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LONDON—BT Group PLC on Tuesday rejected a call from the U.K.'s communications regulator for the carrier to run its lucrative infrastructure arm as a legally separate company within the firm.

The rejection puts the company and the regulator on a potential collision course amid mounting tensions across the British telecommunications industry.

BT, a 170-year-old former state-run monopoly known as British Telecom, lays down most of the U.K.'s telecoms lines and makes a hefty chunk of its revenue through its Openreach division by connecting up the country's copper wire and high-speed fiber-optic cable network.

For years, BT has faced calls for increased regulatory pressure on the division by rival operators which lease the network on a wholesale basis to reach their own customers.

While the U.K.'s Office of Communications, or Ofcom, stopped short of calling for Openreach to be spun off entirely, it said the business should be a "distinct company" in BT, with its own independent board.

Also, under the plans, Openreach would be obliged to consult with customers such as Sky PLC and TalkTalk Telecom Group PLC on "large-scale" investments.

Ofcom says Openreach, which recorded 40% of BT's operating profit in the year to end of March 2015, needs to take its own decisions on budget, investment and strategy. Openreach provides financial power to BT as the group's largest contributor of free cash flow.

Responding to concerns over competition, investment and service across the network, Ofcom said BT must allow easier access to its cables for other operators to build up their own fiber networks. BT competes with companies such as Vodafone Group PLC, Sky and Liberty Global PLC's Virgin Media in the rapidly-developing market for combined telephony, Internet broadband and media services.

Ofcom announced last year that it was considering whether BT should be split up, based on promoting benefits to consumers and businesses. While rivals called for the telecoms giant to be broken up, BT said its ownership of Openreach is key to network investment across the U.K.

Still, Ofcom said on Tuesday its plan would avoid "costs and disruption" resulting from separating off the division entirely.

"We're pressing ahead with the biggest shake-up of telecoms in a decade," said Chief Executive Sharon White, who joined the regulator last year.

In response, BT said it would make "significant governance changes" to Openreach, including forming a new board and greater budget independence.

But it said legal separation would be step too far. And it also disagrees with Ofcom's proposals for Openreach to have its own network assets and staff.

"We believe our proposals are a bold and appropriate response," said BT Chief Executive Gavin Patterson, who said the company would make changes within six months.

"We think we have gone almost as far as we can go," added a BT spokesman.

As well as receiving criticism from regulators and rivals, BT has also faced calls from U.K. lawmakers to reform its business.

The U.K. government has called for the country's homes and businesses to have universal access to fast Internet broadband. And last week, a government committee said BT's lack of investment could total hundreds of millions of pounds a year.

Addressing spending criticisms, Mr. Patterson said BT would invest a further £ 6 million ($7.9 million) over the next three years.

BT shares rose nearly 5% in early deals, as investors reacted warmly to Ofcom's not immediately forcing a structural breakup of BT.

"Avoidance of the worst-case outcome may be a relief for investors," said UBS analyst Polo Tang.

Still, others said the result may only be temporary.

"This move is clearly the first in a multi-stage process toward severing Openreach from the BT group," said Cable.co's Dan Howdle. "Full separation is now inevitable."

On Tuesday, Ms. White warned that Ofcom could still force a full split of BT and Openreach if the telecoms group doesn't act on the regulator's plans.

"We have the powers [to enforce the proposals]," Ms. White told the British Broadcasting Corp. earlier.

Ofcom said it will seek views on its plans until Oct. 4.

The rising pressure on BT follows wider discussions about the U.K.'s telecoms and media market, which has been roiled by a frenzy of deal-making activity in recent years.

In the U.K, as elsewhere in Europe's consolidating telecoms and cable markets, operators are battling for subscribers in an intensified media services fight as they bundle together fixed telephony, mobile, broadband Internet and pay-TV.

BT has spent heavily on a range of sports channels and sports rights to develop its TV service and last year moved to acquire mobile operator EE in a multibillion-dollar deal, which has raised the stakes in the industry.

Rory Gallivan contributed to this article.

Write to Simon Zekaria at simon.zekaria@wsj.com

(END) Dow Jones Newswires

July 26, 2016 06:55 ET (10:55 GMT)

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