Pharmaceutical sales growth in China is expected to outstrip that of Europe and the US in the coming years due to the size of China's population. Domestically, the pharmaceutical industry is also one of the leading industries, covering synthetic chemicals and drugs, traditional Chinese medicines, medical devices, apparatus and instruments, hygiene materials and pharmaceutical machinery.
The competitive dynamic of China's domestic pharmaceutical industry is highly fragmented, with 1,000 domestic companies accounting for a large portion of the sector, while the top-tier pharmaceutical companies are also growing steadily.2 In March 2009, China's government revealed plans for a sweeping healthcare reform. Deepening reform efforts are bringing new opportunities to invest in the market and bring profound change to the competition landscape.3
In the context of China's evolving regulatory regime, this industry is increasingly subject to more stringent competition scrutiny in China. From 2016 onwards, the three Chinese antitrust authorities highlighted pharmaceuticals sector as their enforcement priority under the Anti-Monopoly Law (AML),4 and this trend is likely to continue in 2019. In April 2018, China's three antitrust authorities, namely the National Development and Reform Commission (NDRC) in charge of price-related antitrust matters, the Ministry of Commerce (MOFCOM) in charge of merger review, and the State Administration for Industry and Commerce (SAIC) responsible for non-price related antitrust matters, consolidated into one unified agency: the State Administration for Market Supervision (SAMR). This institutional consolidation is expected to reduce duplicate enforcement mandates and improve efficiencies, as companies will only deal with a single AML agency with a more unified enforcement standard. According to its newly released working plan for 2019, SAMR emphasises that the enforcement priorities of the AML will be focused on public utilities, active pharmaceutical ingredients (APIs), building materials, daily consumer goods and other areas of livelihood.5
Against this backdrop, this chapter will focus on China's merger control rules in the pharmaceutical sector.
II Characteristics of China's pharmaceutical industry
The characteristics of China's pharmaceutical industry are as follows. First, historically, pharmaceutical pricing has been strictly regulated by the NDRC, which is also one of China's antitrust authorities in charge of price-related antitrust investigations, although as part of the healthcare reform the price regulation has been gradually lifted. Since 1 June 2015, except for narcotic and psychotropic pharmaceuticals in Category I, the Chinese government no longer regulates pharmaceutical prices and the prices should be decided through market competition.6 In early 2016, the government launched the 'two-invoice system' for pharmaceutical distribution, which aims to control pharmaceutical prices,7 and continued publishing ancillary regulations. Second, as one component of a broader set of national goals is to push industry consolidation, pharmaceutical companies are encouraged to consolidate domestically, eliminating outdated and excessive capacity. In recent years, active merger and acquisition activity has been very much present in China's pharmaceutical industry, both domestically and from a cross-border perspective. Third, the sector will continue to draw significant investment in research and development (R&D). The pharmaceutical industry is characterised by innovation. Top-tier pharmaceutical companies have to make significant investments in R&D in order to lead in the marketplace. Pharmaceutical innovation entails high risks and long development periods, and, therefore, competition concerns may have to be balanced against the protection of intellectual property rights in order to ensure a proper incentive to innovate. The lack of innovation in China's pharmaceutical sector has historically resulted in more than 95 per cent of synthetic chemicals and drugs circulated in China being generic drugs, which will likely remain the case for a long time. However, since the Chinese government encourages and relies upon innovation to meet industrial targets, patented drugs are also expected to see significant growth.
From the AML's perspective, SAMR has punished a few pharmaceutical companies for their AML violations. Condemned behaviours include cartels, vertical restraints and abuse of dominance. In the past two years, China's antitrust authorities have gradually strengthened their enforcement in the pharmaceutical industry. For instance, in its latest decision in the pharmaceutical industry, SAMR has imposed a fine on one of the undertakings, with a level of 8 per cent of the undertaking's 2017 sales revenue, for its abuse of dominance in the domestic market for chlorpheniramine maleate APIs. This is the case with the highest penalty level so far among all the cases published by China's AML authorities.
III Market definition
All competitive behaviours occur within a particular market scope. The definition of the relevant market purports to identify a market scope within which the undertakings are to compete with each other. Therefore, the definition of the relevant market is usually the starting point for analysing competitive behaviours. This is also applicable to China's merger review in the pharmaceutical sector.
According to the Guidance of the Anti-Monopoly Committee of the State Council for the Definition of the Relevant Market (Market Definition Guidance), it is a normal practice for the authority to define the relevant product market8 and the relevant geographic market.9 The methodologies set out in the Market Definition Guidance are also applicable in the pharmaceutical sector, for example, the consideration of substitution from both demand and supply perspectives.10
There are many ways to classify and categorise pharmaceutical products. Anatomical therapeutic classification (ATC), which is developed and used by the European Pharmaceutical Marketing Research Association, and also by the World Health Organization, is normally recognised as the standard classification for the purpose of defining the relevant product market in China's merger filing for human pharmaceutical products. ATC classifies pharmaceutical products down to five levels according to the effect of the active material on a human organ or system. The third level of ATC classification (ATC-3) allows medicines to be grouped in terms of their therapeutic indications and by MOFCOM, and therefore be used as an operational market definition. In the public decision issued on 29 September 2009 granting the conditional approval of Pfizer's acquisition of Wyeth (Pfizer/Wyeth case), MOFCOM acknowledged the market classification of ATC-3 to appropriate when defining relevant markets in the human pharmaceutical sector.
In addition, in the public decision issued by MOFCOM on 8 August 2013 in the conditional approval of Baxter's acquisition of Gambro (Baxter/Gambro case), MOFCOM determined that the relevant markets were composed of CRRT monitors, CRRT dialysers, CRRT blood lines and blood line dialysers. In the public decision issued by MOFCOM on 30 December 2016 in providing for the conditional approval of Abbott's acquisition of St. Jude (Abbott/St. Jude case), MOFCOM determined that the relevant market was small hole vessel closure devices. In the public decision issued by MOFCOM on 27 December 2017 in providing for the conditional approval of merger of Becton, Dickinson and Company and C R Bard, Inc (BD/Bard case), MOFCOM determined that the relevant market was core needle biopsy devices.
Other than the above, considering the characteristics of the Chinese pharmaceutical industry, factors such as strong patient dependency on certain drugs, drug dosage forms and concern for safety from switching from one drug to the other drug may be relevant in defining a pharmaceutical product market.
Geographic markets in the pharmaceutical sector are defined in two different ways, based on MOFCOM's past decisions. MOFCOM usually considers the national regulatory restrictions on production, importation, registration, pricing, distribution and supply to assess whether the parties' proposed geographic market is appropriate in a specific case. In the Pfizer/Wyeth case and Abbott/St. Jude case, the geographic market was deemed as nationwide. Meanwhile, in the Baxter/Gambro case, MOFCOM eventually assessed the market situations in both China and a worldwide market.
IV Factors to be considered in substantive review of a merger in pharmaceutical sector
According to Article 27 of the AML, the following factors shall be taken into account in a merger review:
- the involved undertakings' market share in the relevant market and their controlling power over that market;
- the degree of market concentration in the relevant market;
- the impact of the concentration of undertakings on market access and technological advancements;
- the impact of the concentration of undertakings on consumers and other undertakings;
- the impact of the concentration of undertakings on national economic development; and
- other factors that may affect market competition, which shall be considered as determined by the Anti-monopoly Law Enforcement Agency under the State Council.
According to Article 5 of the Interim Provisions on Assessing the Impact of Concentration of Undertakings on Competition (Interim Provisions), market share is an important factor when analysing a market structure, including the positions of the undertakings concerned and their competitors in the relevant market. Market shares directly reflect the structure of the relevant market, the positions of the undertakings concerned and their competitors in the relevant market.
However, market share is not the only factor when assessing whether a concerned undertaking may obtain or enhance its market power through a proposed merger or acquisition. According to Article 27 of the AML and Article 5 of the Interim Provisions, the following factors will be taken into consideration by the authority in its merger review.
i Structure of a relevant market and the degree of market concentration
Serious competition concerns may arise when the merging parties account for substantial market shares in a highly concentrated relevant market. According to Article 19 of the AML, the merging parties may be presumed to be dominant if their combined market share accounts for 50 per cent or more in the relevant market. In addition, the authority generally measures the degree of market concentration by the Herfindahl-Hirschman Index (HHI index) and the combined market share of the top companies in the industry (industry concentration index).
For example, in the Pfizer/Wyeth case, regarding the Mycoplasma hyopneumoniae vaccine, MOFCOM explicitly indicated that the merger would substantially change the structure of the market and might also have the effect of eliminating or restricting competition. The obvious increase of market share and the degree of market concentration created by the undertakings' combination were the main factors considered. MOFCOM believed that the market share of the Mycoplasma hyopneumoniae vaccine would reach 49.4 per cent (Pfizer was 38 per cent and Wyeth was 11.4 per cent) after the merger, which is much higher than other competitors and might provide Pfizer with the ability to expand its market position regardless of the presence of other competitors and possibly control the price. MOFCOM measured the degree of market concentration by HHI and concluded that the merger would lead to an obvious substantial increase in the degree of market concentration.
In the Abbott/St. Jude case, MOFCOM explicitly indicated that the merger would substantially change the structure of the small hole vessel closure device market and might also have the effect of eliminating or restricting competition. Abbott and St. Jude combined had more than 95 per cent of the market in 2016, with shares of 71.3 per cent and 23.9 per cent respectively. The HHI before the transaction was already 5,678; HHI index after transaction would be 9,086; that is, a change of HHI of 3,408. MOFCOM concluded that the merger would lead to a substantial increase in the degree of market concentration, while other competitors have limited market power to provide effective competition. MOFCOM noticed the combined market shares of Abbott and St. Jude exceeded 95 per cent in China's small hole vessel closure device market, and therefore the merger would have the effect of eliminating competition in the said market. In MOFCOM's decision, there is no explicit wording of the finding of monopoly power, but an over 90 per cent market shares could create a presumption of dominance under China's anti-monopoly law.
ii Difficulty of market entry
To achieve a complete assessment of the competition status of the relevant market, the authority may consider potential competition from new entries. A highly concentrated market may have more barriers to new entry. As distribution channels, technological advantages or critical facilities are, to some extent, controlled by players with strong market power, these could pose difficulties for new players to enter the relevant market. On the other hand, if the entry barriers are low, the other undertakings will be able to respond swiftly to the exclusivity or restricting effect on competition carried out by a proposed transaction.
According to Article 7 of the Interim Provisions, to assess the difficulty of market entry, the likelihood, switching time and sufficiency of such entry need to be considered. In the Pfizer/Wyeth case, MOFCOM pointed out that R&D of drugs is characterised by the high cost and long duration for entry. MOFCOM further determined that the proposed merger might impose more technological barriers to entry in the relevant market (the Mycoplasma hyopneumoniae vaccine market). After the merger, Pfizer would likely take advantage of its scale to further expand its footprint in the Chinese market, and exclude the other market players in this field. In the Abbott/St. Jude case, MOFCOM pointed out that small hole vessel closure device requires high technology and it takes a long period to obtain market entry approval from relevant supervision departments.
In addition, the complete analysis in the Baxter/Gambro case also illustrates MOFCOM's views regarding the difficulty of entering into the pharmaceutical sector:
Many countries around the world have strict entry restrictions on certain medical supplies, and some products need to meet quality standards in order to obtain the appropriate technical qualifications. In China, it is difficult for undertakings to enter the pharmaceutical sector, due to the prior approvals that have to be obtained from China Food and Drug Administration.
iii Other factors
Apart from the above, factors such as the impact of concentration on public interests, economic efficiency, whether the undertakings participating in concentration are enterprises on the brink of bankruptcy and whether there is any countervailing buyer power, etc., will also be taken into consideration. Besides, the latest regulations may change the overall pharmaceutical industry. Such change will likely affect the authority's considerations.
According to Article 3 of the Interim Provisions for Imposing Restrictive Remedies on Business Concentrations (Remedy Provisions) promulgated by MOFCOM, there are normally three types of remedies: structural remedies, which mainly include divestiture of tangible assets and intangible assets including intellectual property rights; behavioural remedies, which include access to infrastructure, such as networks or platforms, licensing key technologies (including patents, know-how or other intellectual property rights) and terminating exclusive agreements; and comprehensive remedies, combining both structural remedies and behavioural remedies.
i Structural remedies
Structural remedies are aimed at restoring the relevant market's competition structure. The commonly applied structural remedies include, but are not limited to, the divestiture of part of the assets or businesses of the undertakings involved in the concentration.
In the Pfizer/Wyeth case, Pfizer and Wyeth both had business in the Mycoplasma hyopneumoniae vaccine market, and the merger of Pfizer and Wyeth would substantially change the structure of market competition and might also have the effect of eliminating or restricting competition. Therefore, MOFCOM required Pfizer to divest the Mycoplasma hyopneumoniae vaccine business, including the Respisure and Respisure One brands, within the mainland China territory. In the Abbott/St. Jude case, Abbott and St. Jude both had business in the small hole vessel closure device market, and the merger would have the effect of eliminating or restricting competition. As a result, MOFCOM required St. Jude to divest its small hole vessel closure device business to Terumo Corporation. In the BD/Bard case, BD and Bard both had business in the Chinese market of core needle biopsy devices. MOFCOM was concerned that the merger may have had the impact of eliminating or restricting competition after the transaction, the parties would secure a stronger control over the relevant markets in China, and the transaction may have had an adverse impact on technological advancements in the relevant markets. Therefore, MOFCOM required the parties to split up the global product line and the R&D product line of BD's core needle biopsy devices business, including 'R&D product A' and all tangible and intangible assets related to the core needle biopsy devices product line.
ii Behavioural remedies
Behavioural remedies are aimed at modifying or restricting some behaviour of the undertakings involved in the concentration in order to maintain or restore effective competition.
For example, in MOFCOM's decision issued on 13 August 2010 granting conditional approval of Novartis's acquisition of Alcon (Novartis/Alcon case), that the agreements between its wholly owned subsidiary Shanghai CIBA Vision and Hydron lens company post-transaction were deemed to facilitate coordination of product price, production quantity, sales areas or other sensitive information. MOFCOM conditioned approval on Novartis renouncing this agreement within 12 months after the issuance of its conditional approval, so as to reduce the adverse impact of the concentration in the relevant market.
iii Hybrid remedies combining both structural and behavioural remedies
In some complicated merger cases, the application of either structural remedies or behavioural remedies may not be sufficient to reduce the adverse impacts on competition. In such circumstance, the acquiring undertaking may come up with hybrid remedies combining both structural and behavioural remedies.
The authority will assess the effectiveness, feasibility and timeliness of the remedies proposed by the parties. Effectiveness means the remedies are sufficient to reduce the adverse impacts of concentration on competition; feasibility means that the remedies are workable in practice; and timeliness means that the remedies can quickly solve the problem created by the concentration in competition. If the notifying party fails to submit the remedy proposal within the specified period of time, or the submitted remedy proposal is not deemed sufficient to reduce the adverse effects on the competition resulting from the concentration, then the notifying party faces the risk that the authority will prohibit the concentration.
In the Baxter/Gambro case, MOFCOM relied on the market share, market concentration, market power and potential for market entry to determine the effect in the relevant market (CRRT monitors, CRRT dialysers and CRRT blood lines). MOFCOM concluded that the transaction might render Baxter a dominant market player in the CRRT products sector and the proposed transaction would also likely increase the coordination between the undertakings in the Chinese blood line dialyser market, thereby eliminating competition. Also, barriers in the CRRT products market and blood line dialyser market would limit entry. Based on this competition analysis, MOFCOM decided to impose a hybrid remedy combining both structural and behavioural remedies for the approval of this concentration. The remedies include:
- Baxter divesting its global CRRT business, including such tangible and intangible assets as are required for the divested business to be viable and competitive on a stand-alone basis in the relevant markets; and
- by 31 March 2016, Baxter terminating the Nipro OEM agreement in China (except for the previous customer contracts or other legal and regulatory obligations occurred before the release of this decision).
As part of healthcare reform, the pharmaceutical industry in China is facing increasingly strict scrutiny initiated by the top Chinese government officials, including the antitrust authorities. Most notably, certain multinational pharmaceutical undertakings are criticised for having charged excessive prices on patented drugs and medical devices, which have led to high medical costs for the general public in China. In the context of such regulatory pressures and the burgeoning transaction environment, the Chinese pharmaceutical industry may become more complex with multiple market participants further complicating the competitive landscape. Therefore, the competition assessment in a merger review requires a comprehensive understanding of such 'state of play' developments in China's pharmaceutical industry.
1 Susan Ning is a senior partner, Ruohang Zhang is a partner and Ting Gong is an associate at King & Wood Mallesons.
2 Refer to China's healthcare reform (the proposed plan, titled 'Opinions of the CPC Central Committee and the State Council on Deepening the Health Care System Reform') and 12th Five-Year Plan (2011–2015) released in 2011.
3 This statement is based on the report issued by Deloitte, available at: www2.deloitte.com/content/dam/Deloitte/ch/Documents/life-sciences-health-care/ch_Studie_Pharmaceutical_China_05052014.pdf.
5 Refer to the SAMR chief Zhang Mao's Speaking at the National Market Supervision Work Conference on the 27 December 2018.
6 Refer to the Opinions on Facilitating Reform of Pharmaceutical Price published by NDRC together with other authorities on 4 May 2015.
7 Refer to the Notice on Issuing Key Work Tasks in 2016 Pharmaceutical and Cleaning System Reform released on 21 April 2016.
8 Relevant product market refers to a market comprised of a group or a category of products that are considered by consumers to have a relatively strong substitution based on the characteristics, uses and prices of the products.
9 Relevant geographic market is a scope of geographic areas within which consumers can acquire products that have a relatively strong substitution relationship.
10 There are also other methods to define a market, such as the hypothetical monopolist test, which is also called the SSNIP (Small but Significant and Non-transitory Increase in Price) test in Article 10 of the Market Definition Guidance. As an analytical method for defining the relevant market, the hypothetical monopolist test can use economic tools to help solve the uncertainties that may arise from the definition of the market scope within which the undertakings compete with each other.