P. Nicolaides Conflicting Roles of State Aid Control

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EDITORIAL THE CONFLICTING ROLES OF STATE AID CONTROL: SUPPORT OF FINANCIAL INSTITUTIONS VERSUS SAFEGUARDING THE INTERNAL MARKET* PHEDON NICOLAIDEs

§1.

and IOANA ELEONORA Rusu"

INTRODUCTION

The response of EU institutions to the financial crisis can at best be described as varied. The European Commission and the European Central Bank reacted as soon as the crisis broke out in September 2008 to preserve the integrity of the internal market and increase liquidity in the markets, respectively. The Council responded only a month later with recommendations that Member States increase public spending. Finally, the Parliament and the Council together were able to adopt a new regulatory framework only in September 2010.1 The purpose of this editorial is to examine the role of state aid rules in the financial crisis and ask whether they protected the internal market or prevented Member States from providing much needed support to financial institutions. It should be recalled that immediately after the collapse of Lehman Brothers, Member States rushed to inject capital in banks and to raise deposit guarantees to assure the public and prevent runs on banks. 2 The European Commission had to intervene to ensure that national measures used to prop up banking were not discriminatory. As the then Commissioner for competition put

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This article draws extensively on a longer paper entitled 'Financial Crisis and State Aid' that will appear in the Anti-Trust Bulletin. Phedon Nicolaides is Professor of Economics at the European Institute of Public Administration (EIPA), Maastricht, The Netherlands. loana Eleonora Rusu is a research assistant at the EIPA. Proposal for a Regulation of the European Parliament and of the Council on Community macro prudential oversight of the financial system and establishing a European Systemic Risk Board. COM(2009) 499 final. UK - NN 41/2008; Ireland - NN 48/2008; Denmark - NN 51/2008; Sweden and Spain - N 337/2009.

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it, 'state aid rules [were] part of the solution, not part of the problem.'3 The Commission also issued new guidelines on state aid to banks and committed itself to deal with notified measures within record time, normally not more than a couple of days. In December 2008 it broadened the new rules to cover the real economy as well. 4 The first challenge to the functioning of the internal market came in mid-September 2008 with the announcement of the Irish government that it would cover deposits in only six Irish banks by a state guarantee scheme. That presented a serious risk of a large outflow of capital from non-eligible competitors. The Commission asked the Irish government to broaden the coverage of the scheme so that the guarantee would be available to all banks with subsidiaries or branches in Ireland and having a significant presence in the domestic economy.5 Similarly, when France announced its planned aid to the automotive sector which originally raised concerns about state aid and the integrity of the internal market (because it was offered on condition that the recipients repatriated their foreign operations to France), the Commission stated without ambiguity that any aid granted under additional non-commercial conditions concerning the location of investments (and/or the geographic distribution of restructuring measures in another case) could not be regarded as compatible with Treaty rules. After intensive discussion between the Commission and the French authorities, France committed itself to avoid any conditions contrary to the single market rules. This approach has been maintained in all other cases, in particular with regard to the German plans in relation to Opel. In the following sections we consider whether the Commission has accommodated the concerns of the Member States or whether it has imposed conditions on the use of state aid that have had negative effects on the internal market.

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N. Kroes, Briefing to Economics and Finance Ministers, 2 December 2008, MEMO/08/757. In total the Commission has since then adopted the following new guidelines: Communication from the Commission - The application of State aid rules to measures taken in relation to financial institutions in the context of the current global financial crisis [2008 O C 270/8; Communication from the Commission - The recapitalisation of financial institutions in the current financial crisis: limitation of aid to the minimum necessary and safeguards against undue distortions of competition [2009] OJ C 10/2; Communication from the Commission on the treatment of impaired assets in the Community banking sector [2009] OJ C 72/1; Commission communication on the return to viability and the assessment of restructuring measures in the financial sector in the current crisis under the State aid rules [2009] OJ C195/9; DG Competition staff working document - The application of State aid rules to government guarantee schemes covering bank debt to be issued after 30 June 2010, 30 April 2010, electronically available at http://ec.europa.eu/competition/state-aid/studies-reports/phase-out bank-guarantees.pdf (last visited 08.11.2010); Communication from the Commission - Temporary Community framework for State aid measures to support access to finance in the current financial and economic crisis [2009] OJ C 83/1 (subsequently amended on 25 February 2009,28 October 2009 and in December 2009). Ireland - See NN 48/2008. The original Irish scheme had to be modified, in order to delete any discriminatory coverage of banks with systemic relevance to the Irish economy. See Europe Rapid Press releases, State aid: Commission welcomes revised Irish guaranteescheme, 13.10.2008, MEMO/08/615.

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The Conflicting Roles of State Aid Control

§2.

APPLICATION OF THE SPECIAL STATE AID RULES

It is estimated that state aid of more than EUR 4,000 billion has been committed to financial institutions in the form of guarantees, fresh capital and cover for impaired assets. All the cases that have been notified by Member States have been accepted by the Commission. In only about 15% of these cases has the approval of the Commission been made conditional on acceptance of certain requirements concerning compensatory measures. 6 There is no doubt that the special rules for the financial services sector are quite permissive. The mere fact that they exist at all signifies the intention of the Commission to allow aid for that particular sector. In addition, the Commission has been willing to apply laxer rules in view of the gravity of the situation in that sector. For example, banks that receive public funds for restructuring do not have to undertake divestments to the same extent as other undertakings that received aid for the same purpose in the past. With regard to the real economy, some of the aid that is allowed by the Temporary Framework is operating aid that is normally not authorized. But here, again, the avowed intention is not to induce beneficiaries to carry out new investment but to release liquidity so as to enable them to cover their day-to-day costs and remain in business. The emergency state aid rules and procedures have come under critical scrutiny in the literature.7 In order to be able to appreciate how the rules have been applied we have examined in detail the following sample of Commission decisions: -

C 9/2008 on state aid to Sachsen LB 2009/971 [ex C 43/2008] on state aid to WestLB N 244/2009 on state aid to Commerzbank C 10/2009 (ex N 138/2009) on state aid to ING

Our analysis of these Commission decisions leads us to the following conclusions with respect to the most common concerns which have been raised: a) Are the new rules less strict? The answer is certainly in the affirmative. Undoubtedly, however, neither financial markets nor the real economy could function without state support in the form of guarantees, capital injections and cheap loans. Some authors also argued that, in the absence of general economic measures concerning 6

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These statistics are as of March 2010 and can be accessed on the website of DG Competition: http:// ec.europa.eulcompetition/state-aid/studies-reportsexpenditure.html#3 (last visited 23.10.2010). Werner and Maier, 'Procedure in Crisis? Overview and Assessment of the Commission's State Aid Procedure during the Current Crisis', 8 EStAL 2 (2009), p. 177-186; Anestis and Jordan, 'The Handling of State Aid During the Financial Crisis: an Efficient Response or Trouble for the Future?', electronically available at www.globalcompetitionreview.com/reviews/28/sections/98/chapters/1089/state-aid/ (last visited 23.10.2010).

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the economic and monetary policy adopted by the ECOFIN Council, the possibilities of control given to the European Commission were limited to an incidental control of particular sectors and only to individual or ad-hoc measures in the field of state aid and merger control.8 b) Is the Commission's control only cursory? The shortening of the decision-making and the possibility to issue a decision within 24 hours, compared to the rather long procedural burdens of the normal procedure, could lead to the conclusion that the investigation can only be superficial. However, the answer to the question is mostly negative. It is true that the Commission has approved many schemes in record time, but where it had doubts it did not hesitate to open formal investigations, ask Member States to justify their measures and impose conditions in order to approve them. A large number of measures have been approved quickly simply because the new rules have not been too difficult for Member States to follow. The important role given to the pre-notification talks has certainly contributed to a swift authorization process. However, in a number of cases the Commission has been willing to accept perhaps too readily that proposed measures were necessary to remedy a serious disturbance in the economy of the Member States that proposed them. The text of the decisions does not reveal that the Member States concerned had to submit any extensive or detailed analysis of the expected impact of their measures. c) Is there now less legal certainty? The Commission has shown considerable flexibility in deviating from the requirements of the Rescue & Restructuring Guidelines. But precisely because it is not clear under which conditions such deviation is possible and what kind of proof the Commission expects to receive, and because required evidence for the systemic impact on the economy is not well defined, it is not possible to know before hand what the Commission may or may not authorize. Some authors have even argued that the operative parts of some decisions contain significant 'accumulations of empty formulas and quasi-circular reasoning'.9 Effective numbers or hard data on the scale and effects of the measure, which could provide further guidance by determining the general criteria of compatibility, were missing. Certainly, the Commission sees much more data and many more reports than those it reveals in its decisions. However, the overall conclusion on this point must be that we are no wiser on what the Commission will regard, for example, as adequate compensation or adequate own contribution. We only know how the aid recipients and Member States should present their case. d) The partial reasoning of the decisions and the (lack of) transparency of the examination do not only affect the principle of legal certainty but also raise questions concerning the effective right of competitors to contest the approved aid measures.

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Editorial comments: Weathering through the credit crisis. Is the Community equipped to deal with it?, 46 Common Market Law Review 1 (2009), p. 3-12. For example see Jaeger, 'How Much Flexibility is Needed? Commission Crisis Management Revisited', 8 EStAL 1 (2009), p. 4.

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The Conflicting Roles of State Aid Control

Some aid recipients and some competitors have chosen to challenge Commission decisions authorizing state aid. Although it is a well-established point of case law that the Commission enjoys much discretion in assessing the compatibility of state aid with the internal market, a recent ruling of the General Court suggests that the Court is willing to question the Commission's use of numbers. The General Court, in case FreistaatSachsen v Commission,'0 annulled Commission Decision 2007/492 because the Commission did not explain how it added various premia reflecting the creditworthiness of an aid recipient in order to arrive at the rate of interest that it used to determine the existence of state aid. The Court did not question the discretion of the Commission or the formula used by it. Nonetheless, that did not prevent the Court from finding that the Commission should have explained why, for example, a certain type of risk justified an increase of so many basis points. If this judgement reveals a more general trend, then perhaps more Commission decisions will be annulled for failure to provide adequate reasoning on what the Commission regarded to be the right rate of interest or the right remuneration for capital offered by Member States to banks and other financial institutions. e) How should Member States present their case? The Commission wants to see viable plans, substantial own contribution and minimization of distortion of competition. It follows, therefore, that, as the cases above reveal, conservative assumptions, cost reductions, limitation of risk in asset portfolios, extensive divestments that reduce presence on the market and pay for the restructuring, cost-benefit analysis that shows the minimum acceptable level of return on capital employed, avoidance of price leadership and avoidance of acquisitions make a persuasive case. The precise numbers will have to be negotiated with the Commission. Indeed, another outcome of the financial crisis is the importance for Member States to be in command of the issues they discuss with the Commission and be willing to negotiate. f) When will the new rules be terminated? Some of the new rules have explicit expiry dates. However, nothing prevents the Commission from extending their period of validity for as long as conditions in the EU have not improved significantly. However, Member States still have to design their measures to fall within the periods of validity provided by the current rules. To conclude, the new system has advantages in preserving the consistency of the general system of state aid control, by adapting the strict rules of state aid to the need to act swiftly in times of a financial crisis. To summarize so far, the Commission appears to have done reasonably well in view of the magnitude of the problem and the urgency of the measures that were adopted by the Member States.

1o

Joined cases T-120/07 and T-120/07 FreistaatSachen, MB Immobilien Verwaltungs GmbH and MB System GmbH & Co. KG v European Commission, Judgment of 3 March 2010, not yet reported.

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§3.

ARE STATE AID RULES A THREAT TO THE INTEGRITY OF THE INTERNAL MARKET?

The application of state aid rules during the financial crisis instigated a complaint voiced primarily by some German officials." The Commission was criticized for its handling of certain cases of aid to financial institutions because the beneficiaries were allegedly forced to withdraw from other Member States and that was damaging the integrity of the internal EU market. First of all, it is true that the Rescue & Restructuring Guidelines' 2 require that the recipients of aid compensate their competitors. This requirement is intended to minimize the distortive effect of aid. The typical compensatory measure is divestment, closure of capacity or withdrawal from certain markets or activities. Therefore, there was nothing unusual in the Commission's demands. Second, the internal market concept has been defined as an area without barriers or frontiers. The rules of the internal market are phrased in the form of prohibitions. They stipulate the removal of barriers but not the presence of companies in the markets of other Member States. It cannot be expected that in an integrated market all companies will be present in all locations. Their choice of location depends on their competitiveness and business model. In the same way that companies choose not to locate in certain areas within a country, they also choose not to operate in all countries of the EU. Third, getting rid of loss-making assets, disengaging from marginal activities and focusing on core business and customers make companies stronger. This type of restructuring intensifies competition and in the longer term enables companies to offer better products and to enter new markets. The viability of the internal market very much depends on the strength of competition. Fourth, the compensatory measures included in restructuring plans are defined first by the beneficiaries themselves and then proposed by the corresponding Member States. The Commission does not request that companies exit the markets of other countries. However, the Commission does expect to see exits from unprofitable markets [so that companies can return to viability] and substantial limitation of the activities of aid recipients so that their competitors are disadvantaged to the smallest possible extent. Therefore, it is unfair to accuse the Commission of having acted in a way that undermined the cohesion of the internal market.

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According to the Financial Times, 'Europe's competition authorities risk throwing the continent's economic integration into reverse with their response to the financial crisis, [Axel Weber] the head of Germany's Bundesbank, has warned in rare public criticism of Brussels.' See Financial Times, 'Weber Hits out at Brussels', 22 April 2009. D'Sa,'"Instant" State Aid Law in a Financial Crisis - A U-Turn?', 8 EStAL 2 (2009), p. 139-140.

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§4.

CONCLUSIONS

State aid policy has played an important role during the financial crisis. It has allowed Member States to support, initially, financial institutions and then the real economy while at the same time it has strived to prevent excessive distortion to competition and disruption to the flow of resources between Member States. At this stage it is not possible to know whether indeed the distortion has been kept to the minimum. No cost-benefit analysis has been carried out so far. However, it is possible to surmise with a fair degree of confidence that certain forms of distortion have been avoided. Member States have not been allowed to discriminate in favour of their banks. They have not been allowed to grant unlimited amounts of aid. They have been required to submit realistic restructuring plans which in some cases have led to the sale of the beneficiaries or even to their closure.' 3 The more difficult question is whether the permitted amount of aid was excessive. There is no doubt that the special rules which were issued by the Commission were accommodating. Given that similar and even more generous measures have been adopted by countries outside the European Union, it is not unreasonable to conclude that the special rules merely reflected the exceptional nature and unprecedented magnitude of the crisis. The question for the near future is how quickly the special rules will be phased out. In May 2010 the Commission announced that it would demand higher rates of remuneration for state guarantees. The effect of this tightening of the rules would be to make it more costly for banks to ask for public support.14 Although the Temporary Framework for aid to the real economy is due to expire at the end of 2010, the Commission launched a public consultation in October 2010 on a possible extension for a year. Again it appears the Commission is responsive to Member State arguments that the economy is still in need of state support.

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For example, the liquidation aid to Roskilde Bank in Denmark (NN 39/2008). DG Competition staff working document - The application of State aid rules to government guarantee schemes covering bank debt to be issued after 30 June 2010, 30 April 2010, electronically available at http://ec.europa.eu/competition/state-aid/studies-reports/phase out-bank-guarantees.pdf (last visited 08.11.2010).

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