Converging on Brussels

The new economy has created a whole set of competition problems, and the European Commission is struggling to keep up. Dearbail Jordan reports on how competition lawyers are coping with convergence

When the European Commission began policing mergers more than a decade ago, the concept of a new technology conglomerate was merely a twinkle in a geek’s eye.

But while the world gets to grips with the emergence of the new economy and a completely different way of doing business, the EC has remained firmly in the 1990s. Despite a surge in consolidation of the telecommunications and IT sectors, the EC has refused to tweak European merger policy to take into account the divergent structure of new economy companies.

Alec Burnside, competition partner at Linklaters & Alliance in Brussels, says: “The new economy is more likely to increase competition and create competition problems.” Add to this the problems with the EC, and competition lawyers are set to have a lot on their plates in the coming years.

Just take the projected merger between new media luminaries America Online (AOL) and Time Warner, which are attempting to create a one-stop shop giant which will provide internet access and products for sale over the web.

The EC is using such mergers to state unequivocally that it will regulate a merger in a consistent way, regardless of sector.

In the case of AOL, represented by Simpson Thacher & Bartlett, and Time Warner, advised by Cravath Swaine & Moore and Herbert Smith, the merged company would at once become the provider of both the structure and the content to the end user.

The EC intends to examine whether AOL – the largest internet service provider (ISP) in the world with a 40 per cent market share of the sector in the US – can become a gatekeeper to online music distribution. The fact that AOL has an agreement with German-based Bertelsmann – which records, publishes and broadcasts music – is not helping its cause, despite informing the EC that it is willing to break off its covenant with the company.

Competition lawyers are eagerly awaiting the outcome of the case, but the precedents are not altogether auspicious.

The EC recently flexed its muscles over the proposed £76bn merger between US giants MCI WorldCom and Sprint, saying that a fusion between the companies would violate European merger policy.

This was the thirteenth merger blocked by the EC since 1990. It argued that the link-up would have created a monopoly situation.

The EC reached its decision despite persistent lobbying by US firms Covington & Burling and Cravath Swaine & Moore, which represented MCI WorldCom, and King & Spalding, which was Sprint’s counsel on the deal.

What was unusual was the decision by EU competition commissioner Mario Monti to involve the commission at all, since the two companies are both US-based. However, due to the worldwide reach of the internet and the networks that run it, the EC saw that the merger could have an effect on the 15 member states.

To this end the EC hooked up with the US Department of Justice to blow the merger out of the water. In its analysis, the EC stated that the companies providing the internet backbone on which ISPs build on would have been powerful enough to enforce prices and conditions for other operators.

The decision caused a furore. MCI WorldCom claims that the EC failed to understand that mergers under the new economy should be viewed differently from the more traditional tie-ups between bricks and mortar businesses. In short, disgruntled executives who have been slighted by Brussels argue that the EC’s current competition rules do not take into account the volatility of the high-tech sector.

The EC has always taken a stringent approach to consolidation in the new economy. The near-merger last year of Sweden’s Telia and Norway-based Telenor was an example of the EC exercising its powers, after Monti stated that both companies should divest their overlapping interests in the cable TV sector. (As it stands, the merger between the government-owned companies fell through due to internal wrangling between the two sides.)

But Philippe Chappatte, a senior partner in the regulatory and competition practice at Slaughter and May, says that the near Telia/Telenor merger is a prime example of the EC’s tough stance on new economy alliances, and adds that the current merger policy adequately covers the technology sector despite claims to the contrary.

“The commission is taking a consistent approach at looking at a potential monopoly position in the new economy,” says Chappatte, adding waspishly: “Anyone who has had a transaction prohibited by Brussels thinks that it should change its policy.”

These new economy transactions can fall into one of two categories. First, there are those mergers or acquisitions which form a vertically integrated entity, such as AOL and Time Warner.

Second, there are those companies such as MCI WorldCom which provide connection to the internet. Consolidation in this area means that, as cited by the EC, an entity can become a gatekeeper which deflects competition from other like-minded companies. But there are agreements in place, called “peerings”, that allow internet traffic to flow between one or more of these guardians of the backbone, thus allegedly alleviating the so-called anti-competitive problems consolidation presents.

“There are various levels of peering,” says Chris Watson, a corporate telecoms partner at Allen & Overy. “It used to be something between the geeks and the nerds but the key is that it would bring together two of the biggest backbone operators and put them in a dominant position.

“The alternative to internet peering is to pay someone to carry [the traffic] but that is a very delicate thing from an EC point of view. If you have an agreement with a backbone operator on who will or will not peer, you are setting out an agreement to peer and this is not an agreement caught in the merger regulations.”

But Watson says that if a decision is reached between a select few companies controlling internet connection, everyone else will have to pay. “This is therefore anti-competitive and becomes something that justifies an investigation. You need to discover the effect this will have on competition.”

However, there are arguments that the EC does not need to mould European merger policy to suit the whim and fancy of new economy companies. After all, it has been quite capable of ruling on mergers and acquisitions in all sectors over the past 10 years.

A spokeswoman for the Competition Commission says: “In the old economy, most of the time there was a problem of horizontal overlap but with the new economy the issue may be of vertical integration.

“Here a company has both the structure and the content which is not exactly in the same market. It can pose problems with a merged company becoming powerful in that market and it can reduce choice if a company is strong in both the content and infrastructure.”

What is more, the traditional markers for outlining a monopoly situation or anti-competitive behaviour become blurred when dealing with internet companies. Because consumers can download media from the internet for free it is difficult to measure market share and worldwide coverage of the internet adds to this problem.

Linklaters’ Burnside says: “The rules do not need to be changed, only the way in which they are applied is different. The gatekeeper concept is not particular to the new economy, there have been examples of this in bricks and mortar deals.”

However, Burnside argues that because of the constantly shifting nature of the internet and the alarming rate in which new companies and ways of doing business over the web are being formed, the EC has to look into the future to see if potential competition issues may arise. “In the end the same rules apply but the commission has to be forward-looking in assessing the importance of a merger. But I think that they should be slow to clamp down on innovation or change,” he says.

While a question mark continues to hang over the viability of current EU merger policy on telecoms and internet mergers, a number of lawyers are questioning whether the EC has sufficient knowledge of the emerging markets.

“I think it is a given that the commission is having problems in defining e-commerce in a meaningful way or dealing with it in a way that keeps the public happy,” says Rafi Azim-Khan, head of the e-commerce group at McDermott Will & Emery. Azim-Khan points to the E-commerce Directive, which was nearly two years in the making, as evidence that the EC is unable to get a handle on this amorphous market. As it stands, the European Parliament has approved the directive, and once published, the 15 member states have 18 months to implement it.

Among the main changes under the directive are that internet traders will only have to comply with laws under their member states, and a framework for out of court settlements in cross-border disputes has been drawn up. “The E-commerce Directive has taken so long that it is difficult for the commission to regulate it,” says Azim-Khan.

Other lawyers argue that it is a resource issue. Richard Fleck, practice development partner at Herbert Smith, says: “The EC could do with getting a number of people up to date on the complexity of these issues.”

However, a spokeswoman for the Competition Commission hits back at such an idea. “The fact that people are overworked means that they can still do their job and still do it well. We have been dealing with mergers for 10 years so that argument does not hold water,” she says.

But it seems likely that the EC will come under more fire. There is little indication of how it will rule on the AOL/Time Warner deal. Also under the EC spotlight is the proposal by Microsoft (advised by Sullivan & Cromwell and Lovells) to buy a stake in UK-based cable operator Telewest, which will give the IT giant a foothold in the digital TV market. And French-based Vivendi is waiting to complete its billion pound merger with TV provider Canal Plus and Canadian-based Seagram.

And with so many other companies on the sidelines, the EC’s final decision will have important ramifications for the new economy.