Innovation Roadblock: EC Patent Licensing Intervention Threatens Open Standards

Debate about patent licensing and royalties in the technology industry is ongoing, and it’s a topic that’s constantly evolving. But a significant, and extremely negative, change for the tech sector could be on the horizon.

The European Commission (EC) is on the verge of issuing a new draft regulatory framework for licensing and disputes associated with standard essential patents (SEPs). SEPs are essentially the building blocks of tech innovation, forming the basis of the telecom industry’s growth and success. Giant leaps in mobile innovation with 2G, 3G, 4G and 5G wouldn’t have been possible without licensing of intellectual property, as it provides a baseline of capability that’s uniform for all industries and enables technologies to develop and operate at scale.

The EC’s proposal is set for release on 26 April, World Intellectual Property Day. However, a huge wave of opposition from the legal world and tech industry has propelled the issue into the broader consciousness weeks before its official unveiling. An open letter of opposition from the European Telecommunications Standards Institute this week underlines the shortcomings of the proposal, as well as the significant ramifications the legislation could have if it moves forward.

The primary goal of the draft framework was to create an SEP registration database that would help increase transparency. But the addition of provisions to aggregate royalty-rate-setting alongside a parallel court process to adjudicate SEP disputes and make reasonable and non-discriminatory licensing determinations are hugely problematic both practically and in terms of their broader impact. We’ll focus on the latter, rather than on the legal technicalities…

It’s worth considering how SEP licensing works today. The EU has been the driving force behind the licensing of SEPs and the principle that licensing must be fair, reasonable and non-discriminatory — or FRAND, as it’s known. Europe is the leader in the creation of open standards; this has been achieved by an open-market approach to royalty-setting under the FRAND framework. Although there have been a few disputes, the enormous volume of licensing agreements between participants shows that the process works.

The EC’s draft legislation essentially turns this on its head. Rather than the process being market-driven, the state would implement a “top down” approach to rate-setting and dispute resolution. For example, an aggregate royalty rate for patents would be implemented. This is unworkable, as standards contain multiple technologies — the values of which are constantly changing. One standard isn’t the same as another.

The research and innovation inherent in a standard can begin years before it’s completed. Companies involved in this process are doing so with no guarantee that the intellectual property will be relevant, or even what the final standard will look like. In return the system must protect those investments, especially when they come to define a standard. A company’s intellectual property should be protected and rewarded through royalties for risks taken years earlier, should it become fundamental to how a product or standard works.

The EC’s proposal of a cap on value risks disincentivizing companies from innovating when creating potential standards. This would have a detrimental effect on innovation at large and hinder the ability to develop technologies that can achieve scale. Moreover, standards development could break down completely, resulting in fragmentation. The speed at which the industry moved from 2G to 5G — creating enormous economic and social value in the process — would become a footnote in history as the market instead splinters into regional self-interest.

This sounds like hyperbole, but given the geopolitical tensions today, it’s an extremely high risk. A breakdown in the standard-setting process would enable China to spearhead its own agenda and redefine the building blocks of foundational technologies.

This risk isn’t limited to geopolitics. Large industries such as automotive, which lack significant patent portfolios but have a big interest in embracing connectivity, could add to the pile of increasingly proprietary technologies. Indeed, it’s likely that lobbying from the automotive sector resulted in the draft legislation’s proposed changes.

All this highlights the paradox at play here. The West is obsessed with the theme of tech competitiveness. Governments have belatedly grasped the importance of foundational technologies such as semiconductors, as well as the importance of open standards to long-term economic prosperity and stability. Rightly, there’s also concern about China and what it means for technology leadership.

But the EC’s proposal is entirely at odds with the political and economic imperatives being promoted by European and North American governments. A state-led approach to standard-setting risks short-term damage to a major industry, and would enable China to legitimately challenge the basis of hundreds of existing royalty agreements.

In the medium to long term, Europe would lose its leadership in standard-setting, affecting its status, influence and licensing revenues. Policy regarding SEPs would move out of Europe as companies resist the EC’s attempt to dictate a global regulatory approach rather than building on a carefully constructed process that until now has been market- and consensus-driven.

The hope is that the weight of opposition and short-sighted nature of the proposed legislation results in changes before it’s published on 26 April. If it doesn’t, the volume on this debate is going to increase — and the tech industry should be extremely concerned.