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29 August, 2017
Summary
After an 18-month review process, the Hong Kong Competition Commission issued a Block Exemption Order for Vessel Sharing Agreements between liner shipping companies.
Critically, the Hong Kong Competition Commission declined to exempt Voluntary Discussion Agreements, on the basis that evidence provided in support of the claim of economic efficiencies in Voluntary Discussion Agreements was not sufficient.
The Commission also rejected the shipping industry’s supplementary submission to exempt a narrower subset of Voluntary Discussion Agreements, in which Hong Kong-specific pricing discussions would not have been covered by the exemption, but the sharing of certain other types of information would have been permitted. The regulator considered that such discussions could still contravene the competition rules.
This is the first block exemption granted by the Commission. The decision provides valuable insight into the regulator’s approach towards assessment of effects on competition and the extent of evidence expected from parties claiming economic efficiencies.
Introduction
The Hong Kong Competition Commission (the “Commission”) last week adopted a Block Exemption Order (“BEO”) conditionally exempting for a period of five years certain agreements between liners from the new competition regime. This decision came after an 18-month review process involving two public consultations and much heated debate around the subject.
On 17 December 2015, the Hong Kong Liner Shipping Association (the “HKLSA”) applied for an exemption covering two main types of agreements among carriers:
- Vessel Sharing Agreements (“VSAs”) under which liners agree on technical and operational arrangements and exchange or charter vessel space; and
- Voluntary Discussion Agreements (“VDAs”), which allow liners to exchange data about supply and demand and discuss guidelines on recommended rates.
While both types of agreements are common practices in the shipping industry, they were at risk of contravening the Competition Ordinance (“CO”). The HKLSA therefore sought an exemption for both types of agreements in line with other Asian jurisdictions, such as Singapore and Malaysia, where both VSAs and VDAs are deemed legal.
Conditional exemption for VSAs
VSAs are agreements between carriers regarding cooperation on operational matters including coordination or joint operation of vessel services and the exchange or charter of vessel space. As VSAs involve capacity sharing and service coordination between competing carriers, VSAs may lead to competition concerns under the CO, such as exchange of commercially sensitive information, concerted reduction in service variety and joint control of service capacity in the market.
The Commission found that VSAs can expand service frequency and carriers’ range of services in the market. The Commission accepted the HKLSA’s argument that VSAs help maintain Hong Kong’s trans-shipment traffic and status as a hub, and generate further economies of scale.
The Commission has therefore exempted VSAs on three conditions:
- the parties to the VSA do not collectively exceed an aggregate market share of 40% (or 45% over the last two consecutive years);
- the VSA does not authorise or require carriers to engage in cartel conduct; and
- carriers must be free to withdraw from the VSA with reasonable notice without incurring any penalties.
The market share is calculated based on the total volume of goods carried (or the total number of vessels operating) in the market in which the VSA is in place.
The exemption for VSAs is relatively uncontroversial. As the Commission itself noted, the VSAs’ role in an efficient operation of the liner shipping industry has been widely recognised internationally (including in the EU, USA, Australia, Japan, South Korea, Singapore and Malaysia).
However, the market share threshold required to enjoy the exemption has been more debated. While the HKLSA applied for an exemption based on a 50% threshold (following the Singapore model, where the exemption was recently extended for five years), the BEO has set the cursor at 40%, which is likely to be of concern to some of the larger shipping liners.
No exemption for VDAs
The Commission took a tougher stance on the application for exemption for VDAs.
VDAs are agreements between competing carriers in which parties discuss commercial issues relating to particular trade routes. This may include exchange of competitively sensitive information concerning market data and trade flows, supply and demand forecasts and business trends, as well as information concerning pricing and terms of service and other commercial aspects of their activities. Parties to VDAs may also jointly issue non-binding pricing recommendations on freight rates and certain surcharges.
The Commission indicated that pricing guidelines and exchange of information on pricing and service terms could potentially harm competition in contravention of the CO.
In rather strong terms, the Commission rejected the HKLSA’s claims of economic efficiencies arising from VDAs.
The regulator further noted that, even if VDAs gave rise to any efficiencies, they would not satisfy the conditions of the economic efficiency exemption as narrowly interpreted by the Commission. In particular, the Commission was of the view that:
- rate stability, as claimed in the application, is questionable in practice and is unlikely to amount to an “efficiency” for the purpose of the CO;
- while service stability may be accepted as an economic efficiency, there was insufficient evidence to establish a causal link between VDAs and the claimed service stability;
- the fact that some pricing recommendations are not implemented in practice was taken by the Commission as a sign of price volatility, and contrary to the applicants’ claim that such recommendations help achieve rate stability; and
- rate and surcharge transparency arising from the pricing guidelines issued pursuant to VDAs is questionable in the circumstances, and generally cannot be considered as an “efficiency” for purposes of the CO.
In addition, the Commission considered that it was difficult to see how customers benefit from the claimed efficiencies and, even if there were any efficiencies, there were alternative economically practicable and less restrictive means of achieving them. For instance, rate stability may be obtained through fixed rate contracts with customers; service stability and rate and surcharge transparency may be achieved through enhancing the scope of publicly available information.
After the publication of its proposed BEO in September 2016, the Commission received a supplementary submission by the HKLSA, in which the liners revised the scope of the VDAs for which they requested an exemption. Under the supplementary submission, the scope of VDAs was revised to:
- expressly carve out any Hong Kong-specific pricing, discussions and voluntary agreements within VDAs (meaning rates of cargo – including rates and surcharges – where the origin or the destination port is Hong Kong, and excluding transhipment via Hong Kong); and
- permit the discussion and sharing of certain other types of information, such as costs, and supply and demand.
However, the Commission considered that such exchange of information could still lessen competition between carriers on the trade, especially if such information was exchanged on an individualised basis. Without forming a firm view as to whether such practice constitutes an agreement and/or concerted practice in contravention of the CO, the Commission decided to completely exclude VDAs from the scope of the BEO.
Transitional arrangements
The exemption became effective immediately, on 8 August 2017, and will be valid for five years until 8 August 2022, though the Commission will initiate a review of the BEO a year before (i.e. not later than 8 August 2021).
In terms of transition, whilst the Commission excluded VDAs from the BEO (and certain VSAs will not benefit from the BEO when they don't meet the conditions), it recognised that these liner shipping agreements have been in force for several years. On this basis, the Commission decided to:
- allow undertakings which are party to a VDA, or a VSA which does not benefit from the BEO, a “grace period” following the Commission’s decision on the Application within which to make any changes they may consider necessary to their commercial arrangements; and
- refrain from taking any enforcement action against existing VDAs or VSAs which do not benefit from the BEO with respect to the period from 14 December 2015 to the end of the grace period.
The grace period ends six months from the date of the BEO, i.e. on 8 February 2018.
Next steps
Within the bounds of the grace period, the liner shipping industry must now fully comply with the terms of the BEO.
The Commission published a Guidance Note to assist the industry in the implementation of the BEO’s conditions.
The BEO and the Guidance Note together address issues such as the exact scope of the exemption and the calculation of market shares.
Companies active in the liner shipping sector must carefully determine the market shares of the parties, the scope and the characteristics of their VSAs, to ensure that they fully comply with competition rules in Hong Kong. This applies to both existing and new VSAs. They must also put an end as soon as possible to their participation in any VDAs.
Key takeaways
The BEO’s position on VSAs is broadly in line with the HKLSA’s application and echoes the approach in a wide range of other jurisdictions where VSAs are permitted. Although the Commission’s position on VDAs appears to be bold, it is not completely at odds with international practice either. For instance:
- The EU removed the benefit of a block exemption for VDAs in 2008 following a 2-year transitional period.
- Similarly, several other jurisdictions such as India and Israel have recently concluded that VDAs do not merit exemption from competition laws.
- In Australia and New Zealand, VSAs and VDAs may no longer be exempt in the future and may be subject to the general competition law regimes. In China, VDAs came under close scrutiny by the NDRC last year, although they remain permitted at this time.
Beyond the direct impact to liner shippers and others involved in the sector, the BEO is a welcomed development in shedding further light on how the Commission interprets the exclusion for economic efficiency under the CO more generally. The Commission has also shown itself to be willing to take a strong independent stand in such matters – and to be able to resist significant lobbying in favour of a wholesale exemption for the liner shipping sector.
The BEO shows that the Commission expects clear and unequivocal evidence of economic benefits, and any claimed benefits must be shown to be shared with customers. This is a high burden for parties to meet. Industries currently considering whether to apply for an exemption should carefully study the BEO to determine whether they can meet the Commission’s thresholds, and whether they are willing to engage in a complex and time-consuming application process.
For further information, please contact:
Clara Ingen-Housz, Partner, Linklaters
cih@linklaters.com
