78 Cannon Street,
Office of the Secretary
Attention: Mr Donald S. Clark
Dear Mr Clark,
I am the Legal and Corporate Affairs Director of CapCLEAR Limited, a UK incorporated company. CapCLEAR provides clearing, settlement and sophisticated risk management services to B2B Internet Exchanges and their customers. CapCLEAR is a global in its operations. For Internet Exchanges, CapCLEAR provides a legal framework that gives the Exchange's customer's greater confidence in the enforceability of the trades entered into through the Exchange. This enhances the liquidity of the products traded on an Exchange. CapCLEAR also provides international ADR and arbitration services. This ensures that disputes relating to trades are resolved by an independent third party using the highest quality legal remedies In effect, the CapCLEAR service offering is a private sector initiative, with global reach.
The evolution of FTC antitrust policy on B2B electronic marketplaces is of very real interest to CapCLEAR, simply because many of our clients - Internet Exchanges and their customers - will be subject to the enforcement regime of the FTC and so we wish to participate in the debate and assist in whatever way we can to promoting not just consumer confidence, but also regulatory confidence, in B2B electronic marketplaces.
To this end I thought it would be helpful to give my own professional account of the European competition framework and its potential impact on global B2B e-commerce.
The fundamental purpose of any Antitrust/Competition framework is to ensure that an economy operates efficiently by prohibiting restrictive practises and vetting significant mergers or takeovers.
Competition law is complex because restrictive practises can have a hugely different impact on different groups and among different aspects of their well being - their purchasing power, the quality of service etc. Competition law is also challenging because it is such a live commercial subject and because it is one area of the law where economic analysis plays an increasingly important role in legislative decision-making.
The economics of competition focuses on market power - what it is, how it is created, how it is sustained and what its effects are. It follows that Competition policy is, fundamentally, an economic policy that encompasses structures, conduct and effect.
Economic policy has defined national borders and Competition regulators, in the main, can only enforce their rules and regulations within their own territorial jurisdiction. The Internet has no geographical borders. It spans the globe. Growth in B2B electronic commerce, ie. on-line transactions between businesses, institutions or government agencies, is expected to grow from US$145m in 1999 to $7,300b in 2004. Approximately 40% of this projected Internet business will be conducted through Internet exchanges by 2004. In this new global economy the applicability, or inapplicability, of national regulatory rules needs to be carefully addressed.
The stunning growth projections for B2B e-trading platforms are of natural interest to Competition regulators, simply because e-commerce has the potential to truly liberalise the markets, offering participants greater choice and transparency than has ever before been thought possible.
Naturally, Competition regulators must also be mindful of the antitrust issues that can swiftly evolve in a global high-tech economy. Debra Valentine, the General Counsel at the FTC, has expressed with precision the modern regulatory dilemma:
The fact that the FTC convened a Workshop on B2B electronic marketplaces at this early point in the evolution of Internet trading speaks volumes. In taking this initiative the FTC has given a constructive opportunity to entrepreneurs and their regulators to assess and determine the ground rules in order to build these new marketplaces within a competitive framework.
When Competition regulators analyse e-commerce trading activities conducted over the Internet the first question they must address is the cultural ethos of the participants (the owners of, and the buyers and sellers) on B2B internet exchanges. It is fair to say that, thus far, regulation of the Internet has emerged from the bottom up, as opposed to from the top down.
When Competition regulators analyse e-commerce trading activities conducted over the Internet the second question they must address is the jurisdictional one. What are the rules that define and determine regulatory jurisdiction? An effective, workable answer to this key question requires very positive trans-national regulatory co-operation.
The competition policy of a nation, or block of nations such as the EU, is invariably built upon the economic values and assumptions about market power that predominate within that nation or grouping.
In the US, the FTC regime for tackling restrictive and anti-competitive practises is well developed and highly respected. There are some significant differences, however, between the standards imposed by the FTC in the US and the EU - such as differences relating to definitions of market share cut off (45% in the EU and 35% in the US). The greater emphasis on 'market concentration' in US merger analysis has, in some instances, resulted in merger standards that are more restrictive than the EU's.. These different standards create inequalities that have the potential to disadvantage US firms. But, can also be vigorously argued that far from creating competitive disadvantages for US businesses, the energetic antitrust enforcement policies of the FTC have been a significant factor in the in the success of US enterprise in the global markets.
Over time it is likely that the Competition/Antitrust policies of the EU and the US will harmonise, at least to the extent that they do not have wildly differing approaches.
The majority of participants at this Workshop are likely to be Internet exchanges that are incorporated in the US. This simple fact of US legal incorporation will give the FTC jurisdiction, in the first instance, but it is a moot point as to where an Internet exchange's jurisdiction may actually be found to rest in a global virtual world. The answer will depend upon the facts and the connection the issues might have with a given country. With this in mind, I thought it would be helpful to briefly summarise the EU and UK framework for Competition Law.
2. EU and UK Competition Law Framework.
The EU has a young and buoyant competition law system. Each of the EU Member States are bound by the body of EU Competition law and precedent that has been steadily building up since the Treaty of Rome in 1957. One of the primary goals of the Treaty to establish the European Economic Community was market integration. And so, until recently, the cornerstone of EU competition law and policy has been the goal of EU market integration. This resulted in a highly negative attitude towards territorial protections and a passionate enthusiasm for parallel imports. This may change. The EU has gradually become more integrated and so these attitudes and enthusiasms are being modified.
The Member States of the European Union (the "EU") each have their own Competition Authority. These National Competition Authorities enforce their own domestic legislation. However, they all function under the overall policy umbrella of the Competition Directorate General (also known as DG1V) in Brussels.
Economic analysis is now playing a far greater role in EU decision making and legislation.
Pursuant to Article 3 of the EU Treaty:
Article 81 and 82 (formally 85 and 86) of the Treaty are interpreted and applied, together with other Treaty provisions, in order to create and sustain the system of Competition Law within the EU. The sphere of application of EU Competition Law is, however, limited to instances that affect trade between EU Member States.
Article 81 deals with situations involving collusive behaviour between several undertakings ie. agreements, decisions of an association of undertakings, or concerted practises. Contractual and other consensual arrangements between undertakings are, of course, essential features of a market economy. Where the undertakings concerned are actual or potential competitors, what they decide to do together may be of interest to EU competition authorities. Even if they are not competitors, competition authorities may still legitimately take an interest in the impact of their commercial arrangements on the competitive process and on third parties. The competitive relations with which Article 81 deals can be divided into 2 categories, horizontal (between undertakings competing in respect of research, development, production, purchase, or sale of different goods or services) and vertical (between undertakings engaged in the research, development, production, purchase or sale of different goods or services but operating at a different economic level.
In contrast, Article 82 regulates the unilateral behaviour of one or, in certain cases, more undertakings abusing a dominant position. In a nutshell, this means firms holding a substantial amount of market power in one or more of the markets in which they operate. Abuse may consist of: (a) directly or indirectly imposing unfair purchasing or selling prices or other unfair trading conditions; (b) limiting production, markets or technical development to the prejudice of consumers; (c) applying dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage; and (d) making the conclusion of contracts subject to acceptance by the other parties of supplementary obligations which, by their nature or according to commercial usage, have no connection with the subject of such contracts. In addition, abuses may also consist of any kind of behaviour by a dominant undertaking that appreciably distorts competition or exploits customers in the market in question.
Against the backdrop of these EU Anti-Competitive Treaty Articles, and the policies and case law that they have given rise to, a new framework for Competition law came into being in the UK on March the 1st, 2000 - this being the date on which the Competition Act 1998 came into effect. A Brussels White Paper recommending greater decentralisation of Articles 81 and 82 reinforces the notion that within the EU national Competition authorities will be given greater autonomy from their political masters going forward.
Before the 1998 Competition Act came into effect there were clear and major weaknesses in the law in the UK because there were some types of market conduct, such as discrimination and predatory pricing, that it did not cover but which could seriously damage or indeed wipe out companies. The main problem with the 1990 Competition Act was that it provided no effective sanctions or penalties. It also was vague in its attempts to define whether or not a particular course of conduct was predatory or an abuse of a dominant position.
The Competition Act 1998 introduced a prohibition based system and provides for potentially large fines to be levied on those who break those prohibitions. This is potentially very serious for companies, both financially and in terms of reputation. The Act also created a new regulatory authority, known as the Competition Commission.
The Competition Commission has two very distinct roles. It hears appeals against decisions made by the Director General of Fair Trading and other UK sectoral regulators (telecoms, water, gas energy, electricity, financial services etc) under the prohibition provisions of the Act. It has also assumed the functions of the Monopolies and Mergers Commission - including the 1973 Fair Trading Act inquiries into mergers and monopolies, and regulatory inquiries involving appeals by utilities against licence amendments.
The key elements of the Competition Act 1998 are 2 prohibitions. The Chapter I prohibition addresses anti-competitive agreements. The Chapter II prohibition deals with abuse of a dominant position. These prohibitions are modelled on Articles 81 and 82 of the EU Treaty. The Act was drafted so that the prohibitions will be interpreted consistently with EU Community law. This means that the burden on commercial enterprise is kept to a minimum.
However, the Act does provide very strong powers of investigation, powers of fines up to 10% of UK turnover for breach of the prohibitions and interim measures which allow the abuses to be halted pending investigation. The Act also provides third party rights so that consumers and competitors who suffer will have a right to damages through the courts.
4. B2B electronic exchanges in the UK and the EU.
The antitrust regime that an Internet exchange is subject to will be driven primarily, but not exclusively, by its place of incorporation. Because the Internet knows no national boundaries, allegations of anticompetitive practises by exchanges can arise in jurisdictions where the exchange has no physical presence. This is a challenging problem for Competition regulators.
Within the UK, a very definite policy decision was made in respect of the overlap between economic regulation and competition law. The Competition Act 1998 gives concurrent powers to the utilities regulators and the Competition Commission. This distinguishes the regime in the UK from that in other EU Member States. The UK is, in fact, the only EU Member State that has given powerful competition law powers to its regulators in addition to its competition authority.(2)
For B2B Internet exchanges one of the practical consequences of this concurrent regime is the risk of potential inconsistencies of application of the prohibitions. It is worth noting, however, that that there are a number of provisions within the 1998 Act that are designed to ensure consistency. It is also worth noting that the vast majority of decisions taken under the Act will be taken by the DGFT rather than sectoral regulators, simply because the DGFT has far wider jurisdictional coverage. In addition, the sectoral regulators and the OFT must consult in cases where there is an overlap of interest.
The 1998 Act is also drafted to ensure that decisions taken will be consistent with those that would have been taken in handling a similar EU Community case. The 'governing principles' clause (Section 60) makes provision for the interpretation of the provisions in a manner not inconsistent with the principles and case law that would apply to a like matter under Community law. This provision governs decisions regardless of whether they are taken by the sectoral regulators or the DGFT. A full appeals procedure - administrative and judicial - is also provided for.
The net effect of the 1998 Act is a modern Competition regime within the UK. It is certainly the case that the regulatory regime which governs a non-UK, but EU based, B2B Internet exchange will have the national legislative characteristics of whichever EU Member State the B2B Internet exchange is incorporated in. But, it is also the case that a strong element of consistency in the application of Competition law will prevail in relation to B2B Internet exchanges throughout the EU. This is so because the provisions of Articles 81 and 82 of the Treaty, along with the body of EU case that has built up over the last 40 odd years, must be taken into account by the UK Competition authorities and by the Judiciary.
5. B2B Internet Exchanges and the New Global Economy.
In the UK, anticompetitive practises may be levelled at B2B Internet Exchanges by their sectoral regulator or by the DGFT. Anticompetitive behaviour and/or practises are those matters which are prohibited under the 1998 Act.
The ownership structure of exchanges, its criteria for membership, the transparency of its products, the independence of its grievance procedure etc. All of these are factors that will be considered by the regulators if suggestions or allegations of anticompetitive behaviour arise.
An exchange - electronic or traditional - is simply marketplace where people can buy and sell goods. When goods are bought and sold in volume on the exchange, this volume gives liquidity to the market and so the exchange will attract still more people who want to trade its products. Market liquidity of its products is the bottom line, functional specification of a successful exchange. Without market liquidity, an exchange loses its reason for being.
B2B exchanges provide a spot market for commodities - often with high price volatility - that fall outside the remit of the traditional commodity exchanges. They provide a venue for the purchase and sale of commodities like natural gas, electricity and telecommunications bandwidth ie. Altra and Enermetric in natural gas and electricity and Arbinet in telecommunications.
These B2B exchange markets are bid/ask and provide real-time pricing. B2B exchanges allow buyers and sellers to trade anonymously, which is crucial, because identifying buyers and sellers can damage their competitive position and distort pricing. Achieving market share is of paramount important for B2B exchanges. This is because market share is interlinked with liquidity. B2B exchanges whose products fail to generate significant liquidity are likely to fail. However, exchanges that achieve market liquidity for their products, and thereby attain a leading market share, will have achieved extremely defensible competitive positions because the liquidity of their products will make trading on a competitive B2B exchange much less attractive.
In this early race to achieve maximum market liquidity, each of the B2B exchanges will naturally concentrate on the establishment of trading rules that will enhance the attractiveness of their product offering. The creation of strict entry/membership criteria for participation on an exchange will not occur at the very early stages in B2B growth, simply because the market liquidity the exchange seeks to achieve will be more obviously attained by permitting as many entities as possible to trade on the exchange. The high cost of putting in place a legal and regulatory framework of an admission to membership process, along with a framework of rules relating to the conduct of business on the B2B exchange also act as a disincentive and so it is more likely that the membership process will be outsourced to the independent Clearinghouse that the B2B exchange has retained to provide clearing and settlement services for the trades conducted through the exchange.
(1) The Traditional Exchanges
The 'old economy' exchanges, by their nature, have been bodies with a limited number of members. Membership of the traditional exchanges has been limited to specific numbers fulfilling pre-designating criteria that has been established by each exchange. The exchange conducts a thorough investigation of each member applicant, focusing on the applicant's credit standing, financial responsibility, character and integrity. Creating the infrastructure to do this efficiently, and effectively, is an expensive project. The financial cost of joining the club, and obtaining the privileges that membership confers, are also high. However, the commercial cost of being excluded from the club can be even higher and, naturally, gives rise to a number of very fundamental, anti-competitive concerns.
In fact, the limited entry feature of traditional exchanges have often led to exchanges being treated as private clubs which were, therefore, afforded great latitude by the courts in the disciplining of errant members. Concern have been expressed also about the public interest element in the fundamental market mechanism of traditional exchanges The findings of the Special Study of the Securities Markets, which was published by the SEC in 1964, reflects this. In particular, the SEC acknowledged the following as a simple commercial reality:
At the root of these private club, and the self-regulatory, elements in the functioning of an exchange lie complex, but fundamental, antitrust issues. However, many of the anticompetitive practises, levelled at the traditional exchanges, are inter-linked with the fact that the capital markets controlled by the traditional exchanges are, in fact, the centrepieces of an economy. This unique economic status creates a very high public interest element in the commercial activities of traditional exchanges. In consequence, the special standards set for the competitive, and anti-competitive, practises of the traditional exchanges will not necessarily be applicable to B2B exchanges - simply because their economic status is distinguishable from that of the traditional exchanges.
(2) B2B Internet Exchanges.
B2B exchanges cater for specific industry trade requirements - ie, the telecommunications industry, the advertising industry, the computer components industry - and the products that a particular B2B exchange offers will be linked to the market practises and dynamics of the industry base. The criteria for membership of these B2B exchanges is a matter that will be determined by factors that may be particular to a given industry or industry sector.
In some cases, formal exchange membership will be required. In other cases, participation on an exchange will be permitted if an entity can fulfil pre-ordained clearing and settlement requirements for a transaction. In this way, membership of a Clearinghouse will be the most important criteria for participation on a B2B exchange.
The rules that pertain to obtaining B2B exchange membership, and the conduct of business rules that a member is obliged to adhere to thereafter, will certainly advance in sophistication as each exchange gradually develops a regulatory framework that caters for the practical issues that arise its own market.
In the early stages, however, B2B exchanges are likely to depend on their Clearinghouse for many of the fundamental processes that enable participants to transact on an exchange, simply because of the time and expense involved in putting a formalised exchange-specific structure in place. In many ways the most important of these processes will be the membership evaluation that the Clearinghouse provides in respect of exchange participants.
6. The Role of the Clearinghouse in B2B exchanges.
A Clearinghouse has its own membership criteria. Its membership is comprised of (1) B2B exchanges, and (2) the buyers and sellers on each of those B2B exchanges. The creation of a solid legal and regulatory framework for admission to membership of a Clearinghouse is fundamental to the process of providing effective Clearing and Settlement services to a B2B exchange. It follows, therefore, that B2B exchanges that have a Clearinghouse can bypass the time and expense of creating their own framework for exchange membership.
All B2B exchanges need a common touchstone to assure the global commercial community of their bona fides. This can be quickly established through links with an independent Clearinghouse. The Clearinghouse provides clearing and settlement services to the exchange and its customers. It is these services that will reduce commercial concerns about the reliability, and the enforceability, of the Exchange's products.
In order to establish the requisite market liquidity that an exchange needs to survive, it needs to generate high volume trade turnover. It will only achieve this if the transactions that are traded through the exchange clear and settle effectively. This clearing and settlement process is the specific process that will create customer confidence in the bona fides of the exchange. An independent scheme to address grievances is another significant element that a Clearinghouse can provide.
An exchange environment typically consists of 3 layers: Trading, Clearing and
Settlement. In the Trading layer, buyers and sellers are matched; in the Clearing layer
the credit requirements and the legal obligations arising from the trade are determined;
the Settlement layer facilitates delivery of the good traded and payment of the
A Clearinghouse provides vital services to a whole range of B2B exchanges. Whilst the Trading layer is exchange specific, the Clearing and Settlement layers are generic. For this reason, the services provided by a Clearinghouse to a B2B exchange can be as limited, or as comprehensive, as the market capability of the Clearinghouse permits.
Clearing means the final clearance of a matched trade on a B2B exchange. Essentially, it is the process of determining accountability for the exchange of cash and goods between the parties to a trade by matching orders and confirming the trade. If a Clearinghouse has a comprehensive service capability it will, as part of the Clearing process, be able to offer a B2B risk management services to mitigate the credit and legal risks associated with Internet trading.
Settlement describes the process by which an exchange traded transaction is completed so that the goods and funds are delivered and credited to the appropriate accounts. These settlement services are the bottom line determinants that mitigate the legal, credit, operational and counterparty risks associated with Internet trade. It follows that B2B exchange is to ensure that comprehensive settlement mechanisms are available to its customers.
7. Self Regulation.
In one sense, the process of Internet policy formation is actually quite advanced already. There's World Wide Web Consortium (WC3), an Internet Standards body; the Internet Engineering Task Force (IETF), which develops agreed technical standards, such as communications protocols and its steering group IESG, which co-ordinates and approves them.; and the Internet Corporation for Assigned Names and Numbers (ICANN), which oversees the system of domain names.
One of the most interesting things about these Internet governing bodies is that they genuinely believe in information transparency. They document everything and make it accessible on-line. WC3 has an internal rule that says discussions/decisions etc are only valid if posted on the WC3 website. The IETF mail archive lets browsers discover why certain decisions were taken, including decisions of years gone by. ICANN posts transcripts of all board meetings, and even telephone conference calls.
These facts may come as slight surprise, particularly in the light of the fact that it was only in April of this year that Judge Thomas Penfield Jackson ruled that Microsoft was an "abusive monopolist".
Over the last few decades deregulation and trade liberalisation have brought down some significant trade barriers but, in the main, these barriers have tended to be governmental ones. Private anticompetitive conduct is also the clear concern of Competition regulators and enforcers. Although the focus of attention in the Microsoft case has been on the break-up itself, it is important to remember too that it is the most significant government imposed remedy since the divestiture of AT&T in 1983. Essentially what is at issue in all antitrust cases is the question of market power. Market power is not a clearcut concept. Economists now tend to focus the analysis on the power to raise prices above the competitive level.
The Internet is transforming the way in which companies conduct business. It has created a readily accessible infrastructure for global commerce. Each Internet user is a potential new supplier or customer. The Internet has also given these users access to almost limitless market and price information. Knowledge is power. Increased information facilitates more dynamic pricing of goods and services because buyers and sellers are better informed and can therefore re-negotiate the terms of their trades more frequently. These two factors - information transparency and greater market accessibility - make the Internet a very definite pro-consumer development.
Although Internet exchanges have emerged in the recent past they are still at a very early stage of their development. In the race to establish trading platforms the legal framework for operating these exchanges has not yet been comprehensively addressed. Whilst these new Internet exchanges focus on building up their market share Competition regulators are simultaneously considering these new markets in the context of the products and services they will be providing. The regulators are attempting to ascertain whether barriers are being created to prevent other firms from entering the market, thus leaving the dominant firms free to raise prices or reduce output.
In order to be called perfectly competitive, a market has to have a number of characteristics, the main ones being: (1) many suppliers and buyers, (2) no entry barriers, (3) a homogeneous product, and (4) full transparency. Few marketplaces ever attain this Nirvana.
Electronic Internet exchanges will usher in a truly global marketplace. The national regulators of these marketplaces, particularly the competition authorities, have very valid concerns about potential abuses of market power, settlement reliability, and a dependable scheme of remedies to address grievances.
The potential for anti-competitive effects are always prevalent within a marketplace. Private sector initiates can often fill a necessary regulatory gap because burdensome regulation will stifle innovation whereas private sector initiatives offer Internet Exchanges and their customers assurances that certain standards will be met. The range and sophistication of the standards set by the private sector will, of course, vary from marketplace to marketplace and will be driven by customer demand. That has to be good !
1. 'Antitrust in a global high-tech economy'. Prepared Remarks of Debra A.Valentine, General Counsel, Federal Trading Commission at the 8th National Forum for Women Corporate Counsel, April 30th 1999.
2. But some EU Member States have given concurrent competition law powers in banking and telecommunications regulation only.