On 25 January 2010, European Commission said that it is ready to review a plan by the world’s second and third largest iron ore miners, Rio Tinto and BHP Biliton, to combine some iron ore mining operations in Australia. The European antitrust watchdog said that it would investigate whether the companies’ plan to pool iron ore mining in western Australia would affect the global prices or supply for iron ore transported by sea, known as seaborne iron ore. The Commission set no deadline for completion of the investigation, citing the complexity of the case, cooperation from the companies involved and exercise of the rights of defense, among other factors, to justify the open-ended time limit.
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.