Competition Authority decision of 10 June 1994 relating to a proceeding under Section 4 of the Competition Act, 1991

Notification No. CA/199/92E ‑ Irish Stock Exchange Rules in relation to dealings in Irish Government Securities.

Decision no. 335

Introduction

1.	The rules of the Irish Stock Exchange in relation to dealings in Irish Government Securities (Gilts) were notified to the Competition Authority on 29 September, 1992.  The notification requested a certificate, or in the event of a refusal by the Authority to grant a certificate, a licence.  On March 10 1994 the Authority issued a Statement of Objections to the Stock Exchange indicating that it intended to refuse its request for a certificate or licence.  The Authority specifically objected to two aspects of the rules namely those setting minimum commissions for transactions in gilts and providing that stockbrokers act only as agents in respect of such transactions.  On 6 April 1994 the Stock Exchange indicated that it had decided not to challenge the Authority's objections to the fixed commission regime.  It indicated that it did not accept the Authority's views on the agency rule and requested an Oral Hearing.  On 16 May 1994 the Stock Exchange informed the Authority that the rules on minimum commissions would be abolished with effect from 17 May 1994.  On 27 May 1994 the Stock Exchange informed the Authority that it was withdrawing its request for an Oral Hearing having decided not to contest the Authority's objections in respect of the agency rule.  It subsequently announced its intention to change this rule, subject to the approval of the Minister for Finance.

The Facts

(a)	The Subject of the Notification

2.	The notification relates to the rules of the Irish Stock Exchange in relation to dealings in Irish Government Securities (Gilts) by member firms dated January 1987.  The rules set out the basis on which member firms of the Exchange may deal in Irish Gilts.  In particular they provide that brokers may operate in an agency capacity only and prohibit brokers from competing on the basis of commission levels by setting out fixed commissions to be charged by all member firms in respect of gilts with over five years to maturity.  The rate of commission has been approved by the Minister for Finance.

(b)	The Parties

3.	The parties involved in the arrangements are the Irish Stock Exchange and its member firms.  The Irish Stock Exchange is presently constituted as an administrative unit, being in effect the Irish branch of the International Stock Exchange of the United Kingdom and the Republic of Ireland Ltd., which is owned by its member firms throughout Ireland and the UK.  Its functions include the regulation of its member firms.  There are currently 12 member firms of the Irish Stock Exchange and they are listed in Annex 1.1 The Authority is aware that there are proposals to establish the Irish Stock Exchange as a separate entity independent of the UK Stock Exchange.
4.	The Stock Exchange has submitted that none of these firms has a shareholding in any of the other firms listed or any right to control, manage or influence the board or partnership of another.  Some of the stockbroking firms are however, subsidiaries of, or partly owned by, other companies.

5.	Stockbroking firms act as intermediaries in the gilt and equity markets.  They are also engaged in a number of other activities including inter alia the provision of advice to investment clients and the organising of share placings for corporate clients.

(c)	The Product and the Market

6.	A gilt is an Irish Government security.  The Government issues or sells gilts in order to fund its borrowing requirements.  Gilts generally offer a fixed rate of interest for a number of years and have a specific redemption date.  Such gilts are usually bought by institutional investors such as insurance companies, pension funds and banks.  Private investors account for an almost negligible part of gilt sales.

7.	Gilts were traditionally issued by the Department of Finance although this role has now been assumed by the National Treasury Management Agency (NTMA).  The NTMA creates new stocks with a particular maturity date and coupon from time to time.  They might issue only a relatively small amount initially but further amounts may be issued or `tranched' as the need for funds and the market demand for stock allows.  Tranches of existing stocks may also be created.

8.	As an inducement to investors to hold gilts the Department of Finance undertook to buy back stock at a price set from time to time.  Increased budget deficits from the mid 1970s onwards led to a substantial increase in the amount of Government gilts held by institutions.  In addition as investors became more willing to trade their gilt portfolios opportunities for brokers arose to find sellers and buyers of gilts.  This resulted in the development of a secondary market for gilts.  Gilts are bought and sold by investors on the secondary market between their issue and redemption date.  Most transactions on the secondary market are arranged by stockbroking firms with the vast majority of transactions conducted by telephone.  Secondary market trading now dominates overall turnover so that the Department of Finance's role as a market maker diminished over time.  The relevant market is the secondary gilt market.  The relevant geographical market is the State.

9.	The total value of Government stock or gilts outstanding at the end of 1993 was over £14bn.  (See Table 1).  The main holders of gilts are financial institutions.  These can be divided into two broad classes.  Banks and building societies tend to hold gilts for investment purposes on their own account and also, in the former case, to comply with liquidity ratio requirements imposed by the Central Bank of Ireland.  Such institutions tend mainly to hold short dated gilts.  Life assurance and pension funds effectively invest in gilts on behalf of their policyholders and would largely invest in medium and long dated gilts.  The tendency for the different institutions to operate largely in different areas of the market reflects the differing maturity ranges of their respective liabilities.  Insurance companies were the largest domestic holders of gilts accounting almost 29% of stock outstanding.  The personal and corporate sectors hold a very small proportion of outstanding gilts.  In effect the personal sector is a major holder of gilts indirectly through life assurance and pension policies.

10.	In recent years overseas institutions, particularly German institutions, have become major holders of gilts.  At the end of 1991 non‑resident gilt holdings accounted for almost 30% of stock outstanding.  This fell sharply during 1992, due largely to the currency crisis.  By the end of 1993 non resident holdings of gilts was more than £4bn, just £120m below the end 1991 level, representing almost 29% of gilts outstanding.

 	Table 1:  Government Stock ‑ Nominal Holdings £M

						  1993			   1992

Government Departments		  	262.9 (  1.9)	   441.6 (  3.3)
Central Bank				  	180.0 (  1.3)	   240.0 (  1.8)
Associated Banks			          2157.3 ( 15.3)	 2049.6 ( 15.5)
Non‑Associated Banks		  		625.7 (  4.4)	 1023.1 (  7.7)
Building Societies			  	427.4 (  3.0)	   838.1 (  6.3)
Insurance Companies			          4035.9 ( 28.5)	 3702.8 ( 27.9)
Pension Funds				          1115.0 (  7.9)	 1139.5 (  8.6)
Unit and Investment Trusts	  		306.5 (  2.2)	   288.1 (  2.2)
Commercial Companies		  	299.6 (  2.1)	   375.0 (  2.8)
Personal Sector			  	359.7 (  2.5)	   447.7 (  3.4)
Other					  	327.1 (  2.3)	   387.1 (  2.9)
Non‑Resident Holdings		          4047.3 ( 28.6)     2320.7 ( 17.5)

Total					        14144.4 (100.0)  13253.3 (100.0)

Figures in parentheses are percentage shares.

Source: Central Bank; Quarterly Bulletin, Summer 1994, Table D2.

11.	Gilts may be divided into three broad categories according to their maturity date.  Those maturing in less than 5 years would be described as shorts, those with a maturity date of between 5 to 15 years are mediums, while those with a maturity of over 15 years are long gilts.  At end 1992 there were a total of 31 stock issues.2  Table 2 illustrates that 45% of the gilts outstanding are shorts.  This proportion has fallen in recent years.

	Table 2:  Maturity Range of Gilts
	(% distribution)

						1991			1992  		1993
Stocks due to mature in

less than 5 years				51.7			50.0		45.4
5‑15 years					39.8			40.5		45.8
15 years or more			 	  8.4			  9.6	 	  8.8

Source: Central Bank Quarterly Bulletin Summer 1994, Table D2.

12.	Stockbroking firms are engaged inter alia in arranging the purchase and sale of gilts on behalf of investors on the secondary market.  These firms are only allowed by the Stock Exchange to act in an agency capacity and must have on their staff individuals licensed by the Minister for Finance to deal in gilts for commission.
	Table 3:  Gilt Market Turnover £M.

				Under 5 Years		Over 5 Years		Total
			 	to Maturity		 to Maturity

	1990			28180			 7917			36097
	1991			17026			18456			35482
	1992			21093			26809			47902
	1993			30281			36107			66388
Source:  Central Bank Quarterly Bulletin Summer 1994, Table C20.

13.	Total turnover has increased sharply since 1991.  Apart from 1990 more than half of total turnover involved stock with more than five years to maturity.  There were over 19,000 bargains involving gilts with more than five years to maturity in 1993, 55% of all gilt bargains.  The Irish Times reported that total gilt commissions paid to stockbrokers in 1993 by Irish institutions alone amounted to £4.5m.  This was 22% up on the 1992 total.

14.	The market is in fact a highly concentrated one with just four firms accounting for the bulk of gilt market transactions According to a report in the Irish Times, Davy Stockbrokers accounted for almost 31% of gilt market transactions, while the top four firms accounted for almost 90% of the market.  (See Table 4).  In effect many of the smaller stockbroking firms are not heavily involved in the gilt market, with most of their business being accounted for by private clients.  During 1993 two smaller firms have managed to secure a significant increase in their market share.  In one case they did so, according to newspaper reports, by offering a partial rebate of commissions to institutions if and when the current scale of fixed commissions is revised.

	Table 4:  Gilt Commissions Paid to Stockbrokers

					1991		   1992			   1993

					  %		 £m	%		 £m	%

	Davy Stockbrokers		29.3	     	1.19	(32.3)		1.45  	(31.0)
	Goodbody			21.4		0.79	(21.2)		0.90   	(20.0)
	NCB				21.6		0.86	(23.1)		0.86	(19.0)
	Riada				20.8		0.61	(16.6)		0.81	(18.0)
	Bloxham			 ‑		  ‑ 			0.23	(  5.0)
	MMI				 ‑		  ‑ 			0.23  	(  5.0)
	Others			 	6.9		0.25	  (6.7)		0.09	(  2.0)

Note:  Separate figures for Bloxham and MMI were not published for 1991 and 1992 and they are included in the total for others.

	Source:  Irish Times 7 April 1993 and 17 February 1994.

(d)	The Arrangements

15.	The notified arrangements involved the Stock Exchange Rules as they applied to transactions in Government gilts.  They provided that stockbrokers may only act in an agency capacity in respect of Irish Government securities and were obliged to charge a fixed rate of commission on transactions in gilts with more than five years to maturity.  These conditions were set out in the `Rules and Regulations of the Irish Stock Exchange'.  The relevant rules are set out below.
49.1	`A Member firm shall only deal as an agent in respect of any security issued or guaranteed by the Government of the Republic of Ireland.'
75.1	(1) `The Rules and Regulations of the Stock Exchange relating to Commission shall apply in toto on bargains on Securities issued or guaranteed by the Government of the Republic of Ireland, a broker who is subject to the jurisdiction of the Republic of Ireland shall charge his client Commission at not less than the rates laid down in Appendix II to these unit rules and no reduction thereof may be allowed except as authorised by the provisions of the Rules and Regulations of The Stock Exchange.'
77.1	`A broking firm shall charge commission in respect of every bargain made on a client's behalf and in respect of every service for which a charge is prescribed.'
78.1	`In the case of securities issued by the Government of Ireland, the commission chargeable by a Broking Firm shall be at not less than the rates adopted by the Irish Administrative Unit and set out in Appendix II ‑ Irish Government Funds of these rules, except to the extent authorised by these Rules.'

16.	Rule 79.1 and 2 provides for lower, albeit fixed rates of commission to be applied in respect of a new security issue with a maturity date of more than ten years on transactions effected within three months of the first day of dealings done for the same principal in such a new issue.  Rule 80 allows brokers to waive commissions in certain limited circumstances.  Rule 81 allows for certain reductions in the case of a change from one security to another for the same principal.

17.	Details of the rates of commission specified in Appendix II of the Stock Exchange Rules are set out in Table 5 below.
	Table 5:  Scale of Minimum Commissions
	(for Irish Government Funds.)

		 0.52% on the first £2500 consideration
		 0.1625% on the next £15500 consideration
		 0.0813% on the next £232000 consideration
		 0.065% on the next £750000 consideration
		 0.0585% on the next £3000000 consideration
		 0.026% on the next £6000000 consideration
		 0.013% on the excess.

18.	The Irish Times reported on 7 November 1992 that one of the smaller stockbroking firms, MMI, had announced plans to offer discounts of up to 20 percent on gilt deals.  MMI was formed early in 1992 when MMI moneybrokers acquired Doak & Company a small stockbroking firm.  The Stock Exchange reportedly objected to the MMI proposal to charge less than the minimum commissions set in its rules.  The Irish Times report also claimed that a Japanese broking house had decided to make a market in Irish gilts from its London trading room although it appears that they subsequently withdrew from the market.
(e)	Submissions of the Parties

19.	The Irish Stock Exchange has argued that the arrangements do not have as their object or effect the prevention, restriction or distortion of competition in trade in any goods or services in the State or in any part of the State within the meaning of section 4(1) of the Competition Act.  They have argued that fixed commissions are required because banks who are large holders and traders of gilts may also be owners or controllers of broking operations.  Without fixed commissions they could obtain the services of a subsidiary broker at a nominal charge.  Other buyers of gilts would recognise this possibility and would treat brokers as principals quickly leading to a situation where the major participants in the market were principal traders and there would emerge a market making system.  The Exchange argued that this would reduce liquidity and turnover in the market and raise costs.  The Stock Exchange also argued that a `standard' rate of commission would emerge even in the absence of fixed commission arrangements, given the nature of the market involved.  Thus they submitted that the arrangement merely formalised the structure that would emerge under a negotiated commission regime, except that it preserved the agency broking structure of the market, thus ensuring the transparency of every trade.

20.	It was claimed that the agency broking system benefited investors and Government through improved liquidity and lower overall dealing costs.  It was argued that the commission levels prevailing resulted in bid‑offer spreads which were quite narrow.  The parties stated that: `A reduction of commission levels, if it reduced competition in the broking market, would be offset many times by wider spreads.'  They also stated that any restrictions were greatly ameliorated by the freedom of investors to deal direct without the use of brokers, by the existence of alternatives to the gilt market (i.e. futures), by the freedom of entry into broking and by the requirement that the commission rates be approved by the Department of Finance.

21.	The Exchange also argued that, even if the fixed commission rules could be considered to offend against section 4(1), a licence was justified.  It was stated that the primary objective of the fixed commission rules was to implement the provisions relating to the licence to deal in Government securities on a commission basis which must be obtained from the Minister for Finance.  The Exchange submitted that brokers had contributed to the development of the secondary trading in gilts and an increase in the liquidity of the market.  It indicated that without fixed commissions it would be impossible to distinguish between an agency transaction and a principal transaction and that this would lead to a deterioration in the quality of the market.  It was claimed that this would cause a significant number of investors, especially overseas investors, to cease to trade.  Competitive broking would therefore disappear.

22.	The Stock Exchange argued that the elimination of fixed commissions would cause the market to evolve fairly quickly into one of competing market‑makers.  They claimed, however, that there were only two or three domestic banking groups with the high level of capital required for adequate market‑making and that it was therefore unlikely that a competitive market making system could be put in place.  They also submitted that to increase the number of competitive market makers it would be necessary to attract foreign houses, `so transferring employment and value added abroad.'

23.	The Exchange argued that broking was essential to the maintenance of market liquidity.  They also submitted that any change to the system could damage market confidence which would be difficult to re‑establish.  They stated that domestic market participants did not consider that gilt commissions were a particularly important factor.  They went on to state that:
	`The abolition of fixed commission rates would lead rapidly to a fundamental change in the structure of the gilt market and would lead to a less competitive, less liquid market dominated by larger financial institutions whose market making capacity would have to be supported by the Authorities.

	We believe there is a grave danger that in the absence of agency broking ‑ which would disappear without a minimum commission regime ‑ the liquidity of the market would dwindle and its continuing attraction to foreign investors would be greatly reduced.

	The reduction in liquidity would be reflected in wider spreads which would far outweigh any potential savings in commission levels currently required by the voluntary use of an agency broker.'

24.	In support of its request the Stock Exchange submitted a simulation exercise on Market Making on Long Bonds prepared by Mr. Barry Dillon of Davy Stockbrokers.  This claimed that market making would require relatively wide spreads thereby reducing liquidity in the market.  A separate study entitled The Development of the Irish Bond Market prepared by Mr. Jim O'Leary and Mr. Tony Garry, also of Davy Stockbrokers concluded that while spreads on Irish long gilts appeared relatively high, this was attributable to a number of factors including inter alia  the size of the market and the degree of stock dispersion.  It rejected arguments that the replacement of the present agency broking system with a market making system would have a positive effect on market liquidity.

(f)	Legislation.

25.	The Act for the Better Regulation of Stock Brokers 1799 provides inter alia that any licensed stockbroker shall not buy or sell Government stocks or securities on his own account when employed by any person not being a broker.  In 1918 the Stockbrokers (Ireland) Act was enacted which provided that the Dublin Stock Exchange could set maximum rates of fees which may be charged by a licensed stockbroker in Ireland on the sale or purchase of any Government stock or securities, subject to the approval of the Lord Lieutenant.  Responsibility for approving such rates now lies with the Minister for Finance.

(g)	Views of Third Parties.

National Treasury Management Agency

26.	Under the National Treasury Management Agency Act, 1990 the NTMA is responsible for the management of the national debt, a function previously discharged by the Department of Finance.  The NTMA has effectively assumed the Department's role of financing maturing debt and the Exchequer Borrowing Requirement (EBR) through the issue and sale of new gilts.  In addition the NTMA is also engaged in actively promoting depth and liquidity in the gilt market through active intervention in the secondary market.  This latter function is in contrast with the approach adopted by the Department in the past when the development of the secondary market was due purely to the activities of stockbrokers.  The NTMA in its submission to the Authority stated that it had `a vital and unique interest in any matter relating to Government securities, including the rules of the Irish Stock Exchange pertaining to those securities.'

27.	The NTMA went on to state that:
	`In the Agency's view the minimum fixed rate commission arrangement is not necessary for the proper functioning of the gilt market.  Moreover, the arrangement does not allow of a competitive broking system in as much as all investors, regardless of size, are obliged to pay the same price irrespective of the level or quality of service.  The Agency does not accept the Stock Exchange's assertion that the deregulation of commission rates would necessarily lead to a fundamental change in the structure of the market, in the form of market making, and to reduced liquidity.'
It noted that equity market transactions continue to be conducted on an agency‑only broker basis although negotiable commissions have applied since 1986.  It then stated that:
	`In any event, even if some form of market making were to be introduced in the gilt market following the abolition of fixed rate commissions, such a development, which would be in line with practice in most other European markets, would be welcomed in principle by the Agency.'

28.	The NTMA also argued that, while it was true that buyers and sellers of gilts were free to deal directly with one another and avoid paying commissions, the Exchange had the unique characteristics of prudential regulation and investor protection, so that the vast bulk of investors did not deal outside of it, giving brokers a de facto monopoly.  It pointed out that institutions who were actually managing funds on behalf of individual and corporate investors were under an obligation to those investors to deal at the best price.  By not dealing through the market they would be exposed to claims that they had not done so.  The NTMA also indicated that the Stock Exchange simulation, showing that market making in long gilts would reduce liquidity, was seriously flawed.

Irish Association of Investment Managers

29.	The Irish Association of Investment Managers (IAIM) represents institutional investors in the Irish market.  IAIM indicated that it had 18 corporate members who between them held 35‑40% of the total Irish gilt market with a considerably higher share of the medium and long end of the market to which fixed commission rates apply.  They claimed that IAIM members had paid £4.5m in commission on gilt transactions to Irish brokers in 1993.

30.	IAIM stated that it was opposed to the Stock Exchange's application for a certificate on the basis that the system of fixed gilt commissions contravened section 4 of the Competition Act.  It was also opposed to the Exchange's application for a licence as it believed that this would institutionalise an anti‑competitive practice which was not in the interests of the market and was unnecessary for the maintenance of an agency broking system.

31.	IAIM submitted that commission rates were payable to agency brokers for their services as intermediaries.  Commission rates include payment for the basic service of matching buyers and sellers and any added value provided by the broker over and above that basic role.  The latter includes the provision of research, advice, ability to deal in size, knowledge of international markets etc.  These demand a higher payment than would be the case for the basic service.  They argued that fixed commissions incorporated payments for a composite service and that it was anti‑competitive as it prevented new or existing brokers from offering a mix of one or more these services to clients at appropriate commissions.  It forced investors to buy a composite service and meant that brokers competed only on the basis of services offered, rather than on the basis of price and/or services offered.

32.	IAIM argued that an efficient market was not characterised by the existence of fixed commissions and that it could be argued that, with negotiable commissions, turnover and consequently liquidity would be increased.  In addition they submitted that the abolition of fixed commissions would not have the effect claimed by the Stock Exchange.  Specifically IAIM indicated that the move to a market making system was not an inevitable result of the abolition of fixed commissions.  They noted that the abolition of fixed commissions for equities had not resulted in a move to dual capacity.  Similarly they argued that the Exchange's claim that certain banks would use their position as owners or controllers of certain broking firms to obtain their services at nominal charges, thus leading to market making was not sustainable.  In support of this argument they pointed out that banks were the most active players in the short end of the market where commissions are negotiable and their involvement has not affected broking in shorts.  In addition it was claimed that, if such practices were to occur, the banks would realise that other investors would not deal with the broker concerned, thus undermining its viability.  They also claimed that banks with broking subsidiaries should be indifferent to commission levels as they were simply a transfer from one area of operations to another.

33.	In conclusion IAIM argued that the introduction of market making was not related to the issue of fixed commissions.  They did not accept the claim that the possibility of principals dealing directly outside the Exchange ensured that brokers did not have a monopoly.  However, they considered that the emergence of overseas brokers willing to compete on price and not bound by minimum commission rules had the potential to break the stockbroking monopoly.

Other Submissions

34.	A Mr. Frank Kelleher complained that the system of fixed commissions was anti‑competitive and that the granting of a licence for such a practice would not be in the interests of the country.  Mr. Kelleher indicated that he was currently involved in a venture that proposed to set up a technology driven trading organisation in Dublin and that the Stock Exchange had indicated that any attempt by an organisation to undercut the minimum commission rates would result in its membership being revoked.  He claimed that as his organisation aimed to undercut the current minimum level of commissions in order to attract clients, it was unlikely that the Exchange authorities would recommend that his organisation be granted membership, if and when, sought.

(h)	UK Experience.

35.	As pointed out above the Irish Stock Exchange is an administrative unit of the International Stock Exchange of the United Kingdom and Ireland.  Prior to October 1986, the UK Stock Exchange also required UK stockbrokers to charge minimum fixed commissions.  On 9 February 1979 the UK Director General of Fair Trading referred the Stock Exchange rules to the UK Restrictive Practices Court.  Among the main anti‑competitive restrictions cited by the Director General in announcing the reference was the provision preventing stockbrokers from providing services below specified minimum rates of commission.  The reference also cited certain other restrictions such as the provision that jobbers could not act as brokers and the requirement for all deals to be put through a jobber.

36.	On 27 July 1983 the UK Secretary of State for Trade and Industry announced that the Stock Exchange was to amend its rules.  In particular it proposed to dismantle in stages the rules which prescribed minimum scales of commission, with this process to be completed by 31 December 1986.  As a result the Government amended the UK Restrictive Practices Act to exclude the rules of the Stock Exchange from its provisions.  In fact the move from minimum to negotiated commissions was completed on 27 October 1986.  At that time minimum commissions for both equities and short gilts were also abolished in Ireland.  The Minister for Finance announced, however, that such commissions would be retained in Ireland in the case of dealings in medium and long term government gilts, although the rate of commission was reduced considerably.

(h)	Subsequent developments.

37.	In a report in the Irish Times on 3 January 1994, it was stated that the NTMA were anxious to see a change in the operation of the gilt market.  In particular the NTMA was reported to be seeking a move to a `market‑making' system in gilts.  Mr. John Corrigan of the NTMA was reported as expressing the view that such a system would improve liquidity in the market and would thereby lower the gap between Irish and German bond yields.  A report in the Sunday Business Post of 6 February again indicated that the NTMA were anxious to see a change to a market making system.  According to the report the IAIM were opposed to such a change.

38.	On 10 March 1994 the Authority issued a Statement of Objections to the Stock Exchange indicating that it intended to refuse to issue a certificate or grant a licence in respect of the notified arrangements.  In particular the Authority stated that, in its opinion, the rules setting minimum commissions for gilt transactions and requiring that brokers act only as agents in respect of such transactions were anti‑competitive and offended against section 4(1) of the Competition Act.  It also indicated that, in its view, none of these rules satisfied the requirements for a licence set out in section 4(2) of the Act.  On 6 April 1994 the Stock Exchange indicated that it had decided not to challenge the Authority's objections to the fixed commission regime.  It indicated that it did not accept the Authority's views on the agency rule and requested an Oral Hearing.  On 16 May 1994 the Stock Exchange informed the Authority that the rules on minimum commissions would be abolished with effect from 17 May 1994.  A report in the Sunday Business Post on 29 May 1994 indicated that gilt commissions had fallen significantly as a result of the abolition of minimum commissions and the introduction of negotiated commissions for all gilt transactions.  On 27 May 1994 the Stock Exchange informed the Authority that it was withdrawing its request for an Oral Hearing having decided not to contest the Authority's objections in respect of the agency rule.  It subsequently announced its intention to change this rule, subject to the approval of the Minister for Finance.  The IAIM wrote requesting that the Authority indicate in its decision whether the arrangements which IAIM would like to see introduced in place of the agent only rule would meet the requirements for a certificate or licence.

Assessment

(a)	Section 4(1)

39.	Section 4(1) of the Competition Act states that `all agreements between undertakings, decisions by associations of undertakings and concerted practices which have as their object or effect the prevention, restriction or distortion of competition in trade in any goods or services in the State or in any part of the State are prohibited and void.'

(b)	The Parties

40.	The notified arrangements involve certain rules of the Irish Stock Exchange.  The Irish Stock Exchange is constituted as an administrative unit of the International Stock Exchange of the United Kingdom and the Republic of Ireland Ltd.  It is owned by its members which are stockbroking firms.  Section 3(1) of the Act defines an undertaking as `a person being an individual, a body corporate or an unincorporated body of persons engaged for gain in the production, supply or distribution of goods or the provision of a service.'  Stockbroking firms are engaged in the provision of services for gain.  Consequently the Irish Stock Exchange is an association of undertakings within the meaning of section 4(1), as its members are undertakings.  This view is supported by EC law, as Bellamy and Child point out:
	`Although trade associations of various kinds are the commonest `associations of undertakings' the word `associations' is not limited to any particular type of association.  It includes agricultural co‑operatives, associations without legal personality, non‑profit making associations, associations of associations and an association outside the Community.3'
The legal form of the association has been found to be irrelevant.4

(c)	The Arrangements

41.	The notified arrangements involved the Stock Exchange Rules as they apply to transactions in Government gilts.  They provided that stockbrokers may only act in an agency capacity in respect of Irish Government securities and must charge a fixed rate of commission on transactions in medium and long gilts.  These conditions were set out in the `Rules and Regulations of the Irish Stock Exchange'.  The Rules constituted a decision by an association of undertakings.  This view is also supported by EC precedents.
	`The concept of `decision' includes the rules of the association in question, decisions binding upon the members and recommendations.  Agreements implemented within the framework of the association concerned may be analysed either as `decisions' of that association or `agreements' between the members.'5
The Rules of the Exchange and the Rules relating to minimum commissions also constitute an agreement between undertakings since they were agreed by the Member Firms which, as already pointed out, are undertakings.  Each of the relevant rules is now considered.

(d)	Applicability of section 4(1).

(i)	Minimum Commissions

42.	Rules 75.1(1) and 78.1 provided that brokers must charge no less than the rates adopted by the Irish Administrative Unit and set out in Appendix II of the Rules.  Lower rates were permitted under the Rules in certain limited circumstances.  The requirement in both of these Rules that brokers should not charge less than the rate of commission fixed by the Irish Exchange on transactions in Irish Government Gilts prevented price competition between stockbrokers in respect of such transactions.  The vast majority of transactions in Irish Government Gilts were conducted using stockbrokers.

43.	Theoretically it might have been possible for principals to by‑pass brokers and deal directly with one another.  The notifying parties in this instance had sought to argue that the arrangements were not anti‑competitive as investors did not have to deal through brokers.  It was argued in other submissions that this is not a practical alternative for a number of reasons.  Clearly if institutions by‑passed brokers they could avoid paying commission altogether.  The fact that the overwhelming majority of transactions are conducted through brokers implies that direct dealing is not a viable alternative.  Similarly while transactions could also be channelled through the futures exchange, the fact that there is so little activity in that market again suggests that it is not a viable alternative.  It is clear, therefore, that such alternatives do not represent a realistic alternative to brokers and that brokers did not have to depart from the fixed commissions as a result of competition from such alternatives.

44.	It was pointed out above that transactions in short dated gilts were not subject to fixed commissions.  The Authority believes that short dated gilts are not sufficiently close substitutes for mediums and longs to be regarded as part of the same market.  Consequently it does not believe that the absence of fixed minimum commissions on short gilts means that their application to mediums and longs did not amount to a restriction of competition.  Quite simply the Stock Exchange could not discriminate in this fashion between the commission rules applying to the different types of gilts if they were in fact substitutes for one another.  The rule prescribing fixed minimum commissions to be charged by brokers on transactions in Irish Government Gilts prevented brokers from competing on price, and this amounted to a restriction of competition within the State.

45.	Price fixing agreements have been consistently regarded as in breach of Article 85(1) of the Treaty of Rome.  Bellamy and Child point out that:
	`Since price is the main instrument of competition, Article 85(1)(a) expressly prohibits agreements, which "directly or indirectly fix purchase or selling prices or any other trading conditions."  An agreement to fix prices by its very nature constitutes a restriction on competition within the meaning of Article 85(1).'6

46.	They go on to state that:
	`Article 85(1) is infringed by an explicit agreement between suppliers to fix prices, and also by a concerted practice to restrict price competition, for example informal concertation on the dates and amounts of price increases or the exchange of price information.  Similarly the prohibition of Article 85(1) covers not only "prices" in the narrow sense but also discounts, margins, rebates and credit terms.'7

47.	Van Bael and Bellis point out that:
	`Although there exist no per se rules in EEC competition law, horizontal price fixing arrangements have always been held incompatible with Article 85(1) and have generally been denied an exemption'.8
In the US horizontal price fixing agreements have generally been regarded by the courts as a per se violation of the antitrust statutes.

48.	In a number decisions relating to the rules and regulations of a number of the London Futures Exchanges, the EU Commission decided that rules, which set minimum net rates of commission to be charged by members, infringed Article 85(1).  In the London Sugar Futures Market case, for example, the Commission stated that:
	`The Rules and Regulations as originally notified specified the minimum net rates of commission which could be charged by a member.  The Committee had powers to suspend or expel offending members.  The minimum commission rates varied according to who was paying and who was receiving the commission..........The Commission considered the above described system of specified minimum commission rates as a form of price‑fixing that violated Article 85(1) of the EEC Treaty.  The LSFM was requested to abandon the system of fixed minimum rates.  The system has now been abolished as such.  References to the system in the Rules and Regulations have been deleted.  The rules now provide that business concluded on the floor of the market between Full Members may be transacted free of commission.  Commission must be charged on all other transactions between members and non‑members.  The Commission believes that this obligation is not appreciably restrictive of competition because it only entails the obligation to charge `a' commission without any reference to the rate.  It follows that complete freedom exists to negotiate the commission rates.'9
The Commission took an identical view in a number of other cases where negative clearances were granted after the provisions specifying minimum rates of commission were dropped.10

49.	There are also a number of Commission decisions and judgments of the European Court of Justice in other cases which found that price‑fixing agreements infringed Article 85(1) and which are relevant to the present notification.  In IFTRA11 the EC Commission found that an agreement between producers of virgin aluminium not to sell below their published prices was in breach of Article 85(1).  The Commission found that the arrangements `provide the parties with means of shelter from competition to the extent that price stability is increased and that the parties are enabled to predict each other's price policy with a reasonable degree of certainty.12'
It went on to state that:
	`..every producer should have complete discretion to establish his own policy in these matters without risking the accusation that he is violating the spirit of an agreement.  The contractual organisation of a system requiring adherence to various existing prices and whereby price stability is encouraged by the recommendations which are made to the parties to use and adhere to price lists.....constitutes a major restriction of competition, both in its object and its effect.'13

50.	In Cementhandelaren the European Court of Justice ruled that:
	`The fixing of a price, even one which merely constitutes a target, affects competition, because it enables all the participants to predict with a reasonable degree of certainty what the pricing policy pursued by their competitors will be.'14

51.	In the present context it is also relevant that the European Court of Justice has ruled that:
	`A recommendation of an association of undertakings, even if it has no binding effect, cannot escape that article [85(1)] where compliance with the recommendations by the undertakings to which it is addressed has an appreciable influence on competition in the market in question.'15
It is clear, however, that the rules of the Stock Exchange go beyond being mere recommendations.  As pointed out above when one of the smaller stockbroking firms attempted to offer lower commissions on gilts to clients, the Exchange threatened to expel it.  The use or threatened use of sanctions to ensure compliance with the system of fixed minimum commissions supports the view that they are anti‑competitive.

52.	The Stock Exchange argued that a `standard' rate of commission would emerge even in the absence of fixed commission arrangements, given the nature of the market involved.  Thus they submitted that the arrangement merely formalised the structure that would emerge under a negotiated commission regime, except that it preserved the agency broking structure of the market, thus ensuring the transparency of every trade.  The Authority rejects this argument.  It is true that in the absence of fixed minimum commissions a uniform rate of commission might emerge as a result of competition.  In a truly competitive market homogeneous products would tend to sell at a uniform price.  There is, however, a fundamental difference between a price which is set by competitive market forces and one which is based upon an agreement between competitors or upon the rule of an association.

53.	The Authority also wishes to point out that, in its view, price fixing is anti‑competitive regardless of the level at which prices may be fixed.  It has long been recognised under US competition law, for example, that price fixing arrangements cannot be justified on the basis that the prices set were `reasonable'.  Thus, for example in Trenton Potteries16 Mr. Justice Stone noted that:
	`The aim and result of every price‑fixing agreement, if effective, is the elimination of one form of competition.  The power to fix prices, whether reasonably exercised or not, involves power to control the market and to fix arbitrary and unreasonable prices.  The reasonable price fixed today may through economic and business changes become the unreasonable price of tomorrow.'
A similar view was taken in Socony Vacuum Oil17 where the Supreme Court's judgment, as delivered by Mr. Justice Douglas outlining why the reasonableness of prices could not serve to justify price‑fixing stated:
	`The reasonableness of prices has no constancy due to the dynamic quality of business facts underlying price structures.  Those who fixed reasonable prices today would perpetuate unreasonable prices tomorrow, since those prices would not be subject to continuous administrative supervision and readjustment in light of changed conditions.'

54.	The Stock Exchange argued that the abolition of fixed commissions would lead to the breakdown of the agency broking system and the present arrangements would be replaced by a system of competing market makers.  They submitted that this would reduce liquidity and turnover in the market and raise costs.  The claim that the abolition of fixed minimum commissions would lead to the end of an agency broking system was disputed by both the IAIM and the NTMA.  Section 4(1) of the Act prohibits anti‑competitive agreements.  It is designed to protect competition not competitors.  The Authority in considering whether an arrangement offends against section 4(1) is required to decide whether or not it prevents, restricts or distorts competition.  It may be that the removal of anti‑competitive arrangements will result in a market structure very different to that which exists under such arrangements.  In particular it may well change the nature of the entities operating in the market.  It is not, however, for the Authority to express a preference for one type of system over another.  Rather it must decide whether a particular arrangement is or is not anti‑competitive.

55.	The Authority is not convinced that the abolition of fixed commissions would lead inevitably to a move to a system of market makers.  In taking this view it notes the views expressed by the IAIM and the NTMA.  It also notes that the absence of fixed minimum commissions in the equity market and in the case of short dated gilts has not resulted in a move to market making.  It is also relevant that attempts to offer discounts on gilts have been made by one of the smaller broking firms which would be unlikely to have the resources necessary to engage in market making.

56.	The Stock Exchange also argued that the restrictions in respect of commissions did not restrict competition as brokers competed in other ways such as quality of service provided to clients.  Many brokers provide a wide range of back‑up services to their clients including detailed economic analysis and advice.  Such services are financed out of commission income.  While minimum commissions financed such services, they meant that investors are prevented from deciding which services they want.  Many of the larger institutional investors have the resources to carry out their own detailed research and do so.  Yet they were obliged, under the notified arrangements, to pay for such services which they might not want.
57.	The Exchange did not argue that the commission arrangements were designed to prevent free riding although there may be some scope for this.  For example, if commissions varied depending on the level of back‑up services offered by brokers, then investors could obtain detailed analysis and advice from the broker providing such services, but then deal through a broker charging a lower commission and not providing such services.  There appears to be no reason why brokers offering detailed research and analysis to their clients could not specifically charge for such services thereby avoiding the free rider problem.  Indeed it is possible that if cross subsidisation of such services were eliminated a situation might arise whereby specialist firms decided to offer such services to meet the demands of gilt market investors.

58.	In sum therefore the Authority believes that the setting of fixed minimum commissions by the Stock Exchange for transactions in Irish Government securities, which had to be adhered to by all member firms, eliminated the possibility for stockbrokers to compete on price in the secondary market for such securities.  In the Authority's opinion the elimination of price competition in this way prevents competition in the relevant market.  Agreements to fix selling prices are listed as a specific example of the type of agreement prohibited by section 4(1) of the Act.  Consequently in the Authority's opinion the rule requiring Stock Exchange members to charge minimum rates of commission on Irish Government securities offended against section 4(1).

59.	Rule 79.1 and 2 provided for lower, albeit fixed rates of commission to be applied in respect of a new security issue with a maturity date of more than ten years on transactions effected within three months of the first day of dealings done for the same principal in such a new issue.  Again, in the Authority's opinion this rule offended against section 4(1) since it fixed a minimum rate of commission to be charged on such transactions.  The fact that this was lower than the normal rates applied under Rule 78.1 is irrelevant for the purpose of determining whether or not it offends against section 4(1).

60.	Rule 81 allowed for certain reductions in the case of a change from one security to another for the same principal.  Again, however, as this specified the reductions which may be offered from the standard rates it also offended against section 4(1).

61.	The 1918 Stockbrokers (Ireland) Act provides for the setting by the Stock Exchange of a maximum  rate of fees which may be charged by licensed stockbrokers on gilts.  The Rules which were considered in the preceding paras relate to the fixing of minimum rates of commission.  The Authority does not believe that the fixing of minimum commission rates was permitted by that Act thereby excluding such a practice from the scope of section 4(1) of the Competition Act.

(ii)	The Agent Only Rule.

62.	Rule 49.1 provides that Stock Exchange member firms could only deal as an agent in respect of any security issued or guaranteed by the Government of the Republic of Ireland.  If this restriction were removed certain types of institutions which currently operate as principals might be interested in offering broking services.  In reality a number of large financial institutions have stockbroking firms as wholly owned subsidiaries and there appears to be nothing to stop any institution setting up its own broking subsidiary or acquiring one.  Consequently the restriction would not appear to have the effect of preventing new entrants from coming into the market for stockbroking services.

63.	The Authority must also consider whether the restriction on brokers acting as principals prevents, restricts or distorts competition in the gilt market itself.  The Authority has accepted the view that the abolition of fixed commissions will not automatically lead to a system of market making and that in such circumstances brokers may continue to operate in an agency only capacity.  Indeed they would be required to do so if Rule 49.1 remained.  Clearly this rule prevented brokers from operating as buyers and sellers of gilts in the gilt market  The rule requiring brokers to act only as agents prevented them operating as market makers should they wish to, and indeed appeared to prevent any other entity from operating as a market maker, since such an entity would in effect be operating outside of the market.  In the absence of such a restriction some broking firms could conceivably decide to operate as market makers.  This would obviously have some impact on competition in the gilt market itself.

64.	The Authority accepts that the establishment of a market making operation would require a considerable capital investment and that this would appear to be beyond the existing resources of most brokers.  Thus it may be that only a small number of brokers might establish themselves as market makers, while the others would continue to act as agents, or that agent only brokers might not survive.  It might also be that the removal of the agency restriction might cause a number of smaller brokers to establish links with overseas institutions in order to set up a market making operation.  Indeed this appeared to be a concern of the Stock Exchange which submitted that to increase the number of competitive market makers it would be necessary to attract foreign houses, `so transferring employment and value added abroad.'  Again the entry of such overseas entities would appear likely to enhance competition in the market and the Authority would point out that anti‑competitive arrangements cannot be justified on the basis that they keep foreign competitors out of a market.  Essentially the agency only rule prevented the emergence of market makers which might otherwise be expected to operate in the gilt market and other forms of dealing enterprise.  Competition on the gilt market may therefore be said to have been distorted to a degree, by the requirement that brokers act only as agents.  Consequently this provision also offended against section 4(1).

65.	The Authority notes that the 1799 Stock Brokers Act provides that brokers must not buy or sell on their own account when employed by any person not being a broker.  This restriction does not prevent them acting as other than an agent when not employed by some other person.  On balance therefore the Authority concludes that the obligation contained in Rule 49.1 that brokers act only as agents offended against section 4(1).

(e)	Applicability of Section 4(2)

66.	Under Section 4(2), the Competition Authority may grant a licence in the case of any agreement or category of agreements which offend against Section 4(1) but which, `having regard to all relevant market conditions, contributes to improving the production of goods or provision of services or to promoting technical or economic progress, while allowing consumers a fair share of the resulting benefit and which does not ‑
(i)	impose on the undertakings concerned terms which are not indispensable to the attainment of those objectives;
(ii)	afford undertakings the possibility of eliminating competition in respect of a substantial part of the products or services in question.'

(i)	Minimum Commissions

67.	The requirement that brokers charge fixed minimum commissions on transactions in Irish Government Gilts did not satisfy the criteria set out in Section 4(2) of the Act for a licence, in the Authority's view.  The Authority does not believe that the rule on fixed minimum commissions contributes to improving the distribution of goods or provision of services or to promoting technical or economic progress.  On balance it tends to accept the argument that the abolition of fixed commissions would enhance the degree of liquidity in the market.  Consequently minimum commissions may actually hinder the further development of the market.  It accepts that brokers have in the past contributed to the development of the market particularly when official agencies may not have been actively developing such business.  In particular it accepts that they played a major role in attracting overseas investors into the market.  It does not believe, however, that fixed commissions were essential for that purpose.  Given that the Authority does not consider that the arrangements lead to any efficiency benefits, consumers, in this instance the clients of stockbrokers, by definition, do not benefit from such gains.  In fact orthodox economic theory indicates that price‑fixing agreements are detrimental rather than beneficial to consumer interests because cartels are inefficient and lessen consumer welfare.

68.	The Authority does not believe that a system of fixed commissions is indispensable to the continued development of the gilt market.  In addition as the vast bulk of transactions in government gilts is conducted through stockbrokers the arrangements afford the undertakings involved the possibility of eliminating competition in respect of a substantial part of the market in question.  As all four elements of section 4(2) must be satisfied before a licence may be granted the notified arrangements do not meet the requirements for a licence.

69.	In coming to the conclusion that the fixed minimum commission rules do not satisfy the criteria for a licence the Authority took account of the fact that over a period of 30 years the EU Commission has virtually never exempted price‑fixing arrangements from the prohibition contained in Article 85(1).18  It can see no reason for departing from well established EU precedents in the present case.  It is also relevant that price‑fixing is generally prohibited under the competition laws of most developed economies.

(ii)	The Agent Only Rule.

70.	In the case of Rule 49.1 that brokers act only as agents the Authority considers that this can contribute to technical and economic progress and indeed accepts that the agency system contributed to the development of the market over the past decade.  It believes that consumers in the form of investors have shared in such benefits.  It does not, however, believe that the restriction is essential for the development of the market and so it cannot be regarded as indispensable.  The Authority does not believe that the restriction affords the undertakings concerned the possibility of eliminating competition in respect of a substantial part of the market.  Nevertheless as it did not meet all four of the requirements specified for the grant of a licence, the Authority was unable to grant a licence to this restriction. 

The Decision.

71.	The Irish Stock Exchange is an association of undertakings since all of its member firms are themselves undertakings being engaged in the provision of services for gain.  The Rules and Regulations of the Irish Stock Exchange, including those relating to transactions in Irish Government Securities, constitute decisions of an association of undertakings and agreements between undertakings.  In the Authority's opinion the following Rules, namely:
	Rule 49.1 which required that brokers act only as agents in respect of transactions in Irish Government securities;
	Rule 75.1 which required brokers to charge fixed minimum rates of commission on such transactions;
	Rule 78.1 which set out fixed minimum rates of commission which had to be applied to such transactions;
	Rule 79.1 and 2 and Rule 81 which provided for lower rates of commission in certain limited circumstances;
had as their object and effect the prevention, restriction or distortion of competition in the market for Government securities within the State and thus offended against section 4(1).  They did not, in the opinion of the Authority, satisfy the requirements for a licence set out in section 4(2).  Consequently the Authority refuses to issue a certificate or grant a licence to the Irish Stock Exchange Rules in respect of Irish Government securities, (CA/199/92E), notified on 29 September 1992. 

72.	 The rule on fixed commission has now been abolished by the Irish Stock Exchange.  The present decision is not concerned with any new rules which might be introduced by the Irish Stock Exchange in respect of dealings in Government Gilts as no such arrangements have been notified to it. The Authority has not considered the proposals made by the Irish Association of Investment Managers to replace Rule 49.1.  The Authority's role is to consider whether arrangements notified to it by the parties involved offend against section 4(1) and, when they do, whether they meet the requirements for a licence under section 4(2).

For the Competition Authority

Patrick Massey
Member 
10 June 1994

Annex 1:  Irish Stock Exchange Member Firms.

		B.C.P. Stockbrokers, 72 Upper Leeson Street, Dublin 2.

		Bloxham Stockbrokers, 9-12 Fleet Street, Dublin 2.

		Butler & Briscoe, 3 College Green, Dublin 2.

		Campbell O'Connor & Co., 8 Cope Street, Dublin 2.

		Davy Stockbrokers, 49 Dawson Street, Dublin 2.

		Goodbody Stockbrokers, 5 College Green, Dublin 2

		Money Markers International, Stockbrokers Ltd, 26 Lower Baggot Street, Dublin 2

		W & R Morrogh, 74 South Mall, Cork

		NCB Stockbrokers Ltd., 45/53 Lower Mount Street, Dublin 2

		O'Brien Stokes Stockbrokers, 36 Dame Street, Dublin 2

		Riada Stockbrokers, 1 College Green, Dublin 2
			
		Solomons Stockbrokers, Stephen Court, 18/21 St Stephens Green, Dublin 2.