Cement, sugar, ghee/oil, fertilizer & wheat flour: CCP urges SECP to conduct cost audit of sectors

The Competition Commission of Pakistan (CCP) has recommended the Securities and Exchange Commission of Pakistan (SECP) to immediately conduct cost audit of sectors including cement, sugar, vegetable ghee/cooking oil, fertilizer and wheat flour to facilitate policy interventions in a fair, transparent, and independent manner.

In this regard, the CCP has issued a Policy Note to the SECP with the recommendations of reinstating the requirement of cost audit of these sectors.

The CCP added that any limitation placed on cost audits may promote anti-competitive practices that in their very essence are detrimental to public interest. The SECP may direct cost audits in these sectors, on an annual basis, as per any pertinent accounting rules prevalent at the time, as may be specified in Companies Act, 2017.

Under Section 258 of the Companies Ordinance, 1984 (CO, 1984), the Federal Government had the power to direct companies to carry out audit of their cost accounts. Under Section 43 of the Securities and Exchange Commission of Pakistan Act, 1997, SECP was vested with all the powers exercisable by Federal Government under any provision(s) of CO, 1984, thereby making the terms 'Federal Government' and the 'SECP' synonymous for the purpose of CO, 1984.

Once a company or several companies were required to include in their books of accounts particulars referred to in Section 230(1)(e) of CO, 1984, through a general or special order invoked under Section 246 of the said Ordinance, the requirement to carry out a cost audit was explicitly stated in the same order.

SECP, through general orders, such as 'Companies Cost Accounting Records (General Order), 2008' , as well as special orders, required companies included in various sectors to carry out audit of their cost accounts on an annual basis. These cost audits followed professional standards specified in Companies (Audit of Cost Accounts) Rules, 1998. Typical industries in this regard were Fertilizer, Thermal energy, Petroleum refining, Natural gas, Polyester fiber, Sugar, Cement, Vegetable Ghee, and Pharmaceuticals.

In the Companies Act, 2017, it was stipulated that the audit of cost accounts of the company under sub-section (1) shall be directed by the Commission subject to the recommendation of the regulatory authority supervising the business of relevant sector or any entity of the sector.

The major departures regarding the requirement for cost audit in the CA, 2017 were, a. Omission of SECP's authority to issue general and/or special orders requiring yearly cost audits in specified industries

While keeping the provision for directing/requiring cost audit from firms, making it subject to recommendation from a sector regulator in this regard.

Almost all the sectors that have historically been required by SECP to carry out cost audit of accounts, under CO, 1984, do not have a sector specific regulator, thus making the provision for directing cost audit under CA, 2017 ineffectual for all practical purposes.

In lieu of the aforementioned, various government bodies, that may require readily available and credible cost information, may have to rely on industry players or their associations, instead of an independent third party, with no inherent conflict of interest. Not only could this negatively impact Government decisions, but also public interest at large.

The absence of audited cost accounts in any sector and the reliance on industry associations for information, could lead to exchange of commercially sensitive information at the association's platform, impacting competition and hurting consumer welfare.

In putting such reliance, not only does the government inadvertently legitimize such exchange at the association's level, but also risk usage of an association's platform to enter into prohibited agreements, such as price fixing, a behavior universally considered to be very harmful to competition, and against public interest.

COMPETITION CONCERNS: When Associations are relied upon for costing information as against an independent third party fully equipped with carrying out such an audit, there is very high likelihood of sharing of commercially sensitive information between potential competitors, such that factors that give competitive edge to firms, and are best kept a secret, are freely shared between them potentially generating ideas for collective welfare as against individual edge required in a competitive market.

Possibility of cartelization: Potential loss of competitive edge through sharing of commercially sensitive information, can raise the possibility of agreements geared at collective welfare of firms, at the cost of general consumer welfare ensured by firms competing in terms of economically efficient measures.

Obfuscation/Concealment of information due to vested Interests: There is every possibility for Associations that are nothing but a body essentially comprising competing members firms, to manipulate or conceal information, to serve their own interests as against promoting overall sector competitiveness.

Problems in Enforcement under the Competition Act, 2010: Section 4 of Competition the Act prohibits, agreements between undertakings and decisions by associations that have the impact of restricting, lessening, or preventing competition in a given sector or relevant market

As highlighted, when associations are relied upon for information, the authenticity of such data would always be doubtful in identifying any patterns of pricing that can potentially raise a red flag in terms of 'price fixing' or other hard core violations treated as 'prohibited agreements' in contravention of Section 4 of the Act.

Section 3 of the Act prohibits any legal entity to abuse its dominant position. One instance of such abuse is when an undertaking that is dominant in its relevant market, leverages that position to carry out an 'unreasonable increase in price' of its products or services.

One of the most challenging of tasks faced by Competition agencies world over, an inconclusive but important component of all such analysis is 'accounting comparators'. One of the most important accounting comparators is the relationship between the price and cost of a product or service being offered by a dominant entity in a given market. For this analysis to be of any significance, information pertaining to the cost or expenses incurred by a dominant undertaking need to be credible to the core, which cannot be guaranteed, unless an independent third party with no vested interest at any level of supply chain and professional competence is engaged.

Policy Tools provided for in the Act vis-a-vis Government regulated Sectors: In addition to the aforementioned enforcement actions, the Act also empowers the Commission to issue policy note or Opinions addressing competition concerns prevalent in Government regulated sectors or otherwise.

Firstly, the essence of Competition law, is promotion of a free market economy. However, it is a reality that Governments do identify and intervene in certain sectors deemed to be providing absolute essentials for the masses. These could include essential commodities such as sugar, wheat/wheat flour, ghee/cooking oil, but also in some instances, and in relatively poor countries, drugs falling in the lifesaving category.

Secondly, while the Act by no means advocates Government intervention in terms of price or other such matters of commercially sensitive nature, When the Government does regulate such sectors, the Commission, through its policy tools, has been actively involved in identifying inefficiencies in such sectors and suggesting ways in which the various stages of supply chain could be made more efficient, in contributing to overall competitiveness of a sector.

Thirdly, the sectors of the nature mentioned above, are subject to multiple government interventions which inter alia include subsidies, support price and price controls. Having costing accounts of companies, audited, does not only provide credible costing data to pertinent Government departments for making informed and independent decisions, but also equips the Commission to identify areas of economic efficiency, so that a regulated sector can at least closely emulate a market, marked by competition.