Regulatory solutions to competition problems: towards a new UK regime for digital

In July 2020 we wrote about the CMA’s findings on competition in digital advertising and its recommendations for improving competition and consumer outcomes in its market study report published that month. The Digital Markets Taskforce (DMT), led by the CMA, but also involving staff from Office of Communications (Ofcom) and Information Commissioner’s Office, was set up in the wake of that report to advise the Government on setting up a new regime for digital markets.

On 8 December 2020, the DMT published its report - “A new pro-competition regime for digital markets” - proposing a raft of legislative reforms (the Advice). The Advice goes beyond digital advertising into the digital sector more generally. It advocates a major new bespoke “ex ante” control regime for specific companies which will be designated as strategically powerful within the sector. This is an industry-specific regulatory regime of a type rarely introduced in the UK. And this alert, Part two in our series following our July alert, focuses on the suggested regulatory solutions to the competition problems identified.

Background

The DMT, led by the CMA, was tasked by the UK government to build on the CMA’s earlier market study of digital platforms and advertising (and other expert panel studies) and develop a more detailed set of proposals which consolidates the various recommendations.

The Advice follows the Government’s formal backing of the CMA’s July recommendations and a green light for the creation of the Digital Markets Unit, a permanent body to oversee the new regime, from April 2021. The key milestones since the CMA’s report are set out below.

Key milestones

The proposed reforms

The advice covers a wide span of proposals, including:

We explain each of these six core areas in turn, with some of our reactions to the specific proposals along the way, before finishing with a number of overriding comments on the proposals.

1. The DMU’s role

Under the advice, the DMU would wear a number of hats:

• A market monitor: Systematically gather and analyse market data, engage with stakeholders, carry out scoping studies, and review complaints.
• An influencer: Shape the behaviour of digital firms and foster a compliance culture in relation to its new code. It will also share information with other regulators, such as Ofcom and the FCA, support positive industry initiatives, and make recommendations to government for further reform.
• A mediator: It would support the voluntary resolution of disputes relating to the new code.
• An enforcer: Carry out enforcement investigations (for example, in relation to breaches of the code) within set statutory timeframes. Its investigatory powers would mirror those of other regulators (such as the ability to require disclosure of internal documents), although there is no mention of a power to call witnesses for interviews.

2. The criteria for establishing which digital firms would be designated as having “strategic market status” (SMS)

The DMU’s enforcement role would be targeted at digital sector firms with SMS.

The DMT expects only a “small number” of digital businesses to hold SMS. Although, technically, it may be that a small number of firms are initially “prioritised” for SMS designation, leaving the door open to a broader set of designations in the future.

The advice offers the following definition of SMS:

“Substantial, entrenched market power in at least one digital activity, providing the firm with a strategic position.”

This overarching definition of SMS is expanded upon in the Advice:

• Substantial market power: Evidence of such power includes the lack of “good alternatives” and the limited threat of entry or expansion by rivals, such that the firm can increase prices or reduce quality/innovation.
• Entrenched market power: The market power must be more than transitory. This is likely to be based on historic and forecast evidence. Forecasting whether such market power will endure may prove the more contentious, as larger firms will naturally argue that, given the pace of development, there is an ever-present existential threat from the ‘next best thing’.
• Confers a strategic position: The market power wielded must be “widespread and significant” taking into account the following factors about the specific activity in question:
  • the scale/value of transactions conducted;
  • its importance as an access point/input/gateway;
  • whether it enables the firm to determine the “rules of the game”;
  • whether market power can be extended from one activity to another; and
  • its broader social or cultural significance.

Broadly speaking, while the CMA does not use the word, SMS seems to connote a kind of bespoke “super-dominance” or “strategic dominance” designation in the industry.

Only specific “activities” will be covered by the SMS designation. That is, a large firm may have some market activities which are deemed to benefit from SMS, while other activities do not (although the leveraging of market power from one activity to the other may still be captured by the DMU’s enforcement practice).

While a number of firms could theoretically satisfy the above definition (as online markets tend to be characterised by new disruptors in a nascent market, with no immediate rivals), the DMU would apply prioritisation criteria to target a subset of larger firms (for example, by reference to the level of revenues). The following activities would be prioritised: online marketplaces, app stores, social networks, web browsers, online search engines, operating systems and cloud computing services.

3. A binding code of conduct for each SMS firm

The DMT’s advice supports the CMA’s proposal for a separate code of conduct for each SMS firm. Designing and maintaining a-specific code for each firm strikes us as being administratively burdensome, but this is presumably intended to tailor the code to the firm/activities in question.

Each code would have a set core objectives, compliance principles and supporting guidance, all designed, monitored and enforced by the DMU.

The advice replicates the set of overarching objectives proposed by the CMA in its market study:

• fair trading– to address exploitative behaviour by the SMS platform (e.g. not applying unreasonable or unduly discriminatory terms or restrictions);
• open choices– to address exclusionary behaviour (e.g. requiring that core services interoperate with third party technologies); and
• trust and transparency– to ensure the provision of sufficient information to allow users to make informed choices.

Certain aspects of the code are geared towards how customers are treated, while others have a bearing on interactions with competitors or other service providers in the supply chain (which rely, for example, on important inputs).

The principles that flow from these objectives are intended to provide the upfront ‘rules of engagement’. The government’s response noted that the new code will provide those firms with “clear expectations” over what represents acceptable behaviour when interacting with customers, users and competitors.

This seems to be a triumph of hope over experience. Principles are rarely “clear” as to their scope and practical application. For example, one such principle would be “to trade on fair and reasonable contractual terms”. While guidance will supplement the principle, this only takes you so far in practically determining what is fair and reasonable vis-à-vis each counterparty.

In addition, the Advice contemplates SMS firms being able to self-determine if an exception to the code applies because it is necessary, objectively justified, or it brings countervailing efficiency, innovation and competition benefits. Another likely area for contentious interpretation, should the advice be implemented.

The code would apply to designated activities carried out by the SMS firm (purportedly to limit any chilling effect on innovation in greenfield areas being explored by larger firms). However, the advice contemplates that the code may still apply to practices in relation to a different activity in some circumstances (e.g. where it confers an advantage back into the designated activity).

The Advice envisages 6 month-long investigations, from start to end, which may prove challenging in circumstances where the breach is strongly contested.

4. The introduction of a “pro-competitive interventions” regime

The proposals include empowering the DMU to undertake a 12 month review of whether so-called “pro-competitive” interventions (PCIs) are required. This would include a public consultation process.

Unlike the code of conduct, which addresses certain firm behaviours that may manifest from the holding of SMS, PCIs are intended to remedy the root of any entrenched market power, i.e. by addressing major entry barriers or obstacles to faster innovation. They are intended as an additional type of enforcement open to the DMU (i.e. outside the provisions of the code).

While the DMU will be asked to suggest a range of PCIs, the Advice points to the following range of remedial measures:

• Giving consumers more control over their data;
• Requiring choice architecture and defaults to conform to specified standards;
• Mandating third-party access to data on fair terms;
• Requiring interoperability and common standards to be adopted; and
• Directing SMS firms to keep units within the business operationally separate.

The Advice stops short of calling for the power to require divestment of parts of a business (which would require a separate CMA market investigation), however, these still represent a formidable and highly intrusive range of potential measures. It is unsurprising that the Advice suggests that the costs, inefficiencies or other significant adverse consequences for the wider business are taken into account as part of the decision-making process.

Again, the measures would be targeted to designated activities (not the firm as a whole), however, one can see how the effects of a PCI could spill over into related activities.

5. Enhanced merger control measures for SMS firms

The advice contemplates drastic changes to the UK merger regime to the extent that it applies to SMS firms:

• First, a new mandatory notification regime will apply to all SMS firms to notify M&A transactions to the CMA if certain thresholds are met (for example, based on transaction value, assets or number of users). Unlike the measures above, this would not just apply to “designated activities” but the firm as a whole.
• Second, there is a provocative proposal for SMS firms to report every single M&A transaction to the CMA after signing, so that the CMA can itself determine whether the mandatory notification regime is being complied with. While the CMA often monitors such transactions, a statutory obligation to reveal all signed acquisitions is likely to prove contentious.
• Third, and perhaps most controversially of all, the advice calls for a more “cautious” legal test to apply when assessing whether a transaction raises competition concerns in a phase II review. In other words, a lower threshold for the CMA to block the deal.

In relation to the third proposal, oddly, the Advice suggests adopting the phase I threshold (a very low bar) again for a phase II. While the DMT has rejected alternative bespoke approaches put forward in, and in the wake of the Furman review (see below), including reversal of the burden of proof and the introduction of a so-called “balance of harms” test, the proposal it has landed upon is surprising to say the least. In our view, it would render a phase II review somewhat pointless. While the DMT notes that a phase II process would allow more time for consider the evidence, in practice, phase I notifications themselves tend to run for several months (once the pre-notification process is factored in). One can envisage transactions being terminated following a phase I reference, given the risk of re-running an already expensive phase I process all over again, but this time at a greater cost and with no improvement in the prospects of clearance.

6. Consumer law reforms

The Advice calls for a number of additional consumer law reforms in relation to other areas of concern to the CMA:

• Action to address unlawful or illegal content, such as fake online reviews and scam advertisements.
• Action to facilitate greater consumer choice, for example, by tackling ‘choice architecture’ which potentially leads to consumer harm. Such action may take the form of implementing a fairness by design duty on digital firms.
• Measures to allow for stronger enforcement of the Platform to Business Regulation.

Unlike the DMT’s proposals above, which form a cohesive whole, these proposals appear to have been tacked on and reflect both the DMT’s broad remit and the CMA’s increasing activity in consumer law enforcement in relation to digital services.

Final comments

Standing back from the detail, six points stand out.

First, the architecture. Creating a system whereby certain bodies are designated as in scope and then subjected to a code of conduct, or to regulation, is not new. Analogues being talked about include the notion of “significant market power” and the periodic market reviews carried out by Ofcom, and the Groceries Code Adjudicator which enforces a code applied to large retailers. But the CMA is at pains to describe the digital regulatory challenge as a particular situation in special markets which did not exist 20 years ago.

Second, the real challenge will arise when these codes are written. The CMA seems to want the best of both worlds: consensual, principles-based, capable of self-assessment. But a binding code backed up by sanctions. The question is how far the DMU will be drawn into micro-management, where the track record of competition regulators is mixed to say the least.

Third, the perceived need to intervene early in this sector is a persistent one. It drives much of the reform in this area: a feeling that businesses are always one step ahead, competition cases take too long, regulatory interventions come too late, and interim measures are not available when the regulators want them. On the behavioural side, whether the more front-footed approach will work or chill innovation may depend on what the DMU is intervening early to do – holding the ring might be one thing, changing algorithms or opening up APIs could be quite another.

Fourth, on a similar theme, the suggested mandatory merger regime comes in the wake of a perception of having missed mergers in this sector because of the voluntary UK regime or because they are not captured by the share of supply test on account of small target size or operating in an adjacent market. So called “killer acquisitions” where nascent rivals are removed is one underlying concern. Creative use of the share of supply test to review these mergers is under legal challenge (Sabre / Farelogix). But it is one thing to require review of mergers; the Government will need to be mindful that substantive tests are not altered in a way that has unintended chilling consequences.

Fifth, the proposed reforms come at a time of global interest – while the UK reforms stretch back to the Furman review, established by the Chancellor but itself led by a former White House economic adviser, the European Commission’s own 2019 Expert Report led to the launch of the Commission’s proposed Digital Markets Act on 15 December 2020, while the US has seen Congressional hearings and legal actions launched against major platforms in recent months. This is clearly a matter that is attracting global political interest and it seems unlikely, and possibly infeasible, that the CMA will act entirely alone. We are likely to see increasing regulatory co-operation in this area.

The Advice proposes a level of heightened regulatory monitoring, scrutiny, and enforcement which we are unaccustomed to seeing applied to dynamic fast-moving markets. While the Government has signalled its support for the CMA’s work as a general matter, it will now need to decide how far it wishes to adopt the detail of these recommendations. The Department for Business (BEIS) in particular – which has its own competition specialists will be key in this next legislative stage. It will need to take account of some of the points made here.