The Hong Kong Competition Ordinance (“Ordinance”) is expected to come into full effect on 14 December 2015 (barring any last minute legislative delays). Therefore, there are less than 2 months remaining for businesses in Hong Kong to prepare fully for its implementation. One of the key issues that Hong Kong businesses should consider carefully ahead of the arrival of the cross-sector competition law is whether they may have a substantial degree of market power (“SMP”) in a particular market.  While having SMP is not, in itself, prohibited under the Ordinance, companies with SMP are prohibited under the Second Conduct Rule (“SCR”) from abusing that power. The Hong Kong Competition Commission (“HKCC”) has indicated that abuse amounting to “exclusionary conduct” which may harm the process of competition in the market will be the main enforcement focus under the SCR, although the category of conduct capable of amounting to abuse of SMP remains open.

The SCR will likely be of considerable importance in Hong Kong, where a number of sectors appear to be characterised by a high degree of market concentration. Unlike in some other jurisdictions, no indicative thresholds below which companies will be considered unlikely to have SMP have been provided under the Ordinance or in the Guidelines issued by the HKCC. Companies therefore cannot rely on any so-called market share ‘safe harbours’. Furthermore, the HKCC is not required to issue a warning notice in respect of a contravention of the SCR prior to bringing a proceeding before the Competition Tribunal. Therefore, Hong Kong businesses should, ahead of 14 December 2015, assess whether they may have SMP and, if necessary, moderate their conduct accordingly.

1. Second Conduct Rule – Ordinance

The SCR under Section 21 of the Ordinance provides that an undertaking with a substantial degree of market power in a market must not abuse that power by engaging in conduct that has as its object or effect the prevention, restriction or distortion of competition in Hong Kong. Conduct may, in particular, constitute an abuse of SMP if it involves: (i) predatory behaviour towards competitors; or (ii) limiting production, markets or technical development to the prejudice of consumers. The Ordinance also provides a non-exhaustive list of matters which may be considered when determining whether an undertaking has SMP, including: the market share of the undertaking; the undertaking’s power to make pricing and other decisions; any barriers to entry to competitors in the relevant market; and any other relevant matters specified in the Guidelines accompanying the Ordinance issued by the HKCC.

2. Second Conduct Rule – Guideline: When does a business have substantial market power?

The HKCC issued the final version of the Guidelines, including the Guideline on the SCR (“Guideline”), on 27 July 2015. While the Competition Tribunal and other courts will be the ultimate arbiters of the Ordinance, the Guideline sets out how the HKCC intends to interpret and enforce the SCR, thus providing invaluable guidance for Hong Kong businesses on how to assess whether they have SMP and the types of behaviour that may constitute an abuse of SMP.

SMP will arise where an undertaking does not face sufficiently effective competitive constraints in the relevant market for a sustained period of time. The HKCC has been at pains to avoid establishing any market share thresholds below which an undertaking is unlikely to be found to have SMP, despite indications by the Government during the legislative process that a market share below 25% would represent a ‘safe harbour' for businesses.

The HKCC’s approach differs from that of some regulators (e.g. the European Commission takes the general view that a company whose market share is below 40% is unlikely to be “dominant”), and it appears to have more in common with the Australian method of enforcement. It remains to be seen whether the Tribunal will provide further guidance on the interpretation of “SMP” in due course.

While the HKCC considers that market shares may be useful as “an initial screening device”, other factors such as industry characteristics, barriers to entry, availability of supply-side substitution and buyer power will also be relevant. This position allows the HKCC considerable flexibility in its assessment of the various market structures that exist in Hong Kong. However, such flexibility may also be used in certain circumstances to the benefit of businesses as, depending on the characteristics of a particular market, even businesses with very high market shares may avoid a conclusion that they have SMP. In this regard, the HKCC provides in the Guideline a hypothetical example of a business with 70% market share that would not have SMP due to the low entry barriers for entering the relevant market. The HKCC’s proposed approach also finds support in the Supreme People’s Court of China’s judgment in Qihoo v. Tencent, where it concluded that, despite having an 80% market share, Tencent did not have a dominant market position. Conversely, the Guideline makes clear that it is possible for more than one undertaking to have SMP in a relevant market, particularly where the market is highly concentrated with only a few large market participants.

Market definition

Defining the relevant product and geographic market is a necessary analytical step in the HKCC’s assessment of whether an undertaking has SMP. While the approach to market definition will depend on the specific characteristics of the market(s) in question, the HKCC has indicated that demand side substitution will likely be a central factor. As stated in the Guideline, the relevant geographic market may be global or regional, may be limited to Hong Kong or even a part of Hong Kong or, in some circumstances, may include parts of Mainland China (such as the Pearl River Delta).

3. What type of conduct may amount to an abuse of substantial market power?

As noted above, the SCR will catch, in particular, conduct involving predatory behaviour towards competitors and limiting production, markets or technical development to the prejudice of consumers. The HKCC has indicated that exclusionary conduct which may harm the process of competition in the market (i.e. foreclosure of competitors) will be the main enforcement focus under the SCR, although businesses should note that the category of conduct capable of amounting to abuse of SMP remains open. Therefore, potentially any conduct which has the object or effect of harming competition could be found to be abusive under the SCR.

The Guideline provides a non-exhaustive list of the types of conduct that the HKCC may, in appropriate circumstances, consider as an abuse of SMP:

  1. predatory pricing: where an undertaking with SMP sets prices so low that it deliberately foregoes profits in an attempt to force one or more other undertakings out of the market and/or in an attempt to otherwise “discipline” competitors;
  2. tying and bundling: tying occurs when a supplier makes the sale of one product (the tying product) conditional upon the purchase of another (the tied product) from the supplier while bundling refers to situations where a package of two or more products is offered at a discount;
  3. margin squeeze: where a vertically integrated undertaking with SMP supplies an important input to undertakings operating on a downstream market where it also operates. The vertically integrated undertaking reduces or “squeezes” the margin between the price it charges for the input to its competitors on the downstream market and the price its downstream operations charge to its own customers, such that the downstream competitor is unable to compete effectively;
  4. refusals to deal: where an undertaking with SMP refuses to supply an input to another undertaking, or is willing to supply that input only on objectively unreasonable terms (although the HKCC has stated that refusal to deal is likely to be an abuse of SMP only in very limited or exceptional circumstances); and
  5. exclusive dealing: where an undertaking with SMP seeks to foreclose competitors by preventing them from selling to customers through exclusive dealing arrangements.

Some exclusions and exemptions from the SCR apply, including:

  • where the conduct is engaged in by an undertaking with a gross annual turnover of not more than HK$40 million;
  • compliance with legal requirements;
  • services of general economic interest;
  • where the conduct results in a merger;
  • public policy exemptions and international obligations exemptions (as specified by order of the Chief Executive in Council); and
  • statutory bodies, save for those which are specifically brought within the scope of the competition rules.

It should be noted that some exemptions may be interpreted very narrowly and that, unlike under the First Conduct Rule, there is no “economic efficiency” ground for justifying a violation of the SCR.

4. Implications for business

The clock for full implementation of the Ordinance is ticking and there are now less than two months for businesses in Hong Kong to prepare for the arrival of the cross-sector competition law.  Businesses in various sectors should therefore take this final opportunity to carefully assess whether they may have SMP in any relevant market.  This issue is particularly significant in Hong Kong where many sectors are reportedly characterised by a high degree of market concentration.

Firms which may have SMP should revisit their current arrangements to assess whether there are any practices which are likely to be considered as abusive.  Any such practices (and in particular those which could foreclose competitors) should be amended to avoid violating the Ordinance.  Such self-assessment is all the more important given that, unlike for violations of the First Conduct Rule other than Serious Anti-Competitive Conduct, no warning notice will be issued for abusive conduct under the SCR, meaning that the HKCC can proceed straight to the Tribunal in respect of infringements of the SCR.