August 1, 1997
Table of Contents
In June 1996 the Government's budget legislation amended the Radiocommunication Act to give the Minister of Industry explicit authority to use auctions as a method of spectrum assignment. The Minister may now choose to use auctions as a licensing mechanism in those instances where the various policy objectives of the Government can be met through the combination of competitive bidding and any of the other numerous instruments available, such as standards, conditions of licence, or auction rules. The only spectrum auction which has been announced to date is the second round of licensing for Local Multipoint Communications Systems (LMCS) spectrum and hence it is this process which may be the Department's first pilot auction; however, this does not preclude the possibility that another licensing opportunity could become the first pilot auction if the Minister finds it appropriate to do so.
In this document, a number of fundamental issues related to spectrum auctions are discussed. In some cases a number of options or proposals have been laid out. The Department seeks comments and advice on all issues discussed in this paper and looks forward to receiving the input of all interested parties.
Spectrum auctioning offers the possibility of realizing significant gains for Canadian businesses, consumers, and taxpayers alike. Through consultation processes such as this one, the Department is confident that spectrum auctions can be introduced in a manner that ensures Canadians derive the maximum possible benefit from their spectrum resource.
Finally, the Department would like to acknowledge the contribution to its auction development endeavours of Market Design Inc. and Charles River Associates, expert auction consultants who have provided valuable insight and advice.
Although it is only recently that auctions have gained prominence as a means of awarding access to spectrum - largely due to the high visibility of the auctions conducted by the FCC (Federal Communications Commission) in the United States -the advocacy of auctions as sound public policy can be traced at least as far back as the late 1950s.Footnote 1
In Canada, spectrum auctions appear to have been broached for the first time in 1970, as part of the sweeping series of Telecommission consultations and studies that were initiated by the then newly formed Department of Communications. Although spectrum scarcity was not as much of a problem at that time, one Telecommission studyFootnote 2 explored in some depth various alternative approaches to dealing with its expected onset. This study postulated, for the first time in Canada, a conclusion that has only recently been incorporated in spectrum policy and regulation: that market mechanisms are a valid means of dealing with excess demand for spectrum.
By the late 1980s spectrum scarcity had become evident in certain bands in Canada's major urban centres. The Department of Communications undertook a series of internal studies to assess the ongoing efficiency and effectiveness of its spectrum management program. One such study focussed on the economic nature of the spectrum and, similar to the Telecommission study, observed that while competition alone could not be relied upon fully, due to "market failures", there existed potential "approaches such as auctions, user fees and shadow pricing" that were "promising means by which to incorporate economic factors into the administrative process."Footnote 3 Noting that the spectrum management environment was undergoing significant changes and the growing importance of the radio frequency spectrum as an important social and economic resource, the study concluded that, "In view of the fact that deficiencies associated with current management practices are expected to intensify as demand for the resource increases, keeping the current system does not appear to be rational."Footnote 4
In 1990, the Department of Communications undertook a reassessment of spectrum policy in order to respond to the changes taking place. Consultations were initiated towards the formulation of a Spectrum Policy Framework for the Twenty-First Century.Footnote 5 This consultation invited interested parties to provide their views and comments on a number of issues and principles "for the judicious utilization of spectrum resources". In this consultation the views of the industry were again sought with respect to market-based approaches. While the responses indicated opposition to auction approaches because of a perceived need to "consider the best radio application in terms of public interest elements and technical merits in any licensing decision" the Department observed that "the most suitable strategy proposed was to enhance the present competitive licensing process and allow future flexibility to adopt other procedures as circumstances require."Footnote 6 The Department adopted the following policy guideline:Footnote 7
Policy Guideline 11 — Market-Based Approaches
For competitive licensing, where the available spectrum is inadequate to satisfy all demands or where it is necessary to limit the number of new entrants, the Department will continue to refine its current approach - the administrative comparative process, which is used to select licensees from a number of qualified applicants.
If other market-based approaches are deemed to be in the public interest and applicable to specific services or frequency bands, they will be implemented only after full public consultation.
As part of the then recently formed Industry Canada, the continued refinement of the administrative comparative process was undertaken in 1994 in a public review of that process.Footnote 8 Ten issues were targeted in the review in an attempt to discern to what extent the comparative process could be enhanced to account for the full range of social, cultural and economic considerations associated with the award of highly valued radio spectrum.Footnote 9
While auctions were given no particular profile in the Gazette Notice that initiated the review, almost all of the twenty-two respondents provided comments on the advisability of spectrum auctions.Footnote 10 In fact, spectrum auctions accounted for more commentary than the ten issues identified for review. Notwithstanding the negative views on auctioning of many of the industry respondents, the Department considered that a serious examination of spectrum auctioning was in order given its previous studies, the considerable accumulated literature on the public policy advantages of auctions, and their adoption by diverse administrations around the world.
In the course of the review the Department found that those favouring the comparative selection process differed in many important respects as to how it might be improved. This was particularly true with respect to the openness of the process. Suggested measures to achieve greater openness (such as tribunals, divulgence of submissions, opportunities for challenge, etc.) to a large extent were in conflict with the need for expeditious processing and the protection of confidential commercial arrangements and business plans. Measures to realize other improvements generally involved increased requirement for voluminous submissions and greater information processing and intervention by the Department at a time when Government fiscal restraint, increased reliance on market forces, and a need for minimal, flexible and timely regulation were stated Government objectives (and nowhere more so than in telecommunications).
In its review findings, the Department concluded that it would be in the public interest to establish a new alternative to the traditional comparative selection process that would feature competitive bidding where reliance on market forces was appropriate.Footnote 11
Having thus determined that having an ability to conduct spectrum auctions would be in the public interest, the Government announced in its 1996 Budget Plan its intention to take steps "to permit auctioning of the radio spectrum, where appropriate, in the future."Footnote 12 Subsequently, the Government's budget legislation amended the Radiocommunication Act to give the Minister of Industry explicit authority to use a system of competitive bidding to select the persons to whom radio authorizations would be issued.Footnote 13
During the course of the review, and subsequent to it, the Department has had occasion to undertake several licensing processes in which mutual exclusivity in demand was anticipated and/or manifested.Footnote 14 Although these were opportunities in which auctions could have been implemented, the Department chose to continue to use traditional approaches largely because of its commitment to full public consultation prior to implementation of the first pilot auction.
Spectrum management in Canada is generally regarded as having served the public interest and the industry well and is highly regarded internationally. Nonetheless, the Department has had to consider to what extent the criticisms of traditional spectrum management practice in general may equally apply to Canadian practice, and to what extent these practices should be modified. These criticisms are largely based on observations that maximum net social benefit is not being attained from the spectrum resource and that allocation and assignment techniques do not lead to the most efficient use of the spectrum. The most important concerns are listed below.Footnote 15
When resources are made available at less than their associated opportunity costs - equal to the foregone benefits of putting resources to their best alternative use - it is generally observed that over-utilization results. While the effective supply of spectrum is increasing due to technological advances that extend the upper limit of usable spectrum and to greater technical efficiencies, it is outpaced by the increasing demands of those seeking to serve the ever-growing needs of the information or knowledge-based society. An inability to effectively address this demand stifles new services and the realization of efficiencies in economic activity dependent upon the enabling effect of information and communication technologies. This in turn hinders competitiveness, job creation and economic growth. Further, those having access to spectrum may lack the incentives to use it efficiently and substitutes for spectrum, (including technologies that would economize on spectrum use), may not be adequately considered.
The manner in which spectrum allocations, designations and assignments are made is such that as bands fill and/or demand shifts, the previous assignments made to incumbents make changes difficult. Pressures exerted by users, coupled with a general reluctance on the part of spectrum managers to impose unforeseen costs on their clients, act to retain the status quo. Although well-intentioned, rigidity is the result. Less efficient uses are not replaced and spectrum newcomers are assigned to areas of the spectrum that are more costly to exploit.
The opportunity cost of using any resource - like spectrum - in one activity is the value foregone by not using it in the best alternative activity. As a consequence of the absence of market-determined valuations of spectrum, the opportunity costs associated with its various uses remain largely suppressed and unknown and thus are not adequately considered in allocation and assignment decisions. In the absence of market signals, spectrum managers have no effective means of quantifying either benefits or costs and thus are unlikely to achieve optimum allocations and assignments. Where less than optimal decisions are made the opportunity costs of foregone benefits are undeniably but unwittingly borne by society.
Central planning and government management of spectrum is subject to all of the problems generally inherent in public administration which are obvious but not often mentioned. Management through administration and regulation consumes human and financial resources, the costs of which must be borne by spectrum users and/or the public. Government institutions tend to suffer from inefficiencies that result from imposed constraints and a lack of incentive to innovate or adapt behaviour. Administrative decisions are demanding of information and take time, both of which impose burdens on spectrum users who seek to be increasingly agile in order to be competitive and to capitalize on opportunities that may depart from the norm recognized and entrenched in standards, regulations and procedures.
If maximum net social benefit is not generated from the spectrum resource because opportunity costs are inadequately accounted for, then the problem is compounded by the failure to capture the economic value of the resource for the public. In relation to natural resources held in the public domain, society expects compensation from resource users in exchange for the privilege of using them. Oil, minerals, and timber are all examples of public property from which society expects to share in the economic rent. In no case are these natural resources treated as a free good. Similarly with spectrum, it can be argued that the public is entitled to payment for usage rights granted by government.
From the foregoing discussion, one can recognize that the use of spectrum auctions in appropriate circumstances may constitute one significant means by which improvements can be realized.
By identifying those who most highly value spectrum, auctions present an effective means to achieve an efficient allocation of the resource and maximum net social benefit. The market value of spectrum is established through auctioning, thus avoiding the distortions that result from suppressing this value. Auction prices can hence serve as powerful market signals towards the need for improved allocations among services.
Auctions are also an open, objective, and administratively efficient method of selecting licensees and, with proper design, can be conducted quickly. There is no requirement to prepare burdensome and voluminous submissions in an auction. As well, the risks associated with the disclosure of information considered commercially sensitive are avoided. Auctions substitute real world investors and consumers for public servants in the determination of who has the better business plan, the most innovative ideas, the most highly beneficial services, the right technology and the best management team.
Auctions capture appropriate economic rents for the public for the use of its spectrum resources. Furthermore, the required payments established in an auction provide a built-in incentive to put spectrum to productive use in a timely manner and relieve the burden to police spectrum hoarding and speculation.
Finally, auctions are compatible with a wide range of policy instruments that may be required to achieve various social objectives.
At the time of the review of the Comparative Selection and Radio Licensing Process the Department noted the concern expressed by some parties that any revised selection process should not apply to certain users of the radio frequency spectrum. In adding auctions as a means by which licensees may be selected, the Department does not intend to broaden the scope of application beyond that employed in the past. The Department does not foresee any application of auctions in circumstances involving priority users. The Department continues to be of the view, expressed in the 1992 Spectrum Policy Framework, that:
"Radiocommunication systems vital to sovereignty and national security, national defence, public security, safety and emergency will be granted high priority and support in the access and use of the radio spectrum. Also, essential government operations, and other agencies providing critical services to the general public, will have high priority in use of the spectrum."
Some interest has been expressed in the extent to which the Department might implement auctions for broadcast services. It should be noted that broadcast licences are issued by the Canadian Radio-television Telecommunications Commission (CRTC) under the Broadcasting Act. Where a licence issued under the Broadcasting Act entitles the licensee to operate a radio apparatus, the applicant must obtain a broadcast certificate (or assurance that such a certificate will be issued) from the Minister of Industry. Broadcast certificates are issued by the Minister on a non-exclusive basis and as such are not amenable to auction.
As has already been noted, the introduction of auctions does not in any way alter the Minister of Industry's responsibilities under the Radiocommunication Act, the Telecommunications Act or the Department of Industry Act. The exercise of the Minister's licensing authority under the Radiocommunication Act will continue to take into account Canada's social, cultural, and economic objectives in such a manner as to ensure that Canadians derive maximum benefit from their radio frequency spectrum resource. The Radiocommunication Act confers upon the Minister of Industry considerable authority to ensure that non-market policy objectives can be advanced through the use of such instruments as frequency allocations and bandplans; utilization and implementation policies; technical specifications, standards and approvals; terms and conditions of licence; and auction rules and procedures. Where these policy instruments adequately address the non-market policy considerations associated with the spectrum to be authorized, the Minister may choose to rely on the operation of market forces in an auction process for the selection of licensees.
The potential of spectrum auctions to achieve efficient outcomes, to be fair, and to contribute to improved spectrum management to the benefit of all Canadians is highly dependent on appropriate use and proper design. Early auction implementations by some administrations had unfortunate, if not embarrassing, results. These same administrations, however, have gone on to learn from their mistakes and to profit from the experiences and successes of others and today spectrum auctions and other economic techniques have been adopted by a large number of economically, demographically and politically diverse countries.
The Department continues to study the issues associated with auctions and to date has only announced one planned auction that will not occur until 1998.Footnote 16 In the interim, the Department will share the results of its ongoing work and seek the views of interested parties through public consultation prior to implementation of its first pilot auction.
The Department firmly believes that the implementation of spectrum auctions will bring benefits to consumers and service providers alike and it encourages all interested parties to familiarize themselves with both the theory and practice of auctions so as to meaningfully participate in this and other consultations that will contribute to their success.
The overall process leading up to and including an auction has two crucial requirements: (1) all policy matters and auction rules must be clearly and precisely specified prior to the auction so that bidders know exactly what they are bidding for; and, (2) public consultation prior to any auction is critical to ensure that optimal decisions are made with respect to these policy matters and auction rules. Bearing these points in mind, the Department is proposing a process proceeding as set out below.
The consultation process would commence with the publication of a consultation document on the particular spectrum in question and an associated Gazette Notice announcing the document's publication and availability. The consultation document will discuss, present options and/or proposals for, and seek comments on all policy issues such as: eligibility requirements; licence definition parameters; terms and conditions of licence; financial considerations such as pre-auction deposits, reserve prices, and bid payment schedules; auction formats, rules, and procedures; and any other measures that may be required to ensure that any of the Government's policy objectives that might not be adequately met by market forces alone are in fact properly addressed.
As well, the deadline for receipt of comments and associated procedural details (where to send comments, for example) will be specified in the consultation document and/or the associated Gazette Notice.
It is also proposed that a second, perhaps shorter, consultation phase in which interested parties could respond to the first set of comments received might be beneficial.
After the deadline for receipt of public comments has passed, all comments received will be reviewed and the Minister will make decisions regarding all policy matters and
auction rules. At this point the Department will publish a document (and an associated Gazette Notice) describing these decisions and requesting interested parties to apply, by a specified deadline, to be qualified as eligible to participate in the auction.Footnote 17
Beyond those eligibility requirements based in legislation or regulation, such as foreign ownership restrictions, the Department would generally seek both to minimize the number of requirements that any applicant must meet to be able to participate in the auction and to make those requirements clear and precise. For the most part these requirements would consist only of those necessary to ensure the integrity of the auction process. This should also serve to minimize the volume of material that applicants must submit.
Application materials to be submitted to the Department would generally consist of whatever documentation is required to show that the applicant conforms with the stated eligibility requirements (or alternatively, attestations of conformity might be considered sufficient for some or all items), an indication of the applicant's acceptance of the specified licence terms and conditions and auction rules - including measures designed to preclude collusion among bidders, and a bid deposit (preferably an irrevocable letter of credit, the amount of which would be related to the licences upon which the applicant wishes to be able to bid in the auctionFootnote 18).
The Department has found in the past that the publication of a simple list of interested parties early in the licensing process has been helpful to some smaller industry players who, for financial reasons, might wish to investigate the formation of a lawful strategic alliance with others. To facilitate this, a date would be specified in the Policy and Invitation for Applications document by which parties could submit, if they so choose, a "Notification of Interest." This "Notification of Interest" would contain nothing more than basic identifiers such as the name, address, and phone number of the interested party. All Notifications of Interest received by the specified date would be made public shortly thereafter. No further actions regarding Notifications of Interest would be undertaken by the Department except in respect of the administration or enforcement of applicable law, including the Competition Act. The submission of a Notification of Interest would not be a requirement for participation in the auctions.
The Department stresses that the publication of the Notification of Interest does not imply that the Department condones prospective bidders' discussing their bids or bidding strategies with one another. The Department cautions potential bidders that certain types of activities are unlawful under the Competition Act and the Department strongly urges potential bidders to seek the advice of legal counsel before contacting or entering into any agreements or arrangements with any other potential bidder. In particular, the Department refers potential bidders to sections 45 and 47 of the Competition Act. These criminal provisions, which carry severe penalties, prohibit certain types of agreements or arrangements with respect to price-fixing, market-sharing and bid-rigging. The Department may require, as a condition of participation in the auctions and of the awarding or retention of licences, that each bidder make full prior disclosure of any communications, agreements, arrangements or affiliations which they have entered into with any other potential bidder regarding the licence auctions.
After the deadline for receipt of applications has passed, the applications submitted will be reviewed and the Minister will make a determination as to whether or not applicants conform to the eligibility requirements to be a qualified bidder. A qualified bidder certificate will then be issued to all successful applicants along with notification of the auction schedule and a bidder's information package outlining in precise detail how the auction would run. Unsuccessful applicants will be notified and will have their deposits refunded.
As discussed in Section 8.4 below, the Department is developing a sophisticated yet highly user-friendly remote access electronic bidding system. Prior to an auction the Department may arrange opportunities, such as training seminars or mock auctions, for bidders to become familiar with the bidding system and software.
The auction would open as per the previously released auction schedule and would proceed to closure as per the previously specified auction rules. More detail on the actual auction process itself is contained in Section 8.5 of this document.
Once the auction has closed, high bidders will be officially notified and requested to submit any applicable down payments by a specified date as outlined in the original policy/auction rules document. Upon receipt of these down payments, authorizations will be issued. In those cases where the requested down payments are not submitted, the relevant bidder(s) will be deemed to have forfeited their licences and penalties will be imposed as appropriate.Footnote 19 Unsuccessful bidders will have their deposits returned, net of any applicable penalties.