7. Financial Aspects of Auctions
7.1 Pre-auction deposits
The department sought comment in the consultation paper on whether prospective biddersshould submit a pre-auction deposit. It was proposed that the deposit for each biddershould be generally related to the size of the population located within the geographic areasof the licences that bidder is interested in winning.
Respondents generally agreed on the need for a pre-auction deposit to ensure the financialviability and sincerity of the participants. They also agreed that the deposit should be basedon 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 irrevocableletter of credit, be submitted in order to participate in the auction. The required deposit foreach bidder will be linked to the population and bandwidth associated with the licence orlicences on which that bidder wishes to bid. 21
For licence winners, the deposit will be credited toward payment of their winning bids. Forunsuccessful participants, the deposit will be refunded less any penalties 22 they haveincurred. If the penalties exceed the deposit, any outstanding amount will be owed to theCrown.
The pre-auction deposit will be returned to any applicant that is found not to be a qualifiedbidder, to any applicant that provides written notification to the department of itswithdrawal from the process prior to the auction's commencement, and to any bidderwhose bidder eligibility points are reduced to zero during the auction and who is notpotentially liable for any withdrawal penalties.
7.2 Reserve prices
Industry Canada has always operated on the principle that all spectrum users shouldcontribute to covering the cost of spectrum management in Canada. This can beaccomplished within the auction process by establishing reserve prices at a level that takesinto account the cost of managing the spectrum in question for the whole term of thelicence. In practice, it is admittedly difficult to come up with a precise long-run estimationof 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 itexpects will be quite modest reserve prices. The department sees no benefit in establishinghigh reserve prices that might dissuade legitimate service providers from establishingsystems 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 returnbeing 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 thepre-auction deposits referred to above.
7.3 Bid payment
In the consultation paper, thedepartment proposed that winning bidders would pay 25 percent of the amount of theirbids 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 schememight aid smaller players who could have greater difficulty raising capital.
The majority of those who addressedthis issue, in the response to the consultation paper, strongly rejected theuse of instalment payments. Respondentsremarked that the role of lender should be left with the financial markets andnot with the government. As well, they pointed to the problems that have ensuedfrom the PCS C-block auction in the United States where the FederalCommunications Commission (FCC) used an instalment payment scheme. In particular, they noted that the instalmentpayment scheme resulted in speculative bidding,inefficient assignment of licences, artificially inflated bid prices, bid payment defaults, and delayed roll-outof services to consumers.
The evidence and arguments presentedby respondents show that instalment payment plans are largely detrimental tothe auction process and do not serve to aid smaller players — indeed the artificial inflation of bidprices harms the legitimate small players that one might hope to aid through the use ofinstalment payments. As such, thedepartment will not allow the payment of bidsin annual instalments but rather will require that winning bids be paid in full shortly after the closeof an auction.
More precisely, winning bidders willbe required to submit 20 percent of their high bids within 10 business days of theauction's close. This payment will benon-refundable. If the winning bidder fails tomake this initial payment in a timely manner then the licence will not be issued and the bidderwill 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 alsoresult in the licence not being issued and again the bidder will be subject to the applicableforfeiture penalty.
It isalso important to note that beyond the payment of the winning bid, no otherlicence fees or payments will be required for the duration of the licence term. 25
8. Auction Design
In the consultation paper, thedepartment proposed the use of simultaneous multiple round auctions. The rules for the simultaneous multiple roundauction 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 includesthe standing high bids on each licence andinformation about the bidder's own eligibility for bidding. New bids for a licence are requiredto exceed the standing high bid by at least some pre-established increment. In each round bidders are offered an opportunity to withdraw bids submitted inprevious rounds, subject to apenalty. A minimum pace of bidding in theauction is established by the "activity rule," which penalizes bidders who are inactive by reducing their "biddereligibility points." The rounds continue untilthere are no new bids on any licence. Details of the auction format are discussed below.
Auctions would be run electronicallyand bidders would be able to participate remotely from their offices. The simultaneous multiple round auctionremains at the forefront of applied auction theory and has been usedsuccessfully by a number of diverse administrations around the world. Respondents to the consultationpaper were generally supportive of the use of this auction design.
The department therefore expects touse the simultaneous multiple round format for future spectrum auctions. As discussed furtherbelow, both the theoretical and practical aspects of auction design continue toadvance rapidly. The department willcontinue to examine new auction design developments and adopt them as appropriate. It is also important to remember that thedesign of any specific auction will be subject to public consultation prior toits actual commencement. Thus potentialbidders will have an opportunity to comment on any design changes that the department maypropose.
Giventhe complexity of the simultaneous multiple round auction format, thedepartment may hold information seminars and/or mock auctions prior to any realauction to allow bidders to better familiarize themselves with the bidding system and software.
The detailed elements that have nowbecome largely standard in simultaneous multiple round auctionsconducted around the world were discussed in the consultation paper. As proposed at that time, the department expects that futuresimultaneous multiple round auctions will feature the attributes discussed below.
8.1 Bidder eligibility points
Each licence available in an auctionwill be assigned a number of points approximately proportionate to thebandwidth and population covered by that licence. As part of the application package toparticipate in the auction, each prospective bidder will be asked to indicate which licences it may want to bid on during the course of the auctionand to indicate the total number of "points-worth" of licences that it may wish to bidon in any round. 26 This number, which will also determine the pre-auction deposit requiredfrom the bidder (i.e. therequired deposit will be calculated on a dollar-per-point basis), will define that bidder's initiallevel of "bidder eligibility points." The purpose of this information is to assist in thedevelopment of activity rules (discussed in more detail below) that are used tohasten the speed of theauction.
8.2 Activity rule
Before the auction, each bidder mustspecify which licences it wishes to bid on (as per the discussion on biddereligibility points above). A bidder isdefined to be active on a particular licence in a given round if either it has the standing high bid fromthe previous round or if it submitsan 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 acertain percentage of thebidder's eligibility point level (for example, one-half); in the second stage the percentage isincreased (perhaps to three-quarters); and in the final stage bidders must be active on 100 percentof their bidder eligibility point levels. If a bidder falls short of the required activity level, the bidder's eligibility point level shrinksproportionately. An auction begins and continues in stage one until bidding activity declines to anunacceptable level (say, threeconsecutive 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 — andsimilarly to stage three later inthe auction.
8.3 Bid withdrawals and related penalties
In the event that a bidder makes abid that it later wants to change, that bidder will be given the opportunity to withdraw it. Toencourage meaningful bids, however, a bid withdrawal penalty needs to beimposed. It is natural to have thispenalty correspond to the potential loss in revenue causedby the withdrawn bid. If the licence forwhich the bid has been withdrawn ends up selling for more than the withdrawn bid, then no penalty willbe charged to the bidder. If the licenceultimately sells for less than the withdrawn bid, then the penalty will be thedifference between the withdrawn bid and the eventual final selling price. As a measure to reduce the overall time ofthe auction, while not compromising the auction's efficiency, the department will allow bidders to place new bidsand/or withdraw previously submitted bids at the same time during a round, as opposed to havingtwo 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 bythe bid increment. 27 Increments will be set in percentage terms (x percent of the standinghigh bid) and/or in absolutedollar amounts. Bid increments will bechanged during the course of the auction. For example, at the beginning of an auctionwhen bidding activity is likely to be high, bid increments will be relatively large. As the pace of the bidding falls below a certain threshold, bidincrements will be reduced. The rulesfor changing bid increments will be laid out with a fairlyhigh degree of precision prior to the auction. However, to ensure the auction closes in areasonable amount of time, there will be flexibility to "override" the rules regarding bid increments. Allbidders will be given prior notice well in advance of any proposed changes to the size of thebid increments.
8.5 Waivers
Waivers are designed to prevent abidder from losing bidder eligibility points when it does not satisfy the activity requirementsin a given bidding stage. The purpose ofwaivers is to protect bidders against possible mistakes they might make duringthe course of an auction orto allow them to maintain bidder eligibility point levels in the case oftechnical or communication problems. Typically, eachbidder will be given five waivers.
8.6 Stopping rule
An auction will close when a roundgoes by without any acceptable bids or waivers having been submitted on anylicences. In exceptional circumstances, and after all participantshave been notified inadvance, any round can be declared as the final round. Similarly, exceptionalcircumstances, such as a natural disaster, may result in an auction being delayed, suspended orcancelled.
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 specifiedpayment schedule will forfeit its right to have the licence issued toit. Furthermore, the bidder will berequired to pay a penalty in the amount of the difference between the forfeited bid and theeventual selling price of the licence (in a subsequent re-auction), if the re-auction price is lowerthan the forfeited bid. In addition, anamount equal to 3 percent of the original forfeited bid will be charged toaccount for the administrativeexpenses incurred to reassign the licence.
8.8 Discretionary versus non-discretionary bidding
The consultation paper proposed theuse of non-discretionary bidding. Whatthis means is that rather than beingoffered the opportunity to enter any amount that exceeds the standing high bid by atleast some minimum bid increment, bidders would instead have the choice of giving eithera "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 receivedon the issue of discretionary versus non-discretionarybidding and differing views were expressed by those who did specifically address this issue. Concerns about the use of non-discretionarybidding focused primarily on the proposed time-stamp tie-breaking rule. 29 Some respondents felt that a time-stamp tie-breaking rule might favour thosebidders who, for example, had the fastest computers. 30 There is also the possibility thatnon-discretionary bidding with a time-stamp tie-breaking rule could be moresusceptible 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, nineincrements.
The multiple increment bidding formatwould appear to preserve the previously mentioned benefits ofnon-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-discretionarybidding. The department is investigating the use of multiple increment bidding and willpropose its use should it appear tobe the optimal design option. Again, itis important to remember that the design of any particular auction will be the subject of publicconsultation before that auction'scommencement.
8.9 Bidder identities
Several respondents offered commentson the advisability of concealing bidder identities during an auction. While there could be some benefit toconcealing bidder identities in order to deter bidcollusion, the department is of the opinion that only under rare circumstances would thesebenefits outweigh the benefits of full information disclosure to bidders. Therefore, thedepartment expects that for most auctions the identities of all bidders, the licences onwhich 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
Theconsultation paper asked whether the results of future spectrum auctions shouldbe used to adjust thelicence fees of incumbent licensees with similar spectrum.
A significant majority of respondentsadvised 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 forlicences will already have taken into account the existing fees of incumbents with whom they maycompete when they are determining their valuations. If these fees themselves are uncertain, this creates unnecessary complications for the propervaluation 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 madewith the government at the time of initial licensing. Third, one should take into account risks incurred and investments made byincumbents. Uncertainty created by recalibration damages established businesses because they made plans and secured financing under the rules of theday. Finally, readjusting fees basedon future auction prices will create large uncertainties in the wireless sector. These uncertainties would have a major impacton the availability of financing, investment in newtechnologies, and the provision of new services.
Some respondents suggested that thedepartment "grandfather" existing spectrum users and grant them the same rights that wouldbe awarded to those who receive their licences via an auctionprocess. One of the immediate concernsassociated with such adjustment is the potential for an unjustified windfall gain. This might be particularly evident in thecase where incumbents havebeen granted access to spectrum but have not used it and not paid fees for it,or where a nominal feehas been paid, but the spectrum is still not in use.
The department finds the argumentspresented 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 incumbentoperators will be dealt with in an auction scenario. Progression towards the establishment of ahomogeneous regime withrespect to licensee rights will be required for the creation of a fullyfunctioning secondary market forspectrum. The department intends todiscuss possible adjustments to licence definitions,terms, conditions and fees for incumbent licensees in another consultation process. In particular, these issues will be addressedin 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.