On 28 May 2020, the EU’s General Court (“GC”) annulled the European Commission’s (“Commission”) decision of 11 May 2016 in which the Commission had prohibited the acquisition of Telefónica UK (“O2”) by Hutchison 3G UK (“Three”). It is the first time the EU Courts interpreted the EU Merger Regulation in so-called “gap-cases”, i.e., concentrations in oligopolistic markets which do not result in the creation or strengthening of an individual or collective dominant position.
In the days following the judgment, a number of commentators already emphasised the importance of the GC’s ruling. This post intends to carry out a measured review of the judgment, assess the GC’s findings with respect to each of the Commission’s three theories of harm, and probe whether the judgment is indeed a landmark one.
The Commission’s Prohibition Decision was based on Three Theories of Harm
The Commission developed three theories of harm in its prohibition decision, all of which are based on the existence of non-coordinated effects on an oligopolistic market. The first two theories of harm relate to a UK mobile retail market while the third relates to a mobile wholesale market defined by the Commission. According to the Commission:
- The transaction would have removed an important competitor on the mobile retail market, leaving only two mobile network operators (“MNOs”), i.e., Vodafone and British Telecom’s Everything Everywhere (“EE”), to compete with the merged entity (four-to-three merger). The Commission found that O2 was the second largest MNO by revenues and the largest in terms of subscribers. Three was the latest market entrant and allegedly constituted an “important competitive force” (i.e., a term of art used in the Commission’s Horizontal Merger Guidelines (see paras. 37-38) to refer to firms that have more influence on the competitive process than their market shares suggest) or, in any event, exerted an important competitive constraint. The Commission also found that Three and O2 competed closely, both against each other and against the other MNOs. Further, the merged entity would have been the market leader with a share of more than 40%. The Commission concluded that the transaction would likely have resulted in higher prices for mobile services in the UK and reduced choice and quality.
- The four MNOs in the UK were parties to two network-sharing agreements. Three and EE had brought together their networks under the Mobile Broadband Network Limited (“MBNL”) joint venture. O2 and Vodafone had combined their networks to create “Beacon”. This enabled the operators to share the costs of rolling out their networks while continuing to compete at the retail level. The merged entity would have been party to both network-sharing agreements and would have had a full overview of the network plans of the two remaining competitors, i.e., Vodafone and EE. Its network consolidation plans (and other possible integration scenarios considered by the Commission) would likely have reduced the competitive pressure exerted by EE and/or Vodafone. Further, one of the merged entity’s consolidation plans would likely have hampered the future development of mobile network infrastructure in the UK, for example with respect to the roll-out of next generation technology (5G).
- The transaction would have reduced the number of MNOs willing to host mobile “virtual” operators (“MVNOs”) on their networks from four to three. This would have left existing and prospective MVNOs in a weaker negotiating position to obtain favourable wholesale access terms.
The GC’s Findings
The GC first provided important clarifications with respect to the significant impediment to effective competition (“SIEC”) test and the applicable burden and standard of proof:
- On the SIEC test, the GC stressed that Article 2(3) of the EU Merger Regulation (which lays down the SIEC test) must be interpreted in light of recital 25, which provides two cumulative conditions for non-coordinated effects to potentially result in a SIEC, i.e., the concentration must involve (i) the elimination of important competitive constraints that the merging parties had exerted upon each other, and (ii) a reduction of competitive pressure on the remaining competitors. It follows that the mere effect of reducing competitive pressure on the remaining competitors is not, in principle, sufficient in itself to demonstrate a SIEC in the context of a theory of harm based on non-coordinated effects (see paras. 95-97 of the GC judgment).
- On the standard of proof, the GC held that “the Commission is required to produce sufficient evidence to demonstrate with a strong probability the existence of significant impediments following the concentration. Thus, the standard of proof applicable in the present case is therefore stricter than that under which a significant impediment to effective competition is ‘more likely than not’, on the basis of a ‘balance of probabilities’, as the Commission maintains. By contrast, it is less strict than a standard of proof based on ‘being beyond all reasonable doubt’” (para. 118).
The GC then examined each of the three theories of harm developed by the Commission. It held that none of the Commission’s theories of harm met the SIEC test.
First theory of harm: non-coordinated effects on the retail market
The GC found that the Commission’s classification of Three as an “important competitive force”, its assessment of the closeness of competition between Three and 02, and its quantitative analysis of the effects of the transaction on prices, is vitiated by several errors of law and assessment.
First, as regards the classification of Three as an “important competitive force”, the GC found that the Commission had confused three concepts, i.e., the concepts of SIEC (Article 2(3) EU Merger Regulation), “elimination of an important competitive constraint” (recital 25 EU Merger Regulation), and “elimination of an important competitive force” (paras. 37-38 Horizontal Merger Guidelines). The GC held that “by confusing those concepts, the Commission considerably broadens the scope of Article 2(3) … , since any elimination of an important competitive force would amount to the elimination of an important competitive constraint which, in turn, would justify a finding of a significant impediment to effective competition. It follows that the Commission made an error of law and an error of assessment, … , in finding that an ‘important competitive force’ does not need to stand out from its competitors in terms of impact on competition, particularly in so far as such a position would allow it to treat as an ‘important competitive force’ any undertaking in an oligopolistic market exerting competitive pressure” (paras. 173-174).
The GC held that the Commission could not have properly concluded that Three was an “important competitive force” based on the following evidence: Three’s gross add shares (i.e., the share of new customers won), the development of Three’s market share and customer base, Three’s pricing policies, and the historic role played by Three on the retail market (paras. 177-226).
Second, as regards the assessment of the closeness of competition, the GC found that “Three and O2 were not particularly close mobile network operators, even if … all operators are, by definition, close to a greater or lesser extent” (para. 247). The GC held that “although it may indeed be established that Three and O2 are relatively close competitors in some of the segments of a concentrated market comprising four mobile network operators, that factor alone is not sufficient to prove, in the present case, the elimination of the important competitive constraints which the parties to the concentration exerted upon each other and cannot suffice to establish a significant impediment to effective competition; if that were not the case, any concentration resulting in a reduction from four to three operators would as a matter of principle be prohibited” (para. 249).
Third, the GC found that the Commission’s quantitative analysis of the likely effects of the transaction on prices (upwards pricing pressure (“UPP”) analysis) did not establish, with a sufficiently high degree of probability, that prices would increase significantly (para. 282). Interestingly, the GC added that the Commission should have taken into account transaction efficiencies in its UPP analysis and that it was not for the notifying party to demonstrate efficiencies in the context of an economic analysis undertaken by the Commission (paras. 278-279).
Finally, the GC held that the Commission did not at any point specify in its decision whether the non-coordinated effects identified would be significant or would result in a SIEC (paras. 289-290).
Second theory of harm: non-coordinated effects produced by the disruption of the network-sharing agreements
The GC held that a possible misalignment of the interests of the partners in a network-sharing agreement, a disruption of the pre-existing network-sharing arrangements, or even the termination of those agreements did not constitute a SIEC in the context of a theory of harm based on non-coordinated effects. A loosening of the ties within MBNL and Beacon following the transaction could equally encourage greater infrastructure competition between the parties to those agreements and increase network competition (paras. 346-347).
Further, the GC found that the effects of the transaction in relation to a possible exercise of market power, in the form of a degradation of the services offered by the merged entity or of the quality of its own network, were not analysed in the Commission’s decision, even though, as noted above, the assessment of a possible elimination of important competitive constraints between the parties to the transaction and a possible reduction of competitive pressure on the remaining competitors should lie at the heart of the assessment of the non-coordinated effects arising from a concentration (paras. 358-359).
Finally, the GC held that, even if the merged entity had favoured one of the two network-sharing agreements and was induced to reduce the costs associated with the other network, that could not have a disproportionate effect on the position of the other partner in the network-sharing agreement or constitute a SIEC, since the Commission had failed to make the case that the other party would have neither the ability nor the incentive to react following an increase in its costs and would simply cease to invest in the network (paras. 372 and 389).
Third theory of harm: non-coordinated effects on the wholesale market
The GC noted that Three’s wholesale market share was very small, i.e., between 0-5%, and considered that “a particularly small market share of one of the parties involved in the concentration tends to suggest, prima facie, an absence of any significant impediment to effective competition, especially where the other operators have much larger market shares” (paras. 435-437).
The Commission had classified Three as an “important competitive force” based on Three’s gross add shares and on its qualitative analysis of Three’s importance on the wholesale market. However, the GC found that neither of these were sufficient to classify Three as an “important competitive force”. Moreover, “even if the factors taken into account by the Commission were capable of characterising Three as an ‘important competitive force’, they do not show that Three and O2 exerted upon on each other important competitive constraints which would be eliminated following the concentration” (paras. 445-453).
The GC’s judgment is a significant defeat for the Commission. The GC found errors of law and assessment in relation to each of the three theories of harm developed by the Commission and held that the Commission failed to show that the transaction would lead to a SIEC in the retail or wholesale telecom markets in the UK.
At the heart of the judgment lies the application of the SIEC test of the EU Merger Regulation. Under the old EU Merger Regulation, the substantive test for assessing concentrations was one of dominance, i.e., whether a concentration would result in the creation or strengthening of an individual or collective dominant position. The substantive test was extended in the current EU Merger Regulation (adopted in 2004) to address a perceived “gap” in the old Merger Regulation, i.e., that concentrations which do not create or strengthen dominance could still lead to a lessening of competition in oligopolistic markets. The test therefore became whether a transaction would “significantly impede effective competition, … , in particular as a result of the creation or strengthening of a dominant position”, enabling the Commission to prohibit transactions in concentrated markets that significantly harm competition even if they do not create or strengthen dominance.
The EU Courts have now for the first time provided guidance on the application of the SIEC test, specifically in “gap cases”. The judgment emphasises that two cumulative conditions need to be met in order to demonstrate a SIEC based on non-coordinated effects, i.e., a concentration must involve (i) the elimination of important competitive constraints that the merging parties had exerted upon each other, and (ii) a reduction of competitive pressure on the remaining competitors.
The judgment also clarifies the standard of proof. The GC held that the Commission needs to demonstrate a SIEC with a “strong probability” and that the standard of proof lies somewhere between “a balance or probabilities” and “beyond all reasonable doubt”. Massimo Motta, a former Chief Competition Economist at the Commission who worked on the transaction in 2016, already commented on 4 June that the GC’s “analysis is not well documented, and I believe that that they set the standards at too … high a level”. He added that “in merger control, the analysis is prospective, so you cannot have a standard of proof which goes close to ‘beyond a reasonable doubt’”.
Further, the judgment stresses that the Commission will need to revisit its interpretation of the concept of an “important competitive force” and its assessment of closeness of competition:
- An “important competitive force” needs to stand out from its competitors in terms of impact of competition. Concluding otherwise would enable the Commission to treat as an “important competitive force” any undertaking in an oligopolistic market exerting competitive pressure. Further, even if a merging party classifies as an “important competitive force”, that does not necessarily mean that the merging parties exerted important competitive constraints upon each other.
- The GC also indicates that the Commission should have shown that Three and O2 were “particularly close competitors”. This is particularly relevant for mergers in oligopolistic markets where all competitors “are, by definition, close to a greater or lesser extent”.
Assuming the judgment is upheld on appeal (see below), it will require the Commission to revise its review of the non-coordinated effects of mergers in oligopolistic markets. Specifically, the judgment will make it harder for the Commission to prohibit transactions that do not create or strengthen a dominant position. It may therefore open the way for further consolidation, both in the telecom sector and beyond.
In view of the above, the judgment is likely the most important ruling from the EU Courts in merger control in more than 15 years. If it is upheld, it will rank right among Airtours, Schneider, Tetra Laval, and GE/Honeywell in terms of precedent value.
The Commission has two months to appeal the judgment before the Court of Justice. Commissioner Vestager said on 29 May that the Commission is “urgently analysing the judgment”. Given its far-reaching implications for the SIEC test and the standard of proof, it seems likely that the Commission will decide to lodge an appeal. Tommaso Valletti, also a former Chief Competition Economist at the Commission, already tweeted that the judgment is “so extreme and indefensible” that he hopes that the Commission will appeal. To be continued …
The authors would like to thank Konstantina Sideri, legal trainee in the Brussels office, for her support in drafting this post.