Merger Enforcement Guidelines (Banks) - The Efficiency Exception

Merger Enforcement Guidelines (Banks) - The Efficiency Exception

Please Note: This Part no longer applies. Readers should consult 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)

101. The Bureau recognizes that changes in regulations, developments in technology, and globalization will have implications for the structure of the financial services sector. It is expected that banks will respond to these and other changes through various forms of restructuring, including mergers. Notwithstanding the fact that a bank merger may substantially lessen or prevent competition, the Competition Tribunal may not make an order against the merger if the elements of the efficiency exception set out in section 96 are met. First, the efficiencies must represent cost savings to the economy that would not be attained if a remedial order against the merger were made. Second, the cost savings must represent real savings in economic resources, rather than private gains to the merging parties that result, for example, from an increase in bargaining power with suppliers.

102. The onus of demonstrating efficiencies rests with the merging parties. To facilitate expeditious assessment of the nature and magnitude of merger-related efficiencies, merging parties are encouraged to make their efficiency submissions to the Bureau at an early stage of its review of the transaction. It is not necessary to wait until a finding is made that the merger is likely to prevent or lessen competition substantially.

Efficiencies that Would Likely be Attained if an Order Were Made

103. In order to consider cost savings in the efficiency analysis, it must be the case that these savings would not be realized if remedial action was taken against the merger. If any of the claimed cost savings would likely be attained through less anti-competitive means such as internal growth, unilateral rationalization, a merger with a third party, a joint venture, a specialization agreement, or a licensing, lease or other contractual arrangement, then they are not considered in the trade-off analysis.

104. In cases where the Tribunal would order remedies for only a portion of the overall merger, then the relevant efficiencies for consideration are those that arise from this part of the transaction. Efficiency claims related to other parts of the merger that would not be challenged will be achieved in any event, and hence they are not considered in the trade-off. For example, if the Bureau concludes that a bank merger lessens competition in certain local markets, the remedy sought in the Director's application may be divestiture of assets in these markets. In this case, claimed efficiencies that would be outside these local markets will not be considered in the trade-off analysis.

105. The Bureau will also not consider any efficiencies that would likely be attained through some form of co-operation short of a merger. The Bureau recognizes that the nature of the financial services industry, in particular its "network" features, implies that cooperation among institutions often facilitates the efficient provision of products and services to consumers. Past instances of co-operation among banks, including the Interac network and Simcor, suggest that forms of cooperation short of a merger may, in some circumstances, be sufficient to attain the desired efficiencies while decreasing the potential that competition will be substantially lessened. In other circumstances, for example a merger that may facilitate entry into foreign markets, a joint venture with a foreign firm, a joint venture among domestic players solely for the purpose of operating in those foreign markets, or an acquisition of a foreign player may be less anti-competitive. To assess whether efficiencies that have been claimed would likely be attained through a merger with a third party or some other form of cooperation if a remedy against the merger were sought, consideration will be given to existing alternative merger proposals that are less anti-competitive and that can reasonably be expected to proceed if the order in respect of the first proposed merger is made. Efficiencies generally will not be excluded from the balancing process on the speculative basis that they could be attained through a merger with an unidentified third party.

Cost Savings that are Redistributive in Nature

106. Claimed efficiency gains are not considered where they would likely be brought about by reason only of a redistribution of income between two or more persons. For example, gains that are anticipated to arise as a result of increased bargaining leverage that enables the merged entity to extract wage concessions or discounts from suppliers that are not cost justified represent a mere redistribution of income to the merged entity from employees or the supplier, as the case may be. Such gains are not brought about by a saving in resources. This contrasts with the situation where the supplier is able to offer better terms as a result of the fact that larger orders from the merged entity will enable the supplier to attain economies of scale, reduce transaction costs or achieve other savings.

"Greater Than" and "Offset"

107. The words "greater than" are considered to signify that the efficiency gains must be more weighty than, more extensive than, or of larger magnitude than the anticompetitive effects that are likely to result from the merger. By comparison, the term "offset" is considered to suggest that the efficiency gains must neutralize, counterbalance or compensate for the likely anticompetitive effects of the merger.

108. The expressions "greater than" and "offset" are considered to each have qualitative and quantitative connotations. To be assessed in terms of "greater than", efficiency gains must be capable of being weighed in similar terms as all or some of the anticompetitive effects that will likely result from the merger. Efficiency gains and anticompetitive effects that cannot be weighed in similar terms will be evaluated in terms of whether the gains offset the anticompetitive effects. This evaluation can be subjective in nature and will ordinarily require the exercise of the Director's discretion. ⁽³¹⁾ In short, efficiency gains and anticompetitive effects that can be measured in dollar or other similar terms are weighed to determine whether the "greater than" requirement is met; whereas efficiency gains and anticompetitive effects that cannot be balanced in such terms are compared to determine whether the "offset" requirement is met. Where all of the efficiency gains and anticompetitive effects can be measured in similar terms, and where the efficiency gains are "greater than" the anticompetitive effects, they will also be considered to "offset" the anticompetitive effects.

Anticompetitive "Effects"

109. Section 96(1) requires efficiency gains to be balanced against "the effects of any prevention or lessening of competition that will result or is likely to result from the merger or proposed merger". Where a merger results in a price increase, it brings about both a neutral redistribution effect ⁽³²⁾ and a negative resource allocation effect on the sum of producer and consumer surplus (total surplus) within Canada. Ordinarily, the Director measures the efficiency gains described above against the latter effect, i.e., the deadweight loss to the Canadian economy.

110. Quantifying the likely anticompetitive effects of mergers is generally very difficult to make. This is particularly so with respect to the measurement of losses related to a reduction in service, quality, variety, innovation and other non-price dimensions of competition. Insofar as such losses often cannot be quantified, they receive a weighting that is essentially qualitative in nature. In view of the difficulties associated with arriving at precise estimates of both the elasticity of market demand and the magnitude of the prevention or lessening of competition that is likely to be brought about by the merger, several trade-off assessments are generally performed over a range of price increases and market demand elasticities.

111. In calculating the magnitude of likely efficiency gains, cost savings are generally measured across the reduced level of output that will be required to bring about the anticipated material price increase. In estimating the extent of negative resource allocation effects of mergers, the Bureau includes the additional losses in total surplus that arise when market power is being exercised in the relevant market prior to the merger. Similar losses that arise as a result of foregone contribution to fixed costs (due to restricting levels of output) are also recognized.

112. Given that section 96(1) requires efficiencies to be balanced against the effects of "any" prevention or lessening of competition that will result from the merger, anticompetitive effects that are likely to arise in other markets affected by the merger are also considered in the trade-off analysis. However, anticompetitive effects in markets that are not targeted by the remedial order generally will not be substantial in nature.

113.It is the Director’s policy that in cases where there is a strong likelihood of substantial prevention or lessening of competition, and yet the parties to the merger are claiming efficiency gains, the Director will bring such cases before the Competition Tribunal for resolution.

114. While alternative interpretations have been proposed for applying the efficiency exception, the Director’s enforcement approach has been to adopt a “total welfare” approach to the section. Hence, anticompetitive effects refer to the part of the total loss incurred by buyers and sellers in Canada that is not merely a transfer from one party to another, but represents a loss to the Canadian economy as a whole, attributable to the diversion of resources to lower valued uses. This standard is no different from the traditional benefit-cost analysis applied to other public policies. The Director is not convinced that the nature of potential cost savings and the possible anticompetitive effects stemming from bank mergers are sufficiently distinct from mergers in other sectors of the economy to adopt a different standard for analysing efficiencies from that described in the MEGs.

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⁽³¹⁾ Accordingly, if part of the efficiencies likely to result from the merger include dynamic R&D efficiencies (which cannot be measured in similar terms as any of the likely anticompetitive effects) and if part of the anticompetitive effects likely to result from the merger include a reduction in service, quality or variety (which cannot be measured in terms that are similar to any of the likely efficiencies) the Director would exercise his discretion in assessing whether the R&D efficiencies would likely “offset” the effects of a reduction in service, quality or variety.

⁽³²⁾ When a dollar is transferred from a buyer to a seller, it cannot be determined a priori who is more deserving, or in whose hands, it has a greater value.