The financial crisis that ensued from the collapse of Lehman Brothers has led to a wave of financial institutions requiring government backed bail-outs in Europe and the United States. As the financial crisis has spread to the real economy, companies have also turned to government backed schemes for access to credit.
However, in the European Union (EU), there are strict rules on the granting of public subsidies or “State aid”. These rules are designed to prevent the EU Single Market from being undermined by uncompetitive companies being propped up by subsidies. They are enforced by the European Commission to ensure that any State aid granted is done so in a manner that minimises distortion to competition. State aid that is illegally granted may have to be repaid with interest. In order to ensure that EU Member States can address the financial and economic crisis in line with EU State aid rules, the Commission has adopted guidance on the following issues:
- State guarantees to banks (in particular to protect deposits)
- Recapitalisation of banks
- Toxic assets
- State aid to the real economy
Complying with these rules will be crucial to financial institutions in the EU seeking to participate in EU government schemes to restructure their businesses. Companies in the real economy that require additional public support should also be aware of the measures designed to assist them.
What Constitutes State Aid?
According to Article 87(1) of the European Community (EC) Treaty, any “aid” granted by an EU Member State or through State resources that confers an advantage upon certain companies (or products) and distorts competition and trade between Member States is incompatible with the Common Market. State aid can take the form of public funds, State guarantees, loans or tax rebates that are granted by the State and confer a selective advantage to a particular industry or company. State aid will only be considered as compatible if, inter alia, it meets the conditions for an exemption as set out in Article 87(3) EC.
Compatible State Aid to Address the Financial and Economic Crisis
Article 87(3) EC provides that the following categories of aid (amongst others) may be exempt:
- aid to promote the economic development of areas where the standard of living is abnormally low or where there is serious underemployment
- aid to remedy a serious disturbance in the economy of a Member State
- aid to facilitate the development of certain economic activities or of certain economic areas
In view of the exceptional circumstances arising from the current crisis, the Commission has taken the rare step of adopting guidelines under which State aid will be considered exempt as it is being used to address a “serious disturbance in the economy”. This is enabling some extraordinary State aid measures to be granted by Member States to their financial institutions and real economy.
The Commission issued guidance on 13 October 2008 (the Banking Communication) which deals with, amongst other matters, the granting of State guarantees to financial institutions. It acknowledges that State guarantees may be necessary to cover bank deposits to maintain confidence in the banking system. Broadly, the conditions for approval of State guarantees are:
- All measures must have objective eligibility criteria and must be non-discriminatory on grounds of nationality (though conditions may be placed on guarantees to foreign owned branches).
- All measures must be limited in time to what is necessary to address the crisis.
- The beneficiaries and/or the sector must contribute to the cost of the measures.
- There must be sufficient behavioural rules in place to prevent abuse of the support by the beneficiaries.
- There must be appropriate structural adjustment measures for the sector as a whole and/or the restructuring or liquidation of individual institutions that have relied on a scheme.
Example: Irish Banks Guarantee
On 13 October 2008 the European Commission approved the Irish Government’s scheme to guarantee deposits and debt to eligible banks active in the Irish market. The scheme was amended to provide the non-discriminatory coverage of banks with systemic relevance to the Irish economy (not just “Irish” banks) to bring it in line with European law.
The Commission issued detailed guidance in December 2008 on the recapitalisation of banks in line with the State aid rules (which elaborated upon the guiding principles in the Banking Communication) once it became clear that recapitalisation would become increasingly necessary to address the financial crisis. The Recapitalisation Communication states that Member States should receive equity or a similar interest in the bank that is recapitalised. There should also be incentives for the bank to replace State capital with private capital as soon as market conditions permit (such as restrictive dividend policies in favour of the State or behavioural constraints upon the bank). Recapitalisation of distressed banks should only take place on the condition of substantial restructuring or a commitment to wind up the bank.
The Commission issued guidance on how States can deal with “toxic assets” in line with the State aid rules. The Commission highlights the two most effective means of dealing with toxic assets:
- Creating a “bad bank” which pools together all the toxic assets and is then liquidated
- Providing an insurance scheme whereby banks are provided with a guarantee over risky assets
The Commission requires “burden-sharing” of the costs related to the impaired assets between the shareholders, the creditors and the State. The Commission also requires “adequate remuneration for the State” at least equivalent to the remuneration of State capital, which may take the form of high premiums for insurance schemes or sales of good assets in return for the purchase of toxic assets.
Example: UK Assets Protection Scheme
On 27 February 2009 the UK Government announced the implementation of its Asset Protection Scheme to enable participating institutions to insure against future losses with the Government in return for a fee. According to the UK Treasury, conditions precedent to participation in the scheme include State aid clearance of the scheme by the European Commission. The Commission is, however, scrutinising the scheme and its implementation.
In December 2008 the Commission adopted the Communication on Access to Finance (which has since been amended) designed to assist the real economy overcome problems in obtaining access to funds. The Communication considers the following State aid measures as being compatible with the objective of addressing the disturbance to the economy:
- Aid in the form of a cash grant of up to EUR 500,000 per undertaking for companies facing a sudden shortage or unavailability of credit
- Grant of subsidised loan guarantees for payment of reduced premiums to encourage access to finance
- Aid in the form of interest rate reductions
- Aid for the production of green products (aimed at the car industry)
- Aid to promote risk capital by increasing the thresholds in the Commission’s Risk Capital Guidelines (from EUR 1.5 million to EUR 2.5 million)
Example: Schemes in United Kingdom, Germany and France
On 27 February 2009 the Commission approved temporary aid measures introduced by France, Germany and the United Kingdom to deal with the financial crisis. One of the UK measures, interest rate subsidies, provides direct support to the automotive industry on the condition that manufacturers invest in “green” products and processes.
State Aid Approval Procedure: Importance of Notification
State aid must be notified by the granting EU Member State to the European Commission for approval if it is not already automatically exempt under existing EU legislation or pre-approved aid schemes. For this reason, the communications addressing the financial and economic crisis (which are guidelines as opposed to law) do not remove the obligation upon Member States to obtain approval from the Commission for the measures before the State aid is granted.
Aid that is not notified to the Commission amounts to unlawful aid, which the Commission can order to be provisionally repaid or suspended pending an investigation into its compatibility with EU State aid rules. The Commission is entitled to investigate any suspected cases of granting of illegal aid. An investigation is often launched following the submission of a complaint by competitors of the recipient of the alleged aid. Following examination of the aid (whether notified or not), if it is concluded that the aid cannot be exempted, the Commission can order the Member State to recover the aid together with interest from the time the aid was granted.
The onus is on the company in receipt of the aid to ensure this aid is legal. Consequently, a company wishing to receive State aid should ascertain whether the proposed subsidy requires prior notification and, if so, it should ensure that the notification is full and complete so that the Commission’s authorisation is incontestable.
Getting the Aid Through
The measures taken by the Commission provide a window of opportunity for financial institutions and companies to receive State aid in order to weather the economic crisis. It is vital to ensure that the State aid is properly authorised, however, as illegal aid may have to be repaid with interest by the recipient.