Merger Enforcement Guidelines (Banks) - Overview

Merger Enforcement Guidelines (Banks) - Overview

Please Note: Part 5 of the Merger Enforcement Guidelines addressing efficiencies and paragraphs 101 to 114 of the Bank Merger Enforcement Guidelines, no longer apply. In cases where efficiencies are claimed, the Competition Bureau will apply the principles set out in the decision of the Federal Court of Appeal in the Commissioner of Competition v. Superior Propane Inc. and ICG Propane Inc 2001 FCA 104. (PDF 364 KB)

1. This document articulates the analytical framework used by the Competition Bureau (the "Bureau") when assessing the competitive effects of a merger, under the Competition Act, (the "Act") involving two or more Schedule I banks. The Bureau's general approach to assessing a merger is described in the Director's Merger Enforcement Guidelines (the "MEGs").⁽¹⁾

2. This is the first time that the Bureau has released a document that describes how the general guidelines would be applied to a specific industry sector. While the Act is a law of general application and the MEGs are intended to be applied across all business sectors, the Bureau believes that this precedent is appropriate for several reasons. The current policy debate with respect to bank mergers has raised the question of how the Bureau will apply the MEGs to the proposed mergers between the Royal Bank of Canada and the Bank of Montreal and between the Canadian Imperial Bank of Commerce and Toronto Dominion Bank. Both of these transactions involve a large number of products and services which are provided by many market participants across a large number of geographic areas. While the Bureau has experience reviewing mergers in the financial services sector ⁽²⁾ and in other industry sectors involving large numbers of product and geographic markets, the importance of this sector in the economy and to the general public has encouraged the Bureau to provide a clearer view of how the merger review process will be applied. It is also in keeping with the Bureau's open, transparent, and predictable approach to enforcing the Act.

3. The Bureau is assessing the proposed transactions between the Royal Bank of Canada and the Bank of Montreal and between the Canadian Imperial Bank of Commerce and Toronto Dominion Bank simultaneously. In addition, the Bureau will take into account any other merger transactions which may come to its attention pending completion of its reviews of the present two mergers. As with other industries in transition, the Bureau will assess, to the best of its ability, the current transactions in relation to the probable evolution of the financial services sector as a whole. The recommendations of the Task Force on the Future of the Canadian Financial Services Sector will be of particular importance.

4. The approach that the Bureau intends to use in reviewing bank mergers is consistent with the approach described in the MEGs. Rather than articulating a different analytical framework, this document provides a more practical and industry-specific tool for applying the MEGs than is found in the MEGs themselves. The approach outlined herein is applied to what banks do rather than what banks are. As a result, it is not a tool solely applicable to banks, but it may also be used to analyse other mergers in the financial services sector. Indeed, the activities of other financial and non-financial institutions are important considerations in determining whether any single merger among Schedule I banks is likely to contravene the Competition Act.

5. The main objective of the merger review process is to maintain and promote competition within the Canadian economy in order to provide consumers with a wide variety of high quality products that are competitively priced. More specifically, section 92 of the Act states that the Competition Tribunal may order remedies when a merger prevents or lessens, or is likely to prevent or lessen, competition substantially. However, section 96 of the Act provides an efficiency exception to otherwise anti-competitive mergers when there are sufficient cost savings to outweigh the competitive harm likely to arise as a result of the merger and these cost savings would not be attained without the merger. In such circumstances, the Competition Tribunal shall not make an order against the merger under section 92.

6. A merger lessens or prevents competition substantially when it creates, enhances or preserves market power. Market power is the ability to profitably maintain prices, quality, service and/or product variety for a significant period of time at levels that are less favourable to consumers than would exist in competitive markets. While the Bureau is often focused on post- merger prices, service levels are recognized as being particularly important when analysing bank mergers.

7. A merger can substantially lessen or prevent competition in two ways. First, a merger, by reducing the number of competitors in a market, can facilitate interdependent behaviour among firms, including firms that are not party to the merger. Interdependent behaviour refers to explicit or implicit understandings among firms in the market to jointly exercise market power or limit competition on price, quality, service, variety, or any other dimension. ⁽³⁾ In order to determine whether a merger is likely to increase the scope for interdependent behaviour, the Bureau will consider whether market conditions are conducive to reaching, monitoring, and enforcing such understandings. Second, a merger can lessen or prevent competition substantially by enhancing the market power of the merging firms, even absent co-operation with other firms in the market. This is referred to as an unilateral exercise of market power. A merger allows firms to unilaterally exercise market power if the merger, by placing the pricing and supply of the products of the merging firms under common control, enhances the profitability of increasing prices and restricting supply (or limiting competition on some other dimension). When assessing whether a merger will promote the unilateral exercise of market power, the Bureau will consider various factors, most importantly the extent to which the merging firms exert a competitive influence on each other prior to the merger, the remaining choices available to consumers, and the likelihood that lost competition will be replaced by supply responses by existing suppliers or by new entry into the market.

8. The Bureau's review of a merger begins with relevant market definition, which consists of determining the extent to which the merging parties supply substitute products and identifying all suppliers with which the merging parties compete. ⁽⁴⁾ Market definition has both a product and geographic dimension. Banks provide a large number of products from many locations through various means of distribution (e.g. branch tellers, automated banking machines, telephone banking, personal computer banking, or use of debit or smart cards) to different types of customers (e.g. large corporations, small and medium-sized businesses, retail customers). Consequently, there are many relevant markets in an assessment of a bank merger.

9. Each relevant product market includes all products to which customers would likely turn in response to a small but significant, non-transitory increase in the prices of the offerings of the merging parties, and/or a reduction in quality, service or variety of the product offerings of the merging firms.⁽⁵⁾ As a result, the inclusion of several products within a single market occurs when these are closely substitutable for each other, from the viewpoint of customers. Where price discrimination is possible, product markets will be further related to particular types of customers.⁽⁶⁾

10. The geographic boundaries of the relevant market are determined in a similar manner: the geographic market includes all areas in which there are suppliers to which customers would likely turn in response to an attempt by the merging firms to exercise market power. The size of a geographic market varies with the characteristics of a product and the customer, and also the means of distributing the product. As a result, one would expect that different geographic markets will be associated with different products.

11. The next stage in the analysis is the application of market share and concentration thresholds, which distinguish mergers that are unlikely to have anti-competitive consequences from mergers that require further analysis. Generally, mergers will not be challenged on the basis of concerns relating to the unilateral exercise of market power where the post-merger market share of the merging parties would be less than 35 per cent, and mergers will not be challenged on the basis of concerns relating to the interdependent exercise of market power where the share of the market accounted for by the largest four firms in the market post-merger would be less than 65 per cent and the merging parties would hold less than 10 per cent of the market. ⁽⁷⁾

12. Should the Bureau’s review of a bank merger indicate that local geographic markets exist for certain products, the Bureau will need to expedite its review by employing an initial screening test given the large number of branches which any of the Schedule I banks operate. The purpose of such a screen is to quickly eliminate from further review the products and geographic areas which are not likely to give rise to competition concerns in order to focus the Bureau’s review. This initial screen is described in paragraphs 54 to 58. The products and geographic areas which "fail" the initial screen are then subject to a complete competitive effects analysis ⁽⁸⁾.

13. In the banking industry, as in other industries, any review of a merger has to consider recent trends in technology, regulation, and other factors that occur independently of a merger, but that are likely to have an impact on the competitive effects of a merger. These developments may, for example, result in the introduction of new savings and loan vehicles or new means of distribution, possibly by suppliers who are not currently market participants. The delineation of relevant markets and the calculation of market shares and concentration levels on the basis of existing products and suppliers may therefore not accurately reflect the likely competitive effects of a merger. In evaluating the competitive significance of such changes in market conditions, the Bureau will consider whether these changes are likely, timely, and sufficient to offset any enhancement of market power that would otherwise arise because of the merger. The use of electronic banking is of particular importance in this regard, and will be very carefully assessed by the Bureau. Equally important will be the recommendations of the Task Force on the Future of Canadian Financial Services Sector which may alter the current regulatory environment.

14. The remainder of this document is structured as follows. The next section discusses the definition of a "merger" as stated in section 91. This is followed by a description of the anti-competitive threshold for mergers, relevant product and geographic market definition, market share and concentration level calculation as well as the Bureau's initial screening test, and the factors that are used to assess the likelihood that a merger will lessen or prevent competition substantially. The last section deals with the efficiency exception.

15. While the authority of both the Director and the Minister of Finance are spelled out in the Competition Act and the Bank Act, both acts are silent on how the Director and the Minister should interact and how this process should unfold. To ensure that the merging parties are informed of both the competition and other public interest concerns in an efficient, predictable and transparent manner, Annex I, attached hereto, sets out the banking merger review process to be employed by the Competition Bureau.

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⁽¹⁾ These Guidelines were issued by the Director of Investigation and Research in 1991.

⁽²⁾ Mergers involving banks which have been examined by the Bureau include the following: Bank of Nova Scotia/National Trust; Royal Bank of Canada/Royal Trust; Bank of Tokyo/Mitsubishi Bank; Republic National Bank of New York (Canada) /Bank Leumi Le-Israel (Canada); Republic National Bank/Bank Hapoalim; Bank of Montreal/Banca Nazionale; and, Swiss Bank/Bunting Warburg. The Bureau has also assessed a number of transactions involving trust companies, including: Canada Trust’s acquisition of the pension custody business of National Trust; the corporate reorganization of!Co-operative Trust Company of Canada; and, Trust la Laurentienne du Canada Inc./Trustco Prêt et Revenu Inc.

⁽³⁾ This type of behaviour is distinct from co-operative behaviour that has the effect of increasing the efficiency with which firms supply their products. Banks have several such co-operative ventures, including the Interac network, and the Bureau recognizes that such ventures can benefit consumers.

⁽⁴⁾ The term "product" is defined in the Act to include both articles and services. Throughout the remainder of this document, the term product will be used to denote both a product and a service.

⁽⁵⁾ As discussed below in the section on Market Definition, the conceptual tool normally used by the Bureau to define the boundaries of relevant markets is the hypothetical monopolist test. When using this tool, the Bureau generally postulates a price increase by the merging parties, and asks whether consumers are likely to switch to other products in sufficient numbers to render such a price increase unprofitable, and therefore unlikely. In many cases, considering consumers' responses to price increases will be sufficient to determine whether a reduction in quality, service or variety is likely to be profitable. However, when the information gathered by the Bureau suggests that such a test may fail to identify an important dimension of competition, the test will be adjusted accordingly.

⁽⁶⁾ Price discrimination occurs when firms price similar products based on what individual customers, or groups of customers, are willing to pay for the product. Thus, an airline is able to sell a seat on a particular flight at different prices to business travellers versus leisure travellers.

⁽⁷⁾ With concurrent merger examinations underway, the concentration ratios will be calculated assuming that both transactions were to proceed.

⁽⁸⁾ More accurately, market shares and concentration threshold tests are applied to the relevant markets defined around the products that fail the initial threshold test, and the complete analysis is conducted for the markets in which the thresholds are surpassed.