China Law Vision : China Insurance & Anti-Trust Lawyer : Dr. Zhan Hao : Grandall Legal Group : Anti-Monopoly & Competition Law : China Law Vision Blog

The transaction only involves formation of production joint venture between Rio Tinto and BHP Biliton in Western Australia. The joint venture will be responsible for mining iron ores without Rio Tinto and BHP Biliton’s participations. The output of iron ore will be transferred to the two parent companies and marketed separately. This transaction came after the complete takeover bid for Rio Tinto by BHP in 2008. But it was aborted because of the intensifying financial crisis around the globe. The joint venture project was announced in June, 2009.

According to Reuters report, the two parties originally hoped that the transaction would obtain EC clearance by the middle of 2010. They now project the deal to be cleared towards the end of the year. The expected delay is due to the leadership transition going on in the European Commission—Netherland’s Neelie Kroes, former competition commissioner is replaced by Spain’s Joaquin Almunia. Despite the significance of the joint venture for the international iron ore and steel trade, it is not likely to be prioritized by the new commissioner, who will probably devote much of his attention and the administrative resources to deal with restructuring the European economy from the angle of competition policy.

Can China Review the Transaction?

Iron ore is distributed globally. Each year, the world’s largest three suppliers of iron ore, namely, Companhia Vale do Rio Doce of Brazil (“Vale”), Rio Tinto and BHP Billiton, engages in vigorous negotiation with worldwide iron ore users on, among other terms, price for next year’s supply. China has risen as a super powerhouse of economic growth. With that has come China’s huge demand for iron ore. If the transaction gets completed, China will have a harder time getting a good price for future iron ore supply. Given China’s position as a large stake holder in the transaction, one is tempted to ask if China can scrutinize the transaction.

Theoretically speaking, the answer is affirmative. In line with all major antitrust law jurisdictions, China’s Anti-Monopoly Law (AML) has extraterritorial jurisdiction: insofar as economic activities in foreign territories affect competition in relevant market in China, AML applies. Given the two companies’ giant international operations and the significant iron ore trade volumes with China, the transaction can easily surpass the turnover threshold. Given that, whether the transaction triggers concentration review in China then depends on whether the joint venture in production constitutes “concentration” within the meaning of AML.

In March 2009, Ministry of Commerce, the Chinese concentration regulator, released a draft of Measures on Concentration Filing for public opinion. The draft expressly provided that establishing joint venture by two companies is a form of concentration within the meaning of AML. However, the finalized version of the Measures, issued in November 2009 and effective on January 1 2010, deleted the provision on formation of joint venture as concentration. Instead, it merely sets forth three occasions as giving rise to concentration: (1) merger; (2) acquiring control over other undertakings by purchasing equity shares or assets; (3) acquiring control over or exerting decisive influence on other undertakings through contractual arrangement. On a superficial reading, formation of joint venture doesn’t fall into any of the three occasions giving rise to concentration. However, it doesn’t take much to understand that the second scenario, i.e. acquiring control over other undertakings by purchasing equity shares or assets, is broad enough to cover establishing joint venture. To read joint venture as a form of concentration is also consistent with the fundamental rationale why certain concentrations should be scrutinized by antitrust law, because they bring about long-lasting structural change in the competitive landscape of the market. By merging productions of iron ore into one entity, Rio Tinto and BHP Billiton recede from the production markets they occupied previously. Thus the market structure is permanently changed. What’s more, on a practical front, the Ministry’s practice is to treat joint venture as concentration. What’s done is that parties involved in forming joint venture are encouraged to conduct pre-filing consultation with the Ministry. After hearing the descriptions, the Ministry usually offers its opinion, in no writing, whether the joint venture constitutes concentration or not.

However, hypothesis may be paled by reality in this case. Granted, China can proceed to scrutinize the transaction under AML no matter the companies filed submission or not. The Ministry can even slap serious measures against the two companies, including divestiture of the newly formed joint venture, should they illegally carry forward the transaction. However, the ruling is unenforceable, because Rio Tinto and BHP Billiton don’t have many meaningful assets for enforcement in China—their commercial presence in China is limited to set-up of offices. That’s why, according to media report, Chinese steel makers are teaming up to go to Europe and address their opposition to the transaction to the European Commission, instead of doing that home.

Several Issues in the EU Investigation

A.      Market Definition

The first issue relates to the product market definition in EU’s probe. From the antitrust perspective, the initial step in concentration review is to define the product market. Products found to form a product market are substitutable with each other. Differently put, they are in competitive relationship with each other. Often, a product market consists of aggregate of all substitutable products with no qualification. Then why in the EU’s probe, the focus is on iron ore transported by sea? According to a public report, of all the iron ores produced globally in 2007, over half was exported and traded via sea freight. Much of the iron ore that is not exported is produced at mines with integrated or co-located steel-making facilities. Iron ore mines that are co-located with, or wholly owned by steel makers and iron ore mines that do not have access to appropriate transport infrastructure are unlikely to provide an effective competitive constraint on iron ores transported by sea. Therefore, it is a sound approach for the European Commission to zoom in on what’s called the seaborne iron ores.

B.     Full-function Joint Venture?

The second issue relates to whether the transaction in question is a full-function joint venture. According to EU merger regulation, a full-function joint venture has elements of independence, permanence and joint control. Otherwise, a joint venture is not regarded as full-function joint venture, thus not subject to merger regulation. Rather, it is taken as coordination between parent companies, reviewed by rules applicable to horizontal agreements. The distinction makes sense because sometimes, a joint venture can be utilized as a sham to facilitate anti-competitive coordination between parent companies. In one extreme example, two competitors form a joint venture which handles marketing of the goods produced by the parent companies. Through the joint venture, the two competitors engaged in coordination of prices, which is tantamount to horizontal price fixing agreement. In most antitrust jurisdictions, this type of agreement is illegal in its own right.

How to determine the absence of coordination between the parent companies in forming joint ventures? According to EU merger regulation rules, if there is no risk of coordination, it is because the parent companies withdraw from the market on which the joint venture operates and there is no possibility of them re-entering it for a certain period of time. Clearly the test in this case is whether the two parent companies have withdrawn from the market on which the joint venture operates. To recall, the Rio/BHP joint venture only covers mining iron ore in Western Australia. Marketing of the produced iron ore will be kept separate by the two companies. To determine whether BHP Billiton and Rio Tinto have completely and genuinely receded from the production market of iron ore, EU will look to a number of elements, which include (1) whether there are non-competition clause in the joint venture agreement that prevent the two parent companies from engaging in mining activities (the existence of non-competition clause is an indicator that the parent companies decide to withdraw from the market which is occupied by the joint venture); (2) whether there are contracts that concern the transfer of relevant property rights necessary for carrying out mining activity by the joint venture (if not, it is hard to believe that the joint venture has the necessary capability to operate in areas defined by the joint venture agreement) and (3) whether there exist barriers or deterrent to market re-entry by parent companies, such as excessive economic cost of re-entry (Excessive economic cost of re-entry may dampen the incentives of parent companies to re-enter the market and compete with the joint venture, indicating that the parent companies are serious about withdrawing from the joint venture’s market).

C.     Coordinated Anticompetitive Effects

After the joint venture in question is certified by EU as a full-function joint venture, it will be scrutinized under EU’s substantive merger regulation rules. One test the transaction will be subject to is whether the formation of the joint venture facilitates tacit or express collusion between Rio Tinto and BHP Billiton in selling iron ores separately. Alarm goes off if the joint venture is likely to increase the likelihood of coordination among Rio Tinto, BHP, Vale and other sellers in marketing iron ore in the international market or the joint venture increases the likelihood that any existing coordinated interaction among the said sellers would be more successful, complete or sustainable.

To determine whether a certain transaction increases the danger of tacit or express collusion is a multi-factor integrated analysis. Generally speaking, the following factors are relevant to the determination:

(1)   Relatively high barriers or impediments to entry: High barriers to entry prevent the collusion from being undermined by new market entrants, which are attracted by the raised price due to the collusion.

(2)   A relatively high level of concentration: High level of concentration means fewer competitors. The fewer competitors, the easier it is to form and manage collusion.

(3)   A low level of product differentiation: Lower level of product differentiation facilitates collusion because it is easier for competitors to reach agreement over the price increase and output restriction.

(4)   A relatively inelastic demand for the products in question: A more inelastic the demand is, the less alternative choice a customer has to switch to in response to collusive price increase.  

(5)   Similar cost-price ratios in the industry: Again, the more similar is cost-price ratios, the easier it is for competitors to reach agreement over standard price increase and output restriction.

(6)   A large number of small buyers: It means the collusion faces less countervailing power occasioned by large buyers.

(7)   A high degree of transaction frequency and visibility: the more frequent and visible are the transactions in market, the easier to detect defectors who cheat on the collusion and exercise discipline.

(8)   Relatively stable and predictable demand and supply conditions: It means it is easier to keep the collusion stable, without being undermined by the fluctuating market conditions. It also means that competitors tend to have less incentive to deviate from the collusion.

Without delving into detailed facts, iron ore industry is pretty much consistent with the above conditions. For example, market barrier in iron ore market is high, because it involves discovery of new, commercially viable iron ore mines and building infrastructures to haul the mines to sea ports. The seaborne iron ore market is also highly concentrated. It is reported that the three largest global supplier of irons ores, Vale, Rio Tinto and BHP Billiton, control 70% of the market. Iron ores are relatively homogeneous, as compared with other types of commodities. Steel making’s demand for iron ore is also highly inelastic, because only iron ore can be used to produce steel. Through the joint venture, Rio Tinto and BHP Billiton achieve equal production cost. With full knowledge of each other’s production cost, the two companies will find it easier to reach tacit agreement over the final price. To sum, the two companies have highly similar operations in terms of the quality of deposits, scale, cost base and distance to key customers. The danger of coordinated anticompetitive effects arising out of the joint venture is not to be ignored.

D.     Efficiency Justification

Under EU merger regulation rules, despite the anticompetitive potential a transaction entails, in theory, it can be justified by efficiency derived from the transaction that balances out the anticompetitive effects. To do so, the efficiencies must benefit consumers, be merger-specific and be verifiable.

In its public announcement that unveiled the transaction, Rio Tinto and BHP Billiton cited synergy as underlying the transaction. Namely, the synergies are anticipated to come from (1) combining adjacent mines into single operations; (2) cost reduction; (3) capital utilization efficiency and (4) management efficiency.

Without necessary facts and datas, it is difficult to verify the assertion. However, at this stage, it suffices to ask even though the claimed synergies can be achieved through the formation of the joint venture, will consumers get their share of benefit? To recall, the transaction entails no small risk of coordinated anticompetitive effects. If it happens, consumers will suffer by having to pay higher price to purchase iron ores, not to mention that they will get a lower price. Unless Rio Tinto and BHP Billiton can prove and gurantee that the transaction will necessarily benefit consumers and in what form, the efficiency justification should not be available.

The aforementioned questions why people link the AML authority with MOFCOM; a primary reason comes to light.

Prior to the promulgation of the AML, the first regulation to address anti-monopoly issues was The Interim Provisions on the Takeover of Domestic Enterprises by Foreign Investors (Interim Provisions). Within the framework of the Interim Provisions, MOFCOM will accept, investigate and decide the notification regarding a concentration, with SAIC. In practice, MOFCOM played a prevailing role in determining a concentration. Typically, MOFCOM frequently exchanges information with foreign counterparts, including the FTC, MOJ and the European Commission. Therefore, MOFCOM has a large responsibility over foreign investment, inbound and outbound trade, ect., and such responsibility easily allows the public to link MOFCOM with the enforcement of the AML This is especially true due to the most prominent misunderstanding that the AML shall primarily focus on the actions of foreign entities.

After studying the AML carefully, you should begin to recognize that SAIC will act as the indispensable and fundamental AML regulatory organization.

First, as per the power allocation regulation, SAIC retains responsibility over AML affairs related to monopoly agreement(s), abuse of dominance and administrative monopoly(s), though this excludes price-related monopoly behaviors.

The scope of monopoly agreement, abuse of dominance and administrative monopoly is so wide that almost every market power will fall within the grasp of the regulation. Price Fixing, restriction of output, market division, restriction of development and purchase of new technology/products, boycott(s), monopoly high prices above fair market levels, predatory pricing, refusal to trade, tie-in sales, discriminative treatments, etc., are typical monopoly agreements (cartels) and what would be categorized as an abuse of dominance. Thus, domestic and international giants must take caution when embarking upon specific market strategies.

Secondly, triggering SAIC action lies in the hands of the general public. MOFCOM under normal circumstances cannot forwardly investigate monopoly behaviors except where a business operator is directly involved in a concentration, or where they are notified of the presence of a concentration. For SAIC, the initiation of investigation proceedings is triggered by wider sources, including claims from the public, information forwarded by administrative departments and other SAIC information channels. Presently in China, the public including consumers are generally unsatisfied with the presence of monopoly powers and market dominators; this tendency will in turn provoke the action of SAIC.
 

From January 1st, 2009, MOFCOM has published some draft documents regarding the AML. These documents will prove to be increasingly important and include:
Working Guidelines on Anti-monopoly Reviews for Concentrations of Business Operators (09.01.01);Flowchart for Anti-monopoly Reviews for Concentrations of business operators (09.01.01);Guiding Opinion on Reporting of Concentrations of Business Operators(09.01.05);Guiding Opinion on Documents and Information Required for Reporting of Concentrations of Business Operators (09.01.07);Provisional Reviews Regulation for Concentrations of business Operators (09.02.16);Provisional Reviews regulation for the Notification of Concentrations of business Operators (09.02.16);Provisional Regulation for Evidence Collection of Concentration of Business Operators Not Reaching the Notification Threshold (09.02.16);Provisional Regulation for Investigation and Disposal of Violation of Concentration Notification ( 09.02.16);Provisional Regulation for Investigation and Disposal of Concentration of Business Operators Not Reaching the Notification Threshold (09.03.06).

Besides the documents above, MOFCOM also published a Guideline for Decision of the Relevant Market on January 31, 2009, as a means of economic analysis for the AML.

Compared with MOFCOM, SAIC and SDPC appear quite quiet. However, they are also preoccupied by the legislation progress concerning the AML, especially in the field of abuse of dominance, monopoly agreement (cartel) and administrative monopoly. It has been heard that both regulatory organizations will publish the related regulations soon, including substantial and procedural regulations. Chinese anti-trust lawyers hail such legislation in general, and hope such documents will resolve the difficulties in the enforcement of the Chinese Anti-monopoly Law.First, the regulations provide Chinese lawyers and business operators with documents detailing the requirement for the concentration notification.

Article 23 of AML states:
"When making a concentration declaration to the Anti-monopoly Law Enforcement Agency under the State Council, the business operators shall submit the following documents and materials:1. The Declaration Form;2. Explanations of the concentration effects on the relevant market competition situations;3. Concentration agreements;4. The financial and accounting reports for the previous fiscal year of the business operators involved in the concentration, which should be audited by an accounting firm; and5. Other documents and materials required by the Anti-monopoly Law Enforcement Agency under the State Council. The declaration form shall contain the names of the business operators involved in the concentration, their domiciles, business scopes, the date on which the concentration is to be implemented, and other matters prescribed by the Anti-monopoly Law Enforcement Agency under the State Council."

In practice, such a simple and abstract provision is far from use. For instance, how to make explanations concerning the concentration effects on the relevant market competition situations could be understood differently by different lawyers. When notifying a concentration to MOFCOM, Chinese lawyers predominately complain it is hard to prepare a related explanation efficiently. Secondly, it is easy for officials to refuse to accept the relevant documents. Now, the Guiding Opinion on Reporting of Concentrations of Business operators regulates such explanation in detail, including an overview of the concentration transaction, the definition of the relevant market, the market share of the business operators and their control to such market, the main competitors and their market shares, the degree of market concentration, etc.

Furthermore, the regulations correct the former legal provision in fact. For example, when calculating the notification threshold for concentration, the regulation from the State Council simply states it depends on the output amount of the total parties of the concentration. Such provision ignores the market power of affiliated enterprises to the parties of concentration. The Provisional Review regulation for the Notification of Concentrations of business Operators clearly regulates the calculation of output, stating it will take the output of the affiliated enterprises into account. Lastly, new regulations regulate hearing procedure, evidence collection and procedure and investigation procedure. Such procedures will ensure that the enforcement of AWL be more transparent and fair.

Overall, the advent of the new regulations and procedures should be held in high regard amongst Chinese Anti-monopoly lawyers and is a positive step forward for the AML.
 

Lawmaking Before AML: 　

Provisions on Acquisition of Domestic Enterprises by Foreign Investors is regarded as the first Chinese regulation that addressed anti-monopoly issues.Article 51 of Provisions states:

When a foreign investor's acquisition of a domestic enterprise involves any of the following circumstances, the investors shall report the same information to Ministry of Commerce (MOFCOM) and the State Administration for Industry and Commerce (SAIC):

1. during the current fiscal year any of the parties involved in the acquisition has a turnover in the Chinese market exceeding RMB1.5 billion (US$218.3 million);

2. the foreign investor acquires more than ten enterprises in related industries in China in one year;

3. any of the parties involved in the acquisition already controls not less than 20 per cent of the Chinese market; or

4. the acquisition will cause the Chinese market share of any of the parties involved to reach 25 per cent.

At the request of a competing domestic enterprise or the relevant functional authority or trade association, or if MOFCOM or the SAIC is of the opinion that the acquisition by the foreign investor would materially affect market competition, authorities may nevertheless require the foreign investor to file a report, even though the criteria laid out in the preceding paragraph have not been met. The aforementioned “any of the parties to the acquisition” includes affiliates of the foreign investor.

Article 52 states that if the proposed M&A falls under any of the above criteria, a hearing will be held to approve or disapprove of the transaction. It can be concluded from the above-stated regulation that the criteria of notification includes turnover amount, the number of enterprises involved in the takeover, market share of those enterprises, and value of assets involved.

Drafting of the AML

In the early drafts of the AML, the language used regulated the standard of notification, particularly the criteria of declaration regarding turnover in a single fiscal year. The Office of Legislative Affairs stated that the draft took into consideration the economic situation, market competition, and, in particular, the difference between various sectors.

The draft also regulated the criteria of declaration regarding the following three aspects:

• First, it made clear the declaration criteria for the ordinary sector: global turnover of the previous fiscal year for all business operators involved exceeds RMB12billion; domestic turnover of the previous fiscal year for one operator involved exceeds RMB800 million. (Section 1, Article 17).
• Second, it affirmed that the State Council is authorized to stipulate the declaration criteria for the banking sector, insurance sector and any other sector in order to insure that any policy designed towards a specific industry and/or area could be implemented accordingly (Section 3, Article 17).
• Third, the adjustment mechanism of the declaration criteria was designed for easier reporting to the State Council for approval and implementation. However, the specific regulations regarding a declaration of concentration were taken out in the final edition of the AML.

In March of 2008 the State Council issued the Provisions of the State Council on the Declaration of Concentration of Business Operators (Exposure Draft) in order to collect comments from the legal community. It states the following concerning when a concentration must be declared.Article 3:

1. the worldwide business volume of all operators involved in the concentration exceeds RMB9billion in the last accounting year, and the business volume in China of at least two operators exceeds RMB300 million in the last accounting year;

2. business volume in China of all operators involved in the concentration exceeds RMB1.7 billion in the last accounting year, and the business volume in China of at least two operators exceeds RMB300 million in the last accounting year; or

3. the concentration would cause the market share of all operators involved in the concentration to reach 25 per cent or more in the relevant market within the territory of China.

If left undeclared, the concentration is not allowed. The Exposure Draft has not been ratified by the State Council. It appears that the specific regulations on the declaration of concentration of business operators will instead be determined by the enforcement regulation of the AML.
 

In the past, forms of concentration such as mergers, acquisitions, combinations, consolidations, and takeovers were regulated by the General Principles of Civil Law, The Company Law, The Bankruptcy Law, Explanations by the Supreme Court of China regarding Enterprise Reconstruction, and additional regulations of the Ministry of Commerce (MOFCOM). There was no official statutory definition of concentration and the applicable rules created by different regulatory bodies were unclear and not properly coordinated leaving a large gap for differing interpretations of the law.  

The most important statutory rule for concentration before the adoption of the Anti-monopoly Law was in Article 2 of the Interim Provisions on the Takeover of Domestic Enterprises by Foreign Investors. However, many legal commentators criticized the above provision as they believed its regulatory scope was too narrow and the definition of share right and asset takeover did not adequately provide for the many new emerging forms of concentration in the market.

The Chinese legal definition for merger as used in The Company Law and in other rules and regulations refers to the act of purchasing part of the equity and assets of another company; excluding many other forms of concentration such as acquisition, joint venture, strategic alliance, contractual arrangements for shared rights and obligations, and an interlocking director. Similarly, not all forms of concentration are fully encompassed within the American legal definition of Merger and Acquisition (M & A)

The word "concentration"as it is defined under European competition law may be the best model for the Anti-monopoly Law. This is because it focuses on the essential outcome of concentration activity, instead of just describing specific behavior. It also gives consistency to the law by providing a general term covering many different types of consolidations. Thus, if there are other forms of concentration in future practice, such as certain strategic alliances, joint ventures, or other agreements/undertakings between parties that cannot be categorized as a merger, acquisition, interlocking director, franchise or contractual control; it will still fit within the definition of concentration in the Anti-monopoly Law. 

Article 20(3) of the Anti-monopoly Law states that concentration occurs where "a business operator acquires control over a business(s) or is able to exert a decisive influence on a business(s) by contract or any other means." This provision establishes that control may be obtained through contract or any other activity in which a business operator could exert influence on other business operators. Article 217 of the Company Law defines an "actual controller" as "anyone who is not a shareholder but is able to hold actual control over the acts of a company by means of investment relations, agreements or any other method."

It is important for the Anti-monopoly Law to properly take into account the increasingly more complex and diverse forms of concentration that are now emerging, and which will continue to be utilized in the market. By focusing on the "outcome" of concentration activities, the European model best achieves this goal.