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Subversive Thoughts (3) – Regulating Rating Agencies with the Competition Rules
The rating agencies “oligopoly” has been trashed by virtually all EU policy makers in the past days.
The big question on the policy agenda is now: how to regulate them?
Here’s a first taste of my answer, which I will further articulate in a forthcoming paper with my assistant N. Neyrinck. This paper will make extensive use of my prior research on oligopolistic dominance.
Let’s start with two propositions.
Proposition 1: The market for rating services exhibits a bunch of features which makes them prone to antitrust scrutiny. Market structure is oligopolistic, with essentially three big players (Moody’s, S&P and Fitch). Conduct is close to coordination (tacit or explicit), with quasi simultaneous and identical downgrading cycles. Performance is welfare decreasing, with borrowers paying a steep price in terms of interest rates (not to talk of the price to pay for taxpayers, called to rescue downgraded countries)
Proposition 2: The toolbox of antitrust agencies comprises a variety of flexible remedies which could be instrumental to regulate the rating agencies oligopoly (e.g., structural and behavioral remedies). Moreover, competition policy is an exclusive EU competence. Hence, those Member States that are reluctant to regulate the rating agencies cannot undermine Commission action under the competition rules. Finally, the EU competition rules can be enforced in a timely fashion (think of Article 9 proceedings) and also apply to non-EU firms.
Obviously, the main outstanding issue is to build a case around those two basic propositions. This implies devising a credible theory of harm, in other words a scenario of anticompetitive conduct that would allegedly explain the rating agencies’ behavior.
On this, and out of pure speculation, an hypothesis with both a collusion and a foreclosure component can be floated. Together with a number of banks, the rating agencies may be trying to harm other rival banks that have purchased Greek and Portuguese paper. Of course, the main problem here would be to (i) explain why rating agencies have an interest in siding with certain banks and not others; (ii) establish a link, convergence of interests, concertation between the rating agencies and those banks.
But even in the absence of a strategic link with banks, one may still consider that the rating agencies conduct is amenable to antitrust scrutiny. After all, with their self-fulfilling prophecies, the rating agencies risk injuring the structure of banking markets by pushing certain players to bankruptcy. In turn, this will increase market concentration, weaken competition and harm consumer welfare. Note that scenarios of this kind are often found in secondary line injury price discrimination cases (where the seller places some third parties at a “competitive disadvantage” (a sort of negative externality?) in a related market). Hence, it would not be crazy for antitrust regulators to run a theory of this kind. Moreover, the explanation for the rating agencies’ conduct can perfectly be framed in the words used by (i) behavioral economists to describe irrational conduct – why hammer Greece and Portugal, and meanwhile maintain the US’ AAA?- in markets where players are excessively risk averse; or (ii) conventional economists to describe information imperfections and reputation dynamics (to stay credible, agencies need to be tough on rating).
Happy to have your comments on this.
PS: I had initially decided to use a picture of Cassandra to illustrate this post. I changed my mind given (i) the fact that Cassandra was often right, but never believed; and (ii) my musical tastes.
Old Wine, New Bottles
In their 2010 Horizontal Merger Guidelines, the US agencies have poured old wine in new bottles.
The section on coordinated effects adds a theory of harm to standard tacit collusion analysis. It is entitled “parallel accomodating conduct“, and consists in:
“situations in which each rival’s response to competitive moves made by others is individually rational, and not motivated by retaliation or deterrence nor intended to sustain an agreed-upon market outcome, but nevertheless emboldens price increases and weakens competitive incentives to reduce prices or offer customers better terms. Coordinated interaction includes conduct not otherwise condemned by the antitrust laws” (see p.24).
My reaction: this looks familiar, and similar, to unilateral effects scenarios arising in oligopolies as a result of product/location differenciation or in cases of price leadership.
But aren’t those theories of harm already caught under merger control rules?
Moreover, shouldn’t unilateral and coordinated effects scenarios be mutually exclusive on a given relevant market? This also seems to be the view of DG COMP’s former chief economist.
The alternative explanation: an attempt of the US agencies to discretely relax the heavy evidentiary constraints required for a finding of coordinated effects?
PS: it is now summer time in Europe. Our friends keep harassing us with end afternoon drinks proposals at Brussels’ terrasses. For social reasons, Alfonso and I have thus decided to limit our posting pace to three stories a week in July. BTW, I heard through the grapevine that the Hogan Lovells party was huge (in very many respects…).
Job Opportunities
Let’s put headhunters out of jobs :).
I heard on the grapevine that Covington and Burling Brussels is facing a huge stream of new business.
The downside is that current partners and associates are working ’round the clock. Since I have good friends, co-authors and university colleagues there, I am a little concerned.
Now, Covington and Burling is hiring junior and senior associates. I suppose you can send your application to one of the partners working on competition cases.
Slides of GCLC Lunch Talk on Remedies in State Aid Banking Cases
I attach below the slides presented by H. Gilliams (Eubelius) and N. Pesaresi+G. Mamdani (DG COMP) at yesterday’s lunch talk.
Pesaresi and Madamdani – Competition Measures and State Aid Banking Cases
Hans Gilliams — Bank R&R aid — compensatory measures — GCLC Lunch Talk 27 June 2011
The open question to me: the remedial approach enclosed in those slides sought primarily to address the “too big to fail” issue. Now, should this approach be applied to the different setting where banks face bankrupcy issues because they have purchased dirty paper from failing States?
Antitrust Quotes of the Day
On the alleged non-structural views of Chicago scholars => “An industry which does not have a competitive structure will not have competitive behavior” (George J. Stigler, “The Case Against Big Business,” Fortune, May 1952)
On the 2004 Microsoft case => “The Commission’s case was like a jellyfish – shapeless and very painful” (I. Forrester). Thanks to I. Debois for the pointer.
Brussels School of Competition – Materials of Conference on Information Exchange
Yesterday, the Brussels School of Competition held its first conference. This inaugural event was devoted to information exchange agreements.
Unlike other events, we tried to avoid having another Horizontal Guidelines’ bashing conference.
Rather, and in line with the BSC’s second mission (compliance), the conference sought to improve awareness of the key principles applicable to information exchanges.
To this end, we designed a very comprehensive programme, which covered horizontal as well as vertical exchange of information. We also included a presentation on information exchanges promoted by public institutions.
I am certainly biased, but the conference was really good. Loads of questions, great presentations, good timing, nice turnout (approximately 80 participants).
So you can judge by yourself, I attach below the speakers’ slides.
Slides – Frank Wijckmans – Information Exchange through Intermediaries
Slides – Frederic Puel – Government Sponsored Exchange of Information
Slides – Lars Kjolbye – Information Exchange – Dos and Donts
Slides – Cormac O’Daly – Information Exchange through Competitor Contacts
Unknown Truths about a Famous Antitrust Father
I just read a short and interesting piece by W. Kolasky on the life of one of the most anonymous antitrust celebrities: John Sherman. A few things worth keeping in mind:
1. John Sherman’s name has been used by the British army to name Medium Tanks M4. In the British army, it is conventional to name American-built tanks after famous Civil War generals. Whilst John Sherman was a politician, his brother, William Tecumseh Sherman was one of the most famous Union Generals during the civil war.
2. The Sherman Act originates in a bid to protect tariff regulations that promoted domestic US industrial interests (!). In the late XIXth century, the democrats alleged that protective tariffs had caused the spread of domestic trusts. Sherman, a Republican and a fierce defender of tariff legislation, sought to rebuff the link between the rise of trusts and tariffs. Eventually, to reduce pressure to abolish tariff legislation, the republicans were left with no other choice but to promote anti-trust legislation (p.86).
3. Following years of fierce parliamentary debate (p.87), the final version of the Act was expunged of most of the wording initially proposed by Sherman, and replaced by the text that we know (p.87). The disappointed J. Sherman later commented that this change in wording would deprive the bill of all effectiveness. He is quoted to have said that the bill would be “totally ineffective in dealing with combinations and Trusts. All corporations can ride through it or over it without fear of punishment or detection.” (p.88)
PS: Some law firms, like WilmerHale, follow an open-access publication policy. Most papers written by their lawyers are publicly available on their website. Nice.
The Perverse Effects of the Court’s Ruling in Tele2 Polska
In its recent Tele2 Polska ruling, the Court deprived the National Competition Authorities “NCAs” of the ability to take “negative decisions” (C-375/09, Prezes Urzędu Ochrony Konkurencji i Konsumentów contre Tele2 Polska sp. z o.o., 3 May 2011).
Negative decisions – until now, I used to call them positive decisions… – acknowledge in their operative part that there is no infringement of the competition rules, and provide reasons for this. Under Article 10 of Regulation 1/2003, for instance, the Commission can take “inapplicability” decisions (to date, the Commission never adopted any). To take a hypothetical example, in a positive negative decision, a NCA would conclude that firm X conduct does not constitute an abuse of dominance, absent an abusive course of action.
Now, in Tele2 Polska, the Court was asked to determine whether NCAs can take such decisions. For wholly disputable reasons I believe – flawed understanding of the concept of effectiveness of EU competition law, dubious literal reading of Article 5, inconsistency with VEBIC, long-term legal uncertainty effects, etc. – the Court held that NCAs were deprived of this decisional prerogative. As observed by my assistant, Charlotte Lousberg, this suggests that a number of NCAs have lived in a state of illegality for the past 7 years.
But this is not the primary point of this post. Rather, I would like to stress here a number of perverse effects which the ruling may have on the way NCAs conduct their decisional business.
As explained by Wouter Wils in a great paper (Wils, W. P. J. (2004), The Combination of the Investigative and Prosecutorial Function and the Adjudicative Function in EC Antitrust Enforcement: A Legal and Economic Analysis, World Competition, 27 (2), pp. 201 – 224), officials can be subject to a variety of biases, including hindsight bias, i.e., the need to justify past efforts. More generally, officials are rational individuals who seek to maximize the returns of their professional activities (for legitimate career advancement purposes, etc.).
Now, in the real life, it cannot be excluded that following a lengthy, costly investigation, officials will eventually come to the view that a case has no merit (after all, bright competition lawyers might, for once, convince the NCA that the case is worthless). However, with Tele2 Polska, the officials’ investigative efforts can no longer translate into some sort of observable decisional output.
I believe that this may alter officials’ incentives structures, now unable to craft negative decisions, and justify past activities, in meritless cases.
This is first true at the very outset of competition procedures (e.g., when the NCA receives a complaint). Officials might now be increasingly reluctant to “take” complex, difficult cases, including cases which raise novel questions of law, whose outcome is uncertain. NCAs might in turn prioritize their enforcement resources on “easy” cases, regardless of the public interest.
But this is also true during the procedure, if officials realize that the case is going nowhere. In such a setting, officials (who can no longer push for a negative decision) might nonetheless seek to “get something out” of the case, and resort, to this end to other enforcement instrument, which generate some decisional output, but require little proof and reasoning => think of Article 9, commitments’ decisions.
Just random Friday ruminations. There will be more to come on this in July.
Draft Op-Ed on Inflation and Competition Policy in Belgium
It took me part of the day to draft the attached text (in French).
Comments are very welcome. The thing should go to press shortly.
Carte blanche – Indexation automatique Inflation et Concurrence – N Petit
Chillin'Competition 