BT Group plc (NYSE: BT; London: BT.A) received a stark warning from U.K. telecom regulator Office of Communications (Ofcom) yesterday: Stop discriminating against competitors or you could be broken up.

The warning came as Ofcom released proposals as part of its ongoing U.K. telecom sector strategic review, currently in Phase 2 (see Ofcom Unveils UK Sector Proposals).

Ofcom is seeking a response to those proposals by next February from the industry, especially BT.

Basically, the regulator believes there isn’t a level playing field in the U.K. market because BT Wholesale doesn't treat its main customer, BT Retail, in the same way as Retail's competitors. But Ofcom reckons BT can fix that.

”The structure of the market is unstable, though not at crisis point,” Ofcom CEO Stephen Carter told a conference call.

“Competition is fragmented, and the complex regulatory mesh that’s been created during the past 20 years [by the previous regulator, Oftel] is expensive to manage, intrusive, and ineffective. There are still economic bottlenecks, and the terms of access to those bottlenecks are critical to creating true competition.”

The main bottleneck is the access network, and Ofcom believes there are three options to consider as the market shifts towards an IP world based on next-generation networks, two of which could work:

Some progress has been made this year, for example with the reduction of shared access and fully unbundled costs that have encouraged BT rivals such as Cable & Wireless plc (NYSE: CWP) to invest in local loop unbundling (see Ofcom Proposes New LLU Rates and C&W Has $150M Broadband Plan).

But Carter wants a lot more from BT, and quickly, so that all the U.K.’s carriers can plan their future strategies and investments.

“It’s important for everyone to realize that we’re not asking for some more noodling around the edges,” says Carter. “We want real equality of access, which involves the same access, the same processes, the same inputs, and clarity around shared network management information and reporting lines. We believe this can be done. If it doesn’t become a practicable and deliverable reality, then we have a problem.”

Or, rather, BT has a problem. ”By Spring next year we’ll either have an agreement or a position. We strongly urge BT to get to an agreement.”

This delighted the United Kingdom Competitive Telecommunications Association, an industry association representing some of the incumbent carrier’s competitors. “We're delighted to see Ofcom's commitment to giving all competitors a fair crack of the whip,” said the association’s chairman David McConnell in a prepared statement. “BT needs to change its ways if it is to comply with the obligations that we expect Ofcom to put in place.”

BT responded to Ofcom’s proposals with a rather wishy-washy statement (see BT Responds to Ofcom Proposals).

BT may have little option but to comply with Ofcom’s preferred proposal. The prospect of a breakup would severely disrupt the business plan that underpins the operator’s major next-generation network, the 21st Century Network (see BT Moves Ahead With Mega Project and 21CN on Track, Says BT ). It now has four months to prove to Ofcom that it will provide that “real equality of access.”

If it can, that should spell good news for equipment suppliers. Such a move could further encourage investment in local loop unbundling, and therefore new access equipment, by competitive operators. It would also keep BT's $7 billion 21CN on track: Vendors wouldn’t want that process knocked off course.

All of this is resulting in strong interest in Phase 3 of Ofcom’s strategic review, which will focus on next-gen access networks. “We want to ensure BT doesn’t gain an unfair advantage from its next-generation network. The industry needs visibility over the design of the network and how interconnect will be managed,” and this needs to be addressed now, and not after the network is built, says Carter.

BT's share price ended the day down 1.5 pence, less than 1 percent, at 196.75 pence (US$3.66) on the London Stock Exchange.

— Ray Le Maistre, International News Editor, Light Reading