Hong Kong: Merger Control
The entry into force of the Competition Ordinance (Cap 619) (CO) has attracted much attention, especially in relation to the rules on anticompetitive agreements and the abuse of a substantial degree of market power. These rules are commonly referred to as the conduct rules and are addressed in two other chapters in this publication: ‘Hong Kong: Cartels’ and ‘Hong Kong: Dominance’.
The CO also included a limited merger control regime that applies only to mergers involving a telecommunications licence carrier. This is commonly referred to as the Merger Rule. There has generally been less commentary on the Merger Rule than on the conduct rules for possibly two reasons: (i) the Merger Rule is of application just to mergers in the telecommunications industry and is not of general application; and (ii) the Merger Rule is, for the most part, a continuation of the previous merger control regime under the Telecommunications Ordinance (Cap 106).
This chapter seeks to provide an initial overview of the Merger Rule and highlight key points that merger parties need to consider at the outset of any mergers involving a telecommunication licence carrier in Hong Kong. This chapter also seeks to highlight certain seemingly minor changes from the previous merger control regime under the Telecommunications Ordinance that have the potential to change significantly the scope of the regime and introduce challenges for merger parties whose main concerns will be deal certainty and timing.
What is the relevant legislation and who enforces it?
The CO, which came into full force on 14 December 2015, is the first ever economy-wide, cross-sector competition law in Hong Kong. For mergers involving a telecommunications licence carrier, the Merger Rule provides that an undertaking must not carry out a ‘merger’ that has or is likely to have, the effect of substantially lessening competition in Hong Kong.
The Competition Commission (the Commission) and the Communications Authority (CA) have concurrent jurisdiction in relation to the enforcement of the Merger Rule. However, under the terms of a memorandum of understanding between the Commission and the CA, the CA will typically take the lead in relation to matters relating to the Merger Rule.
In addition, the Commission and the CA have jointly issued a guideline setting out how they intend to interpret and give effect to the Merger Rule (the Guideline). The CO also establishes the Competition Tribunal (the Tribunal), which has jurisdiction to hear and determine applications made by the Commission to unwind a completed merger or to prohibit a proposed merger.
Unless specified otherwise, references in this chapter to the CA are to be read as including the Commission.
Scope and nature of the merger control regime
Pursuant to the Merger Rule, the merger control regime only applies to ‘mergers’ involving a carrier licence within the meaning of the Telecommunications Ordinance. Such a carrier licence essentially relates to network operators that establish and maintain wired or wireless transmission facilities that carry ‘communications’ between locations that are separated by public streets or unleased land. This includes the local and external fixed network operators and mobile network operators.
In addition, there is no general requirement for merger parties to notify the CA and there is no suspensory obligation. In practice, this means that merger parties can opt not to submit an application for CA approval even if the relevant thresholds are triggered (see below) and, in any event, the merger parties will not have to wait for CA merger approval to close the relevant transaction.
However, where a party is required to make a mandatory general offer (MGO) under the Codes on Takeovers and Mergers and Share Repurchases (the Takeovers Code) that would result in a ‘change’ in relation to a carrier licensee, the Takeovers Code may require that the MGO offeror obtains prior formal consent from the CA in relation to the ‘change’ to the carrier licensee before it triggers an obligation to make an MGO. The Takeovers Code has not yet been amended to reflect the introduction of the Merger Rule and still refers to the merger control regime under the Telecommunications Ordinance so there is some remaining uncertainty as to the precise requirement in this respect.
What types of mergers are caught?
Only mergers involving a telecommunications licence carrier are caught under the current merger control regime. A ‘merger’ takes place if:
- two or more previously independent undertakings cease to be independent of each other;
- one or more persons or undertakings acquire direct or indirect control of the whole or part of one or more other undertakings; or
- an acquisition by one undertaking of the whole or part of the assets of another undertaking such that the acquirer is in a position to replace or substantially replace the acquired undertaking in the business or part of the business concerned in which the acquired undertaking was engaged immediately before the acquisition.
There are three key points to flag in relation to the definition of a merger.
First, in contrast to the previous merger control regime, which applied only if a target held a telecommunications carrier licence, the Merger Rule applies to cases where either the acquirer or target, directly or indirectly, controls a telecommunications carrier licence. That would seem to be an expansion of the scope of the CA’s jurisdiction and it is perhaps unclear why it was necessary to expand the scope of the regime’s jurisdiction in this regard.
Second, a merger can include the acquisition of minority stakes in another undertaking if ‘control’ is acquired. ‘Control’ is acquired by any person if that person is capable of exercising ‘decisive influence’ in relation to the undertaking through ownership of assets or certain governance rights. ‘Control’ may be established on a legal or de facto basis so that minority and other interests that amount to less than legal control may be caught. Unlike in the previous merger control regime under the Telecommunications Ordinance, no specific percentage threshold for ‘control’ is stated in either the CO or the Guideline. In the absence of any guidance, it may be appropriate to look to other jurisdictions which use a control test, in particular, the European Merger Regulation and the approach of the European Commission under the Consolidated Jurisdictional Notice which also refers to ‘decisive influence’.
Third, the Merger Rule also captures the establishment or acquisition of a joint venture which performs, on a lasting basis, all the functions of an autonomous economic entity. In accordance with the Guideline, performing all the functions of an autonomous economic entity means that a joint venture must operate on a market and perform the functions normally carried out by an undertaking operating on that market. This is not the case if it only takes over one specific function within the parent company’s business activities without access to, or presence on, the market.
No jurisdictional thresholds but an indicative safe harbour
In contrast to many other jurisdictions such as the European Union and China, there are no financial thresholds under the CO or the Guideline to determine whether seeking CA merger approval is warranted. Instead, the question is whether a merger has taken place or is to take place (see above).
Even though there are no financial thresholds under the CO and the Guideline, the CA has identified two indicative ‘safe harbours’ according to which mergers are unlikely to substantially lessen competition.
- First indicative safe harbour: four-firm concentration ratio – where the post-merger combined market share of the four (or fewer) largest firms (CR4) in the relevant market is less than 75 per cent, and the merged firm has a market share of less than 40 per cent; or where the CR4 is 75 per cent or more, and the combined market share of the merged entity is less than 15 per cent of the relevant market.
- Second indicative safe harbour: Herfindahl-Hirschman Index (HHI) – where the post-merger HHI is less than 1,000 in the relevant market; or where the post-merger HHI is between 1,000 and 1,800, and the merger produces an increase in the HHI of less than 100 in the relevant market; or where the post-merger HHI is more than 1,800, and the merger produces an increase in the HHI of less than 50.
Merger parties should, however, treat the indicative safe harbours with caution since the Guideline expressly states that meeting one or both of the safe harbour thresholds does not necessarily mean that the merger does not give rise to competition concerns and that the CA may still commence an investigation in ‘appropriate circumstances’.
How do merger parties seek CA clearance?
Merger parties can seek effective CA merger clearance through two separate routes.
First, merger parties can submit a voluntary notification to the CA seeking ‘informal advice’ on a confidential basis (the Informal Advice Route). The informal advice is not binding on CA but it provides the merger parties with a preliminary view as to whether the proposed merger is likely to raise competition concerns.
Second, parties to a merger may also apply to the CA for a formal decision as to whether the merger is excluded from the application of the Merger Rule on the basis that (i) the economic efficiencies of the merger outweigh the adverse effects caused by any lessening of competition, or (ii) one of the statutory exemptions apply under the CO (the Decision Route). Statutory exemptions cover (i) statutory bodies or specified persons to which the merger rule does not apply pursuant to Sections 3 and 4 of the CO respectively; and (ii) persons engaged in the specified activities to which the Merger Rule does not apply as determined by the Chief Executive in Council by means of a regulation made pursuant to section 5 of the CO.
Under the Decision Route, merger parties will – unless the merger qualifies for a statutory exemption – be required to concede that the merger gives rise to an adverse effect on competition and should receive CA clearance on the basis of efficiencies. The burden of demonstrating that any claimed efficiencies outweigh any harm to competition would fall on the merger party making that claim. Based on the very limited international precedents whereby efficiencies have been used to secure a merger approval, it would seem to be a highly challenging route and merger parties would be well advised to seek legal advice before seeking CA approval through this route.
For completeness, and distinction from the Informal Advice Route and the Decision Route, the Chief Executive in Council may exempt a merger from the application of the merger rule if he or she is satisfied that there are ‘exceptional and compelling reasons of public policy for doing so’.
What is the substantive test under the Merger Rule?
The substantive test to be applied for the Merger Rule is whether the merger has, or is likely to have, the effect of substantially lessening competition in Hong Kong.
The Guideline explains that the CA will generally interpret a substantial lessening of competition by reference whether the merger is likely to encourage one or more firms to raise prices, reduce output, limit innovation, or otherwise harm consumers as a result of diminished competitive constraints or incentives.
According to the CO, the CA will consider a number of factors to determine whether there is a substantial lessening, including typically:
- the extent of competition from competitors outside Hong Kong;
- whether the acquired undertaking has failed or is likely to fail in the near future;
- the extent to which substitutes are available or likely to be available in the market;
- the existence and height of any barriers to entry into the market;
- whether the merger would result in the removal of an effective and vigorous competitor;
- the degree of countervailing power in the market; and
- the nature and extent of change and innovation in the market.
Regulatory timetable and key milestones
No clear indicative timetable is provided by the CA in relation to the Informal Advice Route or the Decision Route. The CA has simply stated that it will endeavour to process applications in an efficient and timely manner but that the timeline for review will ultimately depend on the complexities of the case and the resources available to the CA.
To date, our experience of CA timelines under the Merger Rule and its previous incarnation in the Telecommunications Ordinance have indicated that the CA will indeed work in an efficient and timely manner and within the parties’ time frames wherever possible. Based on the limited precedents available, timelines for CA approval have ranged from less than a month for ‘no issues’ cases to just over six months (a case reviewed under the previous Telecommunications Ordinance regime that raised competition concerns).
The Guideline also provides limited insight into key milestones in any CA merger review that would introduce more clarity into the process and assist merger parties with planning.
The Informal Advice Route
Under the Informal Advice Route – and following the submission of an application for approval – the CA merger review may include the opening of a CA investigation, the determination of the outcome of the investigation and – if applicable – the opening of Tribunal proceedings. We address each of these steps in turn below.
The CA may open an investigation if it has reasonable cause to suspect that a contravention of the Merger Rule has taken place, is taking place or is about to take place. The nature of the investigation will likely vary according to the concerns that the CA has raised in relation to the merger but may take in representations from the merger parties, issue document requests, conduct interviews with employees of the merger parties, and conduct general market inquiries, which might include consultation with competitors, customers, suppliers and trade associations, and consumer groups. Again, there is no indication as to what point in the merger review the CA will initiate an investigation but it must do so within 30 days after the day on which the CA first became aware, or ought to have become aware, that a merger has taken place (ie, completion).
Following the investigation, there are two potential outcomes: (i) the CA considers that there is no reasonable cause to believe that the merger is likely to contravene the Merger Rule; or (ii) the CA has reasonable cause to believe that the merger is likely to contravene the Merger Rule and then the CA may bring proceedings before the Tribunal.
If the CA is to initiate Tribunal proceedings, those proceedings must be brought within the period of six months after the day on which the merger was completed or the CA became aware of the merger (whichever is the later). The six-month period for initiating proceedings can be extended by the Tribunal on application from the CA if the Tribunal considers it reasonable to do so.
The Decision Route
Under the Decision Route, there are a number of key steps to consider, which we outline below.
- Initial consultation: potential applicants are strongly encouraged to engage in an initial consultation with the CA to discuss jurisdictional matters and key issues (including competition concerns) that the CA might need to assess. It has been stated expressly that – at this stage in the process – the CA may highlight to the parties that an alternative procedural route may be more appropriate under the Ordinance.
- Application for a decision: submission of a complete Form M including a non-confidential version that the CA will then publish.
- Preliminary assessment of application: the CA will consider whether the application is suitable for consideration, ie, whether: (i) the application poses novel or unresolved questions of wider importance or public importance; (ii) the application relates to an exclusion under the Ordinance for which there is no existing precedent; and (iii) it is possible to make a decision on the basis of the information provided.
- Publication of notice and consideration of application: assuming the CA is prepared to review the application, prior to making any decision, the CA must publish a notice of the application for a decision and must allow at least 30 days for representations to be submitted to it and consider any representations made.
- Decision: at the end of the review, the CA will make a decision that either (i) the merger is excluded from the Merger Rule (approval); (ii) the merger is excluded from the Merger Rule subject to certain conditions or limitations (conditional approval); or (iii) the merger is not excluded from the Merger Rule (effective prohibition).
Commitments to remedy competition concerns
The CO provides that merger parties may offer a ‘Commitment’ to take any action or refrain from taking action that the CA considers appropriate to address competition concerns it may have raised. Those commitments can involve structural (eg, disposal of assets)or behavioural remedies (eg, third-party access to a fixed network). As a general starting point, the CA has expressed in the Guideline a preference for structural remedies as ‘they are more able to deal with the competition concerns identified at source’ and do not generally require ongoing monitoring activities.
Parties will offer such commitments in return for the CA agreeing not to commence an investigation or bring proceedings in the Tribunal, or to terminate any investigation or proceedings that have commenced.
While it is unclear at what point the CA will disclose any competition concerns – it is also unclear how concerns (if any) will be communicated to the merger parties (ie, orally or in writing) – it seems that the merger parties can offer a commitment at any stage in the process.
What are the possible sanctions involved in closing before clearance?
As filing is voluntary in general, there are no specified sanctions for closing before clearance. However, where the implementation of a proposed transaction would result in a requirement that the offeror make a MGO pursuant to the Takeovers Code, there appears to be a requirement that the offeror obtain prior formal consent from the CA for a ‘change’ to the carrier licensee. Failure to do so may result in disciplinary action under the Takeovers Code. Sanctions include issuance of a public apology, licensed representatives and registered institutions not to act or implement the merger or acquisition.
In addition, the CA may commence an investigation of an anticipated or completed merger and can apply to the Tribunal for a pecuniary penalty to be imposed on any person that the CA has reasonable cause to believe has contravened or has been involved in a contravention of the Merger Rule. The prospect of fines does not sit easily within the voluntary nature of the merger control regime, such that there will be questions as to how this provision might be applied in practice. Apart from the ability to fine, the Tribunal can, on its own motion or on application, make a wide range of orders including orders to unwind the transaction or orders to divest certain assets.
In certain circumstances, the CA can also apply to the Tribunal for interim measures for the purpose of ‘preventing pre-emptive action’ which may prejudice the bearing of the application by the Tribunal. Interim measures would likely include measures akin to hold-separate orders or stand-still obligations.
To date, the limited precedents have demonstrated that the CA will work efficiently to tight timelines and provide informal advice very quickly, which has served to reassure merger parties. Our experience to date has been encouraging in this regard. There remain, however, some important uncertainties in the current merger control process in Hong Kong. Those uncertainties relate principally to the process rather than the substantive analysis and, in the absence of precedents, will create deal certainty concerns for merger parties.
If the merger control regime is expanded beyond the current sectoral focus, there are a number of key issues that should be addressed, including time frames and the overall process for obtaining regulatory approval under the Merger Rule, which remain unsatisfactory at present. The question will be whether such changes could be achieved without the need for legislative changes.