China Competition & Trade Review (Issue #5 - November 2020)

O’Melveny’s China Competition and Trade Reviews offer periodic updates about important antitrust, competition, and trade developments in China. The Reviews are intended to help companies navigate China’s rapidly evolving regulatory landscape with practical, on-the-ground insights into the country’s competitive conditions and the laws framing them.

This installment offers a brief overview of:

1. China’s regulatory focus on big tech companies, which includes efforts to rein in certain digital activities and new markers for lawful competition by online platforms;
2. New merger control developments, including new rules and a pilot program that will allow parties to apply for expedited merger clearance in Shanghai;
3. A slew of new antitrust guidelines from China’s antitrust regulator, the State Administration for Market Regulation (SAMR), covering leniency, voluntary commitments, intellectual property rights, and the auto industry;
4. China’s continued regulatory focus on the pharmaceutical sector and efforts to keep anticompetitive behavior from driving up drug prices; and
5. New antitrust compliance developments, including finalized guidelines from SAMR and a warning against anticompetitive conduct from China’s Supreme Court.

If you have questions about these developments, or any others pertaining to China, please contact the key contacts listed below.

1. Regulatory Focus on Big Tech Activities

Chinese regulators have increasingly turned their gaze to the activities of big tech companies in China. Among the most high profile examples is China’s suspension of the initial public offering by Ant Group—the world’s highest-valued FinTech company and the owner of Alipay—days before Ant’s scheduled debut on the Shanghai and Hong Kong exchanges. That move, and the accompanying regulations governing consumer lending by firms like Ant, suggest China intends to manage closely the influence of private technology companies on consumer welfare and China’s financial sector. Other recent examples of this regulatory focus include:

• Platform Pricing Restrictions. In July, China’s State Council—the country’s central government body—issued a set of “implementation opinions” aimed at improving the business environment in China. The opinions cover a range of topics, from the approval of construction projects to the efficiency of the import-export regime. Notably, they also address competition concerns related to online platforms. The opinions note that platform companies are barred from charging unreasonably high service fees and are “encouraged” to reduce charges related to platform commissions, bar code payment fees, and internet payment fees, especially when charged to small businesses. Failure to adjust service fees to reasonable levels may amount to an abuse of an online platform’s dominant market position under China’s Anti-Monopoly Law.
• Commitments from China’s Big Tech Companies. Amid the increased regulatory focus, Alibaba, Tencent, Baidu, and other major Chinese tech companies recently signed a “commitment statement” promising fair competition and robust corporate governance. The companies promised that they would compete fairly, including pledges (1) not to force businesses on their platforms to enter exclusive arrangements or otherwise restrain businesses from using rival services, (2) that they would not hinder the online operations and products of other companies, (3) not to create or spread false and misleading information meant to damage the reputations of rivals, (4) to enhance governance so that businesses on their platforms do not engage in piracy or the dissemination of misleading prices, and (5) to provide compliance training and to self-report any violations. Other signatories include a number of e-commerce platform operators, search engine providers, social media platforms, video-sharing operators, and online travel companies.
• Draft Regulations Governing Online Transactions. On October 20, 2020, SAMR issued draft regulations governing online platforms and e-commerce transactions. The draft regulations prohibit platforms from abusing their market positions by interfering with the operations of entities that use the platforms. This means that platforms cannot impose unreasonable restrictions or conditions on the use of their platforms or require exclusivity. Platforms must (1) cooperate with SAMR’s market supervision, (2) engage in fair, market-oriented competition, (3) protect users’ personal information, and (4) avoid deceptive activity like fake transactions, misleading pricing methods, or false advertising. Platforms can, however, bundle goods and services as long as they give consumers multiple purchasing choices and the platforms do not make bundling the default purchasing option.
• Draft Antitrust Guidelines for the Platform Economy. On November 10, 2020, SAMR issued draft guidelines for the platform economy, including addressing cartel behavior, abuses of dominant market positions, and merger filings. First, the draft guidelines prohibit cartels, resale price maintenance, and any other anticompetitive agreement reached through a platform’s rules, technology, algorithms, or data. The draft guidelines indicate SAMR intends to assess platforms’ use of most-favored nations clauses when evaluating potentially unlawful agreements. And the draft guidelines ban hub-spoke conspiracies organized by platforms or vendors using the platforms. Second, the draft guidelines address abusive conduct, including exclusivity provisions and the use of algorithms to charge differentiated prices based on shopping history and profiles. Both practices are outlawed if they occur without justification. Justifiable reasons for the behavior includes protecting consumer interests or intellectual property, maintaining a viable business model, and awarding new users. Third, the draft guidelines make clear that transactions involving Variable Interest Entities (VIE) must receive merger clearance if the transaction satisfies the relevant filing thresholds. VIEs are used by foreign companies to access sensitive industries in China subject to foreign investment restrictions. This is the first time SAMR has explicitly required merger clearance for VIE transactions. The draft guidelines also indicate SAMR intends to investigate anticompetitive concentrations in the platform economy that fall below filing thresholds, including killer acquisitions and acquisitions in concentrated markets.

2. Recent Merger Control Developments

For much of the last year, SAMR has sought to streamline merger clearance reviews, clarify procedures, and consolidate existing rules and regulations. The work is intended to make the Chinese regulatory framework for business more business friendly and predictable. Notable new developments include the impending implementation of new merger control rules and a pilot program allowing parties to apply for merger clearance in Shanghai.

• New Merger Control Rules. On December 1, SAMR’s new merger control rules take effect. The rules allow SAMR to entrust some merger reviews to provincial-level market regulators. The rules also indicate that joint venture transactions in which (1) the JV moves from being controlled by two or more undertakings to control by a single one of those undertakings and (2) the controlling undertaking and the JV compete in the same market will no longer qualify for simple case review—which allows for an abbreviated analysis—if the combined market share of the controlling undertaking and the JV exceeds 15 percent. The provisions also allow SAMR to fine divestiture buyers that impede merger remedies by failing to comply with their obligations and monitoring trustees that fail properly to supervise remedy compliance. Although the fine is small (RMB 30,000, which is about USD 4,500) and may not deter conduct on its own, the provision indicates SAMR’s intention to strengthen enforcement against failures to implement merger clearance remedies and a more hands-on approach to the relationship with monitoring trustees.
• Pilot Merger Control Program in Shanghai. Consistent with the new merger control rules, SAMR recently announced that it will launch a merger control program in Shanghai, delegating certain merger control responsibilities to the Shanghai branch of SAMR. The aim is to expedite merger reviews, allowing parties to file and receive approval in Shanghai; traditionally, merging parties could only apply to and receive approval from SAMR’s headquarters in Beijing. To start, the pilot program will operate in Shanghai’s Lingang free trade zone and will, according to regulators, involve simplified processes for transactions in certain strategic industries like integrated circuits, artificial intelligence, bio-pharmaceuticals, aviation and aerospace, and new-energy vehicles. Much about the simplified processes—as well as the Shanghai merger control program more generally—is not yet known. The pilot program is the first initiative to place some merger control responsibilities with a SAMR branch office, although SAMR’s headquarters in Beijing will continue to supervise and “guide the behavior” of the branch office.
• More Efficient Merger Reviews in 2020. Despite the many disruptions caused by the COVID-19 pandemic, Chinese merger reviews moved faster during the first six months of 2020 than they did in 2019. From January to June 2020, SAMR received 217 merger filings. The time it took SAMR to “accept” merger filings improved by 20 percent, while SAMR took roughly 15 percent less time to close a review, according to the regulator.

3. A Slew of New Antitrust Guidelines

SAMR recently published four sets of antitrust guidelines governing the operation and enforcement of China’s Anti-Monopoly Law. The guidelines—which existed in draft form for years—are now final and address (1) leniency applications in cartel settings; (2) the use of voluntary commitments to correct potentially anticompetitive conduct and end investigations; (3) the lawful exercise of intellectual property rights; and (4) competition in the Chinese auto industry:

• Cartel Leniency Guidelines. Under China’s Anti-Monopoly Law, businesses that voluntarily report anticompetitive activity and provide important evidence to SAMR may receive immunity from or reductions in penalties. The Leniency Guidelines govern applications related to cartels. With respect to procedure, the guidelines encourage potential applicants to report conduct as soon as possible—and provide for a marker system allowing businesses to preserve their spot in the leniency queue—although business may apply for leniency even after SAMR launches an investigation. The first applicant to approach SAMR can receive up to 100 percent reduction in penalties or full immunity. The second and third applicants may receive up to 50 and 30 percent reductions in penalties, respectively. Any subsequent applicants may receive up to 20 percent in penalty reductions, although the Leniency Guidelines indicate that SAMR typically will grant leniency to no more than three applicants. To secure leniency, applicants must admit liability (a condition that adversely impacts the attractiveness of the regime), stop all relevant conduct, and provide a detailed description of the cartel arrangement, including the participants, duration, subject, and scope, as well as other important and valuable evidence. Cartel ringleaders and undertakings that coerced others to participate are not eligible for full immunity. The guidelines require SAMR to publish decisions explaining their justifications for any grants of leniency.
• Commitments Guidelines. The Commitments Guidelines allow businesses under investigation by SAMR to enter into voluntary commitments that eliminate the relevant conduct and mitigate any consequences, thereby ending the investigations. Commitments are not available in cartel investigations and generally do not apply if SAMR has already issued a penalty notice. In all other investigations, businesses must specify in writing (1) the relevant anticompetitive conduct, (2) how they propose to correct it, (3) how they will eliminate the consequences of their conduct, and (4) the timeframe and approach for implementation. SAMR will accept commitments only if the commitments are capable of being implemented “autonomously,” although the specific form can be structural, behavioral, or a hybrid of the two. SAMR may consult third parties for their views on proposed commitments, and it can reopen investigations if circumstances change post-commitment.
• Intellectual Property Guidelines. SAMR’s new Intellectual Property Guidelines are intended to bring greater clarity to the intersection of the Anti-Monopoly Law and intellectual property rights in China. The guidelines, for instance, make clear that the mere existence of an intellectual property right does not mean the holder has dominance in the relevant market—that will turn in part on the degree of reliance on the patent in the industry. When dominance exists, a patent holder can violate the Anti-Monopoly Law if it licenses only at unfairly high prices, refuses to license, conditions licenses on tie-in sales, or imposes other unreasonable or discriminatory terms. IP related agreements—including joint research and development pacts, cross licensing arrangements, grant backs, and non-challenge clauses—are presumptively lawful under the antitrust laws if (1) in a horizontal setting the combined market share of the parties does not exceed 20 percent, (2) in a vertical setting the combined market share of the parties does not exceed 30 percent, and (3) there is no evidence that the agreements actually restrict or eliminate competition. The guidelines also indicate that the licensing of IP rights can constitute a “concentration” requiring merger clearance by SAMR if the IP constitutes an independent business to which the company allocates turnover. Finally, the guidelines make clear that both patent pools and standard essential patent holders can violate the Anti-Monopoly Law if, for example, the pool restricts the ability of members to license patents individually or the SEP holder seeks an injunction when it failed to abide by FRAND commitments.
• Auto Guidelines. SAMR considers the Chinese auto sector a pillar of the national economy, and its new Auto Guidelines contain a number of notable provisions governing competition in the industry. First, the Auto Guidelines prohibit car manufacturers from restricting dealers’ unsolicited sales, dealers’ sales of parts for repair services, or dealers’ supply arrangements with other dealers. Second, car manufacturers with less than 30 percent market share can impose certain vertical restrictions on dealers and wholesalers, including territorial or customer restrictions, limits on the sale of parts to competing manufacturers, and certain restrictions on direct sales to end users. Third, resale price maintenance—while generally unlawful under China’s Anti-Monopoly Law—can potentially be employed for periods of less than a year for certain “new-energy” vehicles or if a dealer is a mere intermediary. Finally, manufacturers with a market share over 50 percent in after-sales markets cannot limit the supply of spare parts or prohibit dealers and repair firms from purchasing spare parts of equal quality.

4. Continued Regulatory Focus on the Pharmaceutical Sector

Throughout 2020, China has sought to curb anticompetitive conduct by pharmaceutical manufacturers. Those efforts include path-breaking damages in private litigation, robust penalties for collective abuse of dominance, and, now, new guidelines, investigations, and “discrediting” procedures. Together, the measures are part of a broader effort to check anticompetitive behavior from driving up drug prices in China.

• Discrediting Measures. China’s National Healthcare Security Administration recently announced that pharmaceutical and medical suppliers who violate China’s competition law will be “discredited” as part of China’s larger Social Credit System. Offending companies may be disqualified from participating in bids and tenders, prohibited from supplying products they won in prior bids, and subject to public censure for the wrongdoing. Each penalty is in addition to traditional antitrust penalties and litigation damages.
• Draft API Sector Guidelines. In October 2020, SAMR released draft antitrust guidelines for the active pharmaceutical ingredient (API) sector. The guidelines indicate SAMR will deal aggressively with monopolistic conduct by API suppliers, without any safe harbor for businesses with moderate market shares, in part because SAMR will define single-product markets for each API. The guidelines encourage parties voluntarily to seek merger clearance of pharmaceutical transactions, even when the deals do not satisfy relevant filing thresholds.
• New API Investigation. In addition to the discrediting measures, the National Healthcare Security Administration launched an investigation into the pricing practices of dozens of drug companies. The regulator indicated it summoned and warned over twenty companies about price irregularities and supply issues and has referred some to other agencies for additional probes. SAMR appears to be drawing on the findings. The investigation followed calls from China’s National Committee of the People’s Political Consultative Conference to crackdown on high drug prices.

5. Antitrust Compliance Developments

Both SAMR and the Chinese Supreme Court recently took actions signaling the importance of antitrust compliance, including abiding by international best practices, creating robust compliance departments, and fostering a culture of compliance.

• Antitrust Compliance Guidelines. In September, SAMR issued final Antitrust Compliance Guidelines that describe ways for companies to develop and implement compliance programs consistent with international best practices. Notably, the guidelines encourage businesses to cultivate a culture of compliance through which they abide by antitrust rules in every jurisdiction in which they operate, starting with senior executives committing to compliance and working to identify antitrust risks. The guidelines also recommend the creation of compliance departments with sufficient resources and independence to effectively evaluate and remedy compliance risks. And the guidelines encourage companies voluntarily to submit reports to SAMR detailing the development of their antitrust compliance systems.
• China’s Supreme Court Focused on Anticompetitive Practices. At the end of October, China’s Supreme Court issued a statement describing its forward looking priorities and the “important political task of the people’s court.” The Court identified several areas of focus, including (1) strengthening anti-monopoly and anti-unfair competition adjudications; (2) strengthening judicial protection of intellectual property rights, particularly in emerging industries and for key technologies; (3) building a legal environment that supports technical innovation and investment; and (4) promoting development. One of the Court’s overarching objectives appears to be helping China create a market-oriented business environment that is inviting to the international business community and entrepreneurs. The Court’s statement does not provide detail on how it will strengthen adjudications involving anticompetitive conduct.

O'Melveny & Myers LLP is a foreign law firm registered with the Ministry of Justice of the People's Republic of China. Under current Chinese regulations, we are allowed to provide information concerning the effects of the Chinese legal environment, but we are not authorized to practice Chinese law or to render legal opinions in respect of Chinese law. We work in cooperation with a number of Chinese law firms. Should you require a legal opinion in respect of any Chinese law matter, we would be happy to assist you in obtaining one from a Chinese firm.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Philip Monaghan, an O'Melveny partner licensed to practice law in England & Wales, Ireland, and Hong Kong, Charles Paillard, an O'Melveny counsel licensed to practice law in France and a registered foreign lawyer in Hong Kong, Scott Schaeffer, an O'Melveny counsel licensed to practice law in California and the District of Columbia, and Lining Shan, an O'Melveny counsel in the firm's Beijing office, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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