Regional Development Agencies involved decided to intervene precisely in view of the lack of private initiatives in the concerned areas, it cannot be excluded that market initiatives could become viable in some areas in the medium term. By securing this project, the chosen service providers will be capable of establishing an infrastructure and developing their customer base (ISPs), enjoying a first mover advantage over prospective competitors. 26. The scheme is also selective in that it is addressed to undertakings active only in certain regions or in certain markets for electronic communications services. These selectivity elements also induce a potential distortion of competition. 5 Commission Regulation (EC) No. 69/2001 on the application of Articles 87 and 88 of the EC Treaty to de minimis aid, OJ L 10, , p

6 Effect on trade 27. Insofar as the intervention is liable to affect providers of electronic communications services and service providers from other Member States, the measure has an effect on trade. The markets for electronic communications services are more and more open to competition between operators and service providers, which generally engage in activities that are subject to trade between Member States. There may also be an effect on trade between the businesses using the broadband services enabled by the measure and their competitors in other Member States, although the importance of that effect will probably be low. Conclusion 28. In view of the above, the Commission considers that the notified measure grants an economic advantage to the selected service provider(s), ISPs and final users that exercise an economic activity. The project is publicly funded, distorts competition and has an effect on trade between Member States. Therefore the Commission regards the notified measure as constituting State aid within the meaning of Article 87 (1) of the EC Treaty. 29. Having established that the project involves aid within the meaning of Article 87(1) of the EC Treaty to the selected service providers, third party providers using the open access provision and to businesses, it is necessary to consider whether the measure can be found to be compatible with the common market. V. ASSESSMENT OF THE MEASURE: COMPATIBILITY 30. The Commission notes that the project aims to ensure the widespread availability and use of high-speed broadband services in currently unserved areas with no prospect for coverage on commercial terms in the near and medium term and, as such, does not fall under one of the existing frameworks and guidelines. It should be noted that some areas covered by the project are located within areas eligible under the ERDF rules, as well as Art. 87 (3) (a) assisted areas within the meaning of the Regional Aid Guidelines. 6 However, other areas are outside these assisted regions and hence the measure cannot be assessed under the Regional Aid Guidelines. 31. The Commission therefore considers that the assessment of the compatibility of the measure with the common market needs to be based directly on Article 87(3)(c) of the EC Treaty 7 that states that: aid to facilitate the development of certain economic activities or of certain economic areas, where such aid does not adversely affect trading conditions to an extent contrary to the common interest may be considered to be compatible with the common market. 6 7 OJ 1998 C 74, p.9. This approach was also followed by the Commission in other cases, see for instance: State aid decisions for the UK: N126/04 Broadband for SMEs in Lincolnshire of , N199/04 Broadband business fund of , N307/04 Broadband in Scotland remote and rural areas of , N57/2005 Regional Innovate Broadband Support for Wales of and for Spain: N583/04 Broadband in rural and remote areas of (See: 6

7 Necessity of the measure 32. Broadband access is seen as a necessary step for the modernisation of the EU society and economy and is a crucial aspect of the Lisbon agenda. It is a prerequisite for the development of e-business, e-government, e-learning and e- Health projects. Implementing the eeurope Action Plan , the EU15 Member States have put comprehensive national broadband strategies in place. This process is now extended to all 25 EU Members The notified measure feeds into the UK National Broadband Strategy which was communicated to the Commission. By means of this strategy, the UK government intends to enhance the investments in broadband access via a variety of networks and technologies to improve the availability of connectivity for the end users at adequate prices. The strategy also aims at satisfying existing demand which may be unserved and to achieve a significant leap in broadband access in a very short time. 34. Broadband connectivity is a type of service that by its nature is capable of positively affecting the productivity and growth of a large number of sectors and activities. Regional economic development benefits resulting from greater broadband deployment can include job creation and retention, more industrial growth, improved education and health systems and even reduced traffic congestion 10. Finally, the social and economic case for broadband takes on added significance for rural and remote communities, where improved communications can address a variety of challenges posed by distance Lack of broadband coverage is due, among others, to some of the typical economic problems associated with networks industries. Broadband networks are generally much more cost effective to roll-out, and hence available at cheaper terms, where potential demand is higher and concentrated, i.e. in densely populated areas. Because of high fixed costs, unit costs escalate dramatically as population densities drop. Remoteness also plays a role, requiring bridging longer distances in the backhaul and in the last mile. In other cases it has been estimated that approximately 65-70% of the costs associated with the deployment of broadband in the access network is related to civil infrastructure. 12 In addition, although equipment costs have fallen as volumes increase, they remain a significant cost and major barrier to roll-out. In areas where demand is not very developed and coverage of cost is uncertain, private operators might find it difficult to find a source of funding for infrastructure projects, which have a long life and amortisation period. 36. The present project concerns areas with low population density and/or with difficult topology which act(s) as a significant disincentive to the private sector development of infrastructure necessary for the provision of broadband. The Commission has recognised the need to encourage the deployment of broadband COM(2002) 263. Commission Communication COM(2004) 369 of , Connecting Europe at High Speed National Broadband Strategies. US Department of Commerce, Office of Technology Policy, Understanding Broadband Demand, September OECD Broadband Driving Growth: Policy Responses, October Broadband Stakeholders Group Broadband in Rural Areas,

8 infrastructure in less favoured areas, where geographical isolation and/or low density of population can make the cost of upgrading the existing infrastructure unsustainable Public sector intervention is thus needed to support broadband rollout in some areas, providing seed money to jumpstart private investment in areas otherwise underserved. With the increasing public support for broadband initiatives, there is growing evidence that public intervention may accelerate the establishment of broadband networks in less profitable areas, whilst ensuring, by means of open access requirements, that competition is preserved in the future. 38. The notified measure will offset a geographical and commercial handicap and is objectively justified to address the lack of provision of a service due to the insufficient density of potential and actual subscribers to make delivering broadband services economically viable on a purely market-driven basis. The final target group of the measure includes both local businesses and citizens who will benefit from the availability of broadband services in both their day-to-day business activity and in the quality of life benefits that access affords to citizens. Proportionality 39. In order for the aid measure to be compatible with Article 87(3)(c) of the EC Treaty, it must be proportionate to the objective and must not distort competition to an extent contrary to the common interest. The trade-off between the advantages in terms of promoting the knowledge society and local economic development and the disadvantages in terms of distortion of competition and possible disincentives to private investment has to be assessed. The extent of the measure in terms of service definition, as well as project design features, should also be evaluated to ensure that the least distorting model, which would nevertheless produce the required results, is adopted. 40. Concerning the measure at hand, the Commission notes the following positive elements: (a) Open tender: the selected wholesale infrastructure suppliers benefiting from the subsidy will be solicited from the open market in accordance with EC rules and principles on public procurement. The tender is designed so as to minimise the cost of investment and the associated public funding, while still ensuring an appropriate level of service. Carefully defined and publicized award criteria aim at ensuring a competitive proposal by market players. (b) Technological neutrality: The project is technologically neutral, i.e. it does not favour a priori any given technology. (c) Wholesale access: The selected service providers will be obliged to provide wholesale access to service providers on a transparent and nondiscriminatory basis. The open access provision will be applicable as long as they continue to operate the network installed with the benefit of this funding through a post-termination clause requirement. It is anticipated 13 Commission staff working paper, Guidelines on criteria and modalities of implementation of structural funds in support of electronic communications, , SEC(2003)

9 that over the period covered by the funding, suppliers will have secured sufficient clients to ensure break-even on the operating costs of the network and will continue to operate the network thereafter, without additional public intervention. (d) Use of existing infrastructure: The freedom for the service providers to choose the most efficient way of procuring the necessary infrastructure, either by building, buying or leasing it from third parties minimises duplication and enhances economic efficiency. Since leasing facilities is expected to be more cost effective than building new infrastructure, existing operators have the possibility to contribute their infrastructure to the project, which limits the economic impact of the project for operators that may already have basic infrastructure in place. (e) Limited aid amounts: As a result of the open call for proposals, only the most competitive proposals will be selected. The selected providers are expected to contribute a sizeable amount of the total project costs. Moreover, a reverse payment mechanism, under which a progressive reimbursement of the public funding is expected to take place as demand for services picks up, ensures that only the minimum necessary public funds are used. Given the setup of the project and the number of potential end-users concerned, the aid amount potentially reaching resellers and end-users is likely to be limited. (f) Duration: Whilst the measure aims at ensuring sustainable solutions, the funding will be provided only for a limited amount of time, paid as a oneoff fee at the beginning for the full duration of the project. (g) Minimisation of price distortion: The appropriate pricing of the wholesale service is important to ensure that business end-users and third party service providers benefiting from the aid are not put in a position more favourable than their competitors located in regions where the same broadband services are available on market terms. For this purpose, the tariffs are benchmarked with tariffs offered by service providers in areas which do not benefit from aid, for instance BT s national wholesale price. 41. In view of the above, the Commission considers that the public intervention in the notified measure will only be provided to the extent necessary to develop the offer of broadband services in the designated areas where supply is not available on normal market terms. The intervention is designed in a way that does not distort competition to an extent contrary to the common interest. 9

10 Conclusion 42. In the light of the above, the Commission has come to the conclusion that the aid involved in the Rural Broadband Access Project is compatible with Article 87(3)(c) of the EC Treaty. VI. DECISION On the basis of the foregoing assessment, the Commission has accordingly decided that the aid scheme Rural Broadband Access Project is compatible with Article 87(3)(c) of the EC Treaty. If this letter contains confidential information which should not be disclosed to third parties, please inform the Commission within fifteen working days of the date of receipt. If the Commission does not receive a reasoned request by that deadline, you will be deemed to agree to the disclosure to third parties and to the publication of the full text of the letter in the authentic language on the Internet site: Your request should be sent by registered letter or fax to: European Commission Directorate-General for Competition State Aid Greffe Rue de Spa 3 B-1049 Brussels Fax No: Yours faithfully, For the Commission Neelie KROES Member of the Commission 10