Provisional Legislative Council

PLC Paper No. CB(1) 1189
(These minutes have been
seen by the Administration)

Ref: CB1/PL/ES & CB2/PL/IP

Panel on Economic Services and
Panel on Information Policy

Minutes of joint meeting held on Monday, 9 February 1998, at 2:30 pm in the Chamber of the Legislative Council Building

Members present :

Members of Economic Services Panel

Hon James TIEN Pei-chun, JP (Chairman)
Dr Hon LAW Cheung-kwok (Deputy Chairman)
Hon HO Sai-chu, JP
Hon Allen LEE, JP
Hon Henry WU
Hon Henry TANG Ying-yen, JP
Hon CHAN Choi-hi
Hon CHAN Yuen-han
Hon CHAN Kam-lam
Hon Howard YOUNG, JP
* Dr Hon Charles YEUNG Chun-kam
Hon Mrs Miriam LAU Kin-yee, JP
Hon Ambrose LAU Hon-chuen, JP
Hon LO Suk-ching

Members of Information Policy Panel

Hon CHOY So-yuk (Chairman)
Hon WONG Siu-yee
Dr Hon Raymond HO Chung-tai
Hon MA Fung-kwok
Hon TSANG Yok-sing
Hon Bruce LIU Sing-lee

Members attending :

Hon LEE Kai-ming
Hon Mrs Elsie TU, GBM
Hon Ronald ARCULLI, JP
Hon CHENG Kai-nam
Hon IP Kwok him
Dr Hon TANG Siu-tong, JP
Hon KAN Fook-yee

Members absent :

Members of Economic Services Panel

Dr Hon David LI Kwok-po, JP
Hon Paul CHENG Ming-fun, JP
Hon TAM Yiu-chung, JP

Member of Information Policy Panel

Hon David CHU Yu-lin

Public officers attending :

Mr Stephen IP
Secretary for Economic Services

Deputy Secretary for Economic Services

Information Infrastructure Special Adviser

Mr Geoffrey F WOODHEAD
Principal Assistant Secretary for Economic Services

Mr Anthony S K WONG
Director - General of Telecommunications

Senior Assistant Director of Telecommunications

Attendance by invitation :

Mr Norman K T YUEN
Deputy Chief Executive, Hong Kong Telecom

Mr Alistair GRIEVE
Deputy Chief Executive, Hong Kong Telecom

Dr CHAN Wai-kwan
Secretary General, Hong Kong Coalition of Service Industries
Clerk in attendance :

Ms Estella CHAN
Chief Assistant Secretary (1)4

Staff in attendance :

Mr Andy LAU
Senior Assistant Secretary (1)6

Mr Colin CHUI
Senior Assistant Secretary (2)2

* also a member of the Panel on Information Policy

I Election of Chairman

Members agreed that Mr James TIEN Pei-chun should preside over the election of Chairman. Mr TIEN invited nominations for the chairmanship. Mr TIEN was nominated by Mr CHAN Kam-lam and seconded by Miss CHOY So-yuk. Mr TIEN accepted the nomination.

2. There being no other nomination, Mr James TIEN Pei-chun was declared Chairman of the joint meeting.

II Resolution of the Hong Kong Telecom International Ltd licence

  1. Provisional Legislative Council Brief on the resolution of the licence of Hong Kong Telecom International Limited dated 20 January 1998 (File ref. ESB CR 9/1056/93(98));

  2. Provisional Legislative Council Supplementary Brief on the surrender of the HKTI licence - financial modelling and fair compensation;

  3. Provisional Legislative Council Brief on Telephone Ordinance (Chapter 269) - Telephone (Repeal) Regulation 1998 dated 6 February 1998 (File ref: ESB CR 9/1056/93(98)pt.16); and

  4. Provisional Legislative Council Supplementary Brief on the surrender of the HKTI licence - local network competition.

3. The Secretary for Economic Services (SES) briefed members that the Government had reached an Agreement with Hong Kong Telecommunications Limited (HKT) on 20 January 1998 whereby the Hong Kong Telecom International Limited (HKTI) licence with exclusive rights for certain external circuits and telephone services would be surrendered on 31 March 1998, 8.5 years earlier than its scheduled end-date of 1 October 2006. The exclusivities enjoyed by HKTI were out of line with best current international practices and had adverse implications for our regional competitiveness in telecommunications. As telecommunications underpinned the vital services sector of the economy, the exclusivities also had negative impacts for Hong Kong ' ss competitiveness as a whole. The Agreement with HKT for the early surrender of the HKTI licence was to rectify the situation. He stressed that this Agreement was a good deal for Hong Kong and the compensation payable by the Government was reasonable, modest and not excessive.

4. The Deputy Chief Executive of Hong Kong Telecom (DCE/HKT) briefed members that the HKTI licence represented a valuable asset, which had provided the basis for billions of dollars of investment by HKT that had made Hong Kong ' ss telecommunications infrastructure second to none in the world. As such, the decision by HKT to surrender the HKTI licence was not an easy one. While the cash compensation was an essential element of the Agreement, HKT believed that the overall agreement was beneficial not only to the Company, but also to other industry participants and to Hong Kong generally. As a result of the liberalization, the cross-subsidy from external services to domestic services could not be sustained. However, the Company was fully aware of the concerns of consumers and had agreed to keep the maximum price for residential line rentals below costs for three years and to forego the tariff revision in August this year until 1999.

5. The statements made by SES and DCE/HKT were tabled at the meeting for members ' s reference.

6. The Information Infrastructure Special Adviser (IISA) briefed members that it was a misconception that the HKTI licence was worthless and hence no compensation should be paid for the early surrender of the licence, for the following reasons :

  1. the introduction of call-back services had not posed any threats to the company;

  2. the increase in call-back traffic was beneficial to the Company as call-back traffic did not bypass HKTI ' s monopoly and it increased incoming revenue;

  3. the total compensation package payable to HKT represented less than 6% of HKT ' s market capitalisation of almost $200 billion; and

  4. between now and 2006, HKTI ' s after tax profit would be about $30 billion in net present value (NPV) terms.

He also advised that whilst policy reforms over recent years had already provided some forms of competition to the benefits of consumers, for example, charges on international calls were reduced through call-back operations; these benefits did not extend to all markets, e.g. the Mainland, a destination which accounted for more than 50% of Hong Kong ' s International Direct Dial (IDD) calls. To liberalize the market further would provide opportunities for telecommunications providers to offer alternative products and full services at lower prices. To honour the rule of law, the Government should not unilaterally terminate HKTI ' s licence simply on ground of public interest as this would not avoid the need to pay compensation. The Government considered the compensation payable under the Agreement reached with HKTI to be fair and reasonable, having regard to the tangible and intangible costs and benefits to the community as a whole.

7. A copy of IISA ' s presentation materials was tabled at the meeting for members ' s reference.

8. Members generally were in support of the proposal to liberalize the external telecommunications market so as to bring in more competition to the benefits of consumers. They, however, expressed concern about the justifications for the compensation and the proposal to repeal the price control arrangement, which might lead to higher tariffs for domestic customers. They were also worried that genuine and effective competition might not be achieved.

9. In response, IISA advised that since 1 July 1995, competition had been introduced to the operation of local fixed telecommunication network services (FTNS). Three new operators had been licensed to operate FTNS in competition with the incumbent operator, Hong Kong Telephone Company (HKTC). Notwithstanding the above, HKTC still had 98% of the market share in the supply of telephone lines. Under the Agreement, arrangements would be made so that at least 50% of the residential exchange lines of HKTC would be physically open to competition by the other FTNS operators by 1 January 1999, the date by which the first local tariff increase not constrained by the existing price-cap regulation was scheduled to be implemented. Full opening of HKTC ' s local exchange lines would be effected at a later stage. As a result of the Agreement, other industry players would be given the opportunity to participate in the telecommunications sector and make their own investments and by-pass completely HKTI ' s gateways and other facilities. It was considered that once effective competition in the supply of telephone lines was achieved, prices of the telephone lines would be constrained by competitive pressure and hence, there would be no need for price regulation through legislation.

10. As to the protection to consumers upon the repeal of the price control arrangement, IISA said that HKTC would initially be subject to price caps on the residential exchange line service. According to past experience, telecommunications competition in Hong Kong had proven to be very beneficial with reductions in prices to the consumer, improved quality, substantial innovation and a broader range of service offerings. The Agreement, taken together with the regulatory obligations, provided considerable consumer protection in respect of local exchange line tariffs. For example, the existing flat rate local charging system was locked in place. HKTC had also agreed to forego the price increase to which it would be entitled in August this year under the existing arrangements, so that local exchange line rental would remain effectively frozen at 1997 levels throughout 1998.

11. SES added that presently, among the four FTNS operators, only HKTC ' s tariffs were subject to the approval of the Telecommunication Authority. Even though the other three FTNS operators were not subject to the price control arrangement, they generally priced their lines below the level of HKTC. It was therefore expected that competitive pressure would probably prevent HKTC from increasing its tariffs to the maximum allowed. Furthermore, provisions had been made to restrict any form of anti-competition practices.

12. SES further advised that there were wider, strategic implications of the Agreement between the Government and HKT. Considering the benefits which were likely to flow from the surrender of the HKTI licence, even the tangible benefits alone (by way of IDD and leased circuit price reductions) would no doubt far exceed the costs to the community, which included the cash compensation, the royalty foregone and the potential increase in local tariffs. IDD reductions would occur on all routes even to the Mainland. This was a substantial improvement on the current situation where call-back operations only provided price competition to the liberalised routes but offered no relief to many other destinations (including the Mainland) where call-backs were banned. The many intangible benefits such as greater consumer choices, increased competitiveness of the economy, new investment and new employment etc., were as detailed in the information papers.

13. Regarding members ' s concern about the impacts of the Agreement on other operators in the industry, IISA advised that all existing Internet service providers, value-added service providers and external telecommunications operators would be allowed to continue their operation in the same way as under the present arrangements.

14. Members queried the reason for opening the market to existing FTNS licensees but not other operators. They pointed out that this would adversely affect genuine and effective competition. They asked for further information on the eligibility and assessment criteria for the future external services licence. IISA advised that in accordance with the Government ' s established policy of not limiting the number of service-only operators, a new non-exclusive external services licence would be drafted. Applications for the new licence would not be invited until after the Government completed its FTNS review in mid 1998. Final decisions on who might apply, the number of licences, the scope of the licences and relevant terms and conditions had not been made yet. However, in order to liberalize the market at the earliest possible date and having regard to the international practice that domestic line operators would also be allowed to operate external services, consideration was given to the three other existing FTNS licensees to supply non-exclusive external services from 1 January 1999 and external facilities from 1 January 2000. He assured members that the question of additional external facilities based competitors would be considered in the context of the 1998 FTNS review.

15. SES added that the benefits of competition in the local mobile telecommunications sector were already evident and such benefits would be extended to the external market upon liberalisation. Compared with other countries, Hong Kong was already one of the most open and competitive telecommunications markets in the world. Given the size of Hong Kong, there would be sufficient competition even if there were only four FTNS operators in the market at the initial stage.

16. Members expressed concern that genuine and effective competition might not be achieved as HKT would remain the sole supplier of external leased circuit services until facilities based competition commenced on 1 January 2000. The Director-General of Telecommunication advised that HKT would not be allowed to raise its charges on external leased circuit services, which were an essential input to the business of international simple resale competitors before 1 January 2000. All service providers were entitled to obtain from HKT external leased circuit services in accordance with its published terms and conditions. Under facilities based competition, they would be able to provide public services over their own infrastructure (e.g. satellite stations and cable capacity) and by-pass completely HKTI ' s gateways and other facilities.

17. DCE/HKT added that upon the surrender of its exclusive international licence, the Company ' s revenue would be affected. It was envisaged that the revenue to be generated from the leased circuit services would not be adequate to cover the loss incurred upon liberalization of the market. Nevertheless, the Company would introduce value-added services and improvement measures so as to retain market share and cut costs. IISA advised that the revenue generated from leased circuit services would be further reduced with the improvement of compression technology in transmission.

18. Some members enquired whether FTNS operators were prepared to make substantial investments on their own so that a competitive environment to the benefits of consumers would be created. IISA advised that the Government would take the opportunity to reform the delivery fee arrangements, which set out the revenue sharing mechanisms between the international monopoly and the local operator(s), to correspond with the emerging global reality. The policy objective was to create a viable environment for operators to invest in the local market. The Administration would consult the industry on a proposal to amend the delivery fee arrangements. SES added that in response to the Agreement, one FTNS operator had recently announced its forecast investment of $8 billion and the creation of 1000 jobs.

19. Noting that the amount of compensation was intended to be the net amount received by HKT, free of tax, a member enquired whether the exclusive telecommunications licence to HKTI was regarded as a capital asset of the company which was, indeed, not chargeable to profits tax. IISA advised that subject to the assessment of the Inland Revenue Department, the Administration intended to ask the Finance Committee of the Provisional Legislative Council to appropriate a grossed-up sum of $8 billion inclusive of HKT ' s liability for tax but the tax portion would be withheld by Government.

20. As to members ' s concern about the need for taxpayers to bear the cost of the compensation but not other FTNS operators or users of IDD services, who would directly benefit from the liberalization, IISA advised that at present local telephone services were subsidised by about $1 billion annually by the external services. As external services became increasingly competitive, it was not possible for this subsidy to continue. In addition, the cross-subsidy was simply unsustainable as the international accounting settlements system was undergoing a dramatic reform such that no element of supra-normal profit would remain to fund local cross-subsidies. In the transition of the local telecommunications market from monopoly to competition, it was unlikely that the high levels of cross-subsidy which had historically flowed from external services to local services would be able to be supported, because FTNS operators would have no incentive to invest in a loss-making service. He, however, undertook to review whether it was feasible to impose a special levy on IDD users so as to recoup the compensation payable to HKT.

21. Regarding the basis for the compensation amount, IISA advised that in order to assess fairly the financial impact on HKT of the early surrender of the HKTI licence and to estimate the corresponding tangible benefits, the Administration constructed, with the assistance of a consulting firm, a financial model of the fixed external and internal telecommunications market in Hong Kong. The total cost of the Agreement to the community was a maximum of $13.2 billion, well below the tangible consumer benefits of $17.1 billion (NPV). HKT would not be able to realise all of this as some would accrue to its competitors. The Administration estimated that the amount HKT would realize in compensation would not exceed the lower bound of their valuation range for the licence of $12 billion to $20 billion (NPV). The Administration was confident that the Agreement reached with HKT was a reasonable one and a good deal for Hong Kong. SES added that the cash compensation of $6.7 billion to HKT for the surrender of the HKTI licence represented only about one third of the $18.1 billion (NPV) in returns already received by the Government from the HKTI licence. As such, it represented a justifiable investment to unlock the benefits that the surrender of the HKTI licence would deliver.

22. A member said that he was given the impression that the Agreement was beneficial to all parties, i.e. the Government, HKT, consumers and industry participants, and enquired who would be the loser in the Agreement. SES replied that since telecommunications played a vital role in the development of industries, finance and commerce, and underpinned the increasingly important information industries; hindrances to the development of telecommunications would also hinder Hong Kong ' s competitiveness in these other areas. In order to catch up with other developed economies in the developing Information Age, there was a need to resolve early the exclusivities in the HKTI licence. Upon implementation, the losers would be our competitors in the region. IISA added that the telecommunications market was expanding rapidly at an annual rate of around 10%. Despite competition after the liberalization, the market size would continue to be expanded as a result of improvements in service quality and price. As such, every player in the market including consumers and the community as a whole would benefit from the liberalization.

23. As to whether this was the right timing for the surrender of HKTI ' s licence, which entailed a compensation of $6.7 billion, SES said that notwithstanding the tangible and intangible benefits mentioned previously, global developments had altered dramatically the telecommunications landscape. Liberalisation and competition had taken hold throughout the world as was exemplified by the World Trade Organization (WTO) agreement on Basic Telecommunications which became effective in early 1998. In this Region, countries like Australia and New Zealand had already liberalised the telecommunications market totally, Japan ' s market was being liberalised totally under the WTO Agreement which took effect on 5 February 1998 and our other regional competitors (e.g. Singapore) had also announced plans to liberalise their market. As such, it was necessary for Hong Kong to liberalise its market in order to catch up with the other developed economies.

24. In view of the time constraint and members ' s concerns on the matter, the Administration indicated that they would be happy to continue discussion with members separately to explain why the compensation to be paid to HKT was far less than the benefits of the Agreement to the community as a whole.

III Any other business

25. There being no other business, the meeting ended at 4:40 pm.

Provisional Legislative Council Secretariat
26 March 1998