House of Commons - Regulatory Reform Committee

Themes and Trends in Regulatory Reform - Regulatory Reform Committee Contents

Memorandum submitted by the Competition Commission

SUMMARY

1. Competition and regulation are not mutually exclusive. Competition results from open markets, with competition law addressing market failures. But competition law also has a role in sectors already subject to regulation, perhaps most obviously through use of the market investigation regime. Such investigations can address markets which are not working well for consumers using powers not available to sectoral regulators for addressing failures of competition.

2. The Competition Commission (CC) believes that the benefits of a free and competitive market economy are fundamental to economic well-being and must be preserved, even in difficult times such as the current recession. Competition law must continue to be applied properly, avoiding short-term expediency at the expense of long-term market distortions. Of course, the CC recognizes the need to be pragmatic in its activities, as economic circumstances and the difficulties that are currently being experienced will affect the right course of action in particular cases.

INTRODUCTION

3. The CC welcomes the opportunity to respond to the Regulatory Reform Committee Inquiry into Themes and Trends in Regulatory Reform. We have focused our comments on the following areas raised by the Committee:

— balancing the need for an effective regulatory framework with the conditions for business success;

— understanding businesses sufficiently to design effective remedies; and

— the implications of recent economic developments.

THE CC'S ROLE AND FUNCTIONS

4. The CC is one of the independent public bodies which help ensure healthy competition between companies in the UK for the benefit of companies, customers and the economy. It is essentially a Phase II Authority deciding on mergers, markets and regulatory issues. It is a Phase II Authority in the sense that all cases it considers are on reference from another body-the CC has no jurisdiction to originate cases:

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5. Hence the CC's role is to conduct in-depth investigations into matters where initial investigations have identified concerns that merit further consideration, and to act as an expert body hearing, or providing input to, appeals.

COMPETITION AND SECTORAL REGULATION

The benefits of competition policy

6. Competition policy imposes important discipline on firms which results in lower prices and increased innovation in products and services. It ensures that firms continuously improve their efficiency and productivity. For consumers, it means that they get the best possible product or services at the lowest possible price. For the economy as a whole, it ensures that only efficient firms will be successful in the long run. In markets where there are no natural-or even unnatural-monopolies regulation is normally a poor substitute for competition. The idea of a market economy without a strong competition policy is very unattractive.

The overlap between competition and regulation

7. Competition and regulation are sometimes seen as polar opposites: competition results from open markets, with competition law used to address market failures (applied ex post), whereas regulation is used to control (ex ante) the activities of natural monopolies. Thus, in the ideal world, "regulation" gives way to "competition", except when (natural) monopolies persist.

8. This is a somewhat stylised view of how regulation and competition interact with each other and in reality things are not quite so simple. First of all, not all competition interventions are "ex post". For example, market investigations carried out by the CC are "ex post" in the sense that they assess how markets have worked in the observable past, but are "ex ante" in their assessment and prescription of remedies.

9. Merger investigations are a mix of "ex ante" and "ex post" investigations, depending on whether the merger is in contemplation or whether it has already been completed. The CC Chairman, Peter Freeman, has commented previously on the risks inherent in the UK's system allowing mergers to be completed prior to scrutiny by competition authorities. A copy of his speech "Merging is such Sweet Sorrow" is attached as Appendix 1 to this submission.[115]

10. Secondly, and obviously, regulatory and competition roles are typically combined and fulfilled by single authorities in the UK. Apart from the CC's own particular position, the main economic regulators in the UK have "concurrent" competition powers giving them a choice of measures to use.[116]

11. Thirdly, other jurisdictions' experience also illustrates the range of links between regulation and competition. For example, in the EU, DG Comp has undertaken several sector studies under Article 17 of the Modernisation Regulation.[117] These are intended to examine sectors which appear to exhibit lack of competition to see what further intervention, either by way of competition enforcement, regulation, or de-regulation, may be appropriate. These sector inquiries open up issues that go wider than "a narrow competition focus". For example, its investigation into the energy sector found problems including: a high level of market concentration; vertical integration of supply, generation and infrastructure leading to a lack of equal access to, and insufficient investment in infrastructure; and possible collusion between incumbent operators to share markets.[118] To tackle these problems, it decided to take follow-up action in individual cases under the competition rules (anti-trust, merger control and state aids) and to act to improve the regulatory framework for energy liberalisation.[119]

12. A fuller description of the overlap between competition and regulation is set out in a speech given by CC Chairman Peter Freeman, "Regulation and Competition-Chalk and Cheese?" A copy of this speech is attached as Appendix 2 to this submission.

The use of competition law in regulated sectors

13. Thus the regulatory and competition fields overlap, and can support each other. This is perhaps best seen in the use of market investigation references for regulated activities. Sectoral regulators have the ability to refer to the CC markets for which they are responsible, and in determining any remedies to be imposed the CC must take account of the regulator's objectives, in order to reduce risk of conflict.[120] The OFT also has the ability to refer regulated markets to the CC. For example, payment protection insurance (PPI) has been regulated by the Financial Services Authority since 1 January 2005, but was referred to the CC by the OFT (with the support of the FSA) in 2007. The CC found a lack of competition and has announced that it will impose remedies to address the root causes.[121] Those remedies include actions that the FSA could not itself take to address competition problems[122]—in particular, a prohibition on selling PPI within seven days of the sale of the underlying credit product and a prohibition on selling PPI policies with the lifetime cost of the policy paid at the start of the policy (single-premium policies).[123]

14. There has, however, been little use to date of the market investigation as a tool in the regulated industries. Since the market investigation regime was introduced in June 2003, only one reference has been made by a sectoral regulator—the rolling stock leasing market, by the ORR.[124] Two other recent investigations have involved regulated sectors: PPI (see paragraph 13) and the supply of airport services by BAA Ltd.[125]

15. It is worth considering why the market investigation tool has not been used more frequently in regulated sectors, and in particular whether the regulatory system, taken as a whole, has a built-in tendency to avoid references. From the perspective of an economic regulator, there are some good reasons not to have cases referred to the CC. CC investigations take time (we are currently actively considering how we can reduce significantly the length of our market investigations), cost money and risk reputational damage if a regulator is perceived to have "lost", in the sense of not having achieved its desired outcome. These considerations apply as much to regulated companies as to the regulators. But all the regulators need to be able credibly to threaten a CC reference if they are to achieve any sort of settlement which is worth having. The longer a sector goes without a reference, the risk is the less credible that threat becomes, and the more the regulatory system as a whole comes under scrutiny and pressure.

16. The House of Lords Select Committee on Regulators recommended that "… where possible, utility regulators should work to bring more cases to the competition authorities and that the regulators should work to ensure that the cases most likely to establish useful precedents are brought to the CC" (paragraph 6.26)[126] and the Government's response was "… the Government agrees with the Committee that regulators should be encouraged to think about whether they can be more pro-active in using competition law, including market investigation references to the Competition Commission" (paragraph 1.22).[127]

17. The competition regime is a key tool in regulated industries. It can be used to resolve competition problems, using its significant remedial powers if necessary. It can also be used as a "bargaining chip" by regulators, who can use the prospect of a market investigation to achieve change. However, for it to be effective in both of these ways, it does need to see sufficient use.

REMEDIES IN COMPETITION INVESTIGATIONS

18. The CC has significant powers to remedy problems it identifies. When considering remedies, the CC is required to "achieve as comprehensive a solution as is reasonable and practicable" to address the adverse effect (section 134(6) Enterprise Act). The CC may also have regard to any relevant customer benefits (section 134(7) Enterprise Act). When deciding on what is an appropriate remedy, the CC will consider the effectiveness of different remedies and their associated costs and will have regard to the principle of proportionality (see CC Guidance on Market Investigation References, CC3, at paragraph 4.9).

19. The CC's remedies fall into two basic categories: structural remedies and behavioural remedies. Structural remedies typically involve the divestment of assets-for example, in the Airports market investigation the CC has required the divestment of Gatwick, Stansted and either Glasgow or Edinburgh airports in order to remedy the adverse effects on competition identified.[128]

20. Behavioural remedies fall into two categories. The first is enabling measures which are designed to overcome, for example, barriers to entry. The second category, very much a matter of last resort, is behavioural remedies which control the anti-competitive outcomes, for example by imposing a price cap. Both types of behav-ioural remedy are likely to require ongoing monitoring and, potentially, enforcement, to ensure compliance.

21. The CC (and the OFT) has a preference for structural remedies over behavioural remedies. Structural remedies generally constitute a direct, one-off, measure to restore the competitive position (for example, to restore the rivalry that would be lost by a merger). There is less risk of market distortion, and structural remedies avoid all the difficulties associated with monitoring and enforcing ongoing behavioural remedies. In merger inquiries the CC will generally seek divestiture of the smallest, viable stand-alone business that can compete successfully.

22. It would be unusual for the main remedy in a merger inquiry to be behavioural. They tend to be only appropriate where a structural remedy is not feasible, as in Dräger/Airshields,[129] or where the substantial lessening of competition can be expected to be of limited duration, as in First/ScotRail.[130]

23. There are always exceptions, and an example of a case where behavioural remedies were used in a merger inquiry was the Macquarie/National Grid Wireless merger.[131] This merger brought together the only two providers of national managed transmis-sion services and network access to UK broadcasters. On a cursory assessment, it seemed that structural remedies would be the best solution. However, for several reasons the CC took a different view:

— We identified significant customer benefits which were likely to be lost as a result of the most feasible divestment option.

— There was also a very real risk of delay to digital switchover which is under way and due to be completed by 2012. This would have resulted in significant cost and inconvenience to the broadcasters, the public and the public purse.

— The behavioural remedy was embedded in existing regulation as there was already regulatory control of the network access element. The remedy was supported by Ofcom, as well as by all significant customers, ie the broadcasters.

24. So for reasons of practicality, proportionality and potential loss of customer benefits, a set of behavioural remedies were adopted. This case should not be interpreted as in any way indicating a trend towards the use of behavioural, or regulatory, measures in the CC's practice.

25. In market investigations behavioural remedies have often played a significant part in remedying the competition problems identified. Imposing structural remedies in market investigations is not something that is undertaken lightly, but in order to remedy competition problems we sometimes find that we have to require that assets are divested or businesses ceased; for example, in PPI, with a prohibition on selling PPI at the point of sale of credit, and in Airports, where the CC has imposed a requirement on BAA to sell Gatwick, Stansted and either Edinburgh or Glasgow airports.

26. In conducting its investigations, including its analysis leading to identification of any problems and the consideration of remedies, the CC takes the time needed to learn about the industry it is investigating. It does this through conducting hearings with parties and, when available, industry experts, conducting site visits to understand the physical processes involved and discuss these with the parties who run the sites, and through seeking views on its developing thinking and analysis on all aspects of its investigations. If necessary, it brings in specialist advice-for example, in the Airports investigation the CC engaged the services of an investment bank in order to help it with some aspects of the possible divestments of airports.

27. In summary, the CC's approach to remedies is to find an effective solution to an identified problem, with a view to remedying the problem where possible through a one-off intervention that will minimize the need for new and ongoing regulatory over-sight to ensure that the conditions for effective competition are maintained.

IMPLICATIONS OF THE RECENT ECONOMIC DOWNTURN

28. The recent economic downturn has resulted in some questions being asked about whether regulatory regimes are fit for purpose, both absolutely and in the current economic climate. The competition regime is no exception. We consider here how competition law and policy are interacting with other policy imperatives.

29. Recent CC inquiries have made it clear that not everyone views competition as the answer to all questions. A good example is our Groceries investigation,[132] where many pressure groups and some members of the public voiced their concerns that competitive markets may result in unfavourable "externalities", such as binge-drinking, the extinction of the "small corner shop" and fundamental change in the "high street". Viewed in this way, competition policy can be seen by some as irrelevant or even hostile to the major policy issues that we face. Other policies, such as those tackling climate change, and more recently, financial stability, can appear much more important, and competition policy faces particular challenges in an economic downturn.

30. Competition between suppliers does not have to be sacrificed to achieve other policy goals. The challenge is to make sure that the benefits of competition are retained while, where appropriate, addressing other important policy goals-which can cover policy areas as diverse as environmental, social or fiscal policy. In its investigations the CC must take care to find solutions to competition problems whilst recognizing and working within the other policy goals within regulated sectors. Similarly, other agencies need to ensure that policy measures, or changes to how sectors are regu-lated, avoid restricting competition to the extent possible.

31. Of course, sometimes there will be tensions, at least in the short term. For example, it has become clear from the recent Lloyds TSB/HBOS[133] case that, when faced with the danger of systemic collapse, many will say that safeguarding financial stability should override longer-term concerns about restrictions on competition, and that the benefits of a detailed investigation of a merger should be forsaken in order to ensure that the merger can proceed. Such exceptional events are capable of being accom-modated within the competition regime. There are specified public interest consider-ations within the Enterprise Act for national security and media.[134] In addition, there is now a new public interest criterion for "financial stability"[135] and the Secretary of State can issue an intervention notice pursuant to the Enterprise Act 2002 enabling him to retrieve the power to decide whether a banking merger should be prohibited and to balance competition issues against those of financial stability.

32. Turning to the current economic climate, we note that these are challenging times for businesses, but also for regulators. There is no point in regulators pretending that the challenge does not exist. Just carrying on as if nothing was happening is not a sensible course. The CC intends to be pragmatic in its activities, recognizing that economic circumstances and the difficulties that are currently being experienced will affect what is the right thing to do in particular cases. For example, whilst the merger was not necessitated by the financial crisis, in January 2009 the CC cleared, in just three months, the completed acquisition by Long Clawson Dairy Limited of the Stilton cheese business of Dairy Crest Group plc, on the grounds that Millway would have been closed by Dairy Crest absent the merger.[136] More generally, the CC is consider-ing in depth how it should respond to the current circumstances, using the combined knowledge and experience of its members to take account of the various issues that the current economic circumstances raise for competition authorities.

33. More broadly, the CC believes that it is important not to retreat on the principles of competition. There is a real danger that we will otherwise lose the benefits of a free and competitive market economy, with all the damage that will follow. We should take care not to "kill the goose that lays the golden egg".

112 See: Acquisition by British Sky Broadcasting Group plc of 17.9 per cent of the shares of ITV plc, report sent to Secretary of State (BERR), 14 December 2007. Back

113 ORR's power to make a market investigation reference to the CC derives from section 67(2A) and (2B) of the Railways Act 1993; GEMA's in relation to gas derives from section 36A(2A) and (2B) of the Gas Act 1986 and, in relation to electricity, from the Electricity Act 1989, section 43(2A) and (2B); Ofwat's derives from section 31(2A) and (4) and section 36 of the Water Industry Act 1991; Ofcom's derives from section 370(1) to (3) of the Communications Act 2003; and the CAA's derive from section 86(2) and (4) of the Transport Act 2000. Back

114 The Postal Services Bill, currently before the House of Lords, similarly envisages an appeal function for the CC, against price control decisions made by Ofcom. Back

115 See paragraphs 58-63. Back

116 For a detailed discussion of these issues, see the DTI/HM Treasury report Concurrent competition powers in sectoral regulation, May 2006, URN 06/1244. Back

117 Regulation 1/2003, OJ [2003] L1/1. Back

118 http://ec.europa.eu/competition/sectors/energy/inquiry/. Back

119 http://europa.eu/rapid/pressReleasesAction.do?reference=IP/07/26&format=HTML&aged=0&language=EN&guiLanguage=en. Back

120 Section 168 of the Enterprise Act 2002. Back

121 CC report, Market investigation into payment protection insurance, 29 January 2009. Back

122 The FSA does not have Competition Act powers and as such it cannot use, as a primary basis for imposing rules, the objective of improving the functioning of competition or for addressing competition problems in a regulated market. Back

123 Whilst the FSA cannot itself prohibit single-premium policies for competition reasons, in January 2009 it welcomed moves by some companies to stop selling unsecured personal loan PPI with single premiums (see www.fsa.gov.uk/pages/Library/Communication/PR/2009/012.shtml), and in February 2009 asked all firms still selling unsecured personal loan PPI with single premiums to stop doing so as it had ongoing concerns about whether customers had been treated fairly during the sales process (see www.fsa.gov.uk/pages/Library/Communication/PR/2009/031.shtml). Back