In what could be a significant blow to Telstra, the Government has called for submissions on a regulatory reforms paper in an attempt to redress the failure of accounting and operational separation regimes enforced in 2002 and 2005 respectively.
Two reform options are proposed, consisting either a strengthening of current operational separation arrangements or a mandate for full functional separation of retail and wholesale.
The first option would see stronger governance and so-called ring-fencing arrangements enforced so that Telstra network and wholesale staff could not undertake retail functions or receive whole-of-business incentives.
But the Government has also laid out functional separation as a real option to prevent Telstra from favouring its retail business over wholesale customers while the NBN is still being rolled out.
"What needs to be considered is whether functional separation of Telstra would be more consistent with the type of wholesale-retail market structure the Government envisages for the NBN environment of the future," the paper said.
"Adoption of functional separation would impose strict ring-fencing and reporting requirements around certain business units within Telstra.
"These units would be required to operate at arm's length from the rest of Telstra."
The Government does not appear to put stock in concerns that functional separation would be detrimental for Telstra's shareholder value.
"This is not necessarily the case, particularly if Telstra were cooperative in its implementation," the paper said.
But the chance of Telstra being cooperative with functional separation procedures is unlikely, given its vehement opposition to the proposal last year.
Given recent announcements of its intention to upgrade its HFC network, the incumbent will likely be even less happy with suggestions it be forced to divest the network to improve competitive arrangements.
"Divestment of the cable network could provide the basis for additional infrastructure-based competition for the provision of voice, broadband and subscription television services in metropolitan areas where this cable footprint exists," the paper said.
"If Telstra was required to divest its HFC network restrictions would also need to be placed on its future activities to prevent re-integration."
Competitive Carriers Coalition executive director David Forman said "there should be absolutely no doubt" that Telstra will be structurally separated.
"The new regulatory changes flag the potential for separation of Telstra's retail and wholesale business," he said.
"The discussion paper doesn't just talk about whether to do it, but the best way of doing it."
Matt Healy, national executive for regulatory and government for Macquarie Telecom said it is a "given" that Telstra will be forced into structural separation.
He is also supremely confident the Government will inevitably force Telstra to sell off its cable business.
"The divestiture of Telstra's HFC network is absolutely on the table - not just for discussion, but execution."
Healy recalls the ACCC recommending to the Howard Government some five years ago to force Telstra to sell off its HFC network.
"I am not aware of any country we would want to compare ourselves to that allows the monopoly copper provider to also be the dominant cable company," he said.
Healy expects Telstra's structural separation will be implemented via a combination of new requirements inserted into Telstra's license conditions and legislative change.
The Government's ability to change licensing conditions has already been tested in the High Court, Healy said, in a case which the Government won.
"Will Telstra try to fight it? I hope not. I would like to think Telstra's new management will finally see the world for what it is. I don't think any new manager of their business would be wise to take Sol Trujillo's approach."
"When you see the Prime Minister, the Treasurer, the Finance Minister and the Communications Minister standing shoulder to shoulder, you can bet the Government is aligned on this. What business is going to attempt to rail against that kind of Government mandate at a time when markets really aren't performing that well?"
Analyst Paul Budde said the regulatory documentation "doesn't give Telstra any room to manoeuvre."
"The company can of course participate [in the NBN] but based on the rules of the Government and not based on the monopolistic structure of its current vertical integrated service offerings," he said.