[1] Susan Ning is a Partner and the Head of the Antitrust / Competition Division at King & Wood PRC Lawyers (please see bio at: http://www.kingandwood.com/lawyer.aspx?language=en&id=susan-ning).

[2] Liu Jia is an associate at King & Wood’s Antitrust / Competition Division and Sun Yiming is an intern at King & Wood’s Antitrust / Competition Division.

Most recently, the hottest topic on China’s Anti-monopoly Law (AML) is a piece of news spreading on the internet, indicating that China Telecom, one of China’s largest state-owned enterprises is under antitrust investigation conducted by a “relevant” competition authority for its suspected abuse of dominance in broadband market. If the abuse is successfully established, China Telecom may face huge fines under the AML. The news is also quoted by Xinhuanet.com, an authoritative website run by the government. However there has been no formal response from China Telecom or any competition authorities so far in this respect.

This article outlines details to do with China Telecom’s conduct and examines whether or to what extent such conduct would be considered as an abuse of dominance and thus in violation of the AML.

Fact

From the news and other public available sources, we understand that the antitrust investigation may focus on whether China Telecom abused its dominance in broadband backbone network market by charging other broadband access network operators a price for using its backbone network that is much higher than the price China Telecom charge the other internet operators, for the purpose of squeezing out the other access network operators.

* China Telecom’s position in the market of broadband backbone network services and broadband access network services

The broadband backbone network is the principal data routes that connect different networks among cities, countries or even continents. In China, there are only two nationwide duopolists running backbone networks, i.e. China Telecom and China Unicom. In fact, rather than competing with each other, China Telecom monopolizes the backbone network service market in South China, while China Network monopolizes the market in North China. Broadband access networks are built to approach the broadband end-users such as families and enterprises. China Telecom and China Unicom also are big players in providing access network services, whereas other operators such as Great Wall Broadband, China Railcom and China Mobile are active as well. Since all of these broadband access network operators have to connect to the broadband backbone network, they are heavily dependant on broadband backbone network operators, i.e. China Telecom in South China, and China Unicom in North China. In particular, under the Measures for Inter-network Settlement at Internet Exchange Center (hereinafter referred to as “Settlement Measures”) promulgated by the Ministry of Industry and Information Technology (MIIT), these operators are required to pay backbone network access fees (access fees) to China Telecom and China Unicom. Moreover, the cap of the access fees is also provided in the Settlement Measures.

* China Telecom’s alleged abusive conducts

As alleged in news reports, China Telecom may have charged competing access network operators an access fee that is three times or even a dozen times higher than other types of users such as internet content providers (ICPs). By forcing its rivals to pay much higher access fees, China telecom may thus be in a better position to expand its own business in providing broadband access network services. In practice, to avoid the hefty access costs, the other access network operators usually buy bandwidth from third parties (such as the ICPs), as the cost could be much lower.

* Reported antitrust investigation

The investigation is said to be triggered by an August 2010 internal circular of China Telecom, under which China Telecom required its provincial branches to cut down connection to the backbone network if the access is achieved through buying the bandwidth from a third party. The crackdown measures are reported to have adversely affected a wide range of broadband access network operators including many state-owned operators, and as a result affected thousands of internet end-customers.

It is reported that the antitrust investigation by “a relevant antitrust authority” started in the first half of 2011 and it has already carried out many rounds of inquiries and evidence collections with China Telecom. A number of access operators, research institutions and experts were also approached for verification. It is also reported that the authority has drawn a preliminary conclusion that the conducts of China Telecom as mentioned above can be found as constituting abuse of dominance. So far, there is no official response from any government authorities in this respect.

Comments

Since large state-owned enterprises in telecommunications, a traditionally highly concentrated industry, are involved, the news attracted lots of attention in spite that the sources and accuracy of the information still need to be verified. Observers are pondering whether this is a sign that the Chinese competition authorities are ready and eager to show their teeth to large state-owned enterprises.

* Whether an abuse of dominance can be found?

Assuming China Telecom’s accused conducts truly existed, we consider that such behaviors are likely to be caught by Article 17(1) or Article 17 (6) of the AML. Article 17(1) of the AML provides that a dominant operator shall not abuse its dominance by charging unfairly high or low prices. Article 17(6) of the AML provides that a dominant operator shall not abuse its dominance by “implementing differential treatment for terms of transaction such as transaction price for similar trading counterparts without a valid reason”. As is the case for all abuse of dominance cases, the threshold issue would be to identify a relevant market and then to determine whether there is a dominant position in the relevant market. In addition, in relation to Article 17(1) of the AML, the key issue would be whether the access fee is unfairly high, which could be drawn by a comparison with China Telecom’s relevant costs. In relation to Article 17 (6), it is still left to be argued whether the access network operators and other types of users are “similar trading counterparts” that deserve to be charged at the same price level. To defend itself from both accounts, China Telecom may argue that the highest access fee it charges its rivals is still below the price cap set in the Settlement Measures by MIIT. In other word, the price charged by China Telecom to other access network operators is still in compliance with the guidance price set by the government.

We understand that this case is similar to the famous Deutsche Telekom case, in which Deutsche Telekom charged a higher access fee at wholesale level than at the retail level to force its competitors to charge their end-user higher price (so-called “margin squeeze”). This was found to be an abusive conduct by European Commission in 2003 and confirmed by the European Court in 2008 (Case T-271/03), and the defendant’s similar argument was not accepted by the European Court. The Court pointed out that compliance by Deutsche Telekom with the industrial regulation did not absolve it from responsibility under competition law. Besides, we also noticed that, according to the news report, it is China Telecom’s crackdown measures (rather than the higher price charged) that triggered the possible investigation. We consider that the crackdown itself may also be suspicious of violating Article 17 (3) of the AML which prohibits the dominant operators from refusing to transact with trading counterparts without a valid reason. The disputable point in this scenario is whether China Telecom has any valid reasons to prohibit resale of bandwidth if such resale does not violate any laws or regulations.

* Who is the investigation authority and what are the possible results?

Although no public sources have identified the specific authority, we understand the proper investigation authority should be the National Development and Reform Commission (“NDRC”) since the major conducts under the said antitrust investigation (i.e., charging the other access network operators a much higher access fee) are price-related.

According to Article 47 of the AML, once an operator was found guilty for abusing dominance, the anti-monopoly enforcement agency, who in this case is possibly NDRC, shall order the operator to stop the illegal act, confiscate its illegal income and impose a fine of 1% to 10% of the sales amount of the preceding year. If such penalties are to be imposed, it will not only be the first time for a fine to be imposed on a state-own enterprise under the AML but also will likely involve a huge sum of money, given that, according to the mid-term report published by China Telecom, the revenue generated from broadband access services in the first half of 2011 amounts to almost RMB30 billion. Furthermore, if fines were imposed here, it will be interesting to see how the “illegal income” and specific amount of fines would be determined, by considering the nature, extent and duration of the illegal acts according to Article 49 of the AML.

* Will the fine be imposed to China Telecom.

Early this June, the European Commission imposed a fine on a Polish telecommunications company for abusing its dominant position on the Polish broadband market. We notice that the Polish case as well as the aforesaid Deutsche Telekom case shares many similarities with the reported China Telecom case although we doubt that the Chinese competition authorities would go that far as the European Commission and European Court.On the other hand, stakeholders in the industry seem to hold a negative view on the antitrust investigation and the possible fines. Some of them believe that the issue in the spotlight can only be addressed by revising the Settlement Measures which set a too high price cap for the access fee that is totally outdated. Some even believe that this issue can only be dealt with once and for all by reconstructing the whole broadband industry. MIIT, who is responsible for updating the Settlement Measures and regulating the industry, may also be expected to adopt some measures to solve the issue. This brings us to the common problem of how the anti-monopoly enforcement agencies and industry regulators will cooperate with each other when antitrust issues come forth.

We will keep an eye on this case and follow up if there is any substantive development.