Opening remarks
Good morning and thank you Jean-Pierre (de Raad) for your introduction. It is a pleasure to be here today to give the 2011 update on the work programme of the Commerce Commission (Commission).
The Commission is New Zealand's competition authority and economic regulator. It is responsible for enforcing competition, fair trading and consumer credit contract laws, and has regulatory responsibilities in the electricity, gas, telecommunications, airports, and dairy industries.
In my talk today I will review the past year at the Commission and provide an update on some of the Commission's current work programmes. I will start with a brief comment on how we are continuing to adapt the Commission to meet the changing times. I will then comment on how the economic environment is continuing to affect our work in the Competition Branch, before noting some strategic initiatives we have underway in that branch. I will then review some of the work of our Regulation Branch, focusing on Part 4. Part 4 work has placed major demands on the Commission over the past year, and will be a major focus of our work over the next few years.
The Commission
The Commission aims to use the resources available to it to achieve the best possible outcomes in competitive and regulated markets, for the long-term benefit of New Zealanders.
We recognise the fiscal constraints facing the government and have continued to work on improving our effectiveness. The restructuring of the Commission into two operational branches, namely the Competition and Regulation Branches, has been bedded down, with the economics and legal groups now integrated into these branches. These changes have increased the flexibility with which resources are used and facilitated internal communication, resulting in improvements in efficiency and multi-disciplinary collaboration.
In addition we are increasing our engagement with key stakeholders, to ensure we understand their needs as well as the effect our work has on their businesses. We are proactively talking with stakeholders, and tailoring our approach to particular groups. This has proven effective so far in our outreach initiatives, which I will talk about shortly. We are also aiming to ensure we are making smart, pragmatic decisions about prioritising our work.
Competitive markets
As noted earlier, the Commission has a strong focus on how it can achieve the best possible outcomes in competitive and regulated markets from the resources available to it. I would like to talk about two inter-related strategies which we have implemented in the Competition Branch. The first is to focus more resources on proactive approaches to educating the business community about their obligations under the Commerce and Fair Trading Acts (our outreach programme). The other (related) strategy is our use of a wider range and mix of tools in our enforcement interventions.
Outreach
Research which we commissioned last year found disappointing levels of awareness of the Commerce Act in the business community. Of those businesses surveyed who were aware of the Commission (close to 95 per cent), only 58 per cent believed the Commerce Act applied to them compared to 83 per cent for the Fair Trading Act. As a result, we are seeing few compliance programmes and little staff training in organisations - something we want to change.
The Commission believes the competitive environment in New Zealand will be improved if more businesses understand their obligations under the Commerce and Fair Trading Acts and take responsibility for ensuring they have adequate systems and processes in place to comply. The Commission has adopted a more proactive approach to improving voluntary compliance by educating, encouraging and enabling businesses to comply, and engaging with them more about what the Commission is doing.
Our outreach programme identifies industry sectors in response to emerging issues or on-going areas of concern - focussing on where we think there is the most opportunity to improve compliance and market outcomes.
Two areas we have recently been focusing our advocacy efforts have been the construction sector and the Rugby World Cup.
Construction sector
Early last year we undertook research to better understand the levels of awareness of competition law in the non-residential construction sector. The sector was identified for the research as it is a major driver in the economy, and has also been shown overseas to be prone to anti-competitive conduct.
The findings suggest some construction businesses have low levels of awareness of competition law, and we have since been working with industry associations and relevant media to improve understanding and compliance in the sector.
In particular, the research uncovered that the practice known as 'cover pricing', which may be anti-competitive, is common. Of the 12 construction sector participants interviewed at length, all mentioned unprompted that they were aware of or had participated in cover pricing.
When commercial building contractors talk about cover pricing they mean collaborating with another party in order to invent a believable (cover) price, based on the genuine pricing information that one of the parties intends to go to tender with. The cover price is not intended to win the tender, but it is meant to look like a legitimate bid.
RWC 2011
We also recognised an opportunity with this year's Rugby World Cup to improve businesses' and consumers' awareness of consumer and competition legislation. The Rugby World Cup presents an opportunity for businesses to cash in on the influx of tourists. How much New Zealand will benefit from this in the long term will depend on the quality and value of the experience for those tourists.
Our focus with the outreach in this area is to ensure businesses play by the rules. We do not want tourists to go home feeling they were ripped off, and we do not want businesses colluding to increase prices, for example.
We have a range of communication initiatives underway to get the message out both to businesses and Rugby World Cup fans including working closely with industry associations and groups.
A more tailored approach to enforcement
Another important element of our changing approach is recognising that highly effective outcomes can be achieved without litigation. In other words, we are looking to tailor our approach to the need at hand, and fully utilise all the enforcement options available to us.
Litigation can have real benefits to the Commission and to the public. Useful precedent can be established that allows finality against the specific defendant, but that also instructs the rest of the community as to the law. This is educative, and it is undeniably a function of the Commission to clarify and enforce compliance with various commercial and regulatory statutes. Some areas of the law are so uncertain that the most useful way to deliver genuine guidance is to have the Courts opine on what the law means. Recent areas in which we have sought clarification include s36 of the Commerce Act and the provisions of the Credit Contracts and Consumer Finance Act (CCCF Act).
But not all cases of breach require an authoritative Court decision. Sometimes a more immediate solution is preferable. Where a final Court decision may be many years in the making, an agreed resolution may be almost immediate. The party in breach may agree to stop its conduct and provide compensation to affected consumers. Or it may alter its business practices going forward. Such resolutions will not provide authoritative precedent, but they are more immediate, they have the buy-in of the defendant, and they are considerably less costly to all parties than the litigation alternative. But more than that - they can allow the Commission and the defendant to structure a resolution that would not be within the Court's authority to deliver.
Some recent examples will illustrate what I mean.
ANZ/ING
This time a year ago we announced our largest consumer settlement of a case under the Fair Trading Act, with ANZ/ING. Much has been said about this $45 million settlement, so I will not go into the details again. But I mention it in this context as an example of the benefits of a more flexible approach. The Commission could have gone to court, and argued for a stiff penalty against ANZ/ING. But all the while that the matter was before the Court, 15,000 investors would have been out of pocket. The settlement was the best available outcome for investors.
Freight forwarding
In September last year we filed proceedings under the Commerce Act against a number of companies accused of collusion in the freight forwarding market in New Zealand. This followed an investigation sparked by a leniency application. Even as we filed those proceedings we were being approached by a number of the companies who wished to engage in settlement negotiations. We have already announced settlement with two of those parties, EGL Inc and Geologistics International - and we expect to be able to announce further settlements in the near future. The aggregate penalties from those two settlements is $3.65m.
Other examples
Other cases, on a smaller scale, offer valuable opportunities for the Commission to educate the business community. Late last year, for example, the Commission formally warned two companies who inadvertently agreed prices for air ambulance evacuations to New Zealand. Likewise two TradeMe car tyre vendors were warned that their actions in collaborating over pricing breached the Act. In both cases, and in many similar cases in the competition and consumer areas, the Commission seeks to take a proportionate response to breaches, and to educate the market.
Finally, in 2010 the Commission took a novel approach to a much larger-scale market, the construction sector, as I noted above when discussing our outreach initiatives. Rather than commence backward-looking breach investigations, the Commission commissioned research into the practices that exist in that sector, so as to get a sense of the scope and scale of any problems, as well as to use the chance to educate that industry - and markets generally - about the types of practices that may be illegal under the Commerce Act.
So you can see that there are many ways in which the Commission approaches breaches of the Acts that we enforce. We will always be ready to litigate where the 'deliverables' of litigation are most valuable: precedent, finality, penalty or deterrence. But if we can achieve some or all of those results faster by other means, then we will look to those alternatives.
Commerce Act work update
The global financial crisis has continued to affect our competition work. During the past two years of global recession, the Commission saw a downturn in merger activity. In 2008/09 we received only 11 merger applications, with eight received in 2009/10. This compares with 26 in 2007/08. In the current financial year (2010/11) we are seeing a modest increase in merger activity - and have received eight merger applications in the year to date, one of which was a failing firm case. In that case, involving heat set printing assets, the target company closed its doors while the Commission was considering the application. We determined that the firm had indeed failed and that the sale of the assets (or the business) to a third party was unlikely.
The Commission has just last week received its first application for a merger authorisation; the first merger authorisation we have received since the Air New Zealand/Qantas application in December 2002.
While tough economic conditions might have provided incentives for collusive conduct, we have not seen this. In fact, the number of new cartel investigations has declined significantly. No new major cartels have been identified over the past year. While we are still busy on legacy cartel cases, the absence of new cartel cases will have a significant effect on our workload in the future. We have been able to reallocate resources to progress the legacy cartel cases and have completed a total of 11 collusive conduct cases in the first seven months of the 2010-11 financial year.
As a result of the downturn in competition work, we have made significant savings (primarily through not replacing several staff who have left). We have also reallocated some competition resource to the Informed Consumers area, which has allowed us to complete more low level Fair Trading cases and thereby improve compliance by a number of smaller businesses.
We have also continued to produce guidance material to assist parties comply with the Act. In the past year we have developed guidelines on merger divestment remedies, trade associations, bid-rigging and have updated the cartel leniency policy.
In November 2010, the Australian and New Zealand governments announced cross appointments of commissioners between the Australian Competition and Consumer Commission (ACCC) and the Commerce Commission. ACCC member Dr Jill Walker has been appointed an associate member of the Commerce Commission, and Commission chair Dr Mark Berry as an associate member of the ACCC. Dr Walker's first involvement in the Commerce Commission's work is as a member of the division that is considering Fletcher Building Limited's application for clearance to acquire the Crane Group Limited, a transaction which has trans-Tasman dimensions.
Telecom 0867
I would like to talk about one key case concluded during the year, which has important implications for future section 36 cases, the Telecom 0867 case.
In September last year the Supreme Court dismissed the Commission's appeal in the Telecom 0867 unilateral conduct case. This case was the first opportunity for the Supreme Court to consider and determine the appropriate legal analysis under section 36.
I note that John Land will be speaking on this subject, so I will not rehearse the details of the case, but will rather focus on its implications for the use of the counterfactual test.
The counterfactual test was first adopted by the Privy Council in the 1995 decision in Telecom v Clear. This test asks whether the dominant firm would, or could rationally, have engaged in the conduct it in fact adopted, if it did not have the benefit of its substantial market power.
A key objective of the Commission in appealing the case was to seek a departure from the Privy Council's reliance on the counterfactual test as the sole test of whether a firm takes advantage of its market power. The Commission's key contentions were that:
- the counterfactual test was out of step with Australian jurisprudence in which a more flexible approach had developed, recognising different tests;
- there were concerns about the workability and utility of the counterfactual test, articulated by commentators, the Court of Appeal in earlier cases and by the minority of the Privy Council itself; and
- the counterfactual test, unlike the other more flexible tests in Australia, fails in some instances to properly screen for anticompetitive conduct because it assumes that conduct that is equally rational for a dominant and non-dominant firm to engage in is not of concern.
The Supreme Court's judgment in September 2010 dismissed the Commission's appeal. Interestingly, the Supreme Court did not share the Commission's understanding that the Australian approaches differed materially from the counterfactual test. Instead, the Court emphasised what it viewed to be the essential feature common to all of them, namely the employment of a "comparative exercise".
The Supreme Court rejected the possible use of a range of tests, noting that this "would not assist with the predictability of outcome" (see para 30 of the judgment). The Court held that "[t]he essential point is that if a dominant firm would, as a matter of commercial judgment, have acted in the same way in a hypothetically competitive market, it cannot logically be said that dominance has given it the advantage that is implied in the concepts of using or taking advantage of … a substantial degree of market power" (para 31). And later in its judgment the Court emphasises that "it must be shown, on the balance of probabilities, that the firm in question would not have acted as it did in a workably competitive market" (para 34). This is effectively a restatement of the counterfactual test laid down by the Privy Council.
References elsewhere in the judgment to the concept of "facilitation" may suggest the Court intended to broaden the mandated approach. The Court observes that "market power gives some advantage if it makes easier - that is, materially facilitates - the conduct in issue" (para 33). The Court's apparent decision not to refer explicitly to the "counterfactual test" in its judgment, but rather to speak of a "comparative exercise", may give oxygen to such speculation.
In the Commission's view, the few references to the concept of facilitation must yield to the numerous passages which require the plaintiff to prove that the defendant "would not" have engaged in the conduct at issue in the absence of market power. But the conflicting language used in the Supreme Court's judgment invites a degree of speculation as to whether the Court has intended to soften the counterfactual test in New Zealand.
It appears that any policy preference in New Zealand for clear alignment with Australia will require legislative intervention. Oliver Meech, Minter Ellison Rudd Watts, reaches the same conclusion:[1]
"The position we have arrived at…as a result of [the Telecom 0867 case] is that s 36 in its current form is as flexible as New Zealand's highest court has been able to interpret it. If greater flexibility… is required or substantive similarity with Australian law on single-firm conduct is a driving objective, then legislative amendment to s 36 along the lines of s 46(6A) [of the Australian Trade Practices Act] is now the only option."
Fair Trading
Fair Trading continues to be an area where we are extremely busy irrespective of economic conditions. As staff have been redeployed from competition work, we are making headway through a greater number of cases than normal. There are a few cases I thought worth noting here.
Balmoral Homes
Two directors were fined a total of $30,000 and ordered to pay reparation of $127,000 for falsely representing that their company was a member of the Master Builders Federation and that their contracts came with a Master Build guarantee. This case was of particular interest because both directors were personally bankrupt; however the Judge commented positively on the Commission's detailed analysis of both directors' means, including details of their family trusts which indicated that the directors had the means to make reparation payments.
Royal jelly
The Commission has taken cases against five companies for false and misleading representations in relation to the country of origin of royal jelly products. This product is very important to the Asian tourist market, as many tourists will pay a premium for this product if it is New Zealand royal jelly, as it is considered to be of higher quality and potency. In fact these products were imported Chinese powdered royal jelly, made up into capsules in New Zealand and sold as New Zealand royal jelly. Four companies have been fined by the courts following our successful prosecutions and one remains to be dealt with.
Lead in toys
Prior to Christmas, the Commission issued an alert to consumers about a number of toys sold in bargain variety stores following testing by the Ministry of Consumer Affairs which detected excessively high levels of lead.
The case was treated with extreme urgency because of the safety risks, and the Commission worked very closely with the Ministry to track down the toys and used its media contacts to publicise the issue as widely as possible.
Due to the fact the distributor could not be found, a formal recall could not be ordered. However the Commission advised parents to dispose of the toys immediately or return them to the store where they were purchased for a full refund.
Credit Contracts and Consumer Finance Act
Like the Fair Trading Act, the CCCF Act exists to protect the interests of consumers, enabling them to make informed choices about using credit. As this Act is still relatively young, we recognise that an important part of our role is to provide guidance to the credit industry on the application of the Act. In 2009 we issued draft guidelines on credit fees for public comment. Last May, incorporating this feedback, we issued revised draft guidelines. The guidelines provide our current views on the CCCF Act's fees provisions and will remain in draft form pending further guidance from the courts.
NZ Guardian Trust
In terms of enforcement action, late last year we concluded the last of our open investigations into break fees. NZ Guardian Trust admitted breaching the Fair Trading Act and CCCF Act by making alleged misleading representations that it was entitled to charge break fees calculated using a formula based on bank swap rates rather than the safe harbour formula set out in the customers' contracts. Refunds to debtors totalled $165,000 and brought the total repaid to customers via settlements and ex-gratia payments as a result of our break fee investigations to $1.4 million.
Regulated markets
The development of input methodologies, the setting of Transpower's individual price-quality path and the development of the information disclosure regime for airports involved a large amount of work for the Regulation Branch last year. I will share some of my thoughts on the Part 4 process. Before I do that I will briefly discuss the new responsibilities we have in regards to Transpower. I will not make any comment on the work in telecommunications as you will be hearing directly from Dr Ross Paterson on this. I will then briefly note the key Part 4 work streams we have underway this year.
Transpower
From 1 November 2010, the Commission has taken on responsibility for requesting and/or approving grid upgrade plan proposals for Transpower's capital expenditure. As yet, we have not received any capital expenditure projects to review, but are expecting the first proposal in May. This will be the lower Waitaki reliability investment project, and will be assessed under the rules developed by the Electricity Commission.
The Commission must also develop an input methodology for Transpower's capital expenditure proposals. We commenced work on the capital expenditure input methodology in November 2010, and released a discussion paper just prior to Christmas. Submissions are due in February, and cross submissions in early March. The Commission intends releasing a draft capital expenditure input methodology in the second quarter of this year, with the final input methodology to be determined in October 2011.
Some reflections on the input methodologies process
As noted above, the Part 4 work stream involved a large amount of work for the Commission. The statutory timeframe for the work was very tight and put considerable demands on the Commission and submitters. Below I provide some reflections on the input methodologies process.
The decisions papers
One effect of the prospect of merits review was the substantial amount of material received from submitters, presumably because parties are unable to introduce any new material during the appeal process. Any appeal is conducted solely on the basis of the documentary information and views that were before the Commission when it made its determination.
Naturally, the Commission was conscious of the prospect of merits review when making its decisions. Given the volume of submissions received and the issues that had to be considered, the amount of material produced by the Commission has in turn been large.
The Commission devoted considerable effort to translating the complex economic analysis in the decisions papers into a more (hopefully) user friendly document. We have tried to ensure that the economic arguments would make sense to those who may not have an economics background. To do this, we divided each of the reasons papers into two broad parts: the front section attempts to explain our approach in a relatively non-technical way; with the appendices addressing the issues in more technical detail.
Unfortunately, the technical detail could not be kept out of the determinations. Suppliers need to be able to estimate the material effects of the input methodology on their business, and as such the determinations are inevitably long and detailed.
We consider that the input methodologies will promote certainty for suppliers and consumers by setting out, as clearly as possible, a number of the key 'inputs' to information disclosure regulation and default/customised price-quality regulation. Even if they are appealed there will be significant benefits from eventually settling issues such as the approach to asset valuation - a matter that has been subject to considerable debate over the past ten years.
Emerging views paper
The Commission issued emerging views papers in December 2009. These were issued prior to the workshops that were held in February/March 2010. These papers provided an update to the initial discussion paper, to indicate how the Commission's views were evolving following the conference and cross-submissions. The Commission considered that this would ensure that discussion in the workshops was focused on the key issues. The papers did not provide detailed reasons for the Commission's position as the emerging views papers were not intended to be a substitute for the reasons papers.
While I think the emerging views papers were successful at focusing input from interested parties, they were not entirely well received. The regulated businesses were highly critical of the fact that they did not contain a full explanation of the Commission's reasons. Such reasons were later provided in the draft reasons papers as had always been the intention. This was a learning experience for the Commission, and given the negative reaction of submitters, the Commission is unlikely to adopt this approach in the future.
Value of consumer voice
In developing the airport regulation, we found it very useful to have a strong consumer voice, provided by the airlines (and BARNZ). Having submissions from customers as well as the regulated businesses ensured a more balanced view of the issues, which was very helpful to the Commission.
The consumer input for electricity and gas, largely provided by the Major Electricity Users Group (MEUG), was much more limited. MEUG provided expert commentary on the cost of capital, but relatively brief input on other issues. Obtaining a balanced view of the issues is more difficult, when only one side is presenting evidence. We addressed the concern about the lack of a consumer voice partly through our use of a panel of experts.
Conference/workshops
We were pleased with the effectiveness of the "hot tub" approach to expert input that we adopted for the conferences and workshops. The submitters' experts and our experts were asked to adhere to the High Court rules, and to act as independent experts. The quality of the debate between experts was very high, and the process was very helpful for the Commission.
The workshops also worked well for the discussion of technical issues; for example developing the deferred tax methodology proposed by the regulated businesses.
Use of external experts
The Commission used a panel of economic experts to assist it during the input methodologies process. They provided independent commentary on the Commission's draft and final reasons papers. They also provided input into identifying the outcomes that are typically produced in competitive markets. The Commission found the input of the experts to be very helpful.
Part 4 work in 2011
There is a significant amount of on-going development work for the Part 4 regime that we will undertake in 2011. This includes:
- Capital expenditure input methodology for Transpower (as noted earlier);
- Reset of Transpower's individual price path for the remainder period of the first regulatory control period;
- Starting price adjustments for non-exempt electricity distribution businesses;
- The default price path for gas;
- Information disclosure for electricity and gas;
- Development of incentive mechanisms (e.g. combining quality into the price path, and developing options for energy efficiency); and
- Enforcement guidelines.
Business as usual work, such as compliance, and review of information disclosures will also continue.
Given the completion of the formal process of developing the input methodologies, we hope we can increase our informal engagement with regulated and other interested parties over the next year.
Concluding remarks
As noted at the beginning, the Commission aims to use the resources available to it to achieve the best possible outcomes in competitive and regulated markets, for the long-term benefit of New Zealanders.
The Commission remains mindful of the overall state of the economy and the fiscal constraints faced by government. We have restructured our organisation to improve the efficiency and effectiveness of our interventions, and to improve our productivity.
We will continue to engage with businesses to help ensure better compliance with the Commerce Act and Fair Trading Act. We will continue to seek improved engagement with businesses affected by our decisions and interventions.
We will also carry on with our work on the Part 4 regulatory regime, with the aim of delivering a sound regulatory regime that provides increased certainty to the regulated businesses and consumers.
[1] Oliver Meech, "Taking advantage" of market power, New Zealand Law Journal, November 2010, p 392.
