Draft Revisions To Canadian Megs Released For Comment

Article by Susan Hutton and Marisa Berswick

On June 27, 2011, the Competition Bureau issued draft revisions to Canada's Merger Enforcement Guidelines (MEGs). The MEGs, last revised in 2004, set forth general direction on the Bureau's analytical approach to merger review under Part VIII of the Competition Act. On February 24, 2011, the Commissioner announced that the Bureau would undertake "moderate revisions" to the MEGs. An important factor driving the current revisions is generally understood to be the 2010 revisions to the U.S. Horizontal Merger Guidelines (U.S. Guidelines), although the Canadian revisions did not simply adopt those made in the U.S. In addition, the Canadian MEGs address both horizontal and vertical merger analysis and reflect more recent thinking on our own unique efficiencies defence. The Bureau is seeking public feedback on its draft revised MEGs by August 31, 2011, with a view to publishing them in final form in the fall of 2011.

Substantively, the draft revised MEGs do not appear to indicate dramatic shifts in Bureau merger enforcement policy or practice. They do adopt a more nuanced approach to market definition, however, and provide more detail regarding the Bureau's approach to monopsony (buyer) power, minority interests and interlocking directorates, the use of various economic tools in the analysis of competition between firms with differentiated products ("upward pricing pressure" as such is not specifically mentioned, but is very much there in spirit), a change in the approach to assessing whether entry is likely to be "timely", a more nuanced treatment of coordinated effects, and an expanded analysis of anti-competitive effects in non-horizontal mergers. The revisions are intended to address areas where the 2004 MEGs no longer fully reflected Bureau practice and current economic and legal thinking.

Clarified Role of Market Definition in Merger Review

The draft MEGs specify that merger review should be seen as an iterative process, as opposed to a linear one. In particular, market definition should be viewed as part of the overall analysis in that it is a typical, but neither a mandatory nor necessarily a preliminary step, in analysing the likely competitive effects of a merger. A prominent change is that merger review does not have to begin with defining the relevant product and geographic market. Instead, merger review may take into consideration market concentration in conjunction with other evidence of competitive effects, with the ultimate goal of concluding whether the merger creates or enhances market power. Any economic tool will be considered so long as it is appropriate, and there will not be a preference for any particular mode of analysis.

The change in the role of market definition enhances the flexibility of the Competition Bureau's approach. It appears to be based in part on the 2010 revisions to the U.S. Guidelines. The U.S. Guidelines provide the Federal Trade Commission with wide scope in determining whether there are anti-competitive effects, and there is less focus on strictly assessing market definition, market shares and market concentration. The draft Canadian revisions, similarly, make it clear that market definition is a means and not an end, while emphasizing that, where feasible and useful, markets will still be defined.

Enhanced Treatment of Monopsony Power

Monopsony power refers to the power of a buyer or a group of buyers to control and profitably depress the price of the product or service from sellers, by reducing the quantity of inputs purchased to a level that is below the competitive level for a significant period of time. The draft MEGs now incorporate the more detailed thinking on monopsony power previously available only in Bureau submissions to the Organization for Economic Co-Operation and Development (OECD).

The conceptual basis for defining relevant upstream markets is the hypothetical monopsonist test, although the Bureau will consider both market definition-based and other evidence of competitive effects in monopsony cases. Buying power is said to be anti-competitive when the buyer has the ability to decrease the price of the relevant product below competitive levels by virtue of a reduction in the overall quantity of inputs purchased. If the merged firm accounts for a significant portion of purchases of the relevant product, and barriers to buying the input are high, the Bureau will consider factors such as whether the merged firm has an incentive to reduce its own output (and therefore its purchases), whether long-run supply is likely to be reduced if prices are squeezed lower, and whether upstream supply is already competitive (i.e., countervailing selling power). By implication, the anti-competitive concern ought not to be present when a purchaser can negotiate lower prices that do not diminish the overall supply of the inputs in question. The draft revised MEGs do not go that far, however, and indeed point out that a price reduction obtained from suppliers with perfectly inelastic supply curves (no ability to reduce output in the face of lower prices) which results only in a wealth transfer would still be considered to be anti-competitive.

Enhanced Treatment of Minority Interests and Interlocking Directorates

The draft MEGs provide an extended explanation of minority interests and interlocking directorates, again in accordance with prior Bureau submissions to the OECD. The draft revised MEGs reiterate that the Bureau will review minority interests and/or interlocking directorships if they are either ancillary to a merger transaction or if they provide the party in question with an ability to materially influence the economic behaviour of the business of a competitor (i.e., if they constitute a merger in and of themselves). The MEGs note that the Bureau regularly reviews acquisitions of minority interests above the prescribed notification thresholds of a 20 percent acquisition in a public company or a 35 percent acquisition in a private company. Although interlocking directorships and minority interests below those levels do not trigger any notification requirement in Canada, the enhanced treatment in the MEGs reflects the Bureau's ongoing and increased scrutiny of non-notifable transactions.

Specifically, the draft MEGs provide expanded guidance on what level of minority interest will lead to potential concerns (generally speaking, absent other relationships such as a seat on the board of directors, a shareholding of less than 10% will avoid scrutiny). They also expand on factors that the Bureau considers when determining whether a minority interest and/or interlocking directorate present the requisite level of influence to potentially affect the economic behaviour of either party. Most importantly, the draft revisions make it clear that the Bureau will first examine a minority interest or interlocking directorate as if it were a full merger. If such a merger would not likely prevent or lessen competition substantially, a detailed analysis of whether the minority interest or interlocking directorate gives either party the ability to influence the other's behaviour is not generally required. Where a full merger would indeed raise such concerns, however, the Bureau will then examine the specific nature and impact of the minority shareholding and/or interlocking directorate, including a detailed examination of all of the factors surrounding the potential to influence either party's economic behaviour (e.g. voting and veto rights; shareholders' agreements; board composition, quorum and historical voting patterns; access to confidential information, etc.).

Unilateral Effects and Co-ordinated Effects in Horizontal Mergers

Consistent with the more flexible approach to market definition, the draft revised MEGs note that the Bureau may consider market definition and competitive effects concurrently, in a dynamic and iterative analytical process, although the traditional approach is also likely to be employed where feasible and useful.

Consistent with past practice, where it is clear that the level of effective competition that is likely to remain in the relevant market is not likely to be reduced as a result of the merger, this alone will generally justify a conclusion not to challenge the merger.

The discussion of the analysis of unilateral effects in differentiated product industries has been expanded. Where firms' products are close substitutes for one another, as measured by diversion ratios, the Bureau will examine whether the merged entity will have an incentive to raise prices post-merger, by examining for example the number of buyers who would consider them to be close substitutes, whether either firm has been a vigorous and effective competitor, whether buyers are price sensitive, and other factors such as the likely response of rival firms and buyers. This approach is generally understood to refer to economic tools such as the "upward pricing pressure test" articulated by the economists Joseph Farrell and Carl Shapiro in 2008 and espoused in the 2010 U.S. Guidelines – although that work is not explicitly mentioned in the proposed Canadian revisions.

The Bureau's analysis of coordinated effects is also clarified; it entails determining how the merger is likely to change the competitive dynamic in the market such that coordination is substantially more likely or effective as a result of the merger. The discussion of various factors that may facilitate coordination is enhanced from the prior MEGs, and clarify that coordinated effects may be present with or without explicit agreement among firms, and even if only a portion of the firms in the market are involved in the coordination.

Entry: No specific time-period

The draft revisions have removed the 2-year time frame for potential entry into the market when assessing whether such entry will deter the merged entity from exercising market power. Consistent with the treatment of a substantial prevention of competition, entry must be likely, timely and sufficient to constrain a material price increase in the relevant market. In the prior MEGs, a rule of thumb for timely entry was two years, assuming that in many if not most businesses, the prospect of effective competitive entry within two years would be sufficient to deter a firm with market power from exercising that power. The draft revised MEGs now focus on whether any sufficient new entry would occur rapidly enough to prevent the material price increase or to counteract the effects of any price increase, without reference to any specific time period.

Guidance on Vertical Foreclosure: "Non-Horizontal Mergers"

The draft revised MEGs provide enhanced direction on how the Bureau will assess vertical issues, with a specific focus on vertical foreclosure. Specifically, if by virtue of the acquisition of a supplier or customer (a "vertical" merger), the merged firm is able to limit or eliminate rival firms' access to inputs or markets, thereby reducing or eliminating rival firms' ability or incentive to compete, the merger may be anti-competitive. The draft revised MEGs provide detailed guidance on how the Bureau will assess the likely anti-competitive effect of a vertical foreclosure. Up until this point, the Bureau has not challenged a merger based solely on vertical foreclosure concerns. However, with the recent amendment to the MEGs, it appears to be expanding the scope for potential challenges based on vertical foreclosure alone.

Expanded Treatment of Efficiencies

The draft MEGs provide clarification on the efficiencies defense located in s. 92 and s. 96 of the Act. This addition effectively incorporates the previously released Efficiencies Bulletinfrom 2009 into the MEGs. Specifically, it expands on the Bureau's considerations in evaluating efficiency claims and the parties' burdens in proving such a claim. As a standard guideline, the Bureau does not have to resort to the Tribunal for adjudication of an issue if the gains to be provided by the merger outweigh the anti-competitive effects. That said, in accordance with the guidance from the Federal Court in the Superior Propane case, the Bureau must assess anti-competitive effects in the light of all of the objects mentioned in section 1.1 of the Act, including not only efficiency, but the impact on the ability of small and medium-sized businesses to compete, and the ability of consumers to benefit from competitive prices and product choices. In practice, proving that efficiencies will outweigh anti-competitive effects will continue to be a relatively arduous task. That being said, the proposed revisions to the MEGs clarify that efficiencies are also relevant to the analysis of likely competitive effects and, as such, merging parties should not feel that calling attention to likely efficiencies somehow amounts to an admission of likely anti-competitive effects.

Conclusion

Although the proposed revisions to the MEGs do not indicate fundamental changes in approach, they do better reflect the more nuanced thinking and greater range of analytical tools available to the Bureau since the MEGs were last revised in 2004. In keeping with the Bureau's recent case history, they may also reflect a more activist approach to merger review.

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