UK competition law and the quest for net zero
Businesses commonly cite competition law as a reason for dialling back on joint initiatives that might help to address climate change. This has led to growing pressure on competition authorities to consider if, and how, competition law enforcement should adapt to facilitate collaboration between competing firms for these purposes.
Some authorities, including the European Commission, have been wary of condoning co-operation for sustainability purposes, based on the concern that companies will seek to “greenwash” illegitimate conduct 1. Conversely, the Dutch Authority for Consumers & Markets has been a leading proponent of a more flexible approach, and there have been calls for the CMA to follow-suit.
As anticipated by our previous article, the CMA published draft guidance on 28 February 2023 on the application of UK competition law to environmental sustainability agreements (the Draft Guidance). The Draft Guidance (on which the CMA is currently consulting) represents potentially the most significant departure from EU competition law principles since Brexit, in particular as regards a more flexible approach in relation to “climate change agreements”, which would become easier to exempt from UK competition law.
This approach appears to be partly motivated by the UK’s international obligations in relation to climate change (such as the commitment to net zero by 2050), but also more broadly by what the CMA calls “the special category of threat” that climate change represents. The World Economic Forum’s Global Risk Report 2022 listed climate action failure, extreme weather and biodiversity loss as the three most severe risks on a global scale over the next 10 years. In the UK the Bank of England and FCA see climate risk (both physical and transition) as a significant threat to the economy and financial stability, which they are responding to with stress testing and regulatory change.
The CMA guidance also makes helpful progress in several other areas, including by acknowledging that co-operation between rivals to achieve climate change goals may legitimately overcome first mover disadvantages (in terms of costs/investment relative to rivals) that can otherwise disincentivise companies from taking unilateral action to change their business models to combat climate change.
The legal context
Chapter I, Section 2 of the Competition Act 1998 prohibits certain agreements and practices that have “as their object or effect the prevention, restriction, or distortion of competition”. Not every agreement between competitors falls foul of this provision. But even where an agreement does so, Section 9 of the Competition Act 1998 can exempt agreements that “contribute to improving the production or distribution…or to promoting technical progress, while allowing consumers a fair share of the resulting benefit” provided they do not impose any restrictions that are not indispensable to achieving those objectives and do not eliminate competition.
An assessment under Section 9 requires a balancing act between the competitive harm and the benefits of an agreement. Recent years have seen considerable debate about how environmental benefits should be weighed against competitive harm for these purposes. Although it has long been accepted that environmental benefits can be taken into account, there has been significant debate as regards whether authorities should take account of environmental benefits that accrue to society at large, or just the narrow group of customers who purchase the relevant product or service. European competition authorities have tended to focus on benefits accruing only to the customers who suffer the anticompetitive harm, and not broader societal benefits arising from an agreement, though this interpretation of EU law has been challenged, including by the Dutch Authority for Consumers & Markets.
Overview of the Draft Guidance
The Draft Guidance has three key sections.
The first addresses scenarios where the CMA does not consider competition law is engaged at all. This is relatively modest in scope but helpfully sets out several types of agreement that do not materially restrict competition, including as regards common open standards and certification (for example similar to “Fair Trade” certification).
The second substantive section explains how the CMA will apply the Section 9 exemption to sustainability agreements. The CMA explains its approach to each of the four “efficiency” criteria, that must be established for the exemption to apply:
- the agreement must give rise to benefits to production, distribution or technical or economic progress (Condition 1);
- the restriction to competition arising from the agreement must be indispensable to achieve those benefits (Condition 2);
- consumers must receive a fair share of the benefit (Condition 3); and
- there must be no elimination of competition (Condition 4).
We briefly consider below the CMA’s approach to each of Conditions 1-3 below (the CMA’s approach to Condition 4 does not make any specific allowance for sustainability agreements).
Condition 1 - Efficiencies
The Draft Guidance indicates some of the types of sustainability benefit that the CMA will take into account for purposes of the Section 9 exemption:
- addressing harmful external effects that the markets have failed to correct;
- creating new greener products;
- reducing production and distribution costs, for example by creating economies of scale in relation to a new more sustainable input;
- introduction of cleaner production and distribution technology; and
- driving new innovative environmentally friendly processes.
The Draft Guidance emphasises that these benefits must be objective, concrete and verifiable, although the CMA recognises that longer term future environmental benefits may be relevant (see further below on how benefits can be quantified).
Whilst this part of the Draft Guidance helpfully confirms that the CMA will consider environmental benefits to be “efficiencies” for the purposes of applying Section 9, this was not previously in debate, so the Draft Guidance does not provide a material update in this area.
Condition 2 – Indispensability
The second condition under the Section 9 exemption is that the parties demonstrate that the restriction of competition arising from the agreement is indispensable; in other words “there must be no less restrictive but equally effective, alternative”. The CMA explains that this will be the case where the parties can demonstrate that they would not be able to achieve the same level of benefits, or obtain those benefits as quickly, if they were acting independently.
The Draft Guidance provides two helpful examples where agreements might be considered indispensable within a sustainability context:
- competitors entering into a collective purchasing arrangement in order to increase demand and drive economies of scale for a new more sustainable input (e.g. a plastic replacement); and
- an agreement between competitors to switch to a more environmentally friendly (but more expensive) input in circumstances where no single company would be incentivised to make that change independently – i.e. where there is a “first mover disadvantage”.
The CMA makes clear that the Draft Guidance does not provide a generalised basis to justify moving away from competition simply by referring to pursuit of environmental benefits. Even the above examples will not always be sufficient. In particular, the CMA makes clear that where there is a demand for a sustainable product, and customers will in practice buy the more expensive, sustainable product, it will expect businesses to compete to satisfy that customer demand.
Condition 3 – Consumer benefit
The third condition - that consumers must receive a fair share of any benefit - has been one of the most controversial. There are two main schools of thought in this respect. The conservative approach, at least in recent years, has been restricted to “in-market” efficiencies, i.e. only those customers that purchase a given product can be considered when assessing whether a fair share of the benefits have been passed on.
This is often sufficient when considering supply chain efficiencies – if money is being saved, some of these savings may be shared with customers. However, this approach often falls down when considering sustainability agreements because the true environmental cost of a product is not only borne by the purchasing consumer but is rather spread across society (so-called negative externalities).
The second school of thought, which has been promoted by the Dutch Authority for Consumers & Markets, is that both “in-market” benefits and “out-of-market” benefits should be taken into account, (though some argue that if negative externalities were properly factored into prices in the first place with robust government policies, e.g. through an effective carbon pricing system this point would become moot).
The CMA’s general approach remains that only in-market benefits should be taken into account, except with respect to climate change agreements (addressed separately, below). This can create challenges where the environmental benefits of a given agreement are enjoyed far beyond its consumers, or where those consumers are insensitive to a given sustainability benefit that nevertheless has significant value (though this may be offset by evidence from so-called “willingness to pay” surveys demonstrating consumer demand for more sustainable products). That said, the Draft Guidance does note, consistent with the position of the European Commission, that consumers in “related” markets can be taken into account, provided the consumers affected by the restriction and receiving the benefit are “substantially the same or substantially overlap”.
Once the relevant consumers have been identified, the parties must quantify the benefits of the agreement and demonstrate that they are sufficiently substantial to offset the harm arising from the restriction of competition. The Draft Guidance helpfully notes that in many cases it will not be necessary to quantify the benefits precisely, particularly where they are clearly sufficient to offset the harm to competition, for example because the agreement will give rise to only a limited restriction of competition but a significant sustainability benefit. However, it remains to be seen in practice how many cases the CMA is willing to consider that the benefits are sufficiently clear not to require at least a degree of quantification.
In less straightforward cases, the Draft Guidance provides examples of ‘established techniques’ that can be used, for example, the use of instruments for carbon pricing such as those used in relation to the UK Emissions Trading Scheme to put a price on the greenhouse gas emissions. Many businesses are already using internal carbon pricing mechanisms in order to manage their carbon footprints and reporting on this is anticipated by the draft climate disclosures of the International Sustainability Standards Board (the ISSB).
The Draft Guidance makes clear, however, that the quantification exercise should be proportionate: “businesses should apply these techniques commensurate with the size of the agreement’s effects” and “follow best practice appropriate for the industry in which they operate and the nature of the environmental benefits at hand.” Nevertheless, due to the expertise required to apply some of the methodologies listed as examples, there may well be cases where companies will require assistance in relation to the quantification exercise from external advisers, such as environmental economists, or have calculations audited or verified by an external consultant.
Climate change agreements
The Draft Guidance proposes a different approach in the case of climate change agreements. The CMA plans to exempt these agreements if the “fair share to consumers” condition can be satisfied, taking into account the totality of the benefits to all UK consumers arising from the agreement, not just those that are affected by the distortion of competition. The CMA justifies this approach on the basis that climate change “represents a special category of threat that sets it apart and requires a different approach”.
To benefit from this approach, the parties to the climate change agreement would need to demonstrate that its benefits are in line with legally-binding requirements in relation to climate change or well-established national or international targets, that UK consumers as a whole benefit from the agreement, and that the benefits offset the harm.
Such an exercise therefore still involves, in principle, a quantification both of the potential harm to competition and of the benefits to society. Nevertheless, the CMA has indicated that it may not always be necessary to precisely quantify those benefits. This may include agreements where the benefits to wider society are obvious and significant, but the competitive harm that results is likely to be low, such as only a limited increase in price or reduction of choice to consumers.
Conversely, where it is unclear whether the total benefits are sufficient to outweigh the total harm, the Draft Guidance indicates that the CMA will expect a more precise approach to quantification. In practice, this will be the case for agreements that are likely to result in a significant increase in price to end consumers of the product or service.
What will be considered to be “climate change agreements” for these purposes?
The Draft Guidance provides that “climate change agreements” are a subset of environmental sustainability agreements, and the term covers agreements that contribute towards the UK’s binding climate change targets under domestic or international law: “such agreements will typically reduce the negative externalities from greenhouse gases, such as carbon dioxide and methane, emitted from the production and consumption of goods and services.” 2
The question of exactly where the line is drawn will not always be straightforward. For example, an agreement to reduce or eliminate certain types of plastic packaging may have as an effect a reduction in carbon emissions during the production process, thereby “reduc[ing] the negative externalities from greenhouse gases” such that it could in principle be classified as a climate change agreement. However, the extent to which the CMA will interpret the Draft Guidance flexibly is unclear and we anticipate it will realistically depend on the extent of such reductions in greenhouse gas emissions as a result of the agreement in question.
The CMA does appear to be conscious of the potential difficulty for businesses of determining exactly where the line is drawn, since it is consulting with interested parties on any changes that those parties feel would improve or bring greater clarity to the description of climate change agreements in the guidance.3
An “open door” policy
The Draft Guidance helpfully provides that the CMA intends to operate an open-door policy, enabling businesses to approach the CMA for informal guidance on proposed environmental sustainability agreements.
The CMA does not typically offer this in relation to other categories of horizontal agreements, so it is another indication that the CMA is keen to work constructively with businesses on environmental and sustainability agreements. It may also be an implicit acknowledgement that assessing such agreements may not be straightforward.
The CMA notes that it would typically expect businesses to make contact at an early stage in the development of an environmental sustainability initiative, having first conducted an initial self-assessment of their agreement following the principles set out in the guidance, including a quantification of the relevant environmental benefits. The parties should highlight the specific issues that are not clear from the guidance and where they need advice from the CMA. 4
The CMA draft guidance also suggests that businesses who do seek guidance from the CMA will be able to obtain a certain level of comfort that they will not be fined for entering into the agreement: “We will not issue fines against parties that implement an agreement which was discussed with the CMA in advance and where the CMA did not raise any competition concerns (or where any concerns that were raised by the CMA have been addressed).” 5
This is subject to the condition that the parties did not withhold relevant information from the CMA that would have made a material difference to its assessment. The CMA also expects parties “to make any adjustments required to bring the agreement in line with competition rules”.
Finally, the Draft Guidance suggests that the CMA intends to publish anonymised summaries of sustainability agreements that have been shared with it for consultation. This is intended to enable a body of positive decisional practice to evolve, demonstrating to businesses the types of agreements to which the CMA has given its informal approval.
Conclusion and next steps
The Draft Guidance is encouraging for those who believe that competition law should be doing more to facilitate businesses’ desire to address climate change. Notably, there does appear to be a genuine move towards a more flexible approach for ‘climate change agreements’, which goes significantly beyond the approach adopted by the European Commission. However, there is no clear legal basis for the creation of two tiers of sustainability agreements, and it is unclear how the CMA will distinguish between the two in practice. More broadly, it remains to be seen how the CMA applies the principles in the Draft Guidance in practice; the CMA’s intention to publish a summary of some of the different environmental sustainability agreements or initiatives that it has been approached about as part of the open-door policy is particularly welcome. 6
The CMA is inviting comments on the Draft Sustainability Guidance by 5pm on 11 April 2023. Following the consultation, final guidance will be prepared. The CMA currently intends to integrate the guidance into the broader guidance on the application of the Chapter I prohibition in the Competition Act 1998 to horizontal agreements.
1Note in this regard, Competition policy in support of the Green Deal, Executive Vice-President Vestager’s keynote speech at the 25th IBA Competition Conference of September 10, 2021, delivered by Inge Bernaerts, Director, DG Competition and https://www.macfarlanes.com/what-we-think/in-depth/2021/environmental-sustainability-and-competition-law-in-europe-where-are-we-now/
3 Paragraph 4.3, ‘Draft guidance on the application of the Chapter I prohibition in the Competition Act 1998 to environmental sustainability agreements, Consultation document, 28 February 2022, CMA177con’