Framework for Spectrum Auctions in Canada

7. Financial Aspects of Auctions

7.1 Pre-auction deposits

The department sought comment in the consultation paper on whether prospective bidders should submit a pre-auction deposit. It was proposed that the deposit for each bidder should be generally related to the size of the population located within the geographic areas of the licences that bidder is interested in winning.

Respondents generally agreed on the need for a pre-auction deposit to ensure the financial viability and sincerity of the participants. They also agreed that the deposit should be based on a measure reflecting the potential market size of the licence.

The department will require that a pre-auction deposit, likely in the form of an irrevocable letter of credit, be submitted in order to participate in the auction. The required deposit for each bidder will be linked to the population and bandwidth associated with the licence or licences on which that bidder wishes to bid. 21

For licence winners, the deposit will be credited toward payment of their winning bids. For unsuccessful participants, the deposit will be refunded less any penalties 22 they have incurred. If the penalties exceed the deposit, any outstanding amount will be owed to the Crown.

The pre-auction deposit will be returned to any applicant that is found not to be a qualified bidder, to any applicant that provides written notification to the department of its withdrawal from the process prior to the auction's commencement, and to any bidder whose bidder eligibility points are reduced to zero during the auction and who is not potentially liable for any withdrawal penalties.

7.2 Reserve prices

Industry Canada has always operated on the principle that all spectrum users should contribute to covering the cost of spectrum management in Canada. This can be accomplished within the auction process by establishing reserve prices at a level that takes into account the cost of managing the spectrum in question for the whole term of the licence. In practice, it is admittedly difficult to come up with a precise long-run estimation of the cost of spectrum management attributable to any given spectrum band. Nonetheless, this will be the conceptual model that the department will follow in establishing what it expects will be quite modest reserve prices. The department sees no benefit in establishing high reserve prices that might dissuade legitimate service providers from establishing systems and serving consumers. Furthermore, where the value of a licence is high, the department is confident that the bidding activity will result in an appropriate and fair return being generated for Canadian taxpayers.

Once an estimated long-run spectrum management cost figure has been determined for a band that is to be auctioned, that amount will be distributed over the individual licences to be auctioned in proportion to the "points" 23 associated with each licence to determine its reserve price. Similarly, the dollar per point figure that can be derived by dividing the total estimated long-run spectrum management cost figure by the total of the points associated with all licences up for auction will be used to determine the value of the pre-auction deposits referred to above.

7.3 Bid payment

In the consultation paper, the department proposed that winning bidders would pay 25 percent of the amount of their bids at the auction's close with the remaining 75 percent to be paid in annual instalments over the term of the licence. It was felt that such an instalment payment scheme might aid smaller players who could have greater difficulty raising capital.

The majority of those who addressed this issue, in the response to the consultation paper, strongly rejected the use of instalment payments. Respondents remarked that the role of lender should be left with the financial markets and not with the government. As well, they pointed to the problems that have ensued from the PCS C-block auction in the United States where the Federal Communications Commission (FCC) used an instalment payment scheme. In particular, they noted that the instalment payment scheme resulted in speculative bidding, inefficient assignment of licences, artificially inflated bid prices, bid payment defaults, and delayed roll-out of services to consumers.

The evidence and arguments presented by respondents show that instalment payment plans are largely detrimental to the auction process and do not serve to aid smaller players — indeed the artificial inflation of bid prices harms the legitimate small players that one might hope to aid through the use of instalment payments. As such, the department will not allow the payment of bids in annual instalments but rather will require that winning bids be paid in full shortly after the close of an auction.

More precisely, winning bidders will be required to submit 20 percent of their high bids within 10 business days of the auction's close. This payment will be non-refundable. If the winning bidder fails to make this initial payment in a timely manner then the licence will not be issued and the bidder will be subject to the applicable forfeiture penalty. 24 The remaining 80 percent will be due within 45 business days of the auction's close. Failure by the winning bidder to make this final payment in a timely fashion will also result in the licence not being issued and again the bidder will be subject to the applicable forfeiture penalty.

It is also important to note that beyond the payment of the winning bid, no other licence fees or payments will be required for the duration of the licence term. 25

8. Auction Design

In the consultation paper, the department proposed the use of simultaneous multiple round auctions. The rules for the simultaneous multiple round auction call for a related set of licences to be offered for sale at the same time. Bidding is organized into a series of rounds. At the beginning of each round, bidders are provided with information that includes the standing high bids on each licence and information about the bidder's own eligibility for bidding. New bids for a licence are required to exceed the standing high bid by at least some pre-established increment. In each round bidders are offered an opportunity to withdraw bids submitted in previous rounds, subject to a penalty. A minimum pace of bidding in the auction is established by the "activity rule," which penalizes bidders who are inactive by reducing their "bidder eligibility points." The rounds continue until there are no new bids on any licence. Details of the auction format are discussed below.

Auctions would be run electronically and bidders would be able to participate remotely from their offices. The simultaneous multiple round auction remains at the forefront of applied auction theory and has been used successfully by a number of diverse administrations around the world. Respondents to the consultation paper were generally supportive of the use of this auction design.

The department therefore expects to use the simultaneous multiple round format for future spectrum auctions. As discussed further below, both the theoretical and practical aspects of auction design continue to advance rapidly. The department will continue to examine new auction design developments and adopt them as appropriate. It is also important to remember that the design of any specific auction will be subject to public consultation prior to its actual commencement. Thus potential bidders will have an opportunity to comment on any design changes that the department may propose.

Given the complexity of the simultaneous multiple round auction format, the department may hold information seminars and/or mock auctions prior to any real auction to allow bidders to better familiarize themselves with the bidding system and software.

The detailed elements that have now become largely standard in simultaneous multiple round auctions conducted around the world were discussed in the consultation paper. As proposed at that time, the department expects that future simultaneous multiple round auctions will feature the attributes discussed below.

8.1 Bidder eligibility points

Each licence available in an auction will be assigned a number of points approximately proportionate to the bandwidth and population covered by that licence. As part of the application package to participate in the auction, each prospective bidder will be asked to indicate which licences it may want to bid on during the course of the auction and to indicate the total number of "points-worth" of licences that it may wish to bid on in any round. 26 This number, which will also determine the pre-auction deposit required from the bidder (i.e. the required deposit will be calculated on a dollar-per-point basis), will define that bidder's initial level of "bidder eligibility points." The purpose of this information is to assist in the development of activity rules (discussed in more detail below) that are used to hasten the speed of the auction.

8.2 Activity rule

Before the auction, each bidder must specify which licences it wishes to bid on (as per the discussion on bidder eligibility points above). A bidder is defined to be active on a particular licence in a given round if either it has the standing high bid from the previous round or if it submits an acceptable bid in that current round. There are multiple stages — often three — each containing an unspecified number of bidding rounds. In the first stage bidders must be active on licences whose corresponding points add up to a certain percentage of the bidder's eligibility point level (for example, one-half); in the second stage the percentage is increased (perhaps to three-quarters); and in the final stage bidders must be active on 100 percent of their bidder eligibility point levels. If a bidder falls short of the required activity level, the bidder's eligibility point level shrinks proportionately. An auction begins and continues in stage one until bidding activity declines to an unacceptable level (say, three consecutive rounds in which new bids are placed on 10 percent or less of the licences available). At this point, the auction can move to stage two — and similarly to stage three later in the auction.

8.3 Bid withdrawals and related penalties

In the event that a bidder makes a bid that it later wants to change, that bidder will be given the opportunity to withdraw it. To encourage meaningful bids, however, a bid withdrawal penalty needs to be imposed. It is natural to have this penalty correspond to the potential loss in revenue caused by the withdrawn bid. If the licence for which the bid has been withdrawn ends up selling for more than the withdrawn bid, then no penalty will be charged to the bidder. If the licence ultimately sells for less than the withdrawn bid, then the penalty will be the difference between the withdrawn bid and the eventual final selling price. As a measure to reduce the overall time of the auction, while not compromising the auction's efficiency, the department will allow bidders to place new bids and/or withdraw previously submitted bids at the same time during a round, as opposed to having two distinct phases — one for bid submission and one for bid withdrawal — during each round.

8.4 Bid increments

Bid increments, like activity rules, are necessary to help hasten the auction's progress. For a bid to be acceptable it must be larger than the current standing high bid by the bid increment. 27 Increments will be set in percentage terms (x percent of the standing high bid) and/or in absolute dollar amounts. Bid increments will be changed during the course of the auction. For example, at the beginning of an auction when bidding activity is likely to be high, bid increments will be relatively large. As the pace of the bidding falls below a certain threshold, bid increments will be reduced. The rules for changing bid increments will be laid out with a fairly high degree of precision prior to the auction. However, to ensure the auction closes in a reasonable amount of time, there will be flexibility to "override" the rules regarding bid increments. All bidders will be given prior notice well in advance of any proposed changes to the size of the bid increments.

8.5 Waivers

Waivers are designed to prevent a bidder from losing bidder eligibility points when it does not satisfy the activity requirements in a given bidding stage. The purpose of waivers is to protect bidders against possible mistakes they might make during the course of an auction or to allow them to maintain bidder eligibility point levels in the case of technical or communication problems. Typically, each bidder will be given five waivers.

8.6 Stopping rule

An auction will close when a round goes by without any acceptable bids or waivers having been submitted on any licences. In exceptional circumstances, and after all participants have been notified in advance, any round can be declared as the final round. Similarly, exceptional circumstances, such as a natural disaster, may result in an auction being delayed, suspended or cancelled.

8.7 Bid forfeiture and related penalties

After the conclusion of the auction, any bidder who has submitted the high bid on a licence but fails to comply with the specified payment schedule will forfeit its right to have the licence issued to it. Furthermore, the bidder will be required to pay a penalty in the amount of the difference between the forfeited bid and the eventual selling price of the licence (in a subsequent re-auction), if the re-auction price is lower than the forfeited bid. In addition, an amount equal to 3 percent of the original forfeited bid will be charged to account for the administrative expenses incurred to reassign the licence.

8.8 Discretionary versus non-discretionary bidding

The consultation paper proposed the use of non-discretionary bidding. What this means is that rather than being offered the opportunity to enter any amount that exceeds the standing high bid by at least some minimum bid increment, bidders would instead have the choice of giving either a "Yes" or "No" response as to whether they wish to bid an exact amount equal to the standing high bid plus a predetermined bid increment. Non-discretionary bidding has a number of potential advantages, as outlined below.

  • It drastically simplifies submission of bids, eliminating the errors that sometimes occur when a bidder must fill dozens (or even hundreds) of boxes with potentially quite large numbers.
  • It allows rounds to be more brief and more frequent, both because the mechanics of entering and checking bids are simpler and because the prices, which never jump 28 in the revised design, are more predictable. This also reduces the need for frequent executive oversight during the bidding, saving costs for the bidders.
  • It removes opportunities for bidders to send potentially collusive messages through the trailing digits of their bid amounts.

Relatively few comments were received on the issue of discretionary versus non-discretionary bidding and differing views were expressed by those who did specifically address this issue. Concerns about the use of non-discretionary bidding focused primarily on the proposed time-stamp tie-breaking rule. 29 Some respondents felt that a time-stamp tie-breaking rule might favour those bidders who, for example, had the fastest computers. 30 There is also the possibility that non-discretionary bidding with a time-stamp tie-breaking rule could be more susceptible to certain types of collusive behaviour.

Since the release of the consultation paper, new developments in auction theory and design have occurred and the United States Federal Communications Commission has completed both an auction featuring non-discretionary bidding 31 and an auction featuring "multiple increment bidding." 32 The multiple increment bidding format is a variation on the non-discretionary bidding format, which allows bidders to increase high bids by up to, in the case of the LMDS auction, nine increments.

The multiple increment bidding format would appear to preserve the previously mentioned benefits of non-discretionary bidding while at the same time reducing the incidence of tie bids and any possible related problems. Multiple increment bidding should also lead to the faster conclusion of an auction than would single-increment non-discretionary bidding. The department is investigating the use of multiple increment bidding and will propose its use should it appear to be the optimal design option. Again, it is important to remember that the design of any particular auction will be the subject of public consultation before that auction's commencement.

8.9 Bidder identities

Several respondents offered comments on the advisability of concealing bidder identities during an auction. While there could be some benefit to concealing bidder identities in order to deter bid collusion, the department is of the opinion that only under rare circumstances would these benefits outweigh the benefits of full information disclosure to bidders. Therefore, the department expects that for most auctions the identities of all bidders, the licences on which they are qualified to bid, and their initial eligibility point levels will be made public prior to the commencement of bidding. As well, full information on the bids placed by all bidders will be made available after each round.

9. Treatment of Incumbent Licensees

The consultation paper asked whether the results of future spectrum auctions should be used to adjust the licence fees of incumbent licensees with similar spectrum.

A significant majority of respondents advised that in no circumstances should the department adjust existing licence fees based on auction results. There were several reasons cited. First of all, those bidding for licences will already have taken into account the existing fees of incumbents with whom they may compete when they are determining their valuations. If these fees themselves are uncertain, this creates unnecessary complications for the proper valuation of auctioned licences. Second, recalibration implies the retroactive application of today's valuations to licences awarded in the past. This is regarded as unwarranted and unfair because the current fee structure is based on legitimate good faith arrangements made with the government at the time of initial licensing. Third, one should take into account risks incurred and investments made by incumbents. Uncertainty created by recalibration damages established businesses because they made plans and secured financing under the rules of the day. Finally, readjusting fees based on future auction prices will create large uncertainties in the wireless sector. These uncertainties would have a major impact on the availability of financing, investment in new technologies, and the provision of new services.

Some respondents suggested that the department "grandfather" existing spectrum users and grant them the same rights that would be awarded to those who receive their licences via an auction process. One of the immediate concerns associated with such adjustment is the potential for an unjustified windfall gain. This might be particularly evident in the case where incumbents have been granted access to spectrum but have not used it and not paid fees for it, or where a nominal fee has been paid, but the spectrum is still not in use.

The department finds the arguments presented against fee recalibration compelling and agrees that incumbents' licence fees should not be tied to auction results for all the reasons cited. However, the department still feels there is a need to discuss how incumbent operators will be dealt with in an auction scenario. Progression towards the establishment of a homogeneous regime with respect to licensee rights will be required for the creation of a fully functioning secondary market for spectrum. The department intends to discuss possible adjustments to licence definitions, terms, conditions and fees for incumbent licensees in another consultation process. In particular, these issues will be addressed in the framework of transition of existing users from apparatus-based to spectrum-based licences.

10. Conclusions

  • Any auction will be preceded by a full public consultation. Subsequent policy decisions will then be clearly articulated so that potential bidders will have the fullest possible knowledge prior to the auction. Bidders will be qualified to participate in the auction based on their compliance with clear and objective criteria, and a remote-access simultaneous multiple round auction will then commence.
  • Consultations on the bandwidth and geographic dimensions of licences will be undertaken prior to any auction. Varying sized tiers of subnational licence areas will be based on groupings of Statistics Canada Census Divisions and Subdivisions. In the specific consultation process held before any particular auction, comments will be sought as to which tier or tiers (national, regional, local) should be used.
  • Licensees will be given the maximum possible flexibility in their choice of service offerings and technologies. Limits will generally only be imposed for interference management purposes.
  • Licensees will be allowed, by condition of licence, to transfer and subdivide their licences (along with all attendant conditions and obligations) to third parties who meet the applicable eligibility criteria.
  • Licences will be assigned for an initial 10-year term. Licensees can generally expect to have their licences renewed for subsequent 10-year terms unless a breach of licence condition occurs, a fundamental reallocation of spectrum to a new service is required (e.g. an International Telecommunication Union reallocation), or an overriding policy need arises (e.g. a spectrum reallocation to address a national security issue). To provide a more stable investment climate for licensees, a consultation process would commence no later than two years prior to the end of the licence term (i.e. after year eight). This would address any possibilities that a licence would not be renewed, as well as the imposition of any renewal fees and/or amendments to licence conditions for the initial licensees in the subsequent term.
  • The government will continue to possess all sovereign rights necessary to implement the required reallocation at any time, as per section 40 of the Radiocommunication Regulations, in case an overriding necessity to reallocate spectrum arises within the term of a licence. It is important to note that the department would reallocate spectrum assigned through auction only under extraordinary circumstances — taking into consideration that the licensee complied with the conditions of licence, has made large investments in infrastructure, and is serving an established client base. If there were a reallocation, it would take place only after full consultation.
  • Payment of winning bids will be required in a lump sum amount at the auction's close. Modest reserve prices will be related to long-run spectrum management costs. Pre-auction deposits will be required to ensure the integrity of bidders.
  • Auction results will not be used to recalibrate (up or down) the fees of incumbent licensees with similar spectrum.
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