A year ago the Court of Appeal delivered its judgment in IBA Health v OFT. .
The IBA case related to the duty of the Office of Fair Trading (OFT), under the Enterprise Act 2002, to refer mergers to the Commission at the end of its initial or first phase review. The Court of Appeal held that the OFT must refer if, on a reasonably based analysis, having investigated the matter, it believes that it may be the case that, as a result of the merger, competition may be substantially lessened. The use of may here means a less than 50% likelihood, but more than merely fanciful. The Court of Appeal expressly stated that the OFT could decide not to refer, even if there were grounds for competition concern, if it has enough evidence to conclude that competition would not be substantially lessened.
Changes to the OFT Substantive Assessment Guidance
Since February 2004 the OFT has sought to apply this new interpretation of the statutory test. In October 2004 the OFT amended its Substantive Assessment Guidance in response to the Court of Appeal's judgment. The revised guidance states that the reference test will be met if the OFT has a reasonable belief that can be objectively justified on the facts that there is a realistic prospect that a merger will lessen competition substantially. A realistic prospect is defined to include a prospect that has more than a 50% chance of occurring, and also a prospect that is not fanciful but has less than a 50% chance of occurring. Previously the guidance had referred to a significant prospect.
The revised guidance clarifies that the threshold to be applied by the OFT will differ from that of the Commission, given the OFT's role as a first screen. The revised guidance states that, if the OFT believes there is a greater than 50% chance of a merger resulting in substantial lessening of competition (SLC), then it will be referred. In cases where the OFT believes there to be a less than 50% chance of a merger resulting in a SLC, there is a wide margin within which the OFT must exercise its judgement.
Given the inherent difficulties in assessing the effects of a merger on competition, in particular, due to imperfect information and the limited timeframe, the guidance notes that, if the parties are able to provide the OFT with comprehensive information, the OFT will find it easier to be confident of its assessment. In particular, with comprehensive information at its disposal, the "degree of likelihood that the OFT must require to believe that it may be the case that a merger may be expected to result in SLC may be higher up the scale of probability (albeit less than 50%) than compared to when there is less information available, particularly as regards the central points in the analysis".
OFT expectations
The Enterprise Act 2002 came into force in mid-2003. Before the appeal which culminated in the IBA judgment, the OFT had assumed that the number of references to the Commission would be broadly the same as under the previous regime. For comparative purposes, Table 1 below shows the proportion of cases referred to the Commission under that previous regime.
In its Annual Plan 2004-2005, after the IBA case, the OFT stated that it expected to consider between 180 and 230 public mergers, of which 30 to 50 were likely to raise competition concerns. The OFT expected to refer 20 to 25 of these cases to the Commission. In its draft Annual Plan for 2005-2006 the OFT has slightly adjusted the number of expected referrals to between 10 and 25 mergers.
Year |
Qualifying cases (1) |
Referred |
Expressed as a % |
1998 |
224 |
8 |
3.80% |
1999 |
219 |
10 |
4.90% |
2000 |
171 |
14 |
8.25% |
2001 |
173 |
10 |
5.80% |
2002 |
164 |
14 (2) |
8.50% |
(1) The OFT Annual Reports contain data including and excluding confidential guidance cases. To compare this data with the 2004 data, which incorporates decisions taken by the OFT either to clear, refer or declare that a case does not qualify, it is more appropriate to use the figures excluding confidential guidance, in particular because those cases that later became public are included in these figures. |
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OFT practice in the last year
The statistics
The Enterprise Act regime operated for about 20 weeks before the challenge that led to the IBA judgment. The figures set out in Table 2 compare the number of mergers analyzed under the Enterprise Act 2002 with those referred to the Commission in the 20-week period before the CAT decision of December 3 (pre IBA); the number of mergers and referrals in the period between the CAT judgment and the judgment of the Court of Appeal of February 19 (pending IBA. The CAT decision suggested an even lower threshold for reference to the Commission, which was applied by the OFT until the Court of Appeal's judgment); and the number of mergers and referrals in the period since the Court of Appeal judgment (post IBA). All figures are taken from the list of decisions on the OFT website.
Approx weeks |
Decisions(1) |
Qualifying decisions (2) |
Under-takings in lieu |
Referrals |
% of all qualifying decisions referred |
|
Pre IBA July 16 2003 – December 3 20033 |
20 weeks |
56 |
33 |
0 |
4 |
12% |
Pending IBA December 4 2003 – February 19 2004 |
11 weeks |
25 |
15 |
2 |
3 |
20% |
Post IBA February 20 2004 – January 28 2005 |
49 weeks |
169 |
119 |
6 |
15 |
13% (17% with undertaking cases) |
(1) Published on the OFT website. This figure includes cases found not to qualify. |
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Given the small dataset, and the fact that individual cases are reviewed on their merits, there are real limits to what the statistics can say over such a short period. Nonetheless, the statistics are consistent with the proposition that more references are being made under the Enterprise Act regime than the previous regime. Further, given that the outcome of the IBA case was a test that required a tightening of the OFT guideline, one might indeed have expected higher rates after IBA for references and undertakings in lieu. By comparison, in 2004 only 4% of mergers notified to the European Commission under the European Merger Regulation were put into phase 2 detailed investigation or referred back to a member state for review, with a further 5% being resolved by commitments in phase 1.
Beyond the statistics
The OFT's approach has been consistent with its Substantive Guidance. It is concerned with whether mergers will significantly affect the process of rivalry between firms. Most of the cases that it has referred to the Commission have involved mergers that would create clear market leaders with large market shares. In such cases of concern about unilateral effects (that is, the ability to raise price without coordination with other market players), the market shares are often well above the 40% threshold normally associated with dominance. Indeed, the OFT has continued to clear mergers that might give rise to large market shares where it has been satisfied that:
there are real prospects of new entry or ease of switching to new suppliers (for example, in Atlas Copco/Ingersoll Rand Drilling, the merger would have led to shares of over 60%); and/or
the parties are not close competitors of each other (for example, in Dadco/Aluminium Oxid, the merger would have led to shares of 40% to 50% and there were high barriers to entry but other competitors, or in British Sugar/Billington Food, where the post-merger share was over 50% but the parties' products were not complete substitutes); and/or
there is enough buyer power to offset the concentration brought about by the merger (for example, in Bayard Capital Partners/Landis & Gyr, concerning the purchasing power of energy companies for prepayment meters (post merger share 60% to 70%)).
There have also been cases involving potential coordinated effects, where the post-merger market structure might be characterized by a small group of firms between whom competition is muted by either tacit or explicit coordination. In such cases, the post-merger market share of the merging parties might be low. Examples are the references in Napier Brown/James Budgett and DS Smith/Linpac, despite in each case the merged firm having less than 30% of the relevant market. In Napier Brown the merger involved companies that the OFT described as close competitors for certain customers, and a merger that would reduce the number of competitors from four to three. In DS Smith/Linpac the OFT received a large volume of complaints from customers that the market was not competitive.
Nevertheless the OFT also cleared a number of mergers that reduced the number of big players in a market from four to three where it was satisfied on the evidence that customers would continue to have choice and that the market would remain competitive (for example, in Atlas Copco/Ingersoll Rand Drilling again or Phoenix Healthcare/East Anglian Pharmaceutical, though in the Phoenix case, clearance has been challenged by a competitor).
A review of the OFT's decisions of the last year confirms the perception of practitioners from their individual experiences. This is that the effect of the IBA judgment has been that merging parties have to produce more extensive evidence that their deal will not result in an SLC than had previously been the case to achieve clearance, and that particularly good evidence is required where there are third party complaints.
The Competition Commission's year
The last year has seen the first cases where the Commission has both investigated cases and been the body responsible for the final decision whether to block mergers, clear them, or clear them subject to conditions. Leaving out of-account cases which were abandoned by the parties after the reference was made, the Commission has finally or provisionally reported on 10 of the post-IBA references. At the time of writing (early February). It has cleared or provisionally cleared seven, blocked two and is considering remedies in another. (Such a high clearance rate might be expected in light of the lower reference threshold after IBA).
Again, though, looking beyond the statistics, what interesting developments can be seen?
The standard of proof the Commission works to is whether an SLC is to be expected. This means more likely than not, or more than a 50% likelihood. This leads the Commission to investigate in considerable detail issues of market definition and then merger effects. In considering merger effects, the Commission has paid particular attention to the issue of causation: is it the merger that brings about the adverse effects on competition that third parties have drawn to its attention?
Some examples will illustrate this.
In DS Smith/Linpac the Commission had to consider not only whether the conditions for tacit coordination were present, but also whether the merger would make any difference to competitive conditions. The Commission established that some of the necessary conditions for tacit coordination were met. However, after analysis the Commission was not satisfied that all the necessary conditions had been established, nor that the merger would increase the likelihood of coordination (because the merger would not affect the likelihood of new entry or expansion of smaller competitors who could constrain the behaviour of the leading players).
In Taminco/Air Products and Chemicals the Commission had to consider a merger of two large UK suppliers of certain methylamines and derivatives. The OFT had considered that the merger reduced the number of big European players from three to two in markets where competitors were capacity constrained to compete, there were barriers to entry, and limited buyer power. The Commission considered the merger by reference to a detailed consideration of the counterfactual - that is, the most likely alternative scenario if the merger did not go ahead. While in many cases the counterfactual is the continued operation (and competition) of the merging parties, this is not always so. In this case the Commission considered that Air Products would inevitably exit the relevant businesses. On doing so, it could realistically either sell them to Taminco or to another competitor. Assessed in that light, the Commission concluded that the market shares and level of concentration arising from the merger would not be too different from those under the counterfactual. The Commission therefore found that the merger could not be expected to result in any SLC. The concept of the counterfactual was similarly central to the Commission's clearance decisions in Carl Zeiss/Bio Rad and Arcelor/Corus.
Lastly, in cases where the Commission finds a SLC, it seems that it will continue to be reluctant to accept behavioural remedies (for example, not to increase prices) in markets that are not already subject to some form of regulation. It rejected them in Knauf Insulation/Superglass (glass wool) but accepted them in First Group/Scotrail (bus and rail services).
Author biography
Michael Cutting
Linklaters
Michael specializes in EU and UK competition law and the law and practice of regulating utilities. He has extensive experience of the application of competition law in the telecommunications, utilities, leisure and transport sectors. Recent merger control experience includes National Grid Transco's acquisition of Crown Castle, Centrica's acquisition of Rough Storage (cleared conditionally by the UK Competition Commission in the face of OFT concerns and Ofgem opposition) and advising RMC on the competition issues arising from the bid by Cemex.
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