Yesterday, the Federal Communications Commission (FCC) approved significant changes to universal service fund (USF) and intercarrier compensation (ICC) regimes by establishing a framework designed to redirect $4.5 billion of the $8 billion subsidy pool from circuit-switched voice service to broadband service in high-cost rural areas.

While the FCC has yet to release the text of an order totaling several hundred pages, we believe it relatively safe to make some observations about a material regulatory realignment that can best described as a tale of two reform regimens. One reform framework will be operative during the next five years; another one will presumably kick in afterward.

Incumbent large and midsize telcos should be subject to minimal disruption under USF/ICC reform for the next five years. High-cost support from 2013 to 2017 will be provided by a new Connect America Fund (CAF), subject to certain build-out obligations and service requirements, including the provision of broadband speeds of at least 4 Mbps downstream and 1 Mbps upstream. As such, potential risks appear to be least and potential rewards greatest for incumbent large and midsize local exchange carriers (ILECs) through 2017.

The limited near-term risk that does exists for large and mid-sized ILECs emanates from uncertainty over the design and operation of a yet-to-be determined cost model federal regulators expect to craft and adopt by December 2012. At the conclusion of the five-year period, in which the CAF will distribute $1.8 billion annually, the FCC will employ competitive bidding (reverse auctions) to distribute any universal support required in price-cap territories.

Rural rate-of-return telcos face inherent risk due to lost ICC revenue as the FCC graduates to a national bill-and-keep system and curbs arbitrage (access stimulation, phantom traffic). However, that risk is initially offset in the near term by $2 billion in annual CAF support through 2017 for carriers that offer 4 Mbps/1 Mbps broadband service, subject to request by subscribers.

The FCC will also allow rural rate-of-return carriers to partially recover forgone revenue through imposition of a marginal Access Recovery Charge (ARC) on customers.

More FCC Action

In a further notice of proposed rulemaking, the FCC will consider the creation of a long-term broadband-based support mechanism or rate-of-return carriers and seek public comment on reducing interstate rate-of-return from its existing 11.25-percent level. Given that regulatory trajectory, risk would seem to heighten for rural telcos after 2017.

The establishment of new Mobility Fund represents a partial victory for the wireless sector, with $300 million earmarked immediately and $500 million annually beginning in 2013. Wireless recipients of past USF support (competitive eligible telecommunications carriers) could be hit particularly hard with the FCC’s elimination of the identical support rule. In the past, that rule provided federal telecom subsidies for multiple wireless carriers based on a wireline network cost model.

The FCC also established a new Remote Areas Fund, which will provide $100 million a year to eligible recipients through alternative technological platforms such as satellite and unlicensed services.

For large and small cable operators, USF/ICC reform represents a near-term opportunity lost insofar as broadband support through 2017 but also a step forward on ICC reform. The latter is true as well for competitive local exchange carriers (CLECs). Given the complexity of USF/ICC reform, the role of states and the legal underpinnings of the major policy rebalancing, we would not be surprised to see the FCC decision challenged in federal appeals court.

—  Jeffrey S. Silva, senior policy director/Telecommunications, Media and Technology at Medley Global Advisors LLC. Contact him at jsilva@medleyadvisors.com.

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