Charging of consultancy services provided by the Office of the Telecommunications Authority (OFTA) Trading Fund to other departments;
Hong Kong Electric Co.s proposals on generation development; and
Tariff unification in the paging industry.

(Post-meeting note: At the request of the Administration and with the concurrence of the Chairman, item (b) was deferred to a meeting to be held in September and item (c) was cancelled.)

III. Follow-up on review of price control of Hong Kong Telephone Co.

IV. Consultation on review of pricing structure of local telephone services

(LegCo Paper No. 1673/95-96)

3. The Chairman suggested and members agreed that as agenda items III and IV were closely related, the two items would be discussed together.

4. Mr A S K WONG briefed members on the issues as set out in the information paper.

5. Regarding the progress of the consultation exercise on the pricing structure of local telephone services, Mr WONG advised that the deadline for submission of comments and views was 22 July 1996. Thereafter, OFTA would compile and analyse the views received and then formulate a proposal based on these views. He also advised that the majority of the submissions received so far were concerned with the residential line rental and the majority opinion was in favour of retaining the present pricing structure. Mr Stephen IP remarked that the Administration had kept an open mind on the issue. He assured that the Administration would report back to the Panel on the consultation exercise.

Admin

6. In response to members enquiries about the information set out in the information paper, Mr WONG gave the following explanations:

It was pointed out in paragraph 4 that if IDD had been included in the basket of price control services, the effective value of X in the CPI(A)-X formula would have been in the region of over 10% for the past three years. This was a more accurate comparison with the UK price control formula which covered international telephone services as well as local telephone services. The effective value of X then was marginally higher than 10% and it represented the weighted average (by revenue) of the productivity gains of local and international services shared by consumers. The price reduction of Hong Kong Telecom International Limited (HKTI)s IDD service was 8%, 2% and 2% in 1993/94, 1994/95 and 1995/96 respectively.
The computations in paragraph 10 regarding the impact of revising the price cap for residential line rental from CPI(A)-3% to CPI(A)-6% on Hong Kong Telephone Company Limited (HKTC)s revenue and on consumers were based on the assumption that the overall price cap of CPI(A)-4% covering the basket of local telephone services did not apply, i.e. the prices of other services in the basket were assumed unaffected by the revision of the residential line rental.
In paragraph 14, it was stated that international telephone calls accounted for about 7% (3,450 million minutes) of the total bothway traffic passing through the HKTC local network. These international call minutes included all the IDD calls using HKTIs IDD service as well as those using the call-back services and indirect access IDD services provided by other local telephone companies.

7. Some members felt that the mechanical apportionment of common costs between local and international services on the basis of call minutes as set out in paragraph 14 had not done justice to the fact that HKTC possessed the local network and HKTIs IDD service enjoyed the benefits derived from its direct access to the network. Mr IP remarked that the IDD market was at present very competitive as consumers access to the IDD services of other telephone companies had become very convenient. Indeed, the direct access benefits enjoyed by HKTI in the provision of IDD service were very marginal today.

8. Regarding the apportionment of the revenue from HKTIs international services between HKTI and HKTC, Mr WONG advised that the apportionment ratio was about the same as when the international services were provided by Cable and Wireless (HK) Ltd., i.e. about 40% of the revenue was apportioned to HKTC and 60% to HKTI.

9. A member commented that at present, all other IDD service providers and even the call-back service providers had to pay HKTI for the external carrier services. These contributions from other service providers constituted a significant portion of the revenue of the Hong Kong Telecommunications Limited. In response, Mr WONG advised that HKTC and HKTI were two separate companies under two different licences. Mr IP further advised that if the below-cost prices for local services were to be sustained, there would be little scope for other local licensed telephone companies to compete with HKTC in the provision of local telephone services. The Governments policy was to encourage competition in both the international services and the local services markets. The present situation was that while the international services market was getting competitive, the local services markets was still dominated by HKTC.

10. According to the information paper on Review of Price Control Arrangements: Phase Three Report issued by OFTA on 22 May 1996, HKTC had transferred more benefits to consumers than it gained from the productivity growth for the price-capped services. A member expressed reservation about the accuracy of the calculation on the total factor productivity for price-capped services. In response, Mr WONG said that the calculation was not done by HKTC, but by a financial adviser employed by OFTA. Mr IP added that because HKTC was subject to the licence conditions, it had to abide by the Governments price control arrangements even if such were not in its favour. The member maintained that there should be a more objective audit on the data provided by HKTC and OFTAs calculations on the productivity growth of the price-capped services. He suggested that the Administration invite local academics to conduct a study on the subject.

11. Members observed that the cost of capital was a determining factor for the profitability of various services of HKTC. In response to members enquiries, Mr WONG explained that the cost of capital was set at 15% of the averaged net fixed assets (ANFA) of the company invested in the respective services, and this basis was widely adopted in other countries for the same industry. Some members expressed reservation about the methodology used by OFTA in determining the cost of capital. A member pointed out that as there were a number of common costs shared among local and international services, there would be plenty of room for manoeuvre in computing the cost of capital of each service. In reply to the member, Mr WONG said that all along, OFTAs in-house experts worked closely with OFTAs financial adviser. The in-house experts had full knowledge of and were satisfied with the accounting methods based on which the common costs were apportioned among services.

12. A member opined that because IDD services had to be provided through the local telephone network, IDD services were in fact being subsidised by local telephone services. Raising the prices of local telephone services in order to reduce the "cross-subsidy" by IDD services was unfair to consumers of local services.

13. Another member opined that the crux of the issue was whether the profit of HKTC was reasonable. Even a greater level of "cross-sudsidy" to local services by IDD services might be warranted if HKTCs profits had been very high. Mr IP remarked that the policies on the pricing structure and the "cross-subsidy" should not be based only on the past profit levels of HKTC. The profit of the company could fluctuate greatly from year to year, depending on the market conditions and other factors.

14. Members requested and Mr WONG agreed to provide information on the return on revenue and return on equity of HKTC for 1994/95. Mr WONG advised that as shown in Annex I to the information paper, the residual income after tax ($1,875 million) was less than 15% on ANFA, ie. the cost of capital ($1,973 million), for the year.

Admin

15. In response to members enquiry on whether the Administration had a policy of pricing the business line rental at cost (including the cost of capital), Mr WONG said that although there was no specific price cap on business line rental, the service together with other local services included in the basket of price control services were subject to the overall price-cap of CPI(A)-4%. Over the past three years, due to the low overall productivity gains for local services and the price caps on other local services, there had been little room for HKTC to gear the business line rental toward the cost-recovery level.

16. On the service standard of HKTC, Mr WONG advised that at present about 99% of the call attempts were successful during busy hours and OFTA considered this standard satisfactory. In response to the Chairmans enquiry on whether the Administration would raise the standard requirement, Mr IP said that the present service standard was already higher than the international standard, thus the Administration did not intend to raise the standard requirement on HKTC.

17. On whether there was any contradiction between the principle of revenue neutrality applied to the proposals for the local services pricing structure and the policy to reduce the "cross- subsidy" to local services by IDD services, Mr WONG said that these were two separate issues. The principle of revenue neutrality was to ensure that the revenue for HKTC would not increase or decrease due to changes in the pricing structure with other factors assumed unchanged. The mechanism for ensuring revenue neutrality would be to conduct annual reviews on the companys accounts and then to adjust the pricing structure or prices accordingly.

V. The effect of the change of ownership of Hong Kongs airlines on the industry and the economy

(LegCo Paper No. 1676/95-96)

18. Some members expressed disappointment with the lack of analysis by the Administration of the impact of the changes in shareholding structures of Cathay Pacific Airways Limited (CPA) and Dragonair on the aviation industry and the local economy. Mr IP advised that the Administration recognised that the changes in shareholding structures of CPA and Dragonair were commercial decisions and the decisions had been approved by the shareholders of the companies.

19. Some members pointed out that the transactions might not have been a result of negotiation on fair commercial grounds. They were concerned that other franchised companies in Hong Kong might have to follow the steps of CPA and Dragonair, and enter into unfair commercial transactions with corporations backed by the Chinese authority if they were to maintain viable operations in Hong Kong after the return of the sovereignty in July 1997. In response to members enquiry, Mr IP said that the Administration had no statutory power over the changes in shareholding structures of franchised airlines in Hong Kong. He stressed that there were sufficient safeguards for the interests of CPAs original shareholders under the regulatory framework for publicly listed companies, which included, inter alia, the Listing Rules of the Stock Exchange of Hong Kong and the statutory provisions under the Securities and Futures Commission Ordinance.

20. A member opined that if the Administration were to be empowered to intervene in commercial transactions, it would be a great blow to the capitalist system of the local economy. The member remarked that it was very common, if not necessary, for businesses to take into account political factors in making strategic decisions.

21. Some members opined that the changes in shareholding structures of CPA and Dragonair on this occasion were not normal business transactions. They involved two Hong Kong designated airlines and the transaction price of the new CPA shares was at a significant discount of the market price. In view of these pecularities, the Administration had the responsibility to examine if there had been any unfair dealing involved. A member commented that the alternative financing option of public offerings of new CPA shares would have been more beneficial to CPAs original shareholders. The Administration should provide an analysis in this regard. Mr IP reiterated that the placement of new CPA shares and the Dragonair transaction had been approved by CPAs original shareholders, who had been advised by an Independent Board Committee of CPA, which in turn had been advised by an independent financial adviser.

22. Some members suggested that CPA be invited to a Panel meeting to discuss the subject. In view of the fact that CPA was not a public body, the Chairman considered it more appropriate for the Panel to convey its concern to the company and see if an informal briefing could be arranged. Members agreed that at the informal briefing, CPA should be requested to also brief members on the air safety procedures of the company in the light of the recent accidents involving the airline.

(Post-meeting note: An informal briefing by CPA was held on 5 July 1996 at CPAs premises.)

VI. Port Cargo Forecast

(LegCo Paper No. 1635/95-96)

23. In view of insufficient time for discussion, members agreed that this item be deferred to the next meeting.

24. Members noted that the Port Cargo Forecast report was completed in early 1996. At members request, the Administration agreed to provide the most up-to-date information on port cargo throughput up to February 1996 for reference. Mr A R Clark remarked that the forecast exercise involved long-term strategic planning. Short-term fluctuations in port cargo throughput would have little bearing on the long-term strategies recommended in the report.

VII. Any Other Business

25. Members expressed dissatisfaction with the late arrival of information papers for this meeting except the paper for item V. Mr IP apologised for the late delivery of papers and assured that the Administration would make an effort to improve the situation.

26. There being no other business, the meeting ended at 10:40 am.

LegCo Secretariat
9 August 1996

Last Updated on 14 Aug, 1998

LegCo Panel on Economic Services

Minutes of the Meeting held on Monday, 24 June 1996 at 8:30 a.m. in Legislative Council Chamber

I. Confirmation of minutes of meetings

II. Items for discussion for the next meeting

III. Follow-up on review of price control of Hong Kong Telephone Co.

IV. Consultation on review of pricing structure of local telephone services

V. The effect of the change of ownership of Hong Kongs airlines on the industry and the economy

VI. Port Cargo Forecast

VII. Any Other Business

Minutes of the Meeting
held on Monday, 24 June 1996 at 8:30 a.m.
in Legislative Council Chamber

V. The effect of the change of ownership of Hong Kongs airlines on the industry and the economy