BT will not have to sell off its Openreach broadband division despite concerns that it has been starved of investment and provides a poor quality of service to millions of homes.

The telecoms regulator, Ofcom, has instead ordered BT to give more independence and investment powers to Openreach, which owns the fibre and copper wires that run from the local telephone exchange to homes and businesses.

Ofcom said Openreach should be run as a legally separate company within BT Group, with its own board, an independent chairman and its own brand. The regulator’s chief executive, Sharon White, said the alternative choice of forcing BT to sell the division – as demanded by its rivals – would take too long.

“This is a practical plan that can be implemented within months, unlike a sell-off of Openreach, which would take years,” White said, pointing to issues such as land contracts and pensions. “This model should deliver … without years and years of legal wrangling. This is a structural change in incentives.” She said the UK was lagging far behind other countries, with only 2% of the country receiving ultrafast broadband delivered via fibre-optic lines, similar to Germany. Korea, Spain, Lithuania and Portugal are at around 60%, and Japan at 70%.

Steve Unger, Ofcom’s director of strategy, said a full-blown separation would trigger “very significant costs” related to BT’s £7bn pension deficit, to make arrangements for employees within Openreach. White added that making Openreach a legally separate company within BT would require it to act in the best interests of all broadband customers in the UK and not just BT customers. “Openreach has not done a good enough job on customer service.”

BT’s rivals – Sky, Vodafone and TalkTalk – argue that the company has dragged its heels on opening its network to their engineers, which stymies their ability to offer homes superfast broadband access. White said this would no longer be the case. “This could bring about significant change. It will mean you have faster, more reliable broadband. It will mean engineers turning up on time and getting the job done first time. And crucially for the UK it will mean more investment in fast fibre to the doorstep,” she said.

She defended the regulator’s decision to let BT appoint Openreach’s independent directors, saying they would not be affiliated to BT in any way and would be appointed and removed by BT in consultation with Ofcom. Openreach’s chief executive will be appointed by its board. It will have its own strategy and set its own budget, but this will need to be signed off by BT.Ofcom said a full breakup remained an option. The regulator and BT have yet to reach agreement on the proposals, but White said they would be enforced.

BT’s rivals immediately criticised the proposals. TalkTalk, which is a customer of Openreach because it needs to use the BT network in order to offer broadband to customers, said Ofcom had been too cautious and that its proposals favoured BT.

Dido Harding, the chief executive of TalkTalk, said a full split was needed, and believes that it will eventually happen. “We can’t afford to have something that is a sort of British fudge. We need a clear outcome. Britain has a second-rate infrastructure.” She explained: “Legal separation still means a highly complex web of regulation, and BT has proven itself expert at gaming this system. There is nothing to suggest they will not continue to do so in the new system. In taking one cautious step forward, I fear Ofcom may in practice have taken five steps back.”

Harding added that under the proposals Openreach would not be required to declare what dividends it paid back to BT, so it would not be clear how much profit was being handed to its owner “to buy sports rights or other things”. BT is a major player in football broadcasting thanks to its Premier League and Champions League rights deals, which are used as a marketing tool to lure broadband subscribers.

Harding said the pension issue could be overcome, pointing to a report done by law firm Sacker & Partners for Sky (pdf). She argued that Openreach would be a much more secure home for the pension fund than a company that buys football rights every few years. TalkTalk, Sky and Vodafone are launching a campaign on Wednesday to encourage consumers and businesses to write to Ofcom and “make their voices heard” in the coming months, as the regulator consults on the plans with a deadline of 4 October.

Sky was also critical of the proposal. The pay-TV operator’s chief executive, Jeremy Darroch, said it “falls short of the full change that would have guaranteed the world-class broadband network customers expect and the UK will need. In particular, leaving Openreach’s budget in the hands of BT Group raises significant questions as to whether this will really lead to the fibre investment Britain requires.”

Shares in BT rose more than 4% in early trading. The telecoms group welcomed the plans and said a full structural separation of Openreach would be a disproportionate move. “Our proposals provide Ofcom with every benefit they’re seeking but without any of the substantial and unavoidable costs associated with legal incorporation. We will continue to engage with them over the coming months.”

Gavin Patterson, BT’s chief executive, said the group would invest £6bn over the next three years in improving the UK’s digital network. He said: “It is a sensible way forward. We accept that we can do better and we’ve put forward a proposal that does that.” As well as commercial rivals calling for action, a select committee of MPs last week said Ofcom should consider an Openreach breakup, unless BT spent more money on the service. Politicians and a former regulator joined BT’s commercial rivals in criticising Ofcom for not going far enough with its plans.

Tim Farron, the leader of the Liberal Democrats, accused Ofcom of being toothless by not forcing BT to sell Openreach. “It provides a poor service to customers and has been starved of investment. Giving more powers and investment to Openreach is better than nothing but the crucial thing is it will leave millions of customers with poor quality broadband. That is unacceptable in the modern age when the government claims to be creating a digital economy. If a watchdog yet again fails to bark, perhaps it is time to put it down.”

John Fingleton, a former head of the Office of Fair Trading, tweeted: “It is BT one, Ofcom nil. Conduct regulation has failed, and this is just more failure.”

BT has been accused of leaving millions of people with substandard broadband connections because of a failure to invest. Under the regulator’s plans, Openreach would be obliged to consult formally with customers such as Sky and TalkTalk on large-scale investments. BT’s CEO will not receive feedback on those discussions in order to ensure that Openreach makes impartial decisions on investment.

Separately, Ofcom has begun discussions with the industry to force telecoms companies to provide automatic compensation to customers when their service falls short. The regulator has also published proposals to make it easier for mobile customers to switch network and to switch triple-play bundles (landline, broadband and pay-TV services).