The European Commission on 2 April 2008 launched an in-depth investigation under the EC Treatys rules on state aid into the UK authorities’ package of measures to support the restructuring of Northern Rock, the UK mortgage bank. The Commission received the notification of these measures on 17th March 2008. The opening of an in-depth investigation gives interested parties the possibility to comment on the proposed measures but it does not prejudge the outcome.
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The European Commission is investigating the UK’s proposal to keep state measures in favour of Northern Rock in place until at least 2011 while the restructuring plan is implemented. The proposal is that the lending will be progressively repaid and the guarantees progressively lifted over the restructuring period.
The UK authorities notified the restructuring plan for Northern Rock on 17th March 2008. This was the deadline set under the authorisation on 5th December 2007 of the rescue aid measures, since the rules for rescue aid allow an initial rescue period of six months and the first rescue aid measure was granted on 17th September 2007.
The Commission has received a detailed restructuring plan but is asking the UK for certain additional information. It is also asking third parties to comment, in particular on the measures proposed to avoid undue distortions of competition.
In itself, the nationalisation makes no difference to the investigation. The EU Treaty’s rules, including those on state aid, are neutral as between public and privately owned undertakings. Today’s decision to open an investigation specifically finds that the announced terms for compensation to Northern Rock’s former shareholders do not constitute state aid.
A restructuring plan capable of restoring the long term viability of the firm without further state support must be provided. The state aid must be limited to the minimum necessary, in terms of both duration and amount, to implement the restructuring and the beneficiary must significantly contribute to the cost of restructuring.
The aid must not distort competition to an extent contrary to the common interest. In this respect, the Commission may impose specific conditions and obligations on the beneficiary.
Although the formal transmission of information took place on 17th March, the Commission and UK authorities have been in close contact since last autumn. This enabled the Commission to prepare a decision to launch the investigation very quickly.
Under the rules, the rescue aid measures already approved can continue in place while the Commission reaches its decision on the restructuring plan. Today’s decision also authorises another rescue aid measure, taken on 18 December 2007 and not therefore covered by the 5 December decision: this too can continue in place during the investigation.
The Commission will aim to conclude its investigation as quickly as it can. Third parties have to be given one month to submit comments following publication of today’s decision in the EU’s Official Journal. This in itself may take a few weeks to allow for translation and removal of confidential data. Experience shows that it is very difficult to complete an in-depth investigation in less than 4-5 months.
In a functioning market economy the exit of inefficient firms is a normal and even essential element. It would be detrimental for the functioning of markets if every company in difficulties were to be rescued by the state, because this would mean tolerating inefficiencies and creating adverse incentives for companies (the moral hazard problem). Moreover aid to firms in difficulty raises particular competition concerns as it can shift an unfair share of the burden of structural adjustment and the attendant social and economic cost to competing undertakings who are operating without aid, and to the economies of other Member States.
Aid to firms in difficulty is therefore, regarded as one of the potentially most distortive types of state aid.
As in any other sector, crisis situations in the financial sector are usually triggered by excessive risks, bad management, defective supervision and/or fraud. In the banking sector, this can be aggravated by the risk of contagion through transmission in the interbank market. Also, the danger of moral hazard may be particularly acute in the banking sector. In such situations unchecked subsidies to one or more banks which committed management or judgment errors have, for the above mentioned reasons, the potential to significantly distort competition between banks and between the economies of the Member States.
When discussing the compatibility of and devising procedures for dealing with state aid in the banking sector it must be borne in mind that, depending on the circumstances of the case and the identified transmission channels, a crisis in one or more individual banks may have particularly harmful spill-over effects on other banks or the financial system as such. History shows that a serious financial crisis can have a significant impact on GDP. Preventing those spill-over effects may require:
- rapid state/central bank intervention in order to prevent contagion effects on healthy but interconnected other undertakings
- effective and decisive state/central bank intervention in order to maintain/restore confidence and prevent bank runs
- confidentiality of the preparation of the intervention in order not to jeopardise its effectiveness.
Instead of granting selective advantages to individual banks, Member States/central banks could react to a banking crisis with general measures open to all actors in the market (e.g. lending to the whole market). Such general measures often do not constitute state aid.
The Commission considers for instance that a number of standard activities of central banks such as open market operations and standing facilities are outside the scope of the state aid rules. Emergency liquidity assistance in specific circumstances (in particular if granted subject to sufficient collateral and with a penal interest rate) may also be free of aid, as was decided on 5 December 2007 in the context of the Northern Rock rescue aid measures. Furthermore, consumer reimbursement under self-financed deposit guarantee schemes is also outside the scope of state aid rules.
If Member States have doubts whether an envisaged measure is within or outside the scope of the state aid rules, the Commission endeavours to answer their questions as rapidly as possible. If Member States wish to have legal certainty they can notify the measure and the Commission will assess it and adopt a decision.
Our case experience so far shows again that the R&R guidelines provide an appropriate framework to deal with restructuring cases, also in the banking sector.
In the BAWAG case, the fourth-largest bank in Austria had run into difficulties following speculative financial investments during the period 1995 to 2004. BAWAG made considerable losses and was not able to close its 2005 balance sheet. As depositors withdrew large amounts of money from saving accounts in spring 2006, the Austrian Parliament adopted a law in order to avoid a severe liquidity crisis. The law provided for a financial guarantee worth 900 million to the bank, subsequently authorised by the Commission, under the condition that the restructuring plan and compensatory measures, including the sale of the bank, would be implemented.
In the Bank Burgenland (BB) case, the Commission approved restructuring aid totalling 360 million. BB’s privatisation was an essential component of the restructuring plan which was approved by the Commission.
In February 2004, the Commission approved three aid measures granted in favour of Bankgesellschaft Berlin AG (BGB) with an economic value of about 9.7 billion. In order to compensate for the distortive effects of such significant aid measures, Germany and the Land Berlin committed to a variety of divestitures. This included the undertakings to divest Berliner Bank, one of BGB’s two retail brands, to hive off the real estate services subsidiaries which were the main cause for the crisis and, finally, to sell BGB by the end of 2007.
These cases are good examples of in-depth investigations that did not disturb the banks or the financial sector, but were the start of a successful restructuring story.
On 27 February 2008 the Commission opened investigations on the IKB and Sachsen LB cases.
As regards WestLB, the public owners agreed to provide a guarantee of up to 5 billion to cover any payment defaults of a 23 billion special purpose vehicle which will be ring-fenced from WestLB’s balance sheet. The details of the transaction are not yet finalised. The Commission is in close contact with the German authorities.
