Merger Control of the Telecom Industry in Hong Kong

1. Merger Control of the Telecom Industry in Hong Kong OCED Seminar, Jeju Korea 27 June 2007 Herbert Fung Senior Economic Advisor Office of Telecommunications Authority

2. Agenda • The Legal Framework • Cases Studies • Further Issues and Developments

3. Part I: The Legal Framework

4. A sector-specific regime • Anti-competitive practices prohibited for the telecom & broadcasting sectors only • Merger control for the telecom sector only • No competition law for other business sectors in Hong Kong for the time being

5. Telecom Ordinance (Cap.106) • Section 7K – anti-competitive practices • Section 7L – abuse of position • Section 7P – Authority may regulate changes in relation to carrier licensees

6. Chronology • 1995: licence conditions of the fixed-telephone incumbent prohibit anti-competitive practices & abuse of position • 2000: licence conditions overridden by provisions in Telecom Ordinance • 2004: Merger control enacted

7. M&A control: policy objectives • Fair competition for enhancing consumer interests • Transparent and efficient regulatory regime for M&A activities

8. Light-handed approach • Characteristics of merger control for the telecom sector in Hong Kong: • applies to “carrier licensees” only • safe harbours • voluntary pre-notification • public benefit defence

9. The TA’s Statutory Powers • To investigate an M&A involving telecom carrier licensees • to opine whether the M&A has, or is likely to have, the effect of substantially lessening competition (SLC) in a telecom market in Hong Kong • if yes, to direct remedies

10. Procedures • The TA has a discretion to investigate an M&A on an ex post basis • The parties may request the TA, on an ex ante basis, to give: • an informal advice– confidential but not binding on the TA; or • a formal consent– binding on the TA but not confidential

11. Timetable • Decide whether to investigate within 2 weeks after completion of the M&A • If yes, investigation to be completed: • within 1 monthfor simple cases • within 3 monthsfor complicated cases • An appeal, if any, must be lodged within 14 days after the TA’s decision

12. Appeal Mechanism • Appeal to whom? • Telecommunications (Competition Provisions) Appeal Board • Chairman and board members appointed by the Chief Executive of the HKSAR Government • Appeal Board may refer a Question of Law to the Court of Appeal • Appeal Board’s decision final • Who may appeal? • The aggrieved subject licensee, the acquirer, the acquired (if itself not the subject licensee) • Third parties have no right to appeal

13. Triggering point: A “change” • S7P only operates where there is a “change” in relation to a licensee • when a person’s (either alone or together with any associated person)beneficial ownership or voting control of the voting shares in the licensee crossescertain specified thresholds • Three thresholds: 15%, 30% & 50%

14. Safe Harbours • 2004 M&A Guidelines • screening device & a rule-of-thumb • If within SH  presumption of no SLC • If falls outside  no presumption either way, further enquiry necessary • to give transparency • not intended to replace case-by-case analysis

15. Safe Harbours • Two safe harbours : • CR4 Ratio test • adopted in Australia & Canada • Herfindahl-Hirschman Index (HHI) • adopted in US & EU

16. The Competition Analysis • The economic test • whether or not the change has, or is likely to have, the effect of substantially lessening of competition (SLC) in a telecommunications market • The “counterfactual” • a “future-with-and-without” analysis • A “teleological” approach • Integrated analysis • not a step-by-step, “check-list” exercise

17. The SLC test • … the “effect”… • “purpose” or “intent” not sanctioned • … of “substantially”… • Appeal Board: “must be at least significant but need not be big” • …“lessening competition”… • Creation or enhancement of market power • Market power could be unilateral or collective • A structural test • … in a “telecommunications market” • No jurisdiction if the effect is not in a telecommunications market

18. Barriers to entry Market concentration Countervailing power Potential increase in prices & profit margins Dynamic characteristics (growth, innovation and product differentiation) Matters to be taken into account • Removal of a vigorous and effective competitor • Extent to which effective competition remains • Vertical integration • Import competition • Substitutes • others…

19. Public Benefit Defence • if the change has, or likely to have,a benefit to the public and the benefit outweighs any detriment of SLC • “Public Benefit” • need to be real, • likely to be realized within a reasonable period after the merger, • likely to be sustainable • Examples: consumer benefits, innovation, higher capacity or better quality of services, etc.

20. Remedies • The TA gives directions to eliminate or avoid the effect of SLC • Structural Remedies • e.g. divestiture • Behavioural Remedies • e.g. merged firm be directed not to do certain anti-competitive act after the merger

21. Part II: Case Studies

22. Overview • 7 cases since enactment of merger control: • 2 granted with ex ante formal consent • 5 ex post decisions not to commence an investigation • no formal ex post investigation yet

23. Cases • China Netcom acquiring PCCW shares (Apr 05) • PCCW acquiring Sunday (Jul 05) • China Mobile acquiring Peoples (Dec 05) • Merger of CSL & NWPCS (Mar 06) • Joint ownership of Asia Netcom & C2C (Aug 06) • Pacific Internet acquired by parent of Asia Netcom (Feb 07) • General Electric acquiring AsiaSat (May 07)

24. Case 1:China Netcom acquiring PCCW’s shareholding

25. Case 1: the transaction • Mainland fixed network operator buying into HK incumbent fixed network operator • Both parties are parents to “carrier licensees” • A “change” to the carrier licensee under PCCW Acquire 20% shares 50% Market for the Provision of External Bandwidth to and from HK 100% Reach Networks & Reach Cable China Netcom (HK) Operations & Asia Netcom compete Compete External Cable-based FTNS External Cable-based FTNS

26. Case 1: the relevant market • A “teleological” approach: • PCCW’s and CNC’s businesses overlap only in external bandwidth services (EBS) • The relevant market for EBS: • Route-by-route definition of market too narrow because supply-side substitution from transit routing is strong • Cable (overland and submarine) and satellites are included

27. Case 1: competition analysis • Market share analysis sensitive to the choice of measures: • Activated capacity • Equipped capacity • Upgradeable capacity • Revenues • Excess capacity abundant • Persistently falling prices

28. Case 1: conclusion • No SLC • Ex post decision not to commence an investigation

29. Case 2:PCCW acquiring SUNDAY

30. Case 2: the transaction • The incumbent fixed network operator acquiring control of a mobile network operator • A “change” to SUNDAY Acquire 59.87% shares Fixed carrier licence Mobile carrier licence Fixed-line Services 2G & 3G Mobile Services

31. Case 2: the relevant market • A “teleological” approach: • PCCW’s and SUNDAY’s businesses overlap only if fixed & mobile telephony are in the same market • Treating fixed and mobile as a combined market can most readily identify and analyze any potential competition concern • Market definition may well be different for other cases or purposes

32. Case 2: analysis and conclusion • If fixed & mobile is a combined market: • within safe harbours by CR4 • If fixed & mobile are separate markets: • No change in market structure for fixed or mobile • No SLC, therefore not to commence an ex post investigation

33. Case 3:Merger between CSL and New World PCS

34. Case 3: the transaction • A merger between two mobile network operators: • CSL, owned by Telstra, holds mobile carrier licences for both 2G and 3G mobile services • NWPCS holds a 2G mobile licence only, but its parent New World Group also holds a fixed carrier licence • A “change” to both CSL and NWPCS

35. Case 3: the relevant market • retail market • mobile voice & data services (complements) • MNOs + MVNOs (supply substitution) • both 2G and 3G networks • strong demand substitution from 2G to 3G • Separate markets for fixed and mobile • One-way demand substitution from mobile to fixed not strong

36. Case 3: competition analysis • Competition effects of a reduction from 6 to 5 MNOs marginal • Porting and churn statistics revealed that CSL and NWPCS had not been the most direct competitors due to business segmentation • Better prospects for the merged entity to take on the market leader, HTCL

37. Case 3: conclusion • No SLC • Formal ex ante consent granted

38. Case 4:China Mobile acquiring Peoples

39. Case 4: the transaction Other Mobile Operators in China e.g. China Unicom compete compete Outbound Roaming Inbound Roaming 5 other HK MNOs compete compete

40. Case 4: the transaction • Mainland China’s incumbent mobile network operator to acquire all the shares of a mobile network operator in Hong Kong • A “change” to Peoples, a carrier licensee

41. Case 4: the relevant market • A “teleological” approach • No horizontal overlap of businesses in HK • Possible vertical effect of a speculated preferential roaming arrangement between the parties • Convention of reciprocal arrangements between inbound and outbound roaming • Effect of any roaming arrangement should be on retail-level competition • Relevant market defined accordingly to analyze the retail effects of reciprocal roaming arrangements

42. Case 4: competition analysis • Roaming arrangements is a classic case of cross-border tacit collusion • Roaming prices substantially higher than local calls • Escalated to a political controversy in Europe • “With-or-without” analysis: • limited competition to date • can’t get worse with a preferential arrangement • Nothing to lose

43. Case 4: competition analysis • The potential effects of a preferential roaming arrangement: • Does it make commercial sense for China Mobile to reject roaming revenues from other operators? • China Mobile is not the only mobile operator in mainland China with national coverage • Financial damage to competitors cannot be simplistically regarded as damage to competition • Likely to trigger other operators to break the roaming cartel and cut prices • pro-competitive!!!

44. Case 4: conclusion • No SLC • Formal ex ante consent granted

45. Other cases

46. Other cases: common themes • No ex post investigation, either because of no change in market structure or the change fell within the safe harbour • Horizontal or vertical merger of smaller firms is pro-competitive, as the merged entity takes on the leading firms

47. Part III: Further Issues and Development

48. Shortcomings of the present regime • Legal drafting issues: • e.g. the meaning of “indirect share ownership” and “voting control” • No power to investigate non-licensees • The anomaly of a sector-specific approach

49. The Communications Authority • A “merger” of broadcasting and telecom regulation has been proposed • Extend merger control to the broadcasting sector? • Presumption that market power comes mainly from “carrier licensees” dubious

50. A cross-sectoral approach • The HKSAR government is contemplating a cross-sectoral competition law • May or may not include a merger control regime • The sector-specific regime may be overridden, repealed or left unchanged