EU Merger Reforms Improve Opportunities for Acquisition
February 4, 2003
The European Commission recently released a series of proposals intended to reform the European Merger Control system. The proposals include a draft revision of the EC Merger Regulation (ECMR), with explanatory memorandum; a draft notice on the appraisal of horizontal mergers (Merger Notice); and best practice guidelines on the conduct of merger investigations. The proposed revisions are expected to enter into force in early 2004 and contain three significant changes to reduce the burden of European Union (EU) merger review and to better align EU reviews with the US review. Businesspeople can benefit from these changes but must also be aware of potential concerns that have arisen as a result.
First, the proposals allow the parties to better co-ordinate EU and US merger reviews. The Merger Notice enables parties to extend deadlines in order to address concerns during the review and remedy phases. Moreover, the Merger Notice expedites the review process by enabling notification based on a letter of intent. The guidelines improve the process by requiring the Commission and complainants to explain concerns to the parties through face-to-face meetings.
Second, the Merger Notice seeks to clarify the theories upon which the Commission may oppose transactions. The notice presumes "dominance" where a firm exceeds 50 per cent market share. In all other cases, the notice assesses "co-ordinated" and "unilateral" effects similar to the US Horizontal Merger Guidelines. In this respect, the EU and US merger reviews are more closely aligned in substance.
Third, the proposals seek to reduce the number of multi-jurisdictional notifications by expanding the procedure for referring matters to Brussels. Parties may now invoke a referral prior to submitting notification. The ECMR also provides for referral at the initiative of the member states or the Commission. In all cases, the new referral mechanism introduces deadlines to expedite the process.
Proposals Give Parties Control Over Timing of Review
The proposed reforms include various procedural changes that will provide merging parties with greater flexibility in transaction timing. For example, the draft ECMR removes the requirement that mergers must be notified within seven days of a binding merger agreement. Parties may now notify earlier (e.g., on the basis of a letter of intent) or later. The timing of notification will be left to the parties’ discretion so long as the parties do not close transactions without EU approval. This will bring the initial notification deadlines into harmony with the US system.
The draft ECMR converts all deadlines into "working days" rather than "months." This will have the effect of improving clarity on deadlines. However, the revised ECMR now prescribes a 25-working-day deadline for initial decisions, a two- to three-day increase in the first stage review period.
The draft ECMR enables parties to extend review deadlines to help them gain EU approval. Where the parties offer remedies to address EU concerns, the reforms provide for automatic extensions of the deadlines. In Phase I cases, this extension remains effectively unchanged at 10 working days. However, in Phase II cases, there will be an automatic 15 working day extension of the deadlines where remedies are offered late in the process. In complex Phase II cases, the parties or the Commission (with the parties’ consent) may extend the Phase II deadlines up to 20 working days to allow for more careful review of the transaction. This must be done within 15 days from the start of Phase II proceedings.
The guidelines provide for earlier and better disclosure of Commission concerns. They "unmask" third party complainants by requiring three-way meetings among the Commission, the merging parties and interested third parties. Merging parties may also request "state-of-play" meetings with the directorate general of competition to better understand the basis for any competitive concerns. These changes should significantly improve "transparency," even compared with the US process.
Opportunities
This greater flexibility should prove valuable to merging parties, by enabling them to better co-ordinate EU and US merger reviews. Furthermore, the possibility to extend deadlines in Phase II cases will provide parties with additional time to negotiate remedies where necessary. (The existing rules often limit such opportunities due to strict decision deadlines.) It will also enable parties involved in global mergers to co-ordinate the offering of commitments in the EU with the United States.
The additional transparency provided by these amendments should provide parties greater opportunity to address EU concerns and reduce the impact of complainants. Indeed, these changes should benefit merging parties by enhancing their due process rights.
Risks
For complainants, however, increased transparency may discourage smaller firms from raising complaints. For example, smaller customers that may be dependant on the merging parties will be reluctant to voice opposition to the merger in fear of retaliation because their complaints will be revealed to the merging parties.
The conversion of deadlines into working days is a disguised extension of the Phase I deadline for initial merger decisions by two to three days. Financial institutions and other companies that frequently engage in noncontroversial transactions may find their transaction further delayed.
Parties to Benefit from "US-Style" Merger Analysis
On its face, the Commission has rejected the US "substantial lessening of competition" test and retained the EU "dominance test." The Commission proposes, however, to clarify the application of the dominance test to horizontal mergers through the Merger Notice. Upon closer review, the Commission has, with few notable exceptions, adopted an analytical framework that is similar to the US Horizontal Merger Guidelines
The US Horizontal Merger Guidelines begin with a definition of the relevant market and an analysis of concentration within the relevant market. If the merger unduly increases concentration to unacceptable levels, the guidelines set out the competitive analysis that will be used to evaluate the effects of the merger. Potential competitive harms are classified as either "unilateral" or "co-ordinated" (as is the case in the US Horizontal Merger Guidelines).
The Merger Notice also acknowledges that the analysis must begin with a consideration of the relevant markets and refers to the Commission’s Notice on the Definition of the Relevant Market. While the Merger Notice acknowledges the importance of market shares, they are not uniformly made a predicate for the competitive analysis. Instead, the Merger Notice establishes that possible anti-competitive effects can arise in cases of single firm or oligopoly dominance. While the language of the analysis differs somewhat from the US Horizontal Merger Guidelines, the Merger Notice employs concepts of unilateral and co-ordinated effects.
Single Firm "Dominance" Presumed Above 50 Per Cent
The Commission’s assessment of possible "unilateral" anti-competitive effects is set out under the rubric of single firm dominance and non-collusive oligopoly dominance. The Commission will assess the likelihood that the merger will enable the merged firm unilaterally to reduce competition by raising prices or reducing output.
Where a merger creates or enhances a market share of more than 50 per cent, the Merger Notice creates a rebuttable presumption of "dominance." The Commission acknowledges that it will also test this market share by reference to other factors such as the extent of vertical integration, large scale production, a highly developed distribution and sales network and access to leading technologies or ownership of key brands. Unless outweighed by these factors, the Commission is likely to oppose the merger.
The Merger Notice also recognises that a merger can create or enhance single firm dominance, where the resulting shares are less than 50 per cent by removing important competitive constraints. The guidelines use a market share/concentration screen to eliminate from review transactions unlikely to raise competitive concerns:
- Where the parties produce relatively homogenous products, the Commission introduces the Herfindahl-Hirschman Index (HHI) to assess increases in market concentration. (HHI is the basic tool used by the US Horizontal Merger Guidelines). Where a merger results in a highly concentrated market, with a HHI of more than 2.000 (the US threshold is 1,800), the Commission will assess the potential for oligopoly dominance.
- In differentiated product markets, the Commission will assess the degree of product substitutability and then assess market share. The Commission is unlikely to oppose a differentiated product merger which result in a combined market share of less than 25 per cent.
For those mergers that exceed the screens, the Merger Notice identifies factors that would establish the likelihood that the merger could lead to increased prices or reduced output. In homogenous product markets, this includes excess capacity in the hands of other competitors and the ability of competing firms to expand output offset against price increase or output reduction. In differentiated product markets, key factors include the degree of substitutability between the merged firms’ products and other competing products, the degree of potential diversion to other firms’ products in the event of a price increase and the ability of competing firms to reposition their products.
Likelihood of Collusion Clarified
With respect to collusive oligopolies, the Commission will assess the degree to which the merger enables the remaining firms to co-ordinate their conduct and thereby raise prices, reduce output or share markets. Unlike the US Horizontal Merger Guidelines, the Merger Notice does not employ a concentration screen. Instead, the Commission reiterates the three pre-requisites for co-ordination established by the European Court of First Instance in the Airtours decision (click here to view our June 2002 On the Subject… for an in-depth analysis of the Airtours decision):
- The members of the oligopoly must be able to monitor each other’s behaviour, which requires a sufficient degree of market transparency.
- The members must be able to tacitly co-ordinate their behaviour to ensure it is sustainable over a period of time, which requires adequate deterrents to ensure that the oligopoly members do not deviate from the common policy.
- The reactions of current and future competitors, as well as consumers, must not jeopardise the result expected (e.g., profits from higher prices) from the common policy.
These factors are substantially similar to the factors applied by the US authorities in evaluating "co-ordinated effects" under the US Horizontal Merger Guidelines.
Countervailing Factors Identified
Like its US counterpart, the Merger Notice identifies a number of factors that may mitigate against a finding of dominance, such as "buyer power" and actual or potential entry. The Merger Notice also establishes the requirements for a failing firm defence.
Until now, the Commission has not considered any "efficiencies" that result from mergers sufficient to offset reductions in competition. On the contrary, the Commission has been criticised for using efficiency to oppose a merger. The Merger Notice provides a more reasoned framework for considering efficiencies in line with the US Horizontal Merger Guidelines. The Commission will now look for merger-specific, verifiable efficiencies that are of direct benefit to consumers. The Commission will consider cost efficiencies leading to reductions in variable or marginal costs and efficiencies that result in new or improved products, in particular, to be directly beneficial to consumers.
Opportunities
The increased analytical clarity inherent in the new guidelines offers benefits for merging parties. For example, the Commission’s approach to mergers in differentiated product markets will provide greater opportunity to consumer product companies. Under the guidelines, mergers between consumer product companies are likely to be approved even at a high market share, so long as the transaction does not involve the "closest" competitors.
The increased emphasis on "buyer power" in merger analysis will provide greater comfort in markets characterised by large, powerful buyers, such as government controlled entities. This will be good news for the defence and health care industries, where national ministries of defence or health are the primary purchasers.
Likewise, the Commission’s acceptance of the failing firm defence will assist troubled companies which should be of benefit in markets still coping with the collapse of the stock market bubble. While the particulars of the defence must still be met, this clarification should prove helpful to companies in the technology and telecom markets.
Risks
However, companies in commodity industries may not welcome these changes. Previously, challenges were rare when the merger did not result in one or two firms with high shares. The new guidelines make it clear that markets with several strong firms may find it more difficult to merge given the Commission’s clarification that it will oppose certain mergers where post-merger collusion would be likely. This will be of particular concern to mining, manufacturing and chemical markets that have three of four strong participants.
Requesting Referral to Brussels to Avoid Multiple Filings
Many merger cases involve cross-border effects but do not qualify for investigation under the ECMR because the parties’ turnovers do not trigger notification thresholds. Parties often must file notifications and obtain approval in numerous Member States. The Commission sought unsuccessfully to address this problem in 1998 by establishing a second set of thresholds designed to catch transactions which would require multiple filings. The Commission now aims to address this problem through a revised referral mechanism.
The draft ECMR establishes three possibilities for initiating a referral to the Commission:
- First, prior to notifying a transaction to the concerned member states (where the EU turnover thresholds are not met), parties may request a referral by notifying the Commission that a transaction has significant cross-border effects.
- Second, a member state(s) may request a referral to the Commission within the first 20 working days after receiving notification, or otherwise becoming aware of, a transaction.
- Third, the Commission may request one or more member states to initiate a referral. If a request is forthcoming, it will be treated as if the request came ab initio from the member state for purposes of timing and procedure.
When the Commission receives a request for referral, it will relay notice of the request to the concerned member states. Where the parties initiate the request, the member state(s) will have 10 days to determine whether to refer the matter to the Commission. Where a member state (or states) initiates the request, the other member states will have 20 days to determine whether to refer the matter. If a member state fails to act within the deadline, it will be deemed to have requested a referral.
If all (or at least three) member states concerned request a referral, the Commission will have exclusive jurisdiction over the transaction as if it met the turnover thresholds.
Where the required number of member states do not request a referral, the Commission may still elect to review the transaction, but its jurisdiction will be exclusive only as to the member states requesting referral.
Opportunities
The proposals should provide a number of potential benefits for merging parties. For example, parties will have the opportunity to invoke the benefits of the referral procedure on their own initiative and early in the proceedings. Moreover, the implementation of the various decision deadlines should add some certainty to the procedures in most cases.
Perhaps most important, conferring exclusive jurisdiction on the Commission where a minimum number of member states agree to referral will increase the merging parties’ opportunity to obtain the "one-stop-shop" when it is in their interests. For example, companies in the consumer product industries should find this useful when dealing with diffuse sales across the EU as it will become easier to look at an EU filing as opposed to a series of national filings.
Parties seeking referral will be aided by the fact that member states that do not reject a referral request will be deemed to have made one. Many member states with low, frequently triggered thresholds will be unlikely to act to reject a referral. As a result, silence by two or three of the new member states may act to take jurisdiction away from larger, more enforcement-minded member states. This may enable merging parties to engage in significant "forum shopping."
Risks
The proposed reforms contain a number of potential drawbacks and uncertainties for merging parties. For example, the current draft proposal increases the possibility that in certain circumstances, the merger may be reviewed both by the Commission and various member states. This would occur when an insufficient number of member states request a referral. Also troubling, the draft ECMR appears to eliminate the restriction on the Commission that any enforcement action be strictly limited to impact only the member states making the referral request. This creates the possibility for conflicting decisions covering the same market.
Finally, there are a number of elements of uncertainty in the draft. For example, it is not clear under what circumstances a member state will be deemed "concerned," especially where its jurisdiction is "optional" or based upon imprecise, subjective market share tests. The parties also appear to lose the benefits of timing deadlines in cases where the Commission "invites" member states to make a referral.
The guidelines and Merger Notice are subject to public comment and McDermott, Will & Emery will be submitting comments to the Commission. Should you have any comments you would like us to include, please contact a member of our competition team.
