Canada: Are Canadian Banks Fit to Be Tied?

Article by Carolyn N. Naiman¹ and Jason Brooks²

Published in Canadian Competition Record, Fall 2004.

In both Canada and the United States it is common for banks³ to provide customers with incentives to purchase multiple products. This practice is referred to, in business terms, as "bundling" or "relationship pricing." But there is a fine line between permissible relationship pricing and prohibited tied selling. Tied selling involves making the purchase of one product conditional on the purchase of another.

In the United States, allegations of tied selling by banks have led to investigations by Congress and banking and securities regulators.⁴ In Canada, recent legislative initiatives have strengthened prohibitions against tied selling by banks.

In today’s increasingly competitive financial services markets, there are strong incentives to bundle product offerings. Economically, this makes sense. However, banks must comply with three relatively unharmonized legislative regimes that regulate bundling activities. This article discusses the rules prohibiting tied selling by banks and argues (i) that although the Competition Act rightly recognizes that tied selling is not anti-competitive in all cases, it does not explicitly recognize that tied selling can be efficiency-enhancing; and (ii) that the Bank Act and securities laws – as consumer-protection legislation – overreach, capturing not only individual consumers but also large sophisticated corporations that do not require such protection.

In this article, the term "bank," apart from the section relating to the Bank Act specifically, should be read to include other financial services providers who are "non-bank" financial institutions. The prohibitions against tied selling under the Competition Act and the securities laws described below apply broadly to all businesses in Canada.

Banks may offer bundled products for economic reasons, taking advantage of reduced transaction costs and economies of scope in production and distribution. For example, once a bank has incurred the cost of assessing a customer’s credit for one product, it need not repeat the process for other products and can therefore offer additional credit products at a lower overall cost than if each product were purchased separately.⁵

The Canadian government only becomes concerned about bundling when it can be characterized as tied selling. The prohibitions against tied selling by banks apply when competition is threatened or when tied selling forces customers to purchase products they may not want.

Competition law prohibits tied selling only when it is anti-competitive.

Banking and securities laws reflect a different set of concerns – consumer-protection concerns – and aim to protect small customers by prohibiting forced tying outright. Without consumer-oriented prohibitions, regulators (or legislators) are concerned that banks could take advantage of individual retail customers – for example, by making approval of a mortgage conditional on the purchase of investments. However, these banking and securities laws also prohibit tied selling to large, sophisticated corporate customers – for example, tying a corporate loan to investment banking services, a business practice that has recently received attention on both sides of the border.⁶

What follows is an overview of the tied selling rules applicable to banks in Canada, under the Competition Act,⁷ the Bank Act,⁸ and securities laws.

Tied selling is addressed in section 77 of the Competition Act.⁹ This section applies to all suppliers of "products," which include both articles and services.¹⁰ Under section 77, tied selling occurs when a supplier conditions the sale of one product – say, film – referred to as the "tied product," on the purchase of another product – say, a camera – referred to as the "tying product," or when the supplier requires a customer to refrain from using another company’s product with the tying product. Tied selling also occurs when a supplier does the same thing by inducement – that is, offering the two products on such attractive terms that they are essentially always purchased together. However, tied selling, under the Competition Act, is problematic only where the practice is engaged in by a "major supplier" or is "widespread in a market" and is likely to have an anti-competitive effect.

Tied selling is not prohibited where it "is reasonable having regard to the technological relationship between or among the products to which it applies." Another exception, specific to the financial services sector, applies if the practice is engaged in by a person in the business of lending money for the purpose of better securing loans and is reasonably necessary for that purpose.¹¹

Section 77 of the Competition Act requires three elements to prove that tied selling has taken place: (i) the existence of "two separate products" – the "tied" and the "tying" product; (ii) a "practice" of tying; and (iii) "anti-competitive effects" of the practice, which lead to a substantial lessening of competition. Although no cases under the Competition Act have dealt with tied selling by banks, one case, Tele-Direct,¹² has addressed tied selling in detail.

Separate Products

The first element to be addressed under the Competition Act is whether the tied and the tying products are actually separate products. As interpreted in Tele-Direct, the separate products test has two parts: first, there must be "sufficient demand" for the products to be sold separately; and second, such products must be able to be supplied separately in an efficient manner.¹³

In Tele-Direct, the Tribunal concluded that tied selling will not be found to exist if offering the products separately would result in "higher costs that outweigh the benefits to those who seek to purchase them separately."¹⁴ In doing so, the Tribunal acknowledged that efficiency considerations are relevant in considering the separate products requirement for tied selling.¹⁵

"Practice" Requirement

The second element to be addressed under the Competition Act is whether the supplier is engaged in the "practice" of tying. The term "practice" is not defined in the Competition Act. In NutraSweet,¹⁶ a case involving abuse of dominance and exclusive dealing, the Tribunal defined a "practice" as more than "an isolated act or acts." This reflects the Competition Act’s focus on encouraging competitive market conditions generally, as opposed to protecting individual consumers, regardless of market conditions.

Anti-Competitive Effect

Finally, for a practice of tied selling to contravene the Competition Act, it must have an anti-competitive effect. To meet this condition, the tied selling must be engaged in by a major supplier or be widespread in the market, and have an exclusionary effect that will actually or is likely to result in a substantial lessening of competition. The Competition Act does not define the terms "major supplier" or "widespread in a market"; however, the definitions seem unimportant, in practice, since the Competition Act also requires the presence of exclusionary effects that lead to a substantial lessening of competition. If a substantial lessening of competition exists, it seems likely that the tied selling would be engaged in by a "major supplier" with market power.

The Tribunal has not considered the meaning of a "substantial lessening of competition" in detail in a tied selling case. In Tele-Direct, the Tribunal’s discussion of a "substantial lessening of competition" is very brief. The "substantial lessening of competition" test, as articulated in NutraSweet, the case referred to above, elaborates more fully on the meaning of a substantial lessening of competition by asking whether the anti-competitive act creates, preserves or enhances market power.¹⁷

Market power is the ability to sustain prices materially above competitive levels or to sustain quality, output or variety materially below competitive levels. The Tribunal uses a similar test under the Competition Act’s merger and abuse of dominance provisions. In considering whether particular actions (such as tying) by a firm are likely to substantially lessen competition, market share and barriers to entry will be considered along with other factors. All else being equal, the higher the market share of a supplier and the greater the barriers to entry to the market, the more likely the supplier will be found to have market power.

Competition Act Remedies

If the above conditions are met, the Tribunal may issue a remedial or prohibitive order. Until recently, only the Commissioner of ^{Competition18} could seek orders from the Tribunal to prohibit tied selling, although few applications have been brought to date.

Amendments to the Competition Act, in June 2002, now permit private parties to seek leave from the Tribunal to bring a tied selling application. The Tribunal may grant leave to a private party when it believes that the applicant is directly and substantially affected by the tied selling and is able to meet the substantive test outlined above.¹⁹

To date, no private parties have sought leave to bring a tied selling application since there is currently little incentive to do so.²⁰ The costs to the party may exceed the losses suffered from the tied selling. Currently, the Tribunal has the discretion only to prohibit or remedy the tied selling; it cannot award damages. However, this could soon change. In 2003, the Canadian government released for comment a discussion paper that includes draft legislation that would allow for administrative monetary penalties and awards of damages [emphasis added] to private parties in certain civil matters, including tied selling cases, where an order has been made by the Tribunal prohibiting the conduct or restoring competition in the market.²¹

If the Competition Act is amended to include awards of damages, private parties will have a real incentive to bring applications. A parliamentary committee report acknowledged as much, stating that "in the longer term … we believe damages [emphasis added] and fines will be necessary to realize effective enforcement."²² If ultimately enacted, these reforms would expose businesses to possible monetary penalties and civil damages, a dramatic change from the current situation in which breaches of the Competition Act’s civil provisions (which include tied selling) carry no monetary risk.

In addition to the Competition Act, banks and their affiliates are subject to the tied selling provisions of section 459.1 of the Bank Act. This section provides that a bank shall not impose undue pressure on or coerce a person to obtain a product or service as a condition of obtaining another product or service from the bank. The bank may, however, offer a product with better pricing or on more favourable terms on the condition that another product is purchased.

The Bank Act provision is consumer-protection – not competition – legislation. The rationale behind it is that consumers of banking products have a "special relationship" with banks and have unequal bargaining power.²³

Unlike the Competition Act, the Bank Act prohibits coercive tied selling under all circumstances. However, the Bank Act is also less strict than the Competition Act in that it allows a bank to offer inducements to customers to buy other products – prohibited tied selling occurs only where a bank requires or coerces a customer to buy tied products. Any contravention of section 459.1 is subject to a fine of up to five million dollars.²⁴ To date, there has been no judicial consideration of the Bank Act’s tied selling provisions.

The final source of anti-tying law that applies to banks is securities laws. These laws apply to any person or company selling securities. National Instrument 33-102 ("NI 33-102") provides that:

Like the Bank Act, NI 33-102 is a prohibition with a consumer-protection focus.

Companion Policy 33-102 makes clear that NI 33-102 is designed to prevent "abusive sales practices" but not to prohibit "relationship pricing" or similar selling arrangements. Accordingly, it would not apply if a bank offered a better rate of interest on a loan to a customer who also agreed to buy a mutual fund sponsored by the bank. But it would prohibit such an arrangement if a customer was coerced or forced to purchase the two products together. These securities laws are similar to the Bank Act in substance. Contravention of NI 33-102 is an offence under the Securities Act (Ontario) and, under the general provisions, subject to penalties of up to five million dollars or a term of imprisonment of up to five years, or both. There are also other possible remedies available to securities regulators. To date, there has been no consideration of this provision.

The Competition Act protects consumers against both anti-competitive tied selling and relationship pricing while permitting pro-competitive or competitively neutral tied selling and relationship pricing. In contrast, the Bank Act and securities laws prohibit all forced tying arrangements, but permit any relationship pricing.

Canadian banks face costs in complying with the different statutory anti-tying rules. Are the costs of compliance justified? The answer to this question requires an examination of the economics of tying.

Economics literature recognizes that tying, in its broadest sense, is efficient. For example, tying can enable suppliers to take advantage of economies of scope in production and distribution, and many products sold in competitive markets are sold on a tied basis. It is therefore appropriate that the Competition Act focuses only on situations in which tying is engaged in by a supplier with market power. But the economics literature also suggests that tying arrangements can enhance efficiency even when they are engaged in by a monopolist.

Economists have suggested several non-sinister, efficiency-enhancing reasons why a firm – even a dominant one or a monopolist – may choose to tie products. One of the most commonly accepted is to engage in price discrimination. Price discrimination allows a seller to charge different prices to different buyers of the same product. In these circumstances, tying could act as a metering device, allowing a seller to identify heavy users of a product – who presumably value the product most. Although it allows the seller to extract a greater degree of surplus from consumers, from an efficiency standpoint, price discrimination is generally thought to be an improvement on a "single price" monopoly, since it allows the seller to charge a lower price for its product to those specific consumers who otherwise would have been shut out of the market. This, in turn, results in increased economic output.²⁵

Some economists have also suggested that tying may be used for quality control. For example, the reputation of a camera supplier could be damaged if consumers used low-grade film that resulted in inferior pictures or caused the camera to break down. The camera manufacturer might therefore wish to regulate the sale of its after-market products and services.

Other rationales for tying include the reduction in costs by creating economies of scope, technological interdependence between two products and evasion of a regulatory price ceiling on the primary product.

The original rationale for prohibiting tied selling, adopted by U.S. courts in the early 20th century, has been discredited. The "leverage" theory, which was an early motivation for the prohibition, asserted that a company with a monopoly in one product that ties a second product in a competitive market to the monopoly product can "leverage" its monopoly into the second market that was previously competitive. For example, a monopolist in the camera market could consequently end up with a monopoly in the film market as well.

Critics of the leverage theory have pointed out that no additional monopoly profits are earned. The profitmaximizing strategy for the monopolist is to charge monopoly prices in the market in which it has market power only, since it is possible to earn monopoly rents only once.²⁶ Under the example described above, a monopolist charging the full monopoly price for a product, such as a camera, has already extracted the maximum that consumers are willing to pay for the product. An increase in the price of a tied product, such as film, means the consumer must pay a higher price for the final bundle. But this just leads to prices being higher than the profitmaximizing monopoly price, which leads to lower profits to the monopolist than if it only charged monopoly prices on the one product. In the camera and film example, the price increase on film bundled with cameras will simply reduce the total purchases of cameras and film below levels that would be achieved by charging monopoly prices for cameras and competitive prices for film, which is not in the monopolist’s best interest.

The leverage theory has made a minor comeback with some commentators arguing that leveraging a monopoly in one market into market power in a second market may be profitable in limited circumstances – such as where the second market is not perfectly competitive and is characterized by economies of scale.²⁷ In this situation, a monopolist might be able to leverage monopoly power from the first market to the second market by foreclosing the second market to competitors. A monopolist could do this by driving down prices in the second market, thereby lowering competitors’ revenues below the level that would justify any continued operation. But even if such leveraging were possible, its effect on both consumer welfare and total surplus is ambiguous. If leveraging would not create negative wealth effects, why should it be prohibited?

Economic theory suggests we should be careful about prohibiting tying outright. Since anti-tying laws under Canada’s banking and securities regimes do precisely this (with respect to forced tying arrangements), they are suspect from an economic efficiency perspective. Still, since the purpose of the banking and securities laws is ostensibly to protect consumers, it would be wrong to criticize them solely from an efficiency perspective. These laws may, however, be criticized on their own terms.

The Bank Act prohibition was designed to protect retail consumers in a competitive retail environment in which banks increasingly try to sell their customers different products, and vie for a greater share of the retail customer’s wallet.²⁸ When the banking law was enacted, benefits were promised to individuals and small businesses.²⁹ But it is arguable that the current provisions go too far, since they capture the sale of tied products, such as corporate lending and investment banking products, to large sophisticated corporate customers.

Consolidation of lending and investment banking activities by big banks in the past 20 years in Canada and the United States is increasing incentives to bundle products.³⁰ The question has been raised as to whether there are remedies for retail consumer-related concerns that fall short of the current outright prohibition on forced tying, which also affects large sophisticated corporate entities that do not require such protection.³¹

While anti-tying laws under the Competition Act are not as strict, they are easier to criticise from an efficiency standpoint since one of the explicit goals of the Competition Act is to increase efficiency. Canadian competition laws rightly recognize that tying is not anti-competitive in all cases, and in many cases should be allowed. What the Competition Act should also explicitly recognize is that even if tying is anti-competitive, it may still be beneficial because it is efficiency-enhancing. The Tribunal, in Tele-Direct, acknowledged that it has discretion to consider any efficiency-enhancing aspects of a tied selling argument, and that a supplier with market power may sell items in combination for efficiency-related reasons.³²

The role of efficiencies under the Competition Act is the subject of a national consultation process launched in September 2004 by the Competition Bureau.³³ Canadian competition policy ought to have a single, main objective – that of obtaining the most efficient performance possible from the Canadian economy. Such a policy would maximize productivity (and thereby, real income) for the benefit of all Canadians. It is also likely to be applied more consistently and effectively than a policy focused on other less clear objectives such as consumer protection. A realignment of the Competition Act to more explicitly acknowledge an efficiencyrelated focus would be a welcome development. To this realignment, an amendment relating to the significance of economic efficiency in assessing tied selling arrangements could, fittingly, be tied.

1. Carolyn Naiman is a partner in the Antitrust and Competition Law Group at Torys LLP.

2. Jason Brooks is an associate at Torys LLP.

3. See the explanation of the term "bank," below.

4. The Federal Reserve and Office of the Comptroller General have reviewed the practice and the General Accounting Office, the investigative arm of Congress, issued a report in October 2003 that found little evidence of tied selling but noted this could be because there is no good system for monitoring the practice and recommended stronger enforcement. See U.S., House of Representatives, General Accounting Office, Bank Tying: Additional Steps Needed to Ensure Effective Enforcement of Tying Prohibitions, Committee on Energy and Commerce Report to the Ranking Minority Member, (October 2003). The chairman of the SEC said in his Senate confirmation hearings last year that he would look into the practice. The National Association of Securities Dealers passed a rule in June 2003 to require adequate supervision policies and procedures regarding tying at investment banks. See D. Anason & R. Julavits, "Early Look at One Possible Industry Stand in Tying Fight" The American Banker (13 June 2003) 1; R.D. Atlas, "Corporations in Survey Say Banks Tie Loans to Other Business" New York Times (19 March 2003) C4; and M. Heller, "GAO Sets Tying Probe Report Due Out Oct. 6" The American Banker (12 March 2003) 20.

5. Competition Bureau, "Appendix I - Tied Selling: Background Information for the Task Force on the Future of the Canadian Financial Services Sector Tied Selling Defined" (Submission to the Task Force on the Future of the Canadian Financial Services Sector, http://cb-bc.gc.ca/epic/internet/incb-bc.nsf./vwGeneratedInterE/ct01164e.html).

6. For examples of Canadian coverage of this issue, see D. DeCloet, "A Loan Without Strings" National Post (10 March 2001) C3; D. Francis, "The Banks’ Cozy Brokerage Cartel" National Post (16 June 2001) C3; and A. Willis, "Winning Financing Deals is a Lot Like Selling Big Macs" The Globe and Mail (2 August 2001) B12.

7. Competition Act, R.S.C. 1985, c. C-34.

8. Bank Act, R.S.C. 1991, c. C-46.

9. While not discussed in this article, tied selling may in certain cases be caught under the Competition Act provisions dealing with abuse of dominant position, misleading advertising and predatory pricing.

10. Competition Act, supra note 7, s. 2(1).

11. Ibid., s. 77(4)(b) and (c).

12. Canada (Director of Investigation and Research) v. Tele-Direct (Publications) Inc. (1997), 73 C.P.R. (3d) 1. For a thorough review of this case, see S. Wong, "The First Tied Selling Case" in J.B. Musgrove, ed., Competition Law for the 21st Century: Papers of the Canadian Bar Association, Competition Law Section, 1997 Annual Conference (Ottawa: Canadian Bar Association, 1998) 16.

13. Tele-Direct, ibid. at 119.

14. Ibid.

15. As a practical matter, when it is more efficient to sell products bundled, it is unlikely there will be high demand for the products to be sold separately – the other half of the two-products test – though it is conceivable that this could happen if efficiencies from tying were not passed along to customers.

16. Canada (Director of Investigation and Research) v. NutraSweet Co. (1990), 32 C.P.R. (3d) 1 at 35.

17. Ibid. at 55.

18. Competition Act, supra note 7, s. 2(1).

19. Ibid., s. 103.1.

20. It is noteworthy that the Commissioner of Competition has not brought many cases under this provision either.

21. Views on various matters relating to the proposed amendments to the civil provisions have been widely divergent. See Public Policy Forum, National Consultation on the Competition Act: Final Report (Ottawa, 8 April 2004).

22. Canada, Report of the Standing Committee on Industry, Science and Technology, A Plan to Modernize Canada’s Competition Regime (April 2002).

23. Canada, Department of Finance, 1997 Review of Financial Sector Legislation: Proposals for Changes (June 1996) 17.

24. Canada, Task Force on the Future of the Canadian Financial Services Sector, The Report of the Task Force on the Future of the Canadian Financial Services Sector (September 1998) 133.

25. Of course, this kind of price discrimination could run afoul of the Competition Act, despite having a positive effect on efficiency. As a practical matter, this is not risky activity as there have been very few price discrimination cases to date.

26. See A. Director & E. Levi, "Law and the Future: Trade Regulation" (1956) 51 Nw. U.L. Rev. 281; and R. Posner, Antitrust Law: An Economic Perspective (Chicago: University of Chicago Press, 1976).

27. For instance, see M.D. Whinston, "Tying, Foreclosure and Exclusion" (1990) 80 American Economic Review 837.

28. Canada, House of Commons, Standing Committee on Finance, "1997 Review of Financial Services Sector Legislation: Proposals for Changes 4th Report" (October 1996) at 5.

29. For example, see House of Commons Debates (17 March 1997) at 1535; and Canada, House of Commons, Standing Committee on Finance, "1997 Review of Financial Services Sector Legislation: Proposals for Changes, 4th Report" (October 1996).

30 In the United States, the consolidation of banking and investment banking services has increased considerably following the 1999 passage of the Gramm-Leach-Bliley (Financial Services Modernization Act 1999) P.L. 106-102. This Act lifted restrictions on the amount of investment banking that traditional banks can engage in. In Canada, amendments to the Bank Act in 1987 loosened ownership rules and as a result a number of big banks have purchased brokerage houses.

31. Competition Bureau, "Appendix I - Tied Selling: Background Information for the Task Force on the Future of the Canadian Financial Services Sector Tied Selling Defined," supra note 5.

32. Tele-Direct, supra note 12 at 118.

33. Canada, Competition Bureau, Treatment of Efficiencies in the Competition Act; Consultation Paper (Ottawa, September 2004).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.