Squaring the Circle: EU State Aid Rules and the Banking Bailout
When asked his opinion of investing in the 1920s stock market bubble, Andrew Mellon, Treasury Secretary from 1921 to 1932 (to Presidents Harding, Coolidge and Hoover), replied "Gentlemen prefer bonds." In the wake of another, more recent bubble, some European governments prefer equity, and in the last three months have put hundreds of billions of euros into recapitalising their banks. Other governments have preferred to provide guarantees to their financial sectors. How can these measures be squared with the basic prohibition of State aid in the European Union?
In the European context, State aid is defined as an advantage in any form whatsoever conferred on a selective basis to undertakings by national public authorities. The EC Treaty provides that State aid which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods is, insofar as it affects trade between Member States, incompatible with the common market. The Treaty recognises, however, that in some circumstances interventions by the State can be justified; it accordingly provides that aid with certain policy objectives may be considered to be compatible with the common market.
Normally, a Member State proposing to provide such aid must provide advance notice to the European Commission, which has exclusive responsibility for determining whether aid is lawful, and await the Commission's approval before granting the aid. Since the beginning of October, the Commission has validated over 20 national schemes supporting financial stability, including guarantee schemes (Denmark, Finland, France, Ireland, the Netherlands, Portugal, Slovenia and Sweden), asset purchase schemes (Spain) and recapitalisation schemes (sectoral schemes in Germany, Greece and the UK, and specific bank schemes in France, the Netherlands and Sweden). While by law the Commission may take up to two months to make an initial determination on such requests, the European Council has noted the need for rapid and flexible action in the current economic circumstances.
Among the categories of assistance that may be regarded as lawful is aid to facilitate the development of certain economic activities. On the basis of that exemption, the Commission issued a Communication in 2004 (Community guidelines on State aid for rescuing and restructuring firms in difficulty) setting conditions for both rescue aid and restructuring aid. In recent months, as the global financial crisis unfurled and its scale became apparent, the Commission recognised that those guidelines, which had been framed in a different context, would not be adequate. It accordingly issued a fresh Communication on 13 October 2008 (The application of State aid rules to measures taken in relation to financial institutions in the context of the current global financial crisis) in which it acknowledged that, in light of the level of seriousness of the current crisis in the financial markets and of its possible impact on the overall economy of Member States, aid measures undertaken to address the crisis may be justified on the separate ground, hitherto rarely invoked and strictly interpreted, of aid to remedy a serious disturbance in the economy of a Member State. It is under this heading that Member States have sought approval of their various schemes to support the financial services sector.
In the October Communication, the Commission recognised that recapitalisation schemes are one of the key measures that Member States can take to preserve the stability and proper functioning of financial markets. On the basis of the general principles laid down in the Communication, recapitalisation schemes were authorised subject to the introduction of market-oriented remuneration rates, appropriate behavioural safeguards and regular review. In the rapidly unfolding crisis, however, both Member States and potential beneficiary institutions called for more detailed guidance, and on 5 December 2008 the Commission issued a further Communication (The recapitalisation of financial institutions in the current financial crisis: limitation of aid to the minimum necessary and safeguards against undue distortions of competition).
The December Communication provides that state interventions must be both proportionate and temporary. The Communication notes that, in evaluating any proposed recapitalisation scheme or measure, the Commission will balance the anticipated benefits against three potential forms of competitive harm that might occur, by considering the following principles:
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Recapitalisation by one Member State of its own banks should not give those banks an undue competitive advantage over banks in other Member States;
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Recapitalisation schemes that are open to all banks within a Member State without differentiating on the basis of risk profile should not give an undue advantage to distressed or less well-performing banks; and
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Public recapitalisation, and in particular the costs that banks must pay to take advantage of public funding, should not put banks that seek additional capital on the market in a significantly less competitive position.
The Communication also provides detailed guidance on the principles which the Commission will take into account in its assessment of specific types of assistance plans.
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In assessing temporary recapitalisations of fundamentally sound banks in order to foster financial stability, the Commission will focus on entry and exit strategies: remuneration (reflecting the methodology for benchmarking the pricing of State recapitalisation measures for fundamentally sound institutions in the Euro area proposed by the European Central Bank in its Recommendation of 20 November 2008) and incentives for State capital redemption, together with the need for review after six months.
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In assessing lending to the non-banking sector and for rescue recapitalisations of other banks, unsurprisingly the Commission will impose stricter requirements for remuneration and more stringent behavioural safeguards, such as a restrictive policy on dividends (including a ban during the restructuring period), limitation of executive remuneration or the distribution of bonuses, an obligation to restore and maintain an increased level of the solvency ratio compatible with the objective of financial stability, and a timetable for redemption of State participation.
It remains to be seen how these latest guidelines will be implemented in practice in connection with future requests for approval by Member States.
