Proposed acquisition by Valpak Ltd of an interest in the Environment Exchange Ltd

No. ME/1142/03

A report under section 125(4) of the Fair Trading Act 1973 on the advice given on 29 May 2003 to the Secretary of State for Trade and Industry under section 76 of the Act

Jurisdiction

The merger satisfies the share of supply test of the FTA in respect of the supply of the means whereby companies may meet their obligations to recover and recycle packaging material under the Producer Responsibility Obligations (Packaging Waste) Regulations1997 (the Regulations).

The parties

Valpak Limited (Valpak) is a company limited by guarantee, established in 1997 on a not-for-profit basis. Valpak's principle current activity is the provision of compliance services to its customers through the operation of a registered compliance scheme. A compliance scheme fulfils its members' obligations to recycle packaging waste under the Regulations.  In 2001, Valpak had a turnover of £44.7m.

The Environment Exchange Limited (the Exchange) is a wholly owned subsidiary of Enviromac Limited (Enviromac), whose sole member and director is Angus Macpherson (the current shareholder). In 2002, the Exchange had a turnover of £311,000 and net assets at the end of December 2002 of £67,000. The Exchange provides a means by which Packaging Waste Recovery Notes (PRNs) can be traded and obtained by companies and schemes needing to meet their obligations under the Regulations.

The transaction

Upon completion of the transaction, Valpak, through its subsidiary Valient Holdings Limited will acquire a 40 per cent stake in the Exchange.  Valpak will also have two directors on the board of the Exchange with one vote each and the current shareholder will have two votes. The independent chairman will not have a vote save in relation to a matter in which a director has disclosed an interest. The acquisition of a 40 per cent interest together with two of the four directors is considered to confer on Valpak the ability materially to influence the policy of the Exchange within the meaning of section 65 of the FTA.

Background

The aim of the Regulations is to secure a more sustainable approach to dealing with packaging waste and to reduce the amount of such waste going to landfill.  In order to attain these objectives, they place obligations on businesses in the packaging chain - ranging from producers of raw materials to retailers who sell packaged products (collectively referred to as obligated companies) - to achieve target levels of recycling and recovery (see note 1) in relation to the amount of packaging they place on the market.  The Regulations require obligated companies to register with the appropriate environment agency to recover and recycle specific tonnages of packaging waste, and to certify those targets have been achieved. Broadly, these requirements apply to waste paper, glass, steel, aluminium and wood.  Obligated companies can fulfill their obligations either by taking the individual route and registering direct with the appropriate environment agency or they can join a registered compliance scheme. Membership of a compliance scheme exempts a firm from its own individual recovery and recycling obligations by transferring that obligation to the scheme. 

Assessment and recommendation

This transaction concerns the supply of the means whereby companies may meet their obligations to recover and recycle packaging material under the Regulations in the UK. 

The acquisition of a 40 per cent interest together with two of the four directors is considered to confer on Valpak the ability materially to influence the policy of the Exchange within the meaning of section 65 of the FTA. The resulting merger qualifies on the share of supply test since Valpak fulfils 49 per cent of the total UK obligation under the Packaging Regulations and the Exchange is used by individually obligated firms to meet another 4 per cent of the UK obligation. From an obligated company's point of view the closest substitute to Valpak is probably other compliance schemes and the closest substitute to the Exchange could be a broker, dealing with reprocessors direct, or Valpak / other compliance scheme.

Valpak could have an incentive to raise its prices after the merger knowing that some of the firms that left Valpak would switch to using the Exchange.  However, most of Valpak's customers are likely to switch to other schemes as they are closer substitutes to Valpak and the Exchange only makes up 4 per cent of the total obligation for obligated firms. Thus, increasing its own prices is unlikely to be a profitable strategy for Valpak. Moreover, since Valpak will only have a 40 per cent interest in the Exchange, its proportion of the benefit of any such switching will be limited.

In terms of barriers to entry, starting an exchange on which users could trade PRNs would cost around £350,000 and take three to six months.  The main barrier to a new exchange being successful may be its initial lack of liquidity.  The Exchange's users consider that it is important to be able to buy and sell quickly so it is unlikely that they would switch to an alternative exchange without liquidity unless it had a significant advantage in some way.  In addition, the Exchange appears to have built up a good reputation for efficient and anonymous trading which a new entrant would not have.

Customers of Valpak will not have significant buyer power as each customer only represents a small proportion of its turnover. In addition, customers are unlikely to be very price sensitive as the cost of meeting their obligation is normally only a very small proportion of the customer's total costs. The nature of the Exchange precludes its customers from exercising buyer power as the Exchange's rules stipulate the price and conditions of trading to all customers. Any existing buyer power Valpak has in the purchasing of PRNs will not be increased as a result of the merger as the Exchange does not actually buy the PRNs and does not control the price at which they are put on the Exchange.

There are a number of potential vertical issues arising from the merger since competitors of Valpak use the Exchange to purchase around 12 per cent of the PRNs they need. Third parties raised concerns that through its acquisition of an interest in the Exchange, Valpak may be able to raise its rivals' costs by either increasing the cost of using the Exchange to its rivals or by giving Valpak preferential access to the Exchange.

However, the rules of the Exchange protect the identity and the interests of those - whether sellers or buyers - making use of it.  As currently drafted, those rules would not permit the Exchange to show any preference to Valpak in its business operations. Moreover, Valpak also has an incentive to maintain the profits of the Exchange and so is unlikely to take any action that would damage the confidence of users in the Exchange. In addition, Valpak will not have control of the board nor will it have a majority of the shares in the Exchange and so will not be able to change the rules of the Exchange in its favour.

The current shareholder will continue to have the same incentives as before and can be expected to act in the best interest of the Exchange to maximize profits and the value of the Exchange. This will not be commensurate with giving Valpak an advantage over other compliance schemes. If Valpak is given an advantage there is a risk that customers will lose confidence in the Exchange and use other sources for selling and buying their PRNs which would have a detrimental effect on the value of the Exchange.

Some third parties have raised the concern that Valpak will have access to their confidential information. A number of confidentiality conditions have been agreed as part of the merger so that confidential information on individual trades will not be available to any representative of Valpak.

Given the above analysis it seems unlikely that this merger will lead to a significant lessening of competition. On these grounds we recommend that this merger is not referred to the CC.

NOTES

1. 'Recovery' does not exclusively mean recycling and can include burning waste to provide energy for instance.

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