1. This section outlines a set of proposals that could be adopted in response to the concerns outlined in Section 4. Suggested proposals for the threshold for mergers and acquisitions are presented first. This is followed by suggested proposals for section 36.

Broadening the Threshold for Mergers and Acquisitions

2. As discussed in Section 4, it is likely that the current thresholds for mergers, by ignoring the potential for joint dominance, prevents sufficient scrutiny of mergers that fall short of creating single firm dominance, but may nevertheless result in efficiency losses. In particular, mergers are not scrutinised in terms of whether they facilitate tacit collusion in tight oligopolistic industries. A merger creating such an industry can facilitate the change from firms competing to firms colluding. This loss of competitive rivalry then translates into losses in industry efficiency and consumer welfare.

Proposal - Adopt a Competition Test for Mergers and Acquisitions

3. One way to allow the Act to respond to the problems associated with joint dominance would be to allow for fuller scrutiny of merger and acquisition proposals. To achieve this, the merger threshold, which has the role of identifying what level of market power is likely to be harmful to the economy, would need to be broadened to focus directly on the impact on competition. To achieve this the Australian threshold for mergers could be adopted. This would mean replacing the current prohibition with:

No person shall acquire assets of a business or shares if the acquisition would have the effect, or be likely to have the effect, of substantially lessening competition in a market for goods and services

Benefits of Adopting the Australian Threshold

Merger Scrutiny Will Encompass Joint Dominance

4. Adoption of a competition test for mergers would clearly recognise that single firm dominance is not an essential precondition to the abuse of market power. Single firms acting in concert with a limited number of others, can abuse market power and impose significant efficiency losses. Having the Australian threshold would allow mergers to be scrutinised in terms of the competition and efficiency effects of joint dominance. That is, mergers could be scrutinised in terms of whether the resultant market structure would facilitate collusion, both explicit and tacit. Australian experience suggests that this is unlikely to mean in practice a large increase in the number of illegal mergers. Rather it will mean that the market characteristics that are conducive to illegal collusion, such as few players and product homogeneity, will also need to be considered in merger analysis.

Greater Scrutiny of Mergers in the Non-Tradeable Sector

5. A competition test for mergers will subject a number of mergers that previously escaped scrutiny to authorisation and its efficiency test. In particular, the broader threshold should provide greater scrutiny of mergers occurring in the non-tradeable sector of the economy. This will be beneficial, as mergers within this sector are likely to pose the greatest risk in terms of inefficient outcomes, as the non-tradeable sector is not subject to the pressures of international competition.

6. Changing the threshold for mergers is unlikely to have any particular regional impact. The Act is generic and applies across all sectors of the New Zealand economy. Competition concerns can arise in regions heavily based on the primary sector as much as they can in regions heavily based on the manufacturing and services sectors. When considering matters under the Commerce Act it is generally necessary to define which market or markets are likely to be affected. An important component of market definition is the geographic extent of the market. For example, a market may cover the whole country, or smaller regions or districts. Geographic definition starts at the location of the merging firm and extents out to cover all markets likely to be affected by anti-competitive behaviour on the part of the merging entity. There is no reason why changing the merger threshold will focus geographic market definition on any one region of New Zealand in particular.

7. Greater scrutiny of merger proposals will also be of benefit in recently deregulated industries. In these industries the dominance threshold can offer little guarantee against an inefficient outcome. These losses may be so significant that they erode the efficiencies gained through deregulation.

8. The advantage of greater scrutiny of mergers occurring in these sectors was a key reason why the Australians changed their threshold. As Brunt at the time commented:

In terms of likely impact, more mergers will be examined by the Trade Practices Commission; and more will be sent to authorisation. Some, relatively few mergers, in industries sheltered from international competition, will be stopped. But they will be very important mergers, strategically located with the economy. The new law will be vitally important for the functioning of the deregulated and privatised utilities - industries such as telecommunications, energy and transport. And there are other industries that had an easy ride through the dominance law - such as media, aviation, areas of retailing - that will now come under closer scrutiny.⁵⁷

Sharper Focus for the Commerce Act

9. Having a competition test for mergers would also provide a sharper focus for the Commerce Act on promoting competition and efficiency. Currently the Act has a very narrow merger threshold on the basis that high market concentration is needed to allow firms to realise sufficient economies of scale. Such economies are particularly important to assist firms to be competitive on the world market. At the same time the Act also provides the authorisation procedure as a way to balance the efficiencies of any merger against any anti-competitive effects.

10. In this sense the job of examining efficiencies is done first in a very blunt way that ignores the competition effects (i.e. through the merger threshold), and then in a merger- specific way through authorisation. This approach could weaken the ability of the Act to promote efficiency. As mentioned earlier, in monopolistic or oligopolistic markets where competitive rivalry is lacking, the time periods required to realise the "claimed" potential efficiencies from merger can be long, and the foregone costs of the potential efficiencies high.

11. A preferable approach is to examine the competition effects first, and then balance any loss of competition against the efficiency gains. In our view, the competitive process in our economy will be better served by a competition test for mergers working in tandem with the authorisation procedure.

Consistency in the Treatment of Mergers and Restrictive Trade Practices

12. Having a "substantially lessening competition" threshold for mergers, would remove the current inconsistency in the treatment of restrictive business practices, which fall outside of section 36, and mergers. Anti-competitive outcomes can be the same whether achieved through contract (arrangement or understanding) or through merger. The only real difference is one of form. For example, if two firms agree to engage in conduct that substantially lessens competition this would contravene the Act. Yet if the two firms merge to achieve the same result, then as long as the merger does not result in dominance, or increased dominance, the anti-competitive outcome will not breach the Act.

13. If anything the law should be tougher on mergers because it is the most enduring form of agreement between firms. If firms merge then the opportunity for competition between them is gone forever.

14. The current inconsistency could be creating some incentive for firms to merge to gain the outcomes that they are prohibited from achieving under ss27-29 of the Act.

Consistency with Other Jurisdictions

15. If New Zealand adopted a competition test for mergers it would bring us more in line with the approach taken by almost all OECD countries. In particular it would make our Act consistent with the Australian law. This would minimise the risks of business uncertainty, as Australian jurisprudence would have persuasive effect in the New Zealand courts. It would also simplify the regulatory environment for those businesses operating in both countries.

The Costs of Broadening the Threshold

16. Although using a broader threshold is likely to be of net benefit to the economy, a broader threshold will impose some costs on the economy. This will reflect the increased number of mergers scrutinised and potentially prohibited.

Increase Merger Scrutiny Will Increase Compliance Costs and Administration Costs

17. Since changing its threshold from "dominance" to "substantially lessening competition" in January 1993, Australia tended to experience an increase in the number of mergers scrutinised. It has also experienced a slight increase in the number of mergers opposed in the first three years of the changed threshold. These results are given in the table immediately below.⁵⁸ The statistics do not cover the number of proposals that are not proceeded with because the parties consider they will be in breach of the Act without referring them to the ACCC. So these statistics may underestimate the number of merger proposals prevented by the Act.

Australian Mergers Examined and Opposed

Financial year	No. of mergers examined	No. of mergers opposed
1996/97	149	7
1995/96	120	12
1994/95	118	12
1993/94	78	6
1992/93	86	5

18. Over the first two years of the changed threshold, the amount of time devoted to investigations was significantly greater under the new competition test. Under the dominance test the TPC considered and cleared the vast majority of mergers within one week. However, in 1996 its successor the ACCC indicated that for the few mergers that raised very substantial issues that were likely to breach the Act, six to eight weeks were needed to provide a response. In matters that appear to breach the merger threshold, the ACCC will usually be able to complete its consideration within one month. In cases where it is satisfied that merger thresholds are not breached, the ACCC can usually inform the parties that no action will be taken in 10 to 15 days.⁵⁹

19. We need to be wary in interpreting the Australian experience, as Australia does not have a clearance process, it just has authorisation. However, what can be said is that the number of applications seeking clearance and then requiring authorisation will increase.

20. It is also likely that New Zealand experience of a broader threshold would be similar to that of Australia's. More mergers will be scrutinised but, given authorisation, only slightly more will be opposed.

21. The increased number of mergers scrutinised by the Commission will impose an increase in administration costs for the Commission and an increase in compliance costs for firms. The compliance costs for firms include the cost of applying for clearances and authorisations, and any additional costs if the Commission's decisions are challenged. Currently the application fee for clearance of a merger is $2,250, and $22,500 (both GST inclusive) for an authorisation. Added to these fees are the other costs firms bear in making their applications, which involve executive time and the cost of legal and economic advice. If an authorisation is subsequently required, travel and accommodation costs may also be incurred in attending any Commission conference.

Increase in Uncertainty for Business

22. Altering the threshold for mergers could also create a degree of business uncertainty, to the extent that participants would be unclear of the legal consequences of proposed mergers, particularly in the first years of the new threshold. However, as the "substantial lessening of competition" test applies elsewhere in the Act, and in Australia in relation to mergers and acquisitions, any uncertainty should be minimal. Merger decisions from the ACCC and from the Australian courts will provide useful guidance for the business community, and any residual uncertainty could be addressed by the Commerce Commission issuing revised merger guidelines.

Adopting Section 50(3) of the Trade Practices Act

23. Another way to reduce uncertainty would be to adopt section 50(3) of the Trade Practices Act. Section 50(3) sets out the matters which must be taken into account in determining whether the acquisition would have the effect, or likely effect, of substantially lessening competition:

the actual and potential level of import competition on the market;
the height of the barriers to entry to the market;
the level of concentration in the market;
the degree of countervailing power in the market;
the likelihood that the acquisition would result in the acquirer being able to significantly and sustainably increase prices or profit margins;
the extent to which substitutes are available in the market or are likely to be available in the market;
the dynamic characteristics of the market, including growth, innovation and product differentiation;
the likelihood that the acquisition would result in the removal from the market of a vigorous and effective competitor; and
the nature and extent of vertical integration.

24. One difficulty with providing such guidance in the statute is that it would force the Commerce Commission to consider every matter in section 50(3) in making its decisions even when they all may not be directly relevant. There is also a degree of overlap between the matters listed in the Australian section. Alternatively the Commission could revise its Merger Guidelines to define clearly what the relevant dimensions of market power are in its consideration of merger/acquisition proposals.

Proposal - Streamline the Clearance Process

25. One way in which the increased compliance costs could be minimised, if the merger threshold was broadened, would be try and streamline the clearance process. This could be done with or without a change to the threshold. If achievable, streamlining would better target the Commission's attention on those proposals that will substantially lessen competition, or create or strengthen dominance.

26. The current pre-merger notification regime distinguishes between applications depending upon whether a clearance or authorisation is sought. Clearance requires the Commission to consider whether the acquisition would create or strengthen a dominant position. Authorisation requires the Commission to consider whether the acquisition would be of net benefit to the economy. The time limits for each are 10 and 60 days respectively, with scope for extensions through agreement between the Commission and the applicant.

27. The potential problem with this is that there is a wide variation between the amount of time and effort needed to consider different clearance applications. The most complex clearance proposals can require almost as much analysis as most authorisation applications. The consequences are that:

for straightforward clearance applications the Commission seeks too much information in its standard forms, the 10 day limit is too long, and the application fee of $2,250 is too high; and
for more complex clearance applications the 10-day limit is too short, and the application fee is too low. This may encourage some applicants to seek a clearance where an authorisation application (fee $22,500) is more appropriate.

28. An alternative would be a "short form-long form" system that distinguished applications by the amount of analysis needed, and not whether clearance or authorisation is being sought. A possible recipe, which is an adaptation of the Canadian regime, is as follows:

the applicant has the choice of completing the Commission's "short" or "long" form;
if the applicant submits the "long" form application, the Commission has 60 working days to consider whether to approve the application either on the grounds that it is not anti-competitive, or meets the public benefit test;
the "short" form requires only the most fundamental information about the proposal;
with "short" form applications, the Commission has the option of:

allowing five working days from the date of registration to lapse, in which case the proposal is deemed to be approved. Or at any time within the five days, the Commission could confirm in writing that the proposal has been approved; or
seeking further information from the applicant within the five working days, and extending the review period for up to another 10 days from the date of receipt of the additional information; or
inviting the applicant to complete the "long" form. If the applicant declines the invitation the proposal is deemed to be not approved. If the applicant agrees, the clock starts at zero and the Commission has 60 working days to consider whether to approve the application either on the grounds that it is not anti-competitive or meets the public benefit test.

29. This system could lower both the Commission's administration costs and compliance costs for firms. It could also provide a more efficient distribution of the costs of merger scrutiny between market participants. These advantages suggest that if the clearance process could be streamlined along the lines of the Canadian regime, this would be preferable to the status quo.

Improving the Threshold for Section 36

30. As discussed in Section 4, the key issue associated with the current section 36 is that judicial interpretation has narrowed its scope over time. This has reduced the section's effectiveness in prohibiting and deterring unilateral misuses of market power. This concern could be addressed by either:

Option 1 - amending the definition of "dominance" in section 3(8) and adding definitions of "use" and "purpose"; or
Option 2 - applying the Australian threshold to section 36 and the Australian definition of "purpose".

These options are not mutually exclusive and some hybrid between the two could also be an option.

Option 1 - Amendment of Dominance, Use and Purpose

31. Option 1 would seek to restore section 36 to the scope originally intended by Parliament in 1986. This could be achieved by:

amending the definition of "dominant position" in section 3(8);
clarifying "use" to mean a neutral causal connection between dominance and the purpose; and/or
adding a statutory test for "purpose" similar to section 46(7) of the Australian Trade Practices Act, that will allow for the inference of purpose from the dominant firm's conduct.

Advantages of Option 1

32. The key advantage of Option 1 is that it would lower the threshold for section 36 only to the level originally intended by Parliament. Once case law is well established, this will mean that it will be able to prohibit and deter the dominant firms from misusing market power, with a lower risk that efficiency enhancing conduct is deterred (i.e. as compared with Option 2).

33. A new definition of "dominant" in section 3(8) could focus directly on the concept of the misuse of market power. This would provide a more accurate characterisation of the market failure that section 36 is designed to address. This would refocus the interpretation of section 36 back on to the ability of a firm to behave to an appreciable extent in a discretionary manner without suffering detrimental effect.

34. In several respects Option 1 represents a codification of developing section 36 case law. Codification will create greater clarity in the interpretation of section 36 of the Act and thus greater certainty for market participants. This certainty will be achieved at a lower cost overall, i.e. by the passage of legislation, rather than through the more expensive alternative of private and public sector litigation.

Costs of Option 1

35. Although a redefined threshold for section 36 is likely to be of net benefit, it is acknowledged that an amended section 36 will impose costs on the economy. The key costs of addressing the issues associated with section 36 via Option 1 include:

an increase in the level of legal uncertainty and thus some uncertainty to business. Although the courts are likely to be familiar with the general concepts, such as misuse of market power, the defining lines provided by the new legislation will take time and resources to develop;
an increase in compliance costs for firms, at least in the first few years of the redefined section 36, as firms seek greater amounts of legal advice as a means to manage the increased uncertainty they face; and
a slight deterrence of efficiency enhancing conduct for the largest firms in the economy until the uncertainty surrounding the new section is sufficiently dissipated.

Option 2 - Adopting the Australian Threshold for Section 36

36. The current problems with section 36 could be resolved by replacing the threshold for section 36 with one that refers directly to market power and adding a definition of purpose. This could be achieved by adopting the "substantial degree of power in a market" threshold used in section 46 of the Australian Trade Practices Act. This would incorporate the Australian "take advantage of" in replace of our section's "use". A definition of purpose would be provided via adoption of section 46(7). This would mean that the current threshold for section 36 would be replaced with:

A person who has a substantial degree of power in a market shall not take advantage of that power for the purpose of:

restricting the entry of any person into that, or any other market; or
preventing or deterring any person from engaging in competitive conduct in that, or in any other market; or
eliminating any person from that or any other market.

37. The Australian section 46(7) would be picked up into our Act and this section states:

Without in any way limiting the manner in which the purpose of a person may be established for the purposes of any other provision of this Act, a corporation may be taken to have taken advantage of its power for a purpose referred to in sub-section (1) notwithstanding that after all the evidence has been considered the existence of that purpose is ascertainable only by inference from the conduct of the corporation or of any other person or from other relevant circumstances.

38. Adopting the Australian threshold will have the effect of lowering the threshold for section 36. A firm having a "substantial degree of market power" will have a lesser degree of market power than a firm in a "dominant position".

Advantages of Option 2

39. There would be a number of advantages in resolving the issues concerning section 36, by adopting the Australian threshold. First, the Australian threshold has the advantage that it focuses directly on the concept of market power. As with Option 1, this would provide a more accurate characterisation of the market failure that section 36 is designed to address and should provide a better focus for judicial interpretation.

40. Second, as the Australian threshold of a "substantial degree of market power" is a lower threshold than a "dominant position in a market", this may make it easier for market participants to remedy instances of unilateral abuses of market behaviour. In this way it will be more effective in promoting competition in the economy.

41. Adopting the Australian threshold, would also give the Act the potential to respond to issues of joint dominance. Only one firm can be dominant at any given time within a particular market. However, there may be several firms in a market that have substantial market power, and who are able to jointly exercise that power for the purpose of restricting entry, preventing or deterring competitive conduct, or eliminating competitors.

42. The Australian threshold would also have the advantage of removing any concern about differences in the current thresholds in relation to the use of market power within trans-Tasman markets.

43. It is interesting to note parenthetically, that in the view of Brunt⁶⁰ New Zealand did not intend to achieve a higher threshold than the Australian statute. As she observes:

...it is a relic of a time when the Australian section 46 was couched in terms of a "position substantially to control a market", and is an interesting example of the manner in which the New Zealand statutory design may be caught in the coat-tails of Australian shifts of policy.

Costs of Option 2

44. The costs of addressing the issues associated with section 36 with adoption of the Australian threshold, will differ to some extent to those associated with Option 1. Specifically, Option 2 will not be associated with the same level of legal uncertainty as Option 1 will, as the business community will be able to look to Australian case law as a guide to likely interpretation by the New Zealand courts. The costs of Option 2 arise from lowering the threshold for section 36, which is likely to:

increase compliance costs for business as a greater range of conduct would be expected to be caught;
increase the Commission's costs of enforcing the Act and the costs of enforcement generally as there will be an increase the range of conduct subject to section 36; and
increase the risk that efficiency enhancing conduct is either deterred or prohibited.

57 Brunt M, Australian and New Zealand Competition Law and Policy, paper given at the 19^th Annual Fordham Corporate Law Institute International Antitrust Law and Policy, October 22-23 1992, p 192.

58 Statistics from - The ACCC's Approach to Mergers: a Statistical Summary, Australian Competition and Consumer Commission, January 1998, p 4.

59 ibid. p 11.

60 Brunt M, Australian and New Zealand Competition Law and Policy, paper given at the 19^th Annual Fordham Corporate Law Institute International Antitrust Law and Policy, October 22-23 1992.

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Printed: 24/11/2009