UK merger control enforcement trends in 2018-19

Out-Law Analysis | 17 Sep 2019 | 10:25 am | 13 min. read

The UK's Competition and Markets Authority (CMA) continued to focus its efforts on cases that raised substantive concerns in 2018-19, its fifth full year of merger control enforcement.

Both the total number of cases reviewed by the CMA (56) and the number of cases (46%) found to give rise to material competition concerns (a case review meeting at phase 1) remained broadly consistent this year. The figures show that the CMA's mergers intelligence function is effective at filtering out those cases which do not merit a formal investigation.

Of those cases which raised potential concerns, the trend for CMA intervention continued this year. Eleven cases – 19% of the total – were referred to a full phase 2 investigation; which is the highest proportion of cases referred to a phase 2 investigation in the last five years and well above the five-year 13% average. Meanwhile, the CMA accepted undertakings in lieu of a reference in only two cases - 4% of the total - in stark contrast to 2017-18, in which undertakings were accepted in 12 cases or 19% of the total.

In addition, for the first time in five years, no cases were cleared under the 'de minimis' exception, which allows the CMA to exercise its discretion not to refer a transaction where the total value of the market affected by a merger is sufficiently low for it not to be in the public interest for the CMA to open a phase 2 inquiry.

The percentage of cases in which the CMA imposed ‘hold separate’ orders, under which the merging businesses are required to be managed and run separately during the CMA’s investigation, hit a five-year high in 2018-19.

These figures could be seen as evidence of a tougher, more interventionist attitude on the part of the CMA. However, it should be borne in mind that previous years have occasionally produced similar statistics - for example, 11 mergers were also referred to phase 2 in 2015-16. The figures could therefore be the result of the particular types of mergers being notified to the CMA, for example mergers involving closer competitors.

The figures show that the CMA's mergers intelligence function is effective at filtering out those cases which do not merit a formal investigation.

The CMA continued to assess mergers based on the economic and factual evidence and theories of harm. This approach allows it to assess the effects of a merger, in particular whether or not it could lead to a substantial lessening of competition.

Factors considered by the CMA in its merger assessment

Horizontal effects: assessment of retail markets

The CMA's assessment of the prohibited Sainsbury's/Asda merger generated significant media attention and arguably highlights a more interventionist approach to the economic assessment of retail mergers. Here, the CMA assessed whether the transaction would give rise to a reduction in competition at the national level and in the many hundreds of local areas where the parties' retail outlets overlapped.

The CMA based its decision on a simple measure of the upward pricing pressure that would be generated from the merger, known as the gross upward pricing pressure index (GUPPI). Although it has used this measure in numerous cases in recent years, many commentators noted that its threshold for intervention in this case appeared to be lower than in previous cases. The CMA has historically been careful not to set a specific threshold, although most practitioners would have considered 5% to be a reasonable rule of thumb as to whether or not the CMA would be likely to find a substantial lessening of competition (SLC). However, in the Sainsbury's/Asda case, the CMA adopted a much lower threshold of 1.5% for in-store groceries, online groceries and fuel, before "efficiency credits" - cost savings to countervail upward price pressure resulting from reduced competition post-merger - were taken into account.

In addition, the CMA rejected the merging parties' claims that the merger would give rise to large buying efficiencies based on a detailed review of the underlying factual evidence base, concluding instead that the more modest price reducing efficiencies of 1.25% in groceries and 0% in fuel would be delivered by the merger. Together, these factors significantly increased the number of areas in which an SLC was identified in this case.

Merging parties should therefore expect the CMA to consider the application of the GUPPI framework in its assessment of retail mergers. Moreover, should robust evidence of quantified efficiencies be available, merging parties may be more optimistic of the CMA's consideration of this evidence. However, significant levels of efficiencies may in fact be required in order to have a realistic chance of clearance if the CMA is to continue to adopt a stricter starting GUPPI threshold in retail markets.

Dynamic theories of harm

Where, absent a merger, firms may expand their competitive offering resulting in an increase in the number, or significance, of competitive overlaps, it is open to competition authorities to consider whether a merger may result in a loss of competition taking into account these market dynamics. These so-called 'dynamic theories of harm' played an increasingly important role in the CMA's economic assessment of transactions in 2018-19.

In Headlams/Rackhams, the CMA considered whether, absent the transaction, Rackhams would have instead been purchased by a different firm which may have the competitive constraint it exerted on Headlams. However, this concern was dismissed towards the end of its phase 1 investigation after it found that Rackhams was too small to permit an acquirer to gain material economies of scale, and that alternative targets still existed for a potential competitor to purchase to facilitate such entry.

In PayPay/iZettle, one particular concern raised was that although iZettle had a very limited presence in one of PayPal's core markets pre-merger, it may have been well-placed to significantly expand its competitive offering in the near future. However, following a more detailed phase 2 review of the merging parties' internal strategy documents, the CMA concluded that iZetttle's expansion in this market would likely have only occurred slowly and iZettle would have only remained a weak competitor to PayPal.

Merging parties should therefore expect the CMA to rigorously assess internal documents to identify future growth plans. Where those plans may suggest a greater degree of future competition between merging parties, those competitive overlaps will be investigated carefully by the CMA.

Importance of closeness of competition

An analysis of the closeness of competition between firms remains the most important element of any horizontal merger assessment undertaken by the CMA. Cases from the last 12 months highlight that the CMA may clear cases that otherwise appear problematic where there is no evidence of competitive interactions between the firms.

For example, in Menzies Aviation/Airline Services, the merging parties presented a detailed analysis of their own bidding data demonstrating that they had never been invited to bid for the same contracts against one another as a result of structural differences in their business models. Although the firms provided the same services at certain UK airports, the CMA was able to confirm at phase 2 that they were not actual or potential competitors, and that they instead both only competed directly against the third player in the market which competed to service all forms of contract.

Cases of this nature highlight the importance of submitting detailed evidence on closeness of competition at the earliest possible stage in the merger assessment process.

Exiting/failing firm

If at least one of the merging firms would have failed had the merger not gone ahead, there can be no loss of competition as a result of the merger. While the 'failing firm' defence is rarely successful, it should not be ignored in its entirety when considering a UK merger control assessment.

In Aer Lingus/CityJet, the CMA investigated a 'wet lease' agreement between the parties, where Aer Lingus took over passenger flights operated by CityJet while CityJet provided aircraft crew and maintenance in exchange. The CMA only cleared the agreement upon finding that no other airline was interested in taking over the business: a 'light' failing firm argument. It is of note that CityJet was not 'failing' but rather choosing to strategically exit the market, and Aer Lingus was the only likely counterparty to the 'wet lease' agreement.

Definition of an 'enterprise'

For a merger to fall within the UK merger regime, the business being purchased must fall under the definition of an 'enterprise' under UK law. This is normally a clear-cut exercise, but certain scenarios – for example, where only assets are bought - can raise jurisdictional points to consider.

Two recent cases show how important it is for merging parties to consider the possibility of CMA intervention, even in transactions which at first glance appear to be simple asset purchases.

In Medtronic/Animas, where both firms are active in the supply of insulin pumps, the transfer of customer and patient records was classed as an 'enterprise', as the transfer enabled patients to be transferred between the parties. In Aer Lingus/CityJet, the 'wet lease' agreement between the parties was seen as sufficient to be an 'enterprise'.

Procedural timelines

Extended periods for pre-notification discussions continue to be a feature of the UK merger control process. The CMA expects parties to make contact at least a couple of weeks before the intended formal notification date, but this period tends to be far longer, especially for more complex and/or data heavy transactions – in many cases, six weeks or more. Pre-notification discussions lasted for an average of 33 working days in 2018-19, with the average length of the period for a phase 1 investigation lasting a further 36 working days.

Although a longer pre-notification period can be a burden on merging parties, presenting a case in detail up-front tends to lessen the risk of a 'stop the clock' process during the formal phase 1 statutory period. It can also lead to better preparation for a case review meeting during the phase 1 process, thereby increasing the chances of a clearance decision at phase 1 rather than a referral to phase 2.

The Sainsburys/Asda case resulted in the first appeal to the Competition Appeals Tribunal (CAT) in relation to the procedural timetable during a merger control case. The CAT found that the CMA had set an unreasonable deadline for response to the working papers which set out its thinking on certain issues, as the 19 days given were not sufficient due to the exceptional complexity of the case. The CAT also found that the CMA had set an unfair date for the hearing to be held, as it coincided with the response time for the working papers.

The CAT also raised concerns that an unnecessarily shortened pre-notification period could lead to a lack of time during the strict statutory timetable used during the merger review process. As a result, even where pre-notification is lengthy, it is important for it to be of a sufficient length in the most complex cases and for a transaction timetable to build in sufficient time.

The Sainsburys/Asda case was the first of its type, and highly unusual. It is important for merging parties to maintain a strong working relationship with the CMA during merger reviews, and taking this type of action could have created a more adversarial relationship between the parties. Although the merging parties were successful before the CAT, the deadlines were extended only by a short amount. The merging parties also elected not to recover their costs from the CMA, showing that they were keen for the case not to have a negative impact on the working relationship.

Policy developments in 2018-19

Fines for breaches of interim orders

The UK's voluntary merger control system imposes initial enforcement orders (IEOs) on parties to a completed merger. Where a merger is referred to phase 2, the IEO is replaced with an 'interim order'. These orders are also known as 'hold separate' orders, as they require the parties to hold the merging parties' businesses separate pending merger control approval. Strict rules are put in place to prevent the integration of businesses subject to IEOs or interim orders.

This year, the CMA imposed its first fines for breaches of these orders for actions including: terminating the lease for one party’s business, and appointing the acquiring company's CFO as director of the target company (Electro Rent/Microlease); directing the customers of the target business to make payment to the buyer, the buyer paying for suppliers of the target, and the buyer failing to give the target’s managing director clear delegation of authority to take decisions without consulting the buyer (Ausurus Group/Metal and Waste Recycling); and entering into and implementing an agreement to sell certain assets acquired as part of the merger before the merger control process had concluded (Vanilla Group/Washstation). In July 2019, the CMA imposed a further penalty for IEO breaches involving: relocating staff from the acquired business to the buyer's premises, using the buyer's branded vehicles and its drivers to make deliveries to the acquired business's domestic customers, and failing to provide compliance statements within specified deadlines (Nicholls’ (Fuel Oils)/DCC Energy).

This is clearly an area of focus for the CMA, and merging parties must carefully consider the terms of an IEO or interim order and rigorously ensure compliance particularly when taking action as regards the target that fall outside of the 'ordinary course of business'. The CMA has noted that other potential breaches of these orders are currently under investigation.

Updated CMA mergers guidance documentation

The CMA concluded consultations and published updated guidance documents in a number of areas in 2018-19.

The new 'merger remedies' guidance explains the CMA's approach and requirements in the selection, design and implementation of remedies in phase 1 and phase 2 mergers. The guidance describes in detail the CMA's approach for considering different aspects of structural and behavioural remedies with reference to normal practice, although the CMA will apply the guidance flexibly depending on the circumstances of each merger.

The revised guidance on 'exceptions to the duty to refer' explains how the CMA intends to exercise its discretion to not refer a merger to an in-depth phase 2 investigation when one of three exceptions applies: if the relevant market is of insufficient importance (the 'de minimis' exception); if the merger is insufficiently advanced or unlikely to proceed; or where relevant customer benefits arising from the merger outweigh the substantial lessening of competition identified.

The CMA published new guidance on its approach to requesting internal documents in phase 1 and phase 2 merger investigations. The guidance recognises that the CMA can request documents informally and formally (under a statutory notice), but signals that going forward the CMA intends to routinely use its formal powers, in both phases of merger review, when requesting internal documents from merger parties.

The CMA also published, in June 2019, new guidance on the use of interim measures in merger cases following a second consultation on this subject in May 2019. This latest guidance reflects the CMA's recent experience in several mergers where interim measures were not complied with, and the CMA took enforcement action; and highlights the CMA's robust approach to ensuring interim measures are complied with.

National security reviews

In June 2018, the UK government implemented new rules as regards investments in three sectors of the economy:

  • dual-use and military-use;
  • quantum technology; and
  • computer hardware.

For UK merger control review to apply to transactions in these markets, the turnover threshold was reduced from £70m to £1m and the 25% share of supply test was amended so that the test is met if the target alone has a share of supply in these sectors of 25%, even if share of supply or acquisition does not increase as a result of the merger.

[The] guidance confirms that merging parties should approach both the European and UK authorities where it is possible that both regimes could apply in the event of a 'no deal' Brexit.

The first case to be considered under this new framework was the Gardner/Northern case, which involved the merger of two manufacturers of parts for the aerospace industry. The transaction was reviewed both for competition concerns, and also as to whether the transaction should be permitted on national security grounds. Ultimately the transaction was cleared, as there was almost no competitive interaction between the parties and the UK defence secretary did not consider it would have any national security impact. It is an important first case under these new rules, and shows that notification of any transaction in an industry linked to national security should be considered under this review framework.

The UK government began a further consultation on a new 'national security' notification regime in July 2018, with a proposal to expand its ‘call-in’ power to other types of transactions. This consultation concluded in October 2018; to date the UK government has not published material on the consultation outcome.

Proposals to reform the UK merger control regime

In a policy paper published in February 2019, newly appointed CMA chairman Lord Tyrie proposed a number of substantive changes to UK competition law, including the merger control regime. These proposals included a number of measures designed to respond to any increased workload for the CMA as a result of Brexit.

The proposals include the creation of a mandatory notification regime for transactions above a certain threshold and a corresponding 'standstill obligation', rather than the use of IEOs and interim orders in the current voluntary system; and higher or full-cost recovery from merging parties going through a merger control review process, as the CMA currently recovers half its costs from fees levied. The UK government is due to issue a policy paper on these proposals soon.

Brexit

The UK government is yet to provide clarity on how the UK competition regime will change as a result of the vote to leave the EU. The UK's previously expressed aim of seeking a 'transitional agreement' until the end of 2020 is increasingly in doubt. Such arrangement would result in the merger control system remaining unchanged until the end of that period, with transactions falling under the jurisdiction of the European Union Merger Regulation (EUMR).

Given the risk of a 'no deal' Brexit on 31 October 2019, the CMA has published guidance on the impact this will have on merger control given the EUMR would stop applying midway through live cases without an agreed process for transition. This guidance confirms that merging parties should approach both the European and UK authorities where it is possible that both regimes could apply in the event of a 'no deal' Brexit.

The CMA received a £20m increase in its budget for the 2019-20 financial year in anticipation of an increased workload following Brexit. It has recently recruited 240 staff, an increase of 39% on previous years. The CMA has estimated that Brexit will lead to up to 70 additional merger cases a year, which would be a more than 100% increase on its current workload.

Alan Davis and Angelique Bret are competition law experts at Pinsent Masons, the law firm behind Out-Law. Contributions provided by Paul Williams of Pinsent Masons and Paul Hutchinson and Dean Curry of RBB Economics. This article is adapted from, and updates, the authors' contribution to Global Legal Insights' 2019 Merger Control guide.