Telecommunications: The Brave New World

<i>The domestic telecom market will keep Canadian lawyers - and regulators - hopping for the next several years as technology continues to change at a phenomenal pace</i> <br/> <br/><p>The revolution isn't upon us. The regulatory regime that governs telecommunications, broadcasting and the like in Canada is not being dismantled. The domestic ownership requirements that keep Canadian channels, phone lines and frequencies safe from foreign investors and acquirers are firmly in place. Or are they? The Competition Bureau is getting more, not less, interested in the business of Canada's consolidated—and still consolidating?—communication companies. </p> <br/> <br/>
Telecommunications: The Brave New World
When one door closes, another opens, but we often look so long and so regretfully upon the closed door that we do not see the one which has opened for us.
—Alexander Graham Bell

The revolution isn't upon us. The regulatory regime that governs telecommunications, broadcasting and the like in Canada is not being dismantled. The domestic ownership requirements that keep Canadian channels, phone lines and frequencies safe from foreign investors and acquirers are firmly in place. Or are they? The Competition Bureau is getting more, not less, interested in the business of Canada's consolidated—and still consolidating?—communication companies.

And yet...there is something in the air. A sense of urgency. Of unprecedented change. And not just because everyone, from US private equity fund Kohlberg Kravis Roberts (KKR) to the Ontario Teachers' Pension Plan, is eyeing BCE Inc.

“There really is a recognition that you have to grow and adapt to radically changing circumstances in order to be able to thrive,” says Kathryn Robinson, a partner with the broadcasting, telecommunications and new media group at Goodmans LLP. “It's not an option to stand still and do things the way you always have. It's a time of dynamic change.”

And it has nothing to do with what the regulators and the governments are—or aren't—doing. Canada's telecommunications companies are acutely aware that while their future may be either hindered or somewhat less actively obstructed by domestic policy and legislation, it's entirely at the mercy of a force neither the government of Canada nor industry regulator CRTC can control. That force? Nothing startling: just more and more and more newfangled technology.

“The technology has ramped up and cycled so fast, and these changes have been such that technology is creating, bypassing and overtaking the ability of the regulator and government to control it,” says George Addy, a partner with the Toronto office of Davies Ward Phillips & Vineberg LLP, who leads the firm's competition & foreign investment review group. “It is almost like a new version of your software. By the time the regulatory officials understand what is going on and how and if they are going to regulate it, that technology has been bypassed, and a different version or even something quite new is creating new and different conditions in the marketplace.”

The clients know this better than anyone. In the words of BCE Inc.'s president and CEO Michael Sabia, “in telecom, the regulatory environment is trailing the times, stifling innovation and limiting consumer choice.” In a September 2006 speech to the Canadian Club in Montreal entitled “North American Competitiveness: Smart Technologies, Smart Borders, Smart Business,” Sabia repeatedly stressed the changes wrought on the sector—and North American economy more generally—by technology.

“The question is no longer ‘what worked in the past and how do we repeat it?' but ‘what is necessary for the future and how do we create it?'” he said, pointing out that for BCE, 2006 was a “critical turning point” in which revenue from new income streams “eclipsed” revenue from BCE's traditional telephone business. “Our growth businesses are on a trajectory to provide more and more of our revenue in the years to come, until these ‘new' sources of income become the primary source of income, for a very different company. One that has changed with the times, and one that has helped change the times—through technology.”

BCE and its competitors have a pretty good idea of what they need to do to become these “very different companies.” The question mark over the process, of course, is will the CRTC and the government—or other interested parties, be they Canadian pension funds or US private equity funds—let them?

Great discoveries and improvements invariably involve the cooperation of many minds.
—Alexander Graham Bell

The history of broadcasting and telecommunications in Canada is a history of regulation. The government got into the business of regulating the communication industry as soon as it realized that the big black and white box with moving pictures inside it wasn't just last year's fad. The Board of Broadcast Governors was called into being in 1958, taking on the role of regulatory watchdog previously filled de facto by the CBC. The CRTC started life in 1968 as the Canadian Radio-Television Commission. It changed its name but not its call letters to the Canadian Radio-television and Telecommunications Commission in 1975.

That was about the time when the hot battle in telecom centred on the physical telephone, recalls Andrew Roman, a regulatory partner with the Toronto office of Miller Thomson LLP who chairs the firm's competition law group.

“At that time you had to use a hand telephone set provided by your supplier. And they were arguing at hearings years later, into the early 1980s, that if you used one of those cheap foreign phones it would blow up the system,” says Roman. “You had to have one of those good supplier phones that would last a hundred years and cost a month's salary.”

For Roman, the protracted debate over handsets is emblematic of the “situation” of telecom regulation. “It was years before they even deregulated what was at the end of the wire,” he says. “Now, gradually they extended the process, but if you really think about it, what has happened in telecom isn't truly deregulation at all.”

It's all so very Canadian. Canada's approach to both regulating and deregulating the telecom industry has been marked by commissions, consultations and committees, and some confusion as to the meaning of competition. The most recent—and perhaps least compromising—step in this process was the Telecommunications Policy Review (TPR) Panel, established on April 11, 2005 and delivering into the world a 392-page and 127-recommendation heavy report on March 22, 2006, just as a new Conservative (albeit minority) government was getting comfortable in Ottawa.

The TPR Panel was comprised of Dr. Gerri Sinclair, former general manager of Microsoft Network Canada and director of the Canada Foundation for Innovation, André Tremblay, the former president and CEO of Microcell Telecommunications Inc., and Hank Intven, head of the telecommunications practice at McCarthy Tétrault LLP. It politely echoed what industry players have been shouting for years, namely, “that telecommunications technologies and markets today are in the midst of a profound transformation, and the Panel believes the policy and regulatory framework should change to reflect the new environment.”

“Essentially, our recommendations in the TPR report were to rely more on market forces,” says Hank Intven. To quote from the report: “The Panel concludes that it is time for significant changes to Canada's current policy and regulatory approaches, some of which date back to the early part of the last century. The Panel's report proposes changes to permit the Canadian telecommunications industry to respond more rapidly to new technology and market developments. These proposals seek to accelerate the pace of deregulation of competitive telecommunications markets and will rely more on market forces to achieve Canada's economic goals. At the same time, the proposals will strengthen and better target regulatory approaches to achieve important social objectives and protect consumers' interests in the more competitive environment.”

Hear that silence? The sound of revolution, Ottawa-style.

“The panel came to a conclusion the Minister of Industry loved,” says Roman. “It basically said to instruct the CRTC to rely on market forces wherever possible. Can you imagine anything more Canadian than that? What is ‘possible'? And what ‘market forces' should be used? This is the sort of motherhood statement that is impossible to disagree with. But what does it mean?”

The telecom industry hopes it heralds the biggest paradigm shift since privatization—a real move away from CRTC regulation to regulation by Adam Smith's invisible hand. Certainly, Minister of Industry Maxime Bernier's policy pronouncements over 2006, culminating with the December 11, 2006 announcement that the “government proposes to accelerate deregulation of local telephone service in the interests of Canadian consumers,” have been received with “cautious optimism.”

“What we've seen in Mr. Bernier's direction and policy initiatives over the past few months demonstrates a feeling on the part of the government that they get it, and the industry gets it, and perhaps the regulator wasn't getting it,” says Addy. “Now, that is a little unfair—because the regulator has to deal with the law handed to it.” And has that now changed?

Addy and Intven think the process has started; Roman disagrees.

“The so-called telecom policy debate is another of those statements that has no operational significance,” he suggests. “If a statement is made that is virtually impossible to disagree with, it's not worth anything. Everyone nods their heads and then goes to sleep, and doesn't realize that the CRTC hasn't been told anything.”

For Phil Rogers, a business law partner with the Ottawa office of Osler, Hoskin & Harcourt LLP who practises in the areas of telecommunications, broadcasting, regulatory, Internet and privacy law, the TPR panel's recommendations are significant even if they end up unimplemented in the near-term.

“I think the wind is pretty clearly blowing in a new direction, and the government had instructed the regulator to move in a new direction,” says Rogers. “We cannot go so far as to say that the government has endorsed the entire report. But it has certainly taken steps to move in the direction proposed by the report. And the combination of these circumstances—the content and tone of the TPR report, its generally positive reception by the government, and some of the specific steps taken in policy direction—we are striking out in a new direction.”

But will we move there at a speed compatible with the speed of change in the industry?

Leave the beaten track occasionally and dive into the woods. Every time you do so you will be certain to find something that you have never seen before. Follow it up, explore all around it, and before you know it, you will have something worth thinking about to occupy your mind. All really big discoveries are the result of thought.
—Alexander Graham Bell

The significance of the technology industry in telecom isn't so much what the technology can do, but who is doing it. The mandate of the CRTC in “the early part of the last century” was very much tilted towards protecting and promoting Canadian culture. Towards the last part of the last century, in the telecom sector in particular, one of its roles was to shepherd former government monopolies into a quasi-free market. It was also supposed to “create regulatory conditions that allow competition to grow”; in other words, to encourage competition. This it generally did by regulating the big guys more and new entrants into the market less.

But the giants of the industry have been arguing for a while now that the situation has changed.

“For years, [Rogers founder and CEO] Ted Rogers was telling everyone he was David fighting Goliath,” says Intven. By February 2006, that was demonstrably not true. “For the first time ever, BCE was no longer the biggest Canadian telecom company by market cap,” continues Intven. “BCE was outpaced by Rogers. That single fact is a huge story.” Rogers is now a Goliath—“a very efficient, well-run multi-service firm that provides most of its services from wireless and Internet platforms, not from cable.”

Bell and Telus as underdogs? Well, with long distance dead and worse (remember when no one understood those “VoIP with Vonage” ads? Those were the days…was it only last year?), and Ottawa threatening to rain more cellphone competition down on them—and the Internet almost completely unregulated—seeing the Canadian telecom giants as underdogs is not the stretch it would have been even two years ago. VoIP, you know, stands for “Voice over Internet Protocol.”

“VoIP is one, and very good, example of how this industry is changing,” says Osler's Phil Rogers. “The old long-distance service was built on a market where there were clear boundaries between local calls and long-distance calls. You introduce VoIP, you wipe those boundaries out. That's a huge change in telecom—it fundamentally changes the market.”

The market was still adjusting to an earlier change—“the death of distance.” When the CRTC allowed competition in the long-distance market in 1992, it slashed the incumbents' revenue streams. “Before that,” explains Intven, “the major source of revenue for telecom companies was long distance, particularly international calling. That is still the case in a number of developing countries.” In North America, deregulation led to competition led to dirt-cheap long distance—long before VoIP and Skype entered the lexicon, Intven notes. “So the death of distance was a very important phenomenon for them, because it meant their main money earner was disappearing. This forced all telecom companies in the world to consider other services—cellular phones, wireless data services, and others—because they needed very urgently to replace those long-distances revenues.”

You've got to feel for them. Don't you? Thank goodness RIM invented the BlackBerry.

But back to VoIP, one of several acronyms wreaking havoc on the telecom stage. As per the TPR Panel report: “Telecommunications markets are being revolutionized by the rapid adoption of Internet Protocol (IP)-based networks, broadband and wireless technologies and by the convergence of previously distinct information and communications technologies (ICTs).”

These tools are, the reports authors write, the proverbial double-edged sword. They have “become essential purpose technologies” that contribute to many aspects of Canada's economic prosperity and social well-being.” But as well as being the bearers of “significant economic benefits,” (insert scary music here) “they pose new risks to the international competitiveness of the Canadian economy.” Oh, and “they are challenging the relevance of some elements of Canada's telecommunications policy and regulatory framework.”

Stripped of political politeness, what the panelists probably wanted to say: effective competition in this mad, mad world is hard enough without being hampered by outdated regulation. Stop thinking of the incumbent telcos as monopolies that need to be controlled. Release them before we—the national we, as in the telecommunications industry of Canada—fall so far back that we are destroyed.

This existential angst isn't limited to the telecom sector. All the industries under CRTC's purview share it. For broadcasters, the situation is just as acute—perhaps even worse. Industry analysts predict a review process akin to the TPR Panel taking place in broadcasting shortly, with a similar thrust, but with the “less regulation, more market forces” mantra tempered by cultural complications: the always contentious issue of “Canadian content.”

“The regulators constantly are trying to balance the culture imperative of broadcasting—creating Canadian content—against the international pressure they recognize Canadian broadcasters face,” says Robert Malcolmson, who heads up the communications law practice at Goodmans. “We have lived through the advent of a borderless world where I can go and get content not just from the regulated world, but from YouTube on the Internet.”

“Borderless” means that despite the protected and regulated market, broadcasters are competing internationally.

“They are facing competition not only from their traditional competitors—that is, other broadcasters—but also from international competitors in a way they haven't before as well as from a myriad of unregulated competitors as well,” adds Robinson.

And competitors from industries that used to be in quite separate silos. Can you say television shows on mobile phones? While the term convergence is not quite the fashion it was five years ago (owing at least in part to the splendid failure of the AOL-Time Warner merger, as well as less dramatic un-convergences domestically), lines between telephone companies, cable companies, broadcasters, creators of content, etc. are blurring and what is emerging, says Addy, is a new “media industry.”

“What is telephony when my cellphone can e-mail, browse the Internet and now broadcast television programs. What is that?” he asks. “Is the company providing me with the telephone set a telephone company, an Internet company, a television company or a media company? All those old notions of separate sectors defined by their stovepipes have been completely eroded.”

“It's a world that's changing exponentially,” says Robinson. “Everyone is trying to determine the best strategy for adapting to this environment of dynamic change.”

A man, as a general rule, owes very little to what he is born with — a man is what he makes of himself.
—Alexander Graham Bell

Okay, so a century and some of sociological and economic research proves him wrong. But take Mr. Bell's bon mot and swap Telco for man. Telus (well, at least half of today's Telus) and Bell were born provincial corporations, laden with requisite baggage when they were set “free.” They have been working hard to make themselves competitive media companies. Their cable-originating competitors, the east's Rogers and the west's Shaw Communication Inc., have followed somewhat less shackled and variably ambitious paths to their current identities as providers of a bundle of communication services.

This is what they are, and what they have made themselves into, mostly over the last five to 10 years. None of it is good enough for the future, and they know it. What are they going to make themselves into for tomorrow?

George Addy predicts less, not more, differentiation. “We will see the cable companies migrate and look more like telephone companies, telephone companies will look more like cable companies, and we will end up with media companies,” he says. The process is well underway. In addition to their original “core” services which were, respectively, telephone and cable, Bell and Shaw provide satellite services. Shaw and Rogers still provide cable, of course. Bell, Telus and Rogers provide land lines and cellphones. All provide Internet. Shaw used to own radio stations and specialty television stations. Rogers owns magazines. And so on.

The obvious question leading from this blurring of differentiation is—will they team up?

“The big speculation in the industry is the question of whether there is going to be further consolidation and how will that happen,” says Intven. “There could be a merger between BCE and Shaw, which might be possible, because their operations are in largely different parts of the country. Or there could be a merger between Rogers and Telus, although they now have a fair amount of overlap. It could be Videotron and Rogers.”

Rogers, of course, has shown itself to be very interested in Videotron. It could be Bell and Telus. It could be anyone, even something no one dares think of—even more so than KKR's or Teachers' and Providence Equity's proposed play for BCE. “There is lots of room for potential change,” he says.

And everyone is strategizing—some lawyers close to telecom clients declined to speak to Lexpert because they felt they were “too closely involved” in their clients' strategy. Others were a little too anxious to stress “the Competition Bureau would certainly have serious issues with any telecom mergers.”

Two additional noteworthy events: Lawson Hunter, former head of the Competition Bureau and the Stikeman Elliott LLP partner who fought the Competition Bureau ardently on behalf of Air Canada, has for some time now been a key executive officer at BCE. And Fasken Martineau DuMoulin LLP, which does a lot of work for Rogers—including its successful plays for Microcell (Fido) and Call-Net Enterprises Inc.—has significantly ramped up its telecommunications and competition arm by merging with Ottawa's well-regarded communication law boutique Johnston & Buchan LLP. Something seems to be germinating.

The report of the TPR Panel seems to look forward to consolidation. One of its key recommendations is the establishment of a Telecommunications Competition Tribunal. (The relationship between Canada's Competition Bureau and the CRTC is not a cozy one. As Roman puts it, “The Competition Bureau has been intervening in the hearings of the CRTC right from the beginning of the CRTC's jurisdiction. It is about the only agency that regulatory appears as an intervenor, and what it does in effect is give the CRTC lectures on competition.” That relationship may change now that former Competition Commissioner Konrad von Finckenstein is at the helm of the CRTC.) There are, of course, non-consolidation related competition issues in the sector. But if one expects further consolidation in a sector dominated by three players and populated by only a handful more, having a specialized competition tribunal may not be a bad idea.

Rogers has a more continental idea.

“We are seeing consolidation in Canada, and we will see more consolidation in Canada both in telecom and in broadcasting,” he says. But that's all prep work for the real revolution. “In the end, there is going to be a change in the foreign ownership limitations. If that will occur, no doubt we will see some very major transactions and even more consolidation.” Prescient. Rogers spoke with Lexpert before Minister of Industry Maxime Bernier told New York investors in March 2007 that a federal review of foreign ownership restrictions in telecom was underway, and KKR's interest in BCE leapt into the headlines.

Letting the Americans and Europeans—or the Indians?—buy our telephone companies? Never! Right? Aren't Canadian-owned telephone companies as critical to our national identity as the CBC?

“It's a possibility,” says Roman. “If we lift the foreign ownership laws, that could definitely change the landscape, either by someone buying one or all of the big three or coming in here to compete with them.” And forcing them—and competition authorities—to rethink the viability of mega-domestic mergers. “It does not seem to be on the agenda now, but who knows what will happen in the next mandate of the Harper government. The Minister is a laissez-faire guy.” Indeed. KKR certainly seemed to think so.

But that's all “in the box” thinking—variations on the relatively unimaginative theme of consolidation. Jonathan Levin, a corporate partner with the Toronto office of Faskens, does not forecast marriages between the obvious suspects (he acts for Rogers—if he had an inkling, he couldn't share it). But he expects the telcos and finance industries to start talking more seriously. Not with a mind to merge—but partnering to use the cellular telephone platform for really useful stuff. Money stuff.

“We are going to see cellular telephones used for payment systems and we are going to see cellular telephone companies involved with funds transfers,” says Levin. “They're already being used that way in Japan—customers load cash into a phone, and then use the phone to gain access to subways and so on. We are going to see the cellular telephone system become much more important to other products and services, particularly in financial services. That is the future.”

Cool. So where is this process going to take the Canadian telecom lawyer?

An inventor is a man who looks upon the world and is not contented with things as they are.
—Alexander Graham Bell

“From the point of view of a lawyer who is working with clients who are going through this experience, it is a tremendously exciting time. In many ways, we are looking at uncharted territory. We don't know how things are going to evolve, how our regulatory regime is going to adapt to these changes. And we have a chance to help shape all of that,” says Robinson.

Here's the odd thing about the Canadian telecom sector. It's puny. And in terms of its contribution to law firm billables—all but insignificant. The players are few. And while the heavily regulated environment in which the telcos and their communication industry brethren operate has meant a steady diet of regulatory files, fewer of those are flowing to private practice.

“The truth is that 10 years ago many more lawyers were making a living on telecom than today,” says Roman. “The companies have developed large in-house staff. They tend to use outside lawyers less frequently and for different things. They do use outside lawyers for transaction and securities work, but their consumption of external legal resources is not that great.”

But quite clever. Historically associated with one firm, the telecommunications companies have taken a page from the book of banks and spread the work around. It's hard to find a Montreal law firm that doesn't claim to do a lot of work for BCE Inc. and Bell Canada (Davies and Stikeman Elliott LLP lead the pack). In Toronto, everyone lays claim to Rogers (Torys LLP has a particularly good one: Ted Rogers articled there). In the west, they fight over Telus and Shaw. The flow of work isn't huge, but when it comes, it's interesting, time-intensive and relatively lucrative. Thus desirable. The law firms love it. And they want more of it.

But they seem to be positioning themselves for a situation in which they hope to get more of less. The current climate of deregulation—or at least somewhat less regulation—and policy change will lead to a variety of “battles” before the CRTC and/or competition authorities, says Laurie Dunbar, a former Johnston & Buchan partner and now co-chair of Faskens' communication practice. But that flurry of work is an in-between step.

“Once you open the market to competition, you will see more consolidation,” says Dunbar.

If—when—consolidation comes, it will provide two or four law firms with rewarding transaction mandates, and a combination of corporate, regulatory and competition work that may rival the mythical bank non-mergers in complexity. When the dust settles, there will be half (or less) as many clients. Then if the foreign ownership restrictions are lifted….

Opportunity and chaos. A KKR-BCE deal may be a protectionist patriot's nightmare, but to a telecom—or deal—lawyer, it's the stuff the sweetest dreams are made of.

And then? Well, McCarthy Tétrault has long supplemented its domestic telecom practice by “exporting” its telecom expertise internationally. Intven's team has privatized some 45 telecommunications companies around the world and helped jurisdictions as diverse as Mexico and Libya draft regulatory and competition legislation for the nascent competitive industry sectors. With J&B, Faskens acquires a dollop of similar experience.

But the domestic telecom market will keep its Canadian lawyers hopping for several years to come. While no one dares predict what technologies will define and drive the telecommunications markets of tomorrow, two things are certain. First, the evolution of these technologies will create new markets and new niches as it kills traditional ones. Second, the free market will come to the telecom sector. But the march there will be quintessentially Canadian, full of commissions, consultations and committees.

And some confusion as to what competition in a borderless world entails. Unless, of course, all the players get bought up by private equity funds. But that, fortunately, will have legal challenges of its own.

Marzena Czarnecka is a Calgary-based Lexpert writer.


George N. Addy Andrew J. Roman Hank Intven Robert W. Malcolmson