1. Framework

The cost of capital rate corresponds to the appropriate rate of return for compensating the investment’s opportunity cost. In the context of the telecommunications market regulation, the rate’s definition aims: (i) to ensure the proper incentives to the investment; (ii) to ensure that there are no market distortions, through discriminatory and anti-competitive practises; (iii) to avoid any barriers to the entry of new competitors; and (iv) to protect consumers from excessive prices. It is imperative to define a methodology that allows the calculation, without any accounting and analytical constraints, and in an appropriate way, the cost of capital rate for compensating the investments of regulated companies.

Law No. 51/2011, of 13 September, provides, in paragraph 2 of article 74, that in imposing the obligations relating to cost recovery and price controls, including obligations for cost orientation of prices and obligations concerning cost accounting systems, the National Regulatory Authority (NRA) must take into account the investment made by the operator, allowing him a reasonable rate of return on the capital employed, taking into account any associated risks.

On the other hand, Commission Recommendation of 8 April 1998 (paragraph 5.1 of the Annex thereto), indicates that: ''charges for interconnection be cost-oriented, including a reasonable return on investment'' and that ''the cost of capital of operators should reflect the opportunity cost of funds invested in network components and other related assets''.

Paragraph 5.1. of the referred Annex provides also that ''The cost of capital of operators conventionally reflects the following: the (weighted) average cost of debt for the different forms of debt held by each operator; the cost of equity as measured by the returns that shareholders require in order to invest in the network given the associated risks, and the values of debt and equity. This information can then be used to determine the weighted average cost of capital (WACC) using the following formula: WACC = re * E/(D+E) + rd *  D/(D+E) where re is the cost of equity, rd is the cost of debt, E is the total value of equity and D is the total value of interest-bearing debt.''

By determination of 10/02/2010 1 (hereinafter referred to as ''determination of 2010''), ICP - ANACOM defined the methodology for calculating the cost of capital rate of PT Comunicações (PTC) for the three-year period 2009-2011.

This determination intended to reduce the lack of predictability associated to the calculation of PTC's cost of capital rate and at the same time to provide greater regulatory certainty, in a framework of greater transparency for all stakeholders, given that, historically, the process of cost of capital allocation was undertaken subsequently to the accounting year.

The ex-ante establishment of transparent rules regarding the determination of the cost of capital rate contributes to a predictable environment to which agents may adjust, anticipating and managing their expectations more effectively.

In this regard, it is stressed that the implementation of a methodology defining a priori the cost of capital rate is common practice in several countries, such as Ireland2, France3, Belgium4 and Germany .

Moreover, when ex-ante standards are set out, the need for further investigations, which are typically complex, lengthy, and the matter of disputes, is reduced.

As a result of the determination of 2010, a cost of capital rate of 10.3% was defined, for the 2009-2011 three-year period, having been defined a transition period to allow PTC to adjust its operations to the cost of capital rate resulting from this methodological change (12.3% in 2009, 11.3% in 2010 and 10.3% in 2011).

The referred determination also provided that in case any extraordinary situation occurred, during the period in question, which significantly impacted the validity of assumptions taken into consideration as regards the parameters of a macro-economic nature, and as such external to PTC (risk-free interest rate, tax rate and risk premium), the parameters would be liable to revision.

In the course of the 2009-2011 period, the rate was reviewed twice (2010 and 2011), mainly due to significant changes in the risk-free interest rate and tax rate, resulting in a rate of 11.6%5 compared to 11.3%, in 2010, and of 11.7%6 compared to 10.3%, in 2011.

The current environment of uncertainty and financial instability requires an increased responsibility as regards the definition of the cost of capital rate which, as referred, must reflect, on the one hand, a correct opportunity cost of investors and, on the other, a regulatory and price stability for companies and consumers.

Consequently, having expired the 2009-2011 regulatory period, it is essential to reassess and define the methodology for calculating parameters, namely the risk-free interest rate, the beta factor, the risk premium, the gearing7, the tax rate and the rate of borrowed capital, so that the rate to be applied as from the 2012 accounting year is appropriately calculated.

For this purpose, ICP - ANACOM awarded to Bakertilly (BT) a consultancy work on PTC’s cost of capital rate, the final study of which (available at this Authority’s webpage) includes: (i) a detailed analysis of parameters; (ii) an update of data required to calculate the rate; and (iii) where appropriate, a suggestion of alternative methodologies to calculate parameters.

For analysis and in order to complement this work, other sources of information were also taken into consideration, such as recent decisions issued by NRAs, studies undertaken by consulting firms, as well as academic research.

In the light of the above, this document is intended to analyse and to define a set of methodological principles supporting the calculation of PTC’s cost of capital rate, which applies as from the 2012 accounting year.

ICP - ANACOM adopted a draft decision which was approved on 02/08/2013. The respective hearing report integrates this decision.

Later, by determination of 18/10/2013, the Management Board of ICP - ANACOM approved the notification of the draft decision to the European Commission, to BEREC and NRAs of other Member States of the European Union, under paragraph 3 of article 7 of Directive 2002/21/EC, as amended by Directive 2009/140/EC. On 25/11/2013, the European Commission assessed the notified draft decision, making no comments on the matter.

1 Calculation of the cost of capital of PTChttps://www.anacom.pt/render.jsp?contentId=1014532.
2 Response to Consultation and Decision Notice - Eircom's Cost of Capitalhttp://www.comreg.ie/_fileupload/publications/ComReg0835.pdf.
3 Décision fixant le taux de rémunération du capital employé pour la comptabilisation des coûts et le contrôle tarifaire des activités fixes régulées de France Télécom pour l’année 2012http://www.arcep.fr/uploads/tx_gsavis/11-1466.pdf.
4 Decision of the BIPT Council of 4 May 2010 regarding the cost of capital for SMP operatorshttp://www.bipt.be/public/files/fr/2127/3273_fr_wacc_2010-2013_fr.pdf.
5 Rate of cost of capital of PTC - decision approved on the revision of the calculation of the rate for 2010 and 2011https://www.anacom.pt/render.jsp?contentId=1094048.
6 III. Análise da taxa de custo de capital proposta pela PTChttps://www.anacom.pt/render.jsp?categoryId=346488.
7 Gearing - quotient obtained by dividing the average value of borrowed capital (the average of the sum of medium- and long-term financing) by the average value of invested capital (equity average + borrowed capital average).