I am pleased to give you a "Report from the Front Line" of the telecommunications revolution. I like to think of Texas as a good example of how the Federal Telecommunications Act of 1996 (FTA96) is working. Thanks to the FTA96, and to Texas legislation in 1995 and 1999, Texas has seen marked progress toward a more competitive local market. We are already experiencing the benefits of more competition in the long-distance and data markets.

Competition sets the stage for eventual deregulation, and that is a goal worth working hard for. On our best days as regulators, we cannot begin to compare with a well-functioning market in delivering better prices, more responsive service and unleashed technological innovation to customers.

The FTA96 removed legal barriers to entry of companies into various telecommunications lines of business, and that was a significant step. But that alone has not made competition happen. Undoing the effects of a century of pervasive regulation has taken time, more time than most thought would be needed. These effects are primarily operational in nature and stem from the understandable reluctance of incumbents in all markets to assist in implementing a regime that necessarily erodes their historical market shares.

The FTA96 focused on opening the voice markets to competition, and its primary focus was on opening the non-competitive local markets. The FTA96 also pointed the way for greater competition in long-distance markets. Data services were a small part of the text of the FTA96, but, as technology has speedily evolved, some of the provisions of the Act have been applied to these services as well.

Congress gave the state commissions a significant front line role in implementing the various aspects of the FTA96:

arbitration of unresolved issues in incumbent-competitor interconnection agreements under §§251 and 252, a mandate to reform decades-old universal service subsidy structures under §254, and the responsibility of steering the largest local providers, the Regional Bell Operating Companies, through the §271 long-distance authority checklist.

Working with the federal commission, we have plowed through myriad operational, technical and financial details to implement these provisions. Implementing the Act has been the most resource-intensive project that we at the state level have undertaken in recent decades, requiring us to become experts on every aspect of the telephone network, from the Network Interface Device at a customer's home to ultra-high bandwidth optical transport, and everything in between. We have developed expertise on modern network design, pricing and operational support systems. We have often interpreted the law in real-time, often faced with deciding issues before the FCC or other states did. We have been faced with numerous twists and turns as various federal courts have issued their pronouncements.

State commissioners and our professional staffs have done these things while keeping our focus on the retail customer. There has never been such an opportunity to pull together so many key issues in this industry for comprehensive resolution, and I can fairly speak for my state commission colleagues when I thank Congress for giving us this §§251, 254 and 271 gift, which has allowed us to move swiftly away from the old world of monopoly style regulation to a new world of marketplace competition. We aren't all the way there yet, but I believe that in Texas, at least, we have shown that the FTA96 can and does work.

§252 Arbitrations.

The fundamental business contract model of the Act (interconnection agreements) was different from the tariff-based model familiar to us at the Texas Commission. The FTA96 model is based on the premise that the incumbents and competitors will negotiate many aspects of their business relationship. In fact, in mid-1996, due to the relative imbalance of bargaining position, we were called upon, under FTA96 §252, to arbitrate a comprehensive set of rates, terms and conditions for Southwestern Bell Telephone Company (SWBT) and a host of competitors (AT&T, MCI, Sprint, ACSI and Teleport). My two fellow Commissioners and I presided over this "Mega-arbitration," directly, employing the considerable legal, technical, financial and process-management talents of our staff. After a three week hearing, we issued our Arbitration Award in December 1996, thereby establishing Texas' policies for interconnection, provisioning and pricing. The resulting interconnection agreement was later affirmed in substantial part by the local Federal District Court and the U.S. Court of Appeals for the Fifth Circuit, and numerous other competitors have adopted the agreement for their own.

Following the approval of these initial agreements, the Texas Commission has been involved in numerous follow-up contract interpretation disputes. We adopted the famous "rope 'em and throw 'em" expedited dispute resolution process to facilitate competitive market entry. Often, these complaints related to money. Other issues have related to the technical feasibility of certain network interconnection arrangements and required the opposing parties to provide our staff arbitrators with rapid primer courses in the latest telecommunications technology. Our goal has been for the incumbent to provide the requested service immediately unless it can show direct network incompatibility, and the Commission will swiftly determine the appropriate pricing. This prevents the incumbent from using the dispute process to stall a competitor's entry.

Because most of 1996-1997 agreements had three-year terms, the Texas Commission was called upon in 1999 and 2000 to arbitrate successor agreements. The list of decision points for arbitration was dramatically shorter, perhaps indicating that the initial 1996 decisions were generally acceptable to the parties. Interestingly, these second-round arbitrations focused on new technology issues, such as access to and pricing of xDSL technology, which reflected an increased focus on the data services markets. As before, the Texas Commission has had to make many determinations in real time, without much precedent from other jurisdictions. Where other jurisdictions, such as New York, have plowed similar ground, we have borrowed heavily from their fine work to maximize our resources. NARUC, the state commission national association, has aggressively and successfully facilitated this exchange of information among the states.

At the Texas Commission, we have gotten relatively comfortable with our role as wholesale market referee among industry players. The balance between the FCC, as policy clearinghouse, and the states, as front line arbitrators and watchdogs, seems to be working well.

Universal Service and other subsidies.

Over the years, state and federal regulators used various regulatory subsidy mechanisms to maintain low retail prices for residential service, particularly in rural areas. The arrival of competition into telecom markets has forced us to revisit the way these subsidies are handled. In the FTA96, Congress made clear it wanted the rural universal service support to be maintained. This is challenging, but it can be done. So long as the subsidy is competitor-neutral and technology-neutral, it can be sustained in a competitive market.

In times of industry change, it was important for us to establish early what the ground rules were so that sufficient investment would come to Texas, particularly to rural areas. So, in 1997, the Texas Commission began a two-year process to restructure our rural subsidy support system. For years we had kept intrastate access charges much higher than needed to subsidize the higher cost of providing dial tone to low-density rural Texas. Using some rather complex cost modeling, we quantified the excess cost faced by rural providers (above the revenues obtained from the typical customer). We then removed those amounts from the rates of all providers' access charges, and collected these amounts on a 3.6 percent of retail revenue basis from all telecom customers, including long-distance, local and wireless customers. This explicit surcharge on customers' bills yields $600 million annually for the Texas Universal Service Fund (USF). Although over 90 percent of the fund is for rural support, the Texas USF also supports low income subsidy programs and funds hard-of-hearing customer programs. A separate 1.25 percent surcharge provides support to schools, libraries and rural health institutions to offset costs of advanced technology connections. This ten-year Fund, which began in 1995, is administered by the Texas Infrastructure Fund Board.

I have been a member of the State-Federal Joint Board on Universal Service for the past few years. In the national discourse over the federal USF, I have expressed the view that all states should attempt to address their own rural subsidy issue themselves to the maximum extent possible, relying on the federal USF only as a last resort. This would mean that current recipient states from the federal USF, like Texas, should directly fund more subsidy from state USFs instead, leaving federal support for those states which have few lower-cost urban customers to support a sufficient state fund. With the many present claims on the federal USF and a court determination restricting the assessment base for the federal USF, the current federal USF surcharge level is high and should not be stressed further.

Southwestern Bell Long Distance Entry.

Southwestern Bell Telephone Company (SWBT) serves over three-fourths of the local access lines in Texas. As a Regional Bell Operating Company, it was subject to satisfying the fourteen-point checklist of FTA96 §271 before it could offer long distance to customers in Texas. This "carrot" has been the most effective tool Congress could have given states that desired to open their local markets. But it has not been an easy process.

In March 1998, SWBT asked the Texas Commission to review and approve the steps it has taken to open its local market under the checklist. After a 90-day review process, which included three weeks of hearings before my fellow Commissioners and me, we concluded that SWBT had not met the checklist; we detailed 129 specific issues requiring resolution. We then set up a collaborative process which would include SWBT, its wholesale customers (CLECs) and the Commission staff to work through the list. This ran from July through November, 1998 and resulted in closing out many but not all of the 129 items. Patterning off of New York PSC Chairman O'Mara's closure process earlier that year in his state, and complying with our state's strict Open Meetings law, my fellow Commissioners deputized me to negotiate the remaining items directly with SWBT, which I did (with the assistance of highly capable staff) in the Spring of 1999. Shuttling between a room of SWBT executives and a room of CLEC experts to resolve issues, I was able to recommend to my colleagues in April 1999, a Memorandum of Understanding between SWBT and the Commission closing out all of the issues identified the year before. With some amendments, the full Commission approved the Memorandum.

The Memorandum formed the basis for a comprehensive thousand-page interconnection agreement which we determined fully satisfied the entire fourteen-point checklist. Over the following five months, specific details of the Texas 271 Agreement (T2A) were worked out among the parties, requiring some direct rulings by the Commission on specific language. On October 13, 1999, the Texas Commission formally approved the Agreement, permitting any interested CLEC to adopt the agreement. Over 150 have done so to date, and many others have adopted substantial parts of the T2A into their own customized agreements. I am pleased that our sister state commissions in Oklahoma, Missouri and Kansas have modeled their 271-compliant interconnection agreements on the T2A.

One of the most significant aspects of the T2A was the adoption of over 100 specific performance measures and a Performance Remedy Plan placing up-front financial penalties on SWBT if it delivered sub-par performance to its wholesale customers (CLECs). This set of performance standards continues to serve as the weekly and monthly report card for SWBT's wholesale performance, much the same as the Texas Commission has monitored SWBT's retail performance. It has generated several million dollars in penalties for the State and for individual competitors since October 1999, but, more importantly has provided a very strong incentive for SWBT to swiftly remedy any processes which have failed to meet the performance standard. The measures themselves have undergone two six-month reviews (removal of some measures, amendments to others, creation of new ones) and are being spot-audited by the Commission for accuracy. We have combined this review process with our sister SWBT states to ensure uniformity as much as possible.

While the T2A was being prepared, the Commission was closing out its twelve-month review of SWBT's extensive Operation Support Systems (OSSs) by an independent third-party advisor, Telcordia. All aspects of SWBT's pre-ordering, ordering, maintenance/repair and billing systems (both mechanized and manual) were reviewed. A number of items were found lacking and required rework. The process was a military-style test, in that it ran and re-ran until it was passed. The total bill for the testing process exceeded $14 million and was funded by SWBT.

The final step needed for the Texas Commission to conclude that the SWBT local market was irreversibly open to competition was a review of SWBT's actual performance. By reviewing the results of the monthly performance data with the Commission and CLECs and by diagnosing various shortcomings, SWBT made a number of further business process improvements.

In December 1999, the Texas Commission was fully satisfied with the evidence on SWBT's performance, and we finally voted our unqualified support of SWBT's application to the FCC for long distance authority. Throughout SWBT's initial Texas 271 FCC filing in January 2000, and its updated application in April 2000, the Texas Commission worked with the Department of Justice and the FCC to explain and detail SWBT's application. In July 2000, after receiving the Department of Justice's first endorsement of a §271 application, the FCC granted the request, making Texas the second state to fulfill the §271 requirements.

The SWBT OSS is a regional system. The work of the company and CLECs to meet our requirements in Texas assisted our sister states of Kansas and Oklahoma in their successful §271 grants earlier this year. The Missouri application is now pending before the FCC. Without question, a regional approach on common matters is the most effective way to move forward with the §271 checklist. I note with interest that the fourteen US West/Qwest states are also engaged in a regional collaborative on §271 matters.

Aggressive use of the §271 carrot has greatly accelerated Texas' goal of opening its local markets to competitors. Attachment A to this testimony is a staff compilation of data demonstrating that substantial entry has already taken place in Texas. As of March 2001, approximately 2,636,000 access lines are now being served by some 300 CLECs in SWBT's Texas region. This compares to SWBT's total access line count of approximately 10,210,000 access lines. (September 1999).

Of course, the quid pro quo of this proceeding was SWBT's entry into long distance in Texas. Public reports indicate that SWBT has been successful in attracting about two million customers to its long-distance service. The presence of this significant new competitor has dropped average retail long distance rates below 10 cents per minute for the first time in Texas history.

About 22 percent of the access lines in Texas are not being served by SWBT, and market entry by competitors in these mostly non-urban areas is much lower. (Data from non-SWBT areas is not included in Attachment A). I must fairly point to the lack of the §271 carrot as the principal reason for this disparity. CLECs have discovered that, even in competition-friendly Texas, market opening is not for the poor or the weak-hearted. It requires money, smart people, and patience. By consolidating all issues in a common proceeding, §271 allowed CLECs, SWBT and the Texas Commission to pool efforts to achieve what I believe is the most significant competitive breakthrough in our Commission's history.

Other Texas Points of Note.

Winning approval of a wholesale contract before the Texas Commission is one thing; implementing it in 1200 Texas municipalities is quite another. In 1999, the Legislature passed and Governor Bush signed a law which standardized the municipal rights-of-way process for incumbents and competitors. The law stabilized the municipal franchise fee at the 1999 level and simplified its collection into three fee-per-access-line categories (residential, commercial and point-to-point). Payment of this fee to the end-user's municipality allowed unquestioned access to the necessary municipal rights-of-way by any certified telecommunications provider in any municipality. Many companies in Texas have told me that this is the single best thing Texas could have done to welcome facilities-based carriers to our state.

In 1995, Texas also adopted a building access statute which required multi-tenant building owners to provide equal access to certified telecommunications providers. In 2000, the Texas Commission adopted specific procedural guidelines that should be observed and set out a Commission process to be used if negotiations between building owners and providers failed. To date, the Commission has not been asked to formally adjudicate such a dispute.

More information about the Texas Commission can be found on our Web Page at www.puc.state.tx.us.

Current Issues.

In the five years since the FTA96 was passed, the Internet has transformed our culture. In 1996, "www" was more often the result of a lazy finger sitting on the keyboard than a pervasive form of corporate and personal identification. It is amazing that, despite this dramatic transformation of this industry, some of the fundamental aspects of pricing under the 1996 Act are pending before the U.S. Supreme Court, which may be completed by the sixth anniversary of the Act. The time required for judicial review of every aspect of FTA96 implementation has been, and remains a destabilizing aspect of this transition.

Another issue relates to capital investment. Unlike the transitioning electric power industry nationwide, the telecommunications industry has been relatively successful in attracting capital. We have witnessed a slowdown in capital investment in the past eight months, but I believe this is more a rest stop for the market than an exit. Some business plans are passing sober investor review; others, particularly narrow ones, are not. Nevertheless, one of our bigger challenges is to continue to provide investor certainty with a clear long-range vision and stable rules of the road. Predictable, balanced outcomes and consistent enforcement of obligations are needed to maintain investor confidence in the sector.

One final concern worth pointing out, although it is unquestionably a state jurisdictional issue, is the nature of local phone service pricing. During the years of monopoly phone regulation, most states have priced business service higher than residential service in order to achieve social and political goals. One truth of functioning competitive markets is that prices are driven to cost. Where the retail price of residential service is below the wholesale cost of providing it, the market fails to work.

In Texas, the "all-in" monthly retail price for SWBT basic residential service (with no add-ons such as call waiting or caller ID), is about $17. The corresponding business price is $32. Under the extensive cost-study reviews conducted in the Texas Commission's "Mega-Arbitration" and continued in the SWBT Texas 271 Agreement, the monthly wholesale price for a standard access line is about $21. These numbers go a long way toward explaining why residential competition falls far behind business competition today. While customers who use multiple services will always be attractive, broader residential competition will likely come from other technology platforms (cable, wireless, satellite) rather than resale of incumbent networks. The solution of raising residential rates to enable residential competition is unpalatable. Again, this is an issue for state Legislatures and regulators to wrestle with, but federal decision-makers should understand that it is a core issue.

On behalf of my state commission colleagues across the nation, we appreciate the confidence Congress had in us five years ago when it designated us the "Front Line" for implementing competition in the nation's critical telecommunications industry. I trust we have kept faith with your intent.