Notes for an Address by André Lafond, Deputy Director of Investigation and Research

To the Canadian Bar Association
Competition Law Section
Annual Competition Law Conference
Aylmer, Quebec

September 19, 1997

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Introduction

Thank you for the invitation to this morning's Panel Discussion on "Deregulating Industries". I welcome this opportunity because the issue of deregulation is at the forefront of the Competition Bureau's agenda, and as Deputy Director of the Civil Matters Branch, I am responsible for the Director's statutory interventions before regulatory boards.

As you know, the Bureau's mandate is to promote competition and economic efficiency throughout the Canadian economy. Where appropriate, the Bureau has intervened before regulatory boards to challenge the economic rationale for regulation and advocate opening markets to competition. The economic landscape is changing dramatically through the forces of globalization, trade liberalization and technological change. Many of Canada's infrastructure industries such as transportation, energy, communications and financial services, historically subjected to extensive regulation, are in various stages of transition to competition. Though at different stages of the regulatory reform process, these infrastructure industries are at the top of the Director's priority list.

Greater reliance on competition in these sectors holds the promise of tangible benefits for Canadian consumers and industry. The goal of our intervention work is to assist the regulator in maximizing these benefits by profiling them, identifying the costs of regulation, addressing industry specific issues relating to competition and by clarifying the role of the Competition Act in safeguarding competition in a de-regulated environment. Our involvement at an early stage in the deregulation process also helps reduce the possible need for subsequent enforcement action by promoting reforms leading to structurally competitive markets.

Lessons learned

A number of lessons have emerged from the Bureau's lengthy involvement in industry de-regulation which I believe are relevant to the introduction of competition. I will outline three of these.

1. Regulation Tends to Distort Markets

Where natural monopolies are believed to exist, the role of regulators is to attempt to replicate the economic outcomes which would otherwise occur in a competitive market. However, regulators are not always faithful to the objective of creating efficient market outcomes. Some have pursued social policies through the intermediary of regulated firms, creating cross subsidies and mandating uneconomic service levels. This inevitably produces distortions and inefficiencies and inhibits the regulatory reform process by politicizing it.

2. Competition for the Long Run May Require Some Regulation in the Short Run

Where an incumbent firm controls access to an essential facility, operates across competitive and monopoly markets, or both, specific competitive safeguards are required to ensure that incumbents do not deny new entrants access to essential facilities at economic rates, or cross subsidize competitive services with monopoly revenues. The need for competitive safeguards during a transition period will result in some regulation remaining in place in the short run. However, the amount of regulation should decrease as the industry is opened up to market forces.

3. Weigh the costs before choosing a remedy

The choice of appropriate regulatory instruments to facilitate competition can be complex. Because rate base rate of return regulation creates incentives and opportunities for cross-subsidization, it is unsuitable for the transition to competitive markets. Divestiture or structural separation of monopoly elements of the incumbent firm is the optimal competitive safeguard for ensuring access and preventing cross-subsidy. However, where there are significant economies of scale and scope, the structural approach will have negative consequences for efficiency.

As a general principle the Bureau favours structural remedies over behavioural ones. We favour this approach because it is clear and simple and because it does not require further regulations and subsequent monitoring and reporting activities. To determine whether a structural approach should be adopted in favour of behavioural rules or other alternatives, (such as accounting rules or price caps) the incremental protection of the structural remedy over alternate safeguards should be weighed against the lost economies of scale and scope resulting from structural separation or divestiture. This analysis is by no means easy, but it is the most relevant consideration.

Telecommunications Industry

In recent years, our interventions have focused primarily on telecommunications, an increasingly critical industry in a modern economy. With the CRTC's current proceeding to consider the introduction of competition in local pay phone markets, virtually every sector of the Canadian telecommunications industry is now, or will soon be, subject to competition and market forces, and less to the economic regulation which has characterized the industry for many decades.

While the Bureau's intervention work is continuing, our role in the communications sector will necessarily evolve from regulatory interventions to a greater emphasis on enforcement as regulatory reform is fully implemented. The abuse of dominance provisions of the Act are applicable to a broad spectrum of anticompetitive practices. These include denial of access to essential facilities, exclusive dealing and other practices that tend to have exclusionary effects or otherwise limit competition.

The Bureau's experience with the deregulation of other industries, suggests that telecommunications deregulation is likely to be accompanied by a degree of industry restructuring through mergers and acquisitions and the formation of strategic alliances. Because of the rapid rate at which the communications sector is evolving, the Bureau will have its work cut out in the coming period.

Energy interventions

The Bureau will also continue to participate actively in the regulatory reform of Canada's energy and financial sectors.

While deregulation of the energy sector has recently been a focus of attention in the press and in provincial legislatures, the origins of this process and our involvement go back many years. In the mid 1980's the Bureau participated in the first round of hearings relating to deregulation of the natural gas industry. These proceedings enabled gas distribution companies and to some extent, gas consumers, to purchase natural gas competitively through independent gas agents brokers and marketers.

Most recently, we participated in regulatory proceedings in Ontario and Manitoba in support of removing the remaining impediments to competition and putting in place a market structure at the distribution level of the gas sector that will maximize the benefits of competition for consumers.

The main focus of our energy interventions over the next several years however, will be on electricity. To date we have intervened in support of competition in key electricity market structure reviews in British Columbia and Ontario. While progress on restructuring in this sector has been limited, we will continue to encourage an appropriate balance of regulatory and market structures which maximize the benefits from competition.

Financial Services Sector

The financial services sector is another example of an integral part of the Canadian economy in the process of regulatory reform aimed at greater reliance on competition. It should therefore come as no surprise that the Director is fully participating in this process.

Last year the Director made a submission to the Department of Finance regarding their 1997 regulatory review. The central theme of this submission was that the public policy objectives which underlie financial services sector regulation can best be achieved by greater reliance upon competitive markets. Recognizing that the soundness of the financial system is in the public interest, the Director indicated that there are regulatory changes that can increase efficiency and facilitate competition without concurrently compromising the stability of this critical sector.

The need to reconcile the soundness of the financial system with increased competition underlines the importance for the Bureau to ensure that our interventions are well balanced. It is also important that the consequences for the marketplace of recommendations for regulatory reform be well understood. Indeed, when industries such as financial services, telecom or energy are deregulated, there are major transition issues and other considerations that must be addressed.

The Minister of Finance has established a blue-ribbon private sector Task Force to study and make recommendations aimed at ensuring the continued health of the financial services sector. The recent interim recommendations of the Task Force identified a major role for the Bureau in the assessment of financial institution mergers. This supports the need for the Bureau's input and we intend to make a formal submission by the end of next month. The final report is expected in the fall of 1998.

The Minister of Finance has also established a Canadian Payments Advisory Committee to study issues related to the system, including access. Because we believe access is essential to the promotion of competition in financial and related markets, the Bureau will be making a submission to the Advisory Committee in the near future.

The Bureau's involvement in the financial services sector is not limited to the ongoing policy review process. A steady stream of mergers within the sector has been reviewed and a Consent Order from the Competition Tribunal was obtained in June of last year against Interac Inc. and its nine members. The Order required Interac to expand the representation on its Board and amend its rules and by-laws so as to eliminate access restrictions as well as constraints on product innovation and price competition. The impact of the Interac decision has been significant. In particular it would appear to have influenced Schedule 1 banks to open up access of the Canadian payments system. This change would probably have been unthinkable a year ago and would not have occurred without the Interac decision.

General Principles

Our experience to date with industries in transition has provided us with considerable knowledge regarding the process of regulatory change. While industry specific considerations have to be taken into account, there are also a number of general principles that have application for regulators embarked on this process:

Conclusion

Let me conclude with the following comments. The Competition Bureau has two broad roles: seeking compliance with the Competition Act through enforcement and other mechanisms and competition advocacy through interventions and related initiatives. These two roles are clearly not mutually exclusive; in fact, they complement each other. Providing a competition policy perspective in shaping government and regulatory policy in a manner which "gets it right" at the outset can produce benefits for the economy while at the same time reducing the risk that enforcement action under the Act will later be necessary to address abuses of market power.

There is no doubt that increased participation in the deregulation process will put additional demands on the Competition Bureau's already strained resources. But the benefits to consumers and the economy as a whole of the increased competition generated by deregulation more than offset the cost of any additional effort needed to ensure a competitive marketplace.

Thank you very much.