ACCC Reaffirms Its Concerns On A.S.X. Bid
ACCC Reaffirms Its Concerns On A.S.X. Bid For S.F.E
Australian Competition and Consumer Commission remains
concerned that, based on the information currently available
to it, the Australian Stock Exchange's bid for the Sydney
Futures Exchange would be likely to substantially lessen
competition. It is therefore likely to breach section 50 of
the Trade Practices Act (which prohibits mergers which are
likely to substantially lessen competition)," ACCC Chairman,
Professor Allan Fels, said today.
"On 17 June 1999, the ACCC said that it had significant concerns about the ASX's bid for the SFE. At the ASX's request, the ACCC gave the ASX some time to provide further information. The ASX made an additional submission on 8 July 1999 with further material supplied through until last week. The ACCC has now considered and tested all the information provided. This additional information has not substantially altered its views," he said.
The ACCC undertook extensive market inquiries. It canvassed the views of a wide range of participants, including brokers and investors. The ACCC found that there is a mixed reception to the merger proposal in the market, including negative reactions and concerns about anti-competitive effects.
The ACCC has concerns that the merger would decrease the innovation in financial services markets and delay if not prevent more competitive pricing of financial services products from the combined ASX and SFE.
The ACCC's overall findings remain that:
the absence of the merger, the ASX and SFE are likely to
compete strongly in the future. This is especially the case
for new products. With new financial instruments being
continually devised and, with the market expanding rapidly,
the scope for competition between them is likely to increase
substantially, especially with the proposed regulatory
changes to the Corporations Law. At present the SFE cannot
offer equities trading as a separate licence is required,
nor can it offer independent electronic clearing and
settling services for shares as the ASX's CHESS system is
the only such facility approved under the legislation. The
proposed regulatory changes will allow each exchange to
offer the full range of exchange trading services for
financial instruments without any distinction between shares
· If the merger proceeds, the result would be the creation of one dominant exchange in all exchange traded financial instruments.
· Given that the merger is essentially a merger between the only two currently significant firms in the market, at face value this would likely lead to a substantial lessening of competition. The ACCC then had to consider if these concerns would be overcome by the possible entry of a strong competitor, within a reasonable time, which would supply services competitive to those of a merged ASX/ SFE. The ASX submission has not overcome those concerns.
· On the information available, the ACCC was not satisfied that barriers to entry were not substantial. There are significant costs in establishing trading, clearing and settling facilities that could not be recouped on exit from the industry. The ASX and SFE control the clearing and settling facilities. There are substantial costs involved in establishing alternative settling and clearing systems. However, the ACCC notes access to CHESS is available although, to date, no one has effectively accessed this system.
· Another barrier is the need for a new entrant to achieve sufficient liquidity. This refers essentially to the volume of trading which directly influences the ease with which customers may buy or sell a product on the exchange, and is a measure of the depth and breadth of trading.
· The ASX's submissions did not contain material which persuaded the ACCC that substantial foreign competition in the market for the exchanges' services appears likely within the foreseeable future. Foreign exchanges will not be able to compete effectively in the domestic market due to differing national laws regulating entry, market integrity and investor protection.
· Brokers and institutional investors appear to be unlikely to set up a competing exchange. These groups have little incentive to establish rival trading mechanisms given their primary focus on broking and investment. Broking groups and their employees are major owners of the ASX and would have little incentive to compete with an organisation in which they have equity.
· The merger proposal may be a defensive one to hinder the competitive effects of dynamic factors such as regulatory change, technology, and innovation that may otherwise be realised in the future. The ACCC recognises that there are significant new and dynamic changes occurring in financial markets but is concerned that the merger proposal may prevent these developments and stifle potential competition if they have a detrimental impact on the dominant position of the ASX.
"The ACCC has recently been contacted by Gresham Investment House, which is preparing a submission on behalf of ten SFE brokers," Professor Fels said. "Gresham has requested that the ACCC consider its submission before coming to a final conclusion. The ACCC notes that the proposed acquisition was announced by the parties in April and that other interested parties were contacted by the ACCC to make submissions. Gresham was appointed on 19 July to prepare a submission which it undertook to provide to the ACCC by 11 August. Nevertheless, the ACCC will take Gresham's submission into account when it is submitted.
"The ACCC is considering this merger proposal under
section 50 of the Trade Practices Act 1974. I note that some
issues raised by the parties and others are outside the
scope of an assessment under section 50," Professor Fels
The ACCC has undertaken extensive analysis of the market for exchange traded financial instruments since the ASX and SFE announced their intention to merge in April 1999. The ACCC provided its preliminary view in June 1999 that the proposal would be likely to breach section 50 of the Trade Practices Act. The ASX requested that the ACCC delay its decision and that it be given additional time to provide more information to the ACCC. The ACCC agreed to this request and the ASX provide this additional material in stages through until last week.
The ACCC has also been requested, more recently, by Gresham Investment House, on behalf of a number of major SFE brokers, to further delay its decision, to enable Gresham to provide information which it considers relevant to the ACCC deliberations. The ACCC is concerned that these requests for delay may create undue market uncertainty and consequently states its view based on the information currently available. The ACCC notes that Gresham expects to be able to provide the ACCC with information by mid August.
BACKGROUND TO COMPETITION ANALYSIS
If the merger proceeds, the result would be the creation of one dominant exchange in all exchange traded financial instruments.
Barriers to Entry
Having regard to the elimination of actual and potential competition by this merger, the ACCC must then consider the question of new entry which would constrain the merged exchange. The ACCC found the following barriers to new entry:
barriers to trading include licensing requirements. CHESS
has a statutory monopoly over electronic clearing and
settling of equities. This, however, is expected to be
removed by proposed legislative amendments to the
Corporations Law. The ACCC notes access provisions to CHESS
are available although, to date, no one has effectively
accessed this system.
· The need to be large and offer a broad range of products is substantial, as are set-up costs which cannot be recouped on exit.
· There is also the need for a new entrant to achieve sufficient liquidity. This refers essentially to the volume of trading which directly influences the ease with which customers may buy or sell a product on the exchange, and is a measure of the depth and breadth of trading.
· Customers of the exchanges would be reluctant to switch to an alternative exchange, even if one was available, due to the high costs associated with making such a change.
· Retaliation by a merged exchange against the new entrant is also likely to be a deterrent to entry.
· The broker members of each exchange would have the greatest ability to establish a competing exchange but, as they and their principal officers are owners of a large proportion of the exchanges, they would reduce any incentive to do so.
Since the ACCC has found that the merger will result in the creation of one dominant exchange, it must consider whether foreign competition is an effective check on the exercise of domestic market power by the merged exchange.
The ACCC has heard argument that with new technology and major changes occurring overseas, international competition among exchanges will emerge. Although new technology will have the effect of expanding the market by making transactions quicker and more efficient, the market power of the incumbent exchanges is unlikely to be affected as there is little likelihood of foreign exchanges being able to effectively compete in the domestic market in the foreseeable future because:
· National laws regulating
entry, market integrity and investor protection have
different standards and these differences will prevent
'borderless' trading, at least in relation to Australia, in
the foreseeable future;
· It is difficult to trade Australian equities overseas because investors can only transfer legal title to Australian equities electronically within Australia. While amendments to the Corporations Law will make electronic settling and clearing through an alternative clearing house in Australia possible, this will not impact on the clearing and settling of Australian equities overseas;
· In its market inquiries the ACCC was told that other methods of settling (e.g. American Depositary Receipts) are cumbersome, costly and inefficient. With reduced communication costs, it is easier to trade and settle on the ASX rather than setting up a contrived system to trade Australian equities on an overseas exchange;
· In the case of both futures and equities, the ACCC's inquiries revealed that the market demand and liquidity is in Australia and unlikely to be attracted offshore. In the 1980s there were a number of companies that listed overseas but with communication costs decreasing it is now a disadvantage to trade these shares abroad as both Australian and overseas accounting standards must be met. In addition, there are significant taxation issues; and
· Overseas listing for most companies is costly and inefficient. Only a small proportion of companies dual list and, for most dual-listed companies, less than five percent of their shares trade overseas. Indeed, the ACCC has been informed that, particularly in the case of smaller listed companies, overseas listing is not a realistic option given regulatory costs and the costs of settling transfers using methods such as depository receipts.
The ACCC was told that the market is global because 30% of Australian equities are held by foreigners and 20% of turnover is accounted for by foreigners. These trades, however, are predominantly carried out on the Australian exchange. To the extent they represent Australian equities listed abroad (e.g. News Corp), and are traded on overseas exchanges, it is appropriate to view them as being traded in an overseas market.
In so far as Australian residents and institutional investors trade foreign equities abroad, they make their decision to trade in another market based on a value proposition largely consisting of price/profitability comparisons of foreign equities vs domestic equities rather than in response to price/service packages offered by the relevant exchanges.
The SFE's purchase of the New Zealand
Futures and Options Exchange suggests that the SFE would
have had difficulty trading New Zealand contracts if it had
listed them on its own exchange. Similarly, the ASX's
alliance with NASDAQ may indicate that, an alliance with an
incumbent Australian exchange, was the preferred means for
entry into the Australian market. It was recently reported
that there are overseas exchanges interested in acquiring
the SFE. This is another indication of the difficulty
associated with entry into the Australian market without
alliances or an ownership interest in an established
Removal of a vigorous and effective competitor
History shows that the ASX and the SFE have each sought to devise products to erode the position of the other. Further, in the absence of the merger, the ASX and SFE are likely to compete strongly in the future. This is especially the case for new products. With new financial instruments being continually devised and, with the market expanding rapidly, the scope for competition between them is likely to increase substantially with regulatory changes to remove impediments to competition.
There is no evidence of countervailing power. Institutional investors would require a substantial incentive to establish a competing exchange as they would consider it to be outside their core business and a distraction. Similarly, speculators are unlikely to have the incentive to establish a competing exchange, whereas retail investors are unlikely to have the ability to do so. Brokers and institutional investors would need to put aside their respective competing interests to set up a new exchange and a significant price increase or deterioration in the quality and range of services by the merged exchange would be necessary to trigger such an initiative.
Availability of substitutes
The ACCC's inquiries revealed that electronic communications networks are not an effective substitute for the services of an exchange because they cannot exist without an exchange. Rather, they are complementary.
The existing participants are vertically integrated into all relevant markets. Their control over the essential clearing facilities confers market power over potential entrants thus reducing the incentive to enter at one level.
Legislative changes are likely to remove existing regulatory barriers to entry to clearing. Market growth is likely to be encouraged by incentives for superannuation savings in the context of an aging population. Technological change is capable of reducing the sunk costs of entry. Both exchanges have developed new products and competition is likely to continue to spur innovation. Reducing communication costs and the trend toward cross-border co-operation is likely to enhance the product offering of each country's exchanges internationally through technological advances in communications, thereby reducing the incentive for international competition between exchanges.
Some efficiencies may flow from this merger. However, there appears to be little likelihood of competitive constraint on the merged entity to compel the passing on of efficiency gains to customers
Global Financial Centre arguments
It has been argued that this merger will help to promote Australia as a global financial centre. This issue is not directly relevant to the consideration of the proposed merger under section 50 of the Trade Practices Act. Such arguments are relevant for consideration in the context of an authorisation application. The arguments would then need to be fully tested. The ACCC does however note that based on the material before it, an alternative view is possible. That is, a global financial centre may emerge and prosper in an environment of competition rather than under monopoly.
Section 50 of the Trade Practices Act prohibits mergers which would have the effect or be likely to have the effect of substantially lessening competition in a substantial market for goods or services. Section 50(3) provides that without limiting the matters that may be taken into account in determining whether an acquisition would have the effect, or be likely to have the effect, of substantially lessening competition in the market the following matters must be taken into account:
actual and potential level of import competition in the
· the height of barriers to entry to the market;
· the level of concentration in the market;
· the degree of countervailing power in the market;
· the likelihood that the acquisition would result in the acquirer being able to significantly and sustainably increase prices or profit margins;
· the extent to which substitutes are available in the market or are likely to be available;
· the dynamic characteristics of the market (including growth, innovation and product differentiation);
· the likelihood that the acquisition would result in the removal from the market of a vigorous and effective competitor; and
· the nature and extent of vertical integration in the market.
The ACCC has published revised merger guidelines concerning the methods it employs in assessing the effects of mergers on competition. These are available from ACCC offices.
If the ACCC considers that a merger is likely to breach section 50 of the Act, the prospective merging parties have the following options:
proceed with the merger. In this case the ACCC would be likely to apply to the Federal Court of Australia for an injunction or divestiture and/or penalty. In doing so it would have to prove that the merger would be likely to substantially lessen competition;
modify the nature of the merger;
withdraw the proposal; or
seek statutory authorisation under section 88(9) of the Act.
Mergers which may be considered to substantially lessen competition can be authorised under the Act. Authorisation grants immunity from legal proceedings for mergers which might otherwise breach the Act.
Section 90(9) provides that the ACCC shall not authorise an acquisition unless it is satisfied in all the circumstances that the proposed acquisition would result, or be likely to result, in such a benefit to the public that the acquisition should be allowed to take place. It is specifically required to regard as a public benefit:
significant increase in the real value of exports;
· Significant import substitution; and
· To take account of all relevant matters that relate to the international competitiveness of Australian industry.
It is worth noting that in many major merger situations parties advance arguments to the effect that there would be public benefits from the proposed merger. However, arguments that there are public benefits from the merger can only be considered if there is an application for authorisation. If the parties simply contend that their merger would not breach section 50 of the Act because it does not substantially lessen competition, they can only advance arguments relevant to the competition test. Certain types of public benefit arguments are thereby excluded from consideration of section 50 issues.
ACCC authorisation determinations can be appealed to the Australian Competition Tribunal.
While the mergers that the ACCC opposes or seeks to have modified feature prominently in the public debate about its actions, it should be realised that in excess of 95 per cent of merger proposals are cleared.