Regulation – Law – Advocacy – Litigation

Briefing Note: Ex-Ante and Ex-Post Regulation in Electronic Communications

December 2012

The electronic communication sector is subject to specific “ex-ante“ regulation and “ex-post“ control under general competition laws. This briefing note addresses which of the inherent tensions can be considered as resolved by case law and where legal uncertainties remain.

1. Overall Framework and General Rules

The EU Regulatory Framework for ex-ante regulation provides that regulatory authorities in each EU Member State (“National Regulatory Authorities“ – hereinafter referred to as “NRA’s”) must on a regular basis define relevant product and geographic markets by applying competition law principles on a forward looking basis (as further specified in the EU Commission’s SMP Guidelines) and impose appropriate and proportionate remedies on markets which are dominated by an operator having significant market power.

EU competition rules designed for ex-post intervention extend most notably to the prohibition of abusive conduct of a dominant position (in addition to the prohibition of anti-competitive agreements and concerted practices which will not be discussed hereunder).

Although EU legislation provides little explicit guidance regarding the relationship between ex-ante regulation and ex-post competition rules, the EU Regulatory Framework envisages the co-existence and complementary functioning of both regimes. Indeed, one of the three pre-conditions for the imposition of sector specific legislation is the lack of effectiveness of competition rules alone 1. Also, ex-ante regulation shall to the greatest extent possible be replaced with the (ex-post) application of competition rules as soon as the markets have become sufficiently mature to function without ex-ante regulatory measures2.

Although both sets of rules are based on competition principles, there are a number of fundamental differences between the methodologies of applying competition law principles under both regimes. This may lead to tension in regulated industries, such as in the electronic communications sector.

TELEFON FAX WEB The EU Law Firm Rotselaerlaan 81, B – 3080 Tervuren +32(0)473 95 94 25 +32(0)2 646 39 02 www.theeulawfirm.eu Further, differences in powers and policy priorities emerge between National Competition Authorities and NRAs and amplify the tensions between ex-ante and ex-post regimes. But also where NRA’s have sector specific ex-post competition powers tensions in the application of ex-ante and ex-post systems may arise. Those tensions are mainly due to the following differences:

The ex-post application of competition rules is backward looking and is designed to address market failure in the past. It is thus fact specific, based on historical evidence. It applies relatively narrow definition of product markets, mainly based on demand side substitutability. It addresses mainly strategic behaviour (e.g. exploitative abuses). Price Remedies are often based on actual cost of the dominant player. Also, an increasing trend towards private enforcement before the civil courts (i.e. damage claims) can be witnessed.

By contrast, ex-ante regulation is designed to enable market access and to enhance investments and consumer welfare and to introduce competition to markets dominated by one player. It implies a forward looking analysis and a prognosis of market developments. Hence, it addresses assumed market failures typical for specific market structures and dynamics (e.g. foreclosing practices at the wholesale level). The analysis is therefore less fact specific than under an ex-post analysis. Markets are likely to be defined broader also considering supply side substitutes in order to avoid fragmentation and over-regulation. Remedies are usually detailed (price, quality, etc.) Price remedies are often based on presumptions of efficiency (Long Run Incremental Cost, promoting efficiency which has little to do with a dominant firm’s actual cost during the reference period of the alleged abuse scenario analysed ex-post). Ex-ante regulation is exclusively implemented by NRAs.

2. Precedent

2.1 EU Courts

Further conclusions on the interplay between ex-ante and ex-post regimes under EU Law can be drawn from a growing body of case law at the EU Court and Member State levels. These cases mostly address alleged margin squeezes scenarios of dominant undertakings. They surface the tensions between the ex-post and ex-ante regimes.

On 10 April 2008, the EU’s General Court (“GC” or “the Court”) delivered its judgment in the Deutsche Telekom AG v European Commission appeal (“GC Judgment”). It upheld the European Commission’s decision in which Deutsche Telekom (“DT”) was held responsible for abusing its dominant position on the market for access to its fixed network by abusively creating a margin squeeze between its wholesale access prices and its own retail access charges. During the relevant time frame, retail access charges were subject to a price cap regulation under which DT had flexibility to determine retail prices in a way that would or would not result in a margin squeeze. More specifically, the GC confirmed that the European Commission can apply EU competition rules in addition to ex-ante regulatory measures adopted by NRA’s unless the system of sector specific regulation confers upon the dominant firm no margin of discretion in applying the sector specific obligations. From a jurisdictional perspective, the GC ruled that even if the German NRA had also considered competition rules, the European Commission, having jurisdiction of cases with an EU dimension, would not be bound by the German NRA’s conclusions. From a substantive perspective, the GC ruled that dominant firms must ensure that their pricing does not infringe Article 102 TFEU, even if their pricing schemes are approved ex-ante by the NRA. Due to their “duty of special responsibility” to the marketplace, dominant firms must use any discretion which the regulatory approval leaves (e.g. under a price cap type of regime) to avoid abusive pricing. Conversely, the regulatory (ex-ante) “approval” of such firm’s pricing schemes would still allow the European Commission (or national competition authorities) to establish that the dominant operator abusively squeezes margins. To this end, an “equally efficient competitor” test is applied as a benchmark for whether the cost incurred by an allegedly foreclosed competitor were reasonable while the incumbent’s cost is measured by reference to its own charges and long run incremental cost. The European Commission only needs to establish that the incumbent’s spread between wholesale and retail prices insufficient, while it does not need to prove anti-competitive effects (even where retail prices are in themselves not predatory).

The Court of Justice confirmed in 2011 in the TeliaSonera case3 that margin squeezes were a standalone scenario of abusive conduct. Contrary to Deutsche Telekom and Telefonica (see below), TeliaSonera was under no obligation to supply ADSL wholesale services. The court ruled that “(I)t follows that the absence of any regulatory obligation to supply the ADSL input services on the wholesale market has no effect on the question of whether the pricing practice at issue (...) is abusive” in the context of an ex-post analysis.

In 2012, the GC confirmed the primacy of competition rules in the Telefonica case. The facts were similar to those in the Deutsche Telekom case (although in Spain it was less clear whether Telefonica had sufficient flexibility to set retail prices), as were the conclusions drawn by the Court. In addition, the Court has addressed a number of highly disputed issues relating to the questions whether or not the Spanish NRA has exceeded its powers by applying competition rules to a regulated sector or breached the principles of legal certainly (by imposing ex-post obligations although there was ex-ante regulation in place). The GC confirmed the European Commission’s decision4.

2.2 European Commission Precedent

Currently, the European Commission continues to apply ex-post Competition rules to telecommunications companies which are already subject to ex-ante regulation. In the Telekomunikacja Polska (“TP” - the dominant operator in Poland) case5, the European Commission as Competition regulator imposed a 127 Million Euros fine on TP, since that company had failed to grant adequate wholesale broadband access to access seeking rivals. In this case, only the ex-post application of competition rules could remedy the inefficiencies and resulting ineffectiveness of ex- ante regulation. In addition, the European Commission currently examines an alleged margin squeeze by the incumbent in Slovakia.

2.3 Further Precedent at the Level of EU Member States

A substantive body of case law emerges at the level of competition authorities across the EU Member States akin to demonstrate the interplay between ex-ante and ex-post application of competition rules. Examples include the following: On 26 May 2009, the Belgian Competition Council fined Proximus, the mobile arm of the traditional Belgian communications provider, a record fine of 66.3 million Euros for having squeezed its competitors’ margins between 2004 and 2005. During that period, the prices for on-net calls charged to Proximus' professional customers were lower than the regulated mobile termination rates charged to its competitors.

In 2005, the French NRA published a draft regulatory ex-ante measure which was based on findings that the two leading mobile operators in the country had a position of joint dominance in the market for mobile access and call origination. ARCEP had to withdraw its draft decision following an intervention of the European Commission in the context of the so-called Article 7 procedure, claiming that the evidence for assuming joint SMP was insufficient. However, following the withdrawal of the draft measure, the French competition authority launched a cartel investigation against the two operators. The result of the investigation revealed a cartel seeking to keep MVNO’s out of the market.

3. Issues Resolved

The following issues under the EU regime appear to be resolved:

 The EU Courts clarified that ex-post competition rules apply in addition to ex-ante regulation at least where the entities subject to such regulation have discretion in implementing regulation.

 The powers are not restricted to the specific, supranational competencies of the European Commission; also national competition authorities can apply ex-post competition rules in regulated sectors.

 Margin squeezes are a standalone case of abuse of dominance which does not require the proof of anti-competitive effects on the market.

 Further clarifications on the extent to which an ex-post regime can alter an ex-ante regulatory with retroactive effect are partly included in the GC’s ruling in the above referenced Telefonica case.

 Moreover, precedent at the national level confirms that provisions prohibiting anti-competitive agreements can apply in addition to an ex-ante regulatory regime. In particular, in cases of joint SMP – whether proven or not in ex ante procedures – does not prevent NCAs to refrain from investigating ex-post into the existence of a cartel.

• 4. Unresolved Tensions

• Beyond the initial clarifications on the interplay of the ex-ante and ex-post application of competition rules a number of legal uncertainties and frictions remain. By way of example, they include the following

• 4.1 Non-Discrimination • Vertically integration of incumbents in the electronic telecommunications sector implies a particularly high risk of discrimination between the wholesale conditions that the incumbent’s own retail arm enjoys and those available to access seeking competitors. While ex-ante regulators (NRAs) have the habit of imposing open ended and unspecified Non-Discrimination remedies6, ex-post regulators (NCAs) have imposed more differentiated remedies which appear to apply an “effects based approach” that allows for certain differentiations between operators and an assessment of consumer welfare. Legal uncertainty arises where ex-post regulators seek to complement existing wholesale regulation7.

• 4.2 Standards of proof for establishing an abuse scenario

Contrary to other ex-post scenarios of abuse of dominance, anti-competitive effects no longer need to be proven in margin squeeze cases. Instead these effects are assumed on the basis of facts relating to the margin squeeze. This approach reminds of a methodology used under a forward looking ex-ante analysis. Ex-ante and ex-post approaches appear to become blurred.

4.3 Cost Model to ensure Access

Under an ex-ante regulatory regime, crucial wholesale services were price regulated on a basis reflecting the cost of a hypothetically efficient operator (thus excluding inefficiencies of the incumbent operator from the pricing and enhancing market entry of competitors), for example on the basis of a model reflecting Long Run (Average) Incremental Cost (LRIC)8 to enhance market access. By contrast, ex-post remedies often designed against a dominant operator’s cost, which often have little or nothing to do with the modeled LRIC approach. Nevertheless, the European Courts have used LRIC to establish DT’s cost basis in the above referenced ex-post margin squeeze cases. Again, the boundaries of ex post and ex ante rules become blurred.

4.4 Screening

NRA’s have started to screen the market as to whether new products or product bundles offered by the incumbent result in margin squeezes or predatory prices. The screening is mostly carried out on the basis of the assumption that the incumbent is hypothetically efficient9. By contrast, under an ex- post regime, the test would be conducted on the basis of the ‘as efficient as the incumbent operator’ assumption – which may turn out to be significantly different. Where ex-post and ex- ante competencies in the electronic communications sector are split between the NRA and the NCA, this may lead to diverging understandings of both authorities of which cost they consider in assessing the existence of a margin squeeze.

4.5 Functional and Structural Separation

These remedies are used mainly to render discriminatory practices transparent. Under the current ex- ante regime, these remedies are considered as the last resort in case nothing else works. By contrast, ex-post regulators may come to the conclusion that these remedies are necessary tools to monitor non-discrimination, although the ex-ante regulator avoided imposing them. 5. Conclusions

Although a new EU Recommendation set to adopt a new regulatory paradigm 10 in the field of broadband regulation is likely to mitigate the effects of remaining unresolved tensions (e.g. insofar as the level of detail of non-discrimination remedies is concerned), the application of ex-ante standards in ex-post competition cases blurs the rationale for principally different approaches under ex-post and ex-ante regimes. Legal uncertainties remain. They are reinforced by the fact that the court precedent from which they emerge also does not give clear orientation of what an appropriate spread between wholesale tariffs and retail tariffs is. Ex-post and ex-ante regulators may take different views. 1

Refer to the “3-criteria test” in Recommendation 2007/879/CE.

2 Ex-ante regulation is merely perceived as tool to open a market to competition.

3 Case C-52/09.

4 Case T-336/07 Telefónica and Telefónica de España v Commission, OJ 2007 C 269, page 55 and Case T- 398/07 Spain v Commission, OJ 2008 C 8, page 17.

5 Case Comp/39.525, 22 June 2011.

6 I.e. “treat your own downstream business and all competitors equally” (although a new EU Recommendation is set to change the open ended nature of ND obligations in the Broadband Markets: Draft Recommendation on Non-Discrimination and Costing Methodologies.

7 Example: a non-discrimination obligation imposed ex-ante only extends to the treatment of competitors on a wholesale termination market, but later on, on- net / off-net price differentials (not addressed ex ante) become an issue in an ex-post case.

8 Less crucial services are also seen being regulated on a “retail-minus” basis.

9 ERG (09) o7: report on the Discussion of the Application of Margin Squeeze tests to Bundles.

10 Draft Recommendation on Non-Discrimination and Costing Methodologies.