Openreach should become a distinct company within the BT group, the regulator said, reports the BBC.
BT had not voluntarily addressed competition concerns Ofcom laid out in July, it said.
Ofcom said it was preparing a formal notification to the European Commission to start the process.
The regulator has resisted calls to split Openreach off entirely, which telecoms rivals have sought.
Ofcom said BT had not gone far enough to address its concerns about BT’s ability to favour its retail business when making investment decisions in Openreach.
It wants Openreach to become a distinct company with its own board, with non-executives and a chairperson not affiliated with BT. It also wants Openreach to have control over its branding and budget allocation.
Openreach would also have a duty to treat all of its customers equally, the regulator said.
BT shares fell slightly in early trading on the FTSE 100 by around 0.5 per cent
BT’s rivals, including Sky and Talk Talk, had complained bitterly about the service they received from Openreach, saying it charged too much for the use of broadband lines and was unresponsive to their demands. They wanted a full break-up of BT, with Openreach being turned into a separate company.
Ofcom has come some of the way, with Openreach now to become a legally separate entity, with its own independent board. But crucially it will still be owned by BT. Telecoms experts say the devil will be in the detail – how much control will BT be able to exert over Openreach under the new structure?
Sky and Talk Talk will be watching for any signs of too much influence – but if BT has no say at all over Openreach, it may in the end decide to break itself up anyway.
On Monday, BT announced that the first Openreach chairman would be Mike McTighe, who was on the board of Ofcom between 2007 and 2015.
Announcing the appointment, BT chairman Sir Michael Rake said: “We promised in July to create an Openreach Board and we are delivering on that promise.
“I remain hopeful this significant move by BT can help to underpin a sustainable, proportionate and fair regulatory settlement that is in the interests of the whole country.”