The crisis approach - From guarantee schemes to asset relief measures and restructuring plans

Table of content

BIBLIOGRAPHY

CASES

ABBREVIATIONS

1. STATE AID LAW IN TIMES OF A CRISIS
a. The financial crisis and the European Union
b. Banks under pressure
c. Common measures to support troubled banks
d. EU state aid regulation
e. Pre crisis standards - the R&R Guidelines
f. The communications and the crisis approach

2. GUARANTEE SCHEMES AND RECAPITALISATIONS
a. Guarantees
i. Design and effect
ii. Material scope of a guarantee
iii. Time limitations
iv. Private sector contribution and burden sharing
v. Behavioural constraints and safeguards
b. Recapitalisations
i. Design and effect
ii. Special competition concerns
iii. Pricing of Capital
iv. Fundamentally sound banks
v. Participation of private investors
vi. Rescue aid to troubled banks
vii. Incentives for State capital redemption
viii. Behavioural constraints
ix. Regular Review
c. Cases and exemplary implementations
i. ING - a compatible recapitalisation
ii. Sweden - a compatible guarantee scheme
d. Mid-term conclusion and prospects

3. BAD BANKS AND ASSET RELIEF PROGRAMS
a. The bad bank idea
b. Design-decisions when creating a bad bank
c. Key challenges
d. Competition concerns

4. THE FRAMEWORK SET IN THE IAC
a. Design
b. Transparency and disclosure
c. Burden-sharing
d. Aligning incentives for participation
e. Eligible assets
f. Valuation and pricing guidelines
g. Management of assets
h. Budgetary context
i. Restructuring and follow-up measures

5. APPLICATIONS AND APPROVALS UNDER THE IAC

6. THE GERMAN ASSET RELIEF SCHEME
a. The SPV-model
i. The design
ii. The Com's assessment
iii. Analysis of the SPV-model
b. The Agency Model
c. A bad bank for WestLB
i. The design
ii. The Com's assessment
iii. Analysis of the WestLB Case
d. Individual approvals of asset relief in Germany
i. LBBW
ii. Hypo Real Estate

7. THE IRISH ASSET RELIEF SCHEME - NAMA
a. The design
b. The Com’s assessment
c. Analysis of the NAMA scheme

8. RESTRUCTURING PLANS AND DECISIONS
a. The Restructuring Communication
b. The obligation to submit restructuring plans
c. The design of a restructuring plan
d. Principles of restructuring
i. Degree of restructuring
ii. Burden sharing
iii. Restructuring aid
iv. Length of the restructuring process
v. Procedure
e. Proposed restructuring measures
i. Divestment and restrictions on expansion
ii. Sale of the ailing bank
iii. Creation of a "good bank”
f. Restructuring in practice
i. Change of ownership
ii. Closure of branches
iii. Sale of subsidiaries and participations
iv. Structural and organisational changes
v. Cutting and downsizing measures
vi. Other measures
g. Preview

9. CONCLUSIONS

Bibliography

Books:

Conor Quigley, European State Aid Law And Policy (Hart Publishing, 2009)

Ioannis Kokkoris and Rodrigo Olivares-Caminal, Antitrust Law Amidst Financial Crisis (Cambridge University Press, 2010)

Martin Heidenhain (Edt.), European State Aid Law (Hart Publishing, 2010)

Martina Maierhofer, Good Bank, Bad Bank: Vorschläge zur Auslagerung toxischer Wertpapiere (Good Bank, Bad Bank: Proposals on the outsourcing of toxic securities) (Diploma Thesis at the Institute for Banking and Finance at Vienna University of Business and Economics, March 2010)

Paul Craig and Gràinne de Bùrca, EULaw (Oxford University Press, 4th edition, 2008)

Vivien Rose, Peter Roth and Andrew Macnab, Bellamy & Child - European Community Law of Competition (Oxford University Press, 2010)

Articles:

Anna Metzner, “Bad Bank - Bad Idea?”, Finance, February 2010, pp. 18-21.

Benedikt Wolfers and Markus Rau, “Finanzmarktstabilisierung 3. Akt - Bad Banks zur Entlastung der Bilanzen” (Financial Market Stabilisation 3rd act - bad banks to ease balance sheets), NJW, 2009, pp. 2401-2406

Braun and Kühling, “Article 87 EC and the Community Courts: From Revolution to Evolution”, Common Market Law Review, 2008, pp. 465-498.

Burghard Hildebrandt and Uwe Müller, “Das Bad-Bank-Gesetz als Eckpfeiler der Finanzmarktstabilisierung” (The bad-bank-act as the corner stone of financial market stabilisation), Finanzbetrieb, 2009, pp. 741 - 750

Christian Ahlborn and Daniel Piccinin, “The application of the principles of restructuring aid to banks during the financial crisis”, EStAL, 2010, pp. 47-65

Dorothea Schäfer and Klaus Zimmermann, “Bad Bank(s) and the Recapitalisation of the Banking Sector’, Intereconomics, July/August 2009, pp. 215-225

Editorial Comment, “From rescue to restructuring: The role of State aid control for the financial sector’, Common Market Law Review, 2010, pp. 313-118.

Elena Duggar and Srobona Mitra, “External Linkages and Contagion Risks in Irish Banks’, IMF Working Paper WP07/44, 2007

Emily Adler, James Kavanagh and Alexander Ugryumov, “State aid to banks in the financial crisis: the past and the future”, Journal of European Competition Law and Practice, 2010, pp. 68-73

Hanno Vollmann, “Staatliche Hilfsmaßnahmen in der Finanzkrise - Beihilfenrechtliche Rahmenbedingungen” (Public rescue measures amid the financial crisis - State Aid rules framework), ecolex, 2009, pp. 109-112

Matthias Laier, “Bad Banks - Neue Entlastungsmöglichkeiten für den Finanzsektor” (Bad Banks - new relief opportunities for the financial industry), Gesellschafts- und Wirtschaftsrecht, 2009, pp. 435-440

Thomas van Rijn, “Die Rolle der Gemeinschaftsorgane während der Krise” (The role of Community institutions during the crisis), EuZW, 2009, pp. 193-194

Wilfried Stadler, “Finanzmarktpolitische und regulatorische Ursachen der Finanzmarktkrise”

(Financial and regulatory causation of the financial crisis), ecolex, 2009, pp. 104-109

Wolfgang Deselaers and Lars Küpper, “Umstrukturierungsbeihilfen für Banken in der Finanzkrise - neue Welt, alter Standard?” (Restructuring aid for banks during the financial crisis - new world, old standards?), Europäisches Wirtschafts- und Steuerrecht, 2009, pp. 212-216

Živilé Didžiokaité and Minke Gort, “Restructuring in the banking sector during the financial crisis: the Northern Rock case”, Competition Policy Newsletter, 01/2010, pp. 74-78

Newspaper articles:

“BayernLB and WestLB in merger talks”, Financial Times, 20 September 2010 “Die Uhr tickt” (The clock is ticking), manager magazin, 12 November 2009 “Dublin in move to split Anglo Irish Bank”, Financial Times, 8 September 2010 “Dublin to put fresh €5bn into Anglo Irish“, Financial Times, 28 September 2010 “EU extends review of WestLB state bail out”, Reuters, 22 June 2010 “EU raises NAMA concerns”, The Independent, 10 April 2010

“Europe’s stress tests were a mixed affair. Many banks still face an uphill struggle to finance themselves”, The Economist, 29 July 2010 “Hypo Real Estate losses narrow”, Financial Times, 13 August 2010 “ING to appeal EU state aid decision”, Wall Street Journal, 29 January 2010 “Ireland’s bad bank, The morning after”, The Economist, 17 September 2009 “Ireland”, Financial Times, 20 July 2010

“Irish deficit balloons after new bank bail-out“, BBC Business News, 30 September 2010 “Irish lender’s losses put at €30bn“, Financial Times, 29 September 2010

“Irish NAMA: Sees 25% Of Loan Repayments By 2013“, Wall Street Journal, 10 September 2010

“Markus Zydra: Sanio warnt und droht” (Markus Zydra: Sanio warns and threatens), Süddeutsche Zeitung, 20 May 2009

“Private sector role vital to keep debt off balance sheet”, Sunday Business Post Online, 21 September 2010

“Seven Banks fail EU stress test”, Financial Times, 23 July 2010.

“The bottomless bail-out”, The Economist, 30 September 2010

“The crisis and fair-value accounting”, The Economist, 20 September 2009

“Weber hits out at Brussels”, Financial Times, 22 April 2009

“WestLB braucht bis zu 6 Milliarden Euro” (WestLB needs up to 6 billion Euros), Der Spiegel, 23 November 2009

“WestLB to restructure in deal for aid”, Financial Times, 12 May 2009 “WestLB wins EU breathing space on state aid”, Financial Times, 22 June 2010

Online Resources:

“EU extends review of WestLB state bail out”, Reuters, 22 June 2010, <reuters.com>

“Update on discussions with the European Commission in relation to EU Restructuring Plan”, press release by Bank of Ireland, 16 April 2010, <bankofireland.com>

“WestLB Sale to Start by End of September After Supervisor Named”, Bloomberg, 17 June 2010, <bloomberg.com>

Anastasia Tsakatoura, "State Aids in the EU Banking Industry", Inter-Lawyer Lex E Scripta, <inter- lawyer.com/lex-e-scripta/articles>

Conor Quigley, “NAMA, the National Assets Management Agency: an Irish solution to an Irish problem”, ERA Forum, 2010, <www.springerlink.com>

EU Commission, DG Competition, “Scoreboard on State Aid”, Spring 2010, <ec.europa.eu/competition/state_aid/studies_reports>

EU Commission, DG Competition, “Scoreboard on State Aid”, Spring 2009, <ec.europa.eu/competition/state_aid/studies_reports>

European Central Bank, “Recommendations of the Governing Council of the European Central Bank on the pricing of recapitalisations”, 20 November 2008, <ecb.eu>

Freshfields Bruckhaus Deringer, “German Bad Bank Act in force”, Briefing, August 2009, <freshfields.com/publications>

Heike Joebges and Alexandra Krieger, “Bad Bank, Ausgleichsforderungen und Kreditversicherungen” (Bad Bank, Redemption-Claims and Credit-Insurance), IMK Policy Brief, February 2009, <boeckler.de/pdf/p_imk_pb_02_2009.pdf>

Luis Correia da Silva, “State aid and the banking crisis”, Oxera, 2009, <oxera.com/main.aspx?id=7860>

Marcel Magnus, Sabine Crome, Anna Samsel, Martin Löffler and Max Lienemeyer, “The WestLB restructuring decision”, Competition Policy Newsletter, 02/2009, <ec.europa.eu/competition/>

Press Release IP/08/1600, “Commission approves Swedish support schemes for financial institutions”, 30 October 2008, <europa.eu/rapid/>

Press Release IP/09/741, “WestLB”, 12 May 2009, <europa.eu/rapid/>

Press Release IP09/186, “Commission approves modifications to Swedish support schemes for financial institutions”, 29 January 2009, <europa.eu/rapid/>

Press Release IP09/652, “Commission approves amendments to Swedish bank guarantee”, 28 April 2009, <europa.eu/rapid/>

Press Release, “Kroes: state aid rules “part of the solution” to banking crisis”, 6 October 2008, <europa.eu/rapid/>

Thomas J. Doleys, “Managing State Aid in Times of Crisis: The Role of the European Commission”, Paper prepared for presentation at the ECPR Fifth Pan-European Conference on EU Politics, 2010, 16 July 2010, <jhubc.it/ecpr-porto/virtualpaperroom/084.pdf>

Cases

European Commission Decisions:

C 10/2008 IKB Germany, OJ (2008) C76/04 C 14/2008 Restructuring Aid to Northern Rock, OJ (2008) L112/38 C 15/2009 Hypo Real Estate, OJ (2010) C13/13 C 16/2009 Hypo Group Alpe Adria, IP/09/1998 C 26/2009 Restructuring aid to JSC Parex Banka, OJ (2009) C26/01 C 28/2002 Bankgesellschaft Berlin, OJ (2002) C141/02 C 40/2009 Additional aid for WestLB, OJ (2010) 66/08 C 42/1993 Re State Aid to the Merco Company, OJ (1993) L005 C 43/2008 WestLB restructuring decision, OJ (2009) L345/52 C 9/2009 Dexia SA, OJ (2009) C181/09 C 10/2009 ING, OJ (2009) C158/06 C 17/2009 LBBW, OJ (2010) L188/53 C 18/2009 (ex N 360/2009) KBC, OJ (2010) L118/53 C 9/2008 SachsenLB, OJ (2009) L104/52

Case N 149/2009 Recapitalisation of Bank of Ireland, OJ (2009) C234/01

Case N 161/2010 Further recapitalisation of HRE, OJ (2010) C190/03

Case NN 18/2010 Restructuring aid to Carnegie Investment Bank, OJ (2009) C29/01

Case N 241/2009 Recapitalisation of Allied Irish Bank, OJ (2009) C223/01

Case N 261/2010 Second restructuring aid for BAWAG P.S.K., OJ (2010) C250/02

Case N 333/2009 Acquisition of shares in HRE, OJ (2010) C13/13

Case N 249/10 Prolongation of temporary approval of additional aid for WestLB, OJ (2010) C230/53

Case N 26/2009 Amendment to the support measures for the banking industry in Sweden, OJ (2009) C37/01

Case N 314/2009 German asset relief scheme, OJ (2009) C199/01

Case N 380/2009 Restructuring aid for Kaupthing Bank Luxembourg SA, OJ (2009) C247/01

Case N 356/2009 Recapitalisation of Anglo Irish Bank, OJ (2009) C235/01

Case N 422/2009 and N 621/2009 Royal Bank of Scotland, OJ (2010) C119/01

Case N 428/2009 Restructuring of Lloyds Banking Group, OJ (2010) C46/01

Case N 512/2008 Rescue package for credit institutions in Germany, OJ (2009) C143/01

Case N 528/2008 Aid to ING Groep N.V., OJ (2008) C328/03

Case N 533/2008 Support measures for the banking industry in Sweden, OJ (2008) C308/02

Case N 557/2009 Further recapitalisation of HRE, OJ (2010) C13/13

Case N 61/2009 Anglo Irish Bank, OJ (2009) C177/01

Case N 694/2009 Emergency guarantees for HRE, OJ (2010) C25/06

Case N 725/2009 Establishment of a National Asset Management Agency, OJ (2010) C94/11

Case N 9/2009 Recapitalisation of Anglo Irish Bank, OJ (2009) C177/01

Case NN 61/2009 Rescue and restructuring of Caja Castilla-La Mancha, IP/10/855

Case NN 25/2008 WestLB, OJ (2008) C189/01

Case NN 36/2008 Roskilde Bank, OJ (2008) C238/02

Case NN 44/2008 Rescue aid to HRE, OJ (2008) C293/01

Case NN 48/2008 Guarantee scheme for banks in Ireland, OJ (2008) C312/01

Case NN 70/2007 Northern Rock, OJ (2008) C43/01

European Court of Justice:

Case C-30/59 De Gezamenlijke Steenkolenmijnen in Limburg v High Authority [1961] ECR 1

Case C-303/88 Italy v Commission [1991] ECR I-1433 Case C-42/93 Spain v Commission [1994] ECR I-04175 Case C 256/1997 DMT [1999] ECR I-03913

Joined Cases T-132/96 and T-143/96 Freistaat Sachsen and Volkswagen AG v Commission [1999] ECR II-3663

Abbreviations

Abbildung in dieser Leseprobe nicht enthalten

1. State aid law in times of a crisis

a. The financial crisis and the European Union

This diploma thesis focuses on the legal aspects and consequences of the financial meltdown that started in 2007. Although its main emphasis is on assets relief measures and bank restructuring, it will also touch the issue of state guarantees and recapitalisations of banking institutes. Since length and scope do not allow for an in­depth explanation of all economic reasons for the present incidents, a basic understanding of economics, finance and accounting might be necessary for a perfect comprehension of the following pages.

Despite scattered evidence for an asset bubble on the financial market since the beginning of 2007^[1], not until the fall of Lehman Brothers Holdings Inc. in mid September 2008 did the public, the governments and the European decision makers realise the severity of this financial turmoil. The events were triggered by a bursting asset bubble in the US subprime housing market and spread globally by unprecedented inter-country capital flows. A network of widely unregulated default insurance contracts caused precarious distrust and accounting rules^[2] worsened the situation. The financial crisis and its threatening implications for EU banks, and in succession for the credit-depending real economy, became obvious in fall 2008.

b. Banks under pressure

Investment- and commercial-banks were the first European undertakings to be affected by the financial meltdown. There are several reasons for their difficulties.

First of all, many European banks had, and still have, ill-fated US-RMBS^[3] on their balance sheets. The market price for these securities directly reflected the US sub­prime mortgage crisis and hence plummeted dramatically throughout 2008, causing huge write-downs and eventually a complete collapse of the market for mortgage derivatives. The resulting losses forced some banks to deleverage their balance sheets and hence sell off other profitable assets to maintain adequate solvency ratios^[4]. This caused all asset prices to decline^[5] and carried the risk forward to every institution, even sound ones with healthy business models, and those not exposed to investments in RMBS.

The relatively new and under regulated financial instruments, so called Credit Default Swaps (CDS)^[6], further stressed the banks. The danger of default, and the dubiety of who insured whom, made it impossible to treat troubled institutions independently. The risk of an insolvency-domino-effect emerged and some market players were declared “too big to fail”. In late September and the following weeks, inter-bank lending basically stopped and the risk of a systemic run^[7] became inherent.

In the face of these unprecedented occurrences, namely the dreadful threat of a systemic bank’s insolvency, a credit crunch to the real economy, and a yearlong recession - an extensive state intervention seemed to be the only appropriate countermeasure. Politicians and experts agreed^[8] that banks urgently ought to be supported and Member States’^[9] governments, as well as EU institutions, started to deliberate and develop aid-schemes for the banking industry.^[10] However, most of the rescue measures suitable to cope with the stressed institutions, e.g. loan-guarantees or capital injunctions and eventually asset transfers to external institutions (e.g. bad banks), are likely to distort competition and impair EU-Law on state aid as they favour aid receiving institutions to the detriment of others, operating within the same Member State or in other Member States. Thus, designing proper rules required a delicate balancing act by the institution in charge, the European Commission (Com).

c. Common measures to support troubled banks

In order to restore confidence among investors, and to ensure lending to the real economy, banks had to be provided with access to fresh capital. This can basically be achieved by means of guarantees for liabilities, recapitalisations, liquidity schemes involving the central bank, or the transfer of stressed assets to a separate entity. In the most severe cases, the nationalisation of a bank^[11] or a controlled winding up might be the ultimate solution.

Most cases, especially in the beginning of the crisis, were preferably tackled by guarantees or by recapitalisations. Guarantees for debt are easy to handle since they are only contingent liabilities, whereas, for example, recapitalisations require an up­front call on state resources.^[12]

General measures open to all players on the market, in particular liquidity schemes and monetary interventions by central banks, are likely to fall outside the scope of state aid rules and hence are favoured by the Com.^[13]

d. EU state aid regulation

State aid control constitutes ^[14]an important part of the EU competition policy, contained in Title VII Chapter 1 Section 2 of the Treaty on the Functioning of the European Union (TFEU). Art 107 (ex Art 87) states that:

"... any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the common market. ”

This general prohibition of state aid to undertakings is a necessary condition to achieve and safeguard the functioning of the Single European Market, since public interventions tend to distort trade and competition between Member States.^[15] The notion of state aid has been interpreted broadly by the ECJ. It covers all kind of positive benefits, as well as the mitigation of charges an undertaking would normally bear.^[16] It is defined by reference to its effects. The basic idea behind state aid regulation is to allow market forces to reward the most competitive firms, strengthen innovation and provide consumers with lower prices and higher quality.

A measure is defined as aid when the following four elements are comprised: a) an advantage, b) granted by a Member State or through state resources, c) favouring certain undertakings or the production of certain goods, d) distorting competition and/or inter-state trade.^[17]

When distinguishing between legal state investment and illegal state aid, the Com and the courts apply the market economy investor test (MEIT). If the aid awarded to a private company exceeds the amount a long-term profit oriented private investor under equal conditions would be willing to commit^[18], the transaction is characterised as state aid for the purpose of Art 107 (1).^[19]

However, Art 107 knows exceptions. Art 107 (2) enumerates certain types of aid, which are regarded to be compatible with the common market. Yet, none of them could serve as a legal basis for public intervention of the type and size needed to provide stability to the financial markets and EU-banks during the current crisis.

Nevertheless, Art 107 (3) specifies types of aid that could be compatible with the TFEU if the Com authorises it. Of special interest for the problems on hand is Art 107 (3) (b), which provides that state aid ...

... “to promote the execution of an important project of common European interest or to remedy a serious disturbance in the economy of a Member State” ...

... may be considered as compatible with the treaty. This provision has only been used once before^[20] and is of extraordinarily narrow scope^[21]. Furthermore, state aid could be drawn upon Art 107 (3) (c). The latter option was used to tackle with the first cases emerging in 2008.

Obviously, the state aid provisions in the TFEU are much too abstract to allow for a clear assessment whether certain measures constitute illegal aid or not. Like in EU competition law in general, the Com enjoys the most important role in defining and developing substantive policy in this area.^[22] It does so through formal legislation, informal rule-making, via individual decisions, informal guidelines and communications, with the latter being the most common type.^[23] Communications are non-binding “soft-law”. They indicate how the Com will interpret state aid provisions and are in so far binding for the Com. Even though its actions are subject to judicial review, the Com possesses wide discretion as to the general approach to be taken.

e. Pre-crisis standards - the R&R Guidelines

Before the Com was able to adopt special rules on how to handle state aid provisions during the global crisis, the only guidance in existence was a horizontal communication called: Community guidelines on state aid for rescuing and restructuring firms in difficulty24 (R&R Guidelines). This non-sector specific communication applies to all kinds of firms but does not sufficiently recognise the specifics of the financial sector.^{[24] [25]} Even though “the exit of inefficient firms is a normal part of the operation of the market”^[26], the R&R Guidelines provide for the authorisation of temporary support in cases where firms are facing financial turmoil and their disappearance would cause serious social difficulties^[27].

The R&R Guidelines distinguish between two forms of aid, rescue aid and restructuring aid. Rescue aid refers to temporary assistance for the purpose of keeping an ailing firm afloat for the time needed to work out a restructuring or liquidation plan. It must be limited to the minimum necessary and cannot exceed a time-frame of six months. Restructuring aid, on the contrary, is based on a comprehensive plan to solve the underlying cause of the turmoil and to restore a firm’s long-term viability.

The R&R Guidelines outline basic principles, which have to be followed in order to support an ailing firm or to design an approvable aid scheme:

- Substantial contribution by the beneficiary firm (min 50% of the costs)
- Aid limited to the minimum necessary
- Adverse effects on competition must be minimised by compensatory measures
- One time last time (no repeating aid within 10 years of time).

Although many of those principles were repeated and substantiated in the communications addressing the financial crisis specifically, it will later be shown how the Com has weakened some of these principles fundamentally for the sake of financial stability.

In the absence of adequate legislation, the emerging cases of banks in difficulties during the first phase of the crisis were tackled with the R&R Guidelines.^[28] When the crisis became systemic in October 2008, and the needful measures more complex, however, the R&R Guidelines could not provide sufficient legal certainty anymore. Not all banks seeking for help were “firms in difficulties” since even sound banks with successful risk adverse business models were endangered and some measures simply exceeded the scope of the guidelines.

f. The communications and the crisis approach

In the weeks after Lehman collapsed, the Com was confronted with mounting pressure from Member States, which felt the urge to support their banks as quickly and broadly as necessary. At a meeting of the ECOFIN Council on 7 October 2008, the ministers announced their intention to take “all necessary measures” to restore financial markets and prompted the Com to “act quickly” and provide “flexible” guidance.^[29] Politically, the Com faced startled ministers willing to do everything in their power to fend off a financial breakdown. As the EU state aid regime has never before been questioned more than in these weeks, and even a temporary suspension of state aid control was argued^[30], the Com had to react in a cautious and flexible manner.^[31]

Consequently, the Com issued four communications concerning state aid measures for the financial industry between October 2008 and August 2009. While the first communication, C 270/8^[32] from 13 October 2008 (Banking Communication), includes general guidelines applicable to guarantee schemes and recapitalisation programs, the two later ones , C 10/03^[33] from 5 December 2008 (Recapitalisation Communication), and C 72/01^[34] from 25 February 2009 (Impaired Assets Communication), provide national lawmakers with detailed criteria on how to design the respective measures. The fourth communication, C 195/9^[35] from 19 August 2009 (Restructuring Communication) was issued to bring more clarity and flexibility on how to compose restructuring plans where they are required.

In the Banking Communication, the Com acknowledged, that in the light of the seriousness of the circumstances, Art 107 (3) (b) constitutes a proper legal basis for measures undertaken to handle systemic problems. This is particularly the case for general schemes open to all financial institutions.^[36]

The Com further assured its commitment to come to decisions as quickly as possible. Had procedures under the R&R guidelines lasted up to several months, the Com now promised to approve aid, if necessary, within 24 hours and over weekends, given that Member States cooperate closely, and timely inform the Com about intentions and strategies.^[37]

The Banking Communication laid down some general conditions for crisis-aid to be in compliance with the EC-Treaty (now TFEU). These principles apply to all types of aid discussed in this paper and share a common purpose - minimising the distortion of competition.

General principles Granted aid may not exceed what is strictly necessary to achieve its purpose. All distortions of competition and all negative spill-over effects on competitors, other sectors and other Member States have to be minimised. Support measures have to be well-targeted and proportionate.

Serious disturbance Invoking Art 107 (3) b TFEU (ex Art 87 (3) (b) EC- Treaty) requires an immediate threat to the economy of a Member State as a whole. State aid can only be exempted from the prohibition in Art 107 (1) TFEU as long as the intensive disturbance prevails. The use of this yet undetermined provision equipped the Com with helpful leeway on how to interpret it.

Non-discrimination Eligibility for a support scheme may not be based on nationality but on objective criteria.^[38] Pursuant to Art 18 TFEU (ex Art 12 EC-Treaty), all institutions incorporated in the Member State concerned, including subsidiaries, or those with significant activities in that state should be covered by the scheme. In the early stages of the crisis, beggar-thy-neighbor policies by Member States acting individually caused intensive debating.^[39]

Time limitation Recourse to Art 107 (3) (b) is only acceptable as long as the situation justifies its application. Thus, all schemes have to be reviewed regularly (at least every six months) and must be terminated as soon as permissible. Most of the approved schemes still in place at the moment expire on 31 December 2010 and will only be prolonged if necessary.

Two types of banks The first two communications recognise that fundamentally sound banks with illiquidity problems due to the exceptional external circumstances on the market should be distinguished from those affected because of excessive risk taking and poor management (unsound banks).^[40] This critical differentiation is relevant for every type of aid^[41] and the categorisation leads to different conditions, e.g. only the latter will need far reaching restructuring. Additionally, this distinction should be reflected in the extent of safeguards and compensation in return for state aid. However, the Com blurred the concept in the Impaired Asset Communication and used a more differentiated approach, taking into account the diversity of causes for unsoundness.^[42]

Behavioural constraints Member States must ensure that beneficiaries do not abuse the support received. Thus, aggressive expansion strategies to the detriment of other institutions, including those in other Member States, should be impeded. Also, the aid granted should not be subject to advertising campaigns.

2. Guarantee schemes and recapitalisations

Most Member States first reacted to the crisis by means of guarantees that targeted the disrupted interbank-lending market. At the same time or shortly after, recapitalisations were enacted to strengthen capital bases and restore lending to the real economy. Only where these measures showed to be insufficient to restore confidence in the market, impaired asset relief was launched.^[43] Consequently, the different means of supporting banks exist side by side and bad bank structures cannot be considered insulated from the other operations.

a. Guarantees

i. Design and effect

As stated above, a guarantee, which covers the liabilities of banks, is a fast and easy manageable measure to restore lending and liquidity. It eases the process of refinancing significantly but does not contribute much to a strong equity capital base in the long term. A guarantee can be established by way of declaration, legislation or contractual regime and does not affect the state budget unless it has to be drawn upon.

The Com pointed out, that guarantee schemes may not be abused to hold up structural inefficiencies. Therefore, every scheme needs to be accompanied by adjustment measures and restructuring plans regarding banks for which a guarantee has to be drawn upon. In case of activation, the Com has to be informed and a more comprehensive investigation will be conducted.

ii. Material scope of a guarantee

In order to encounter the immediate threat of bank runs during autumn 2008, almost all Member States increased the amount of retail deposits guaranteed. This policy response is seen as legitimate, since it is based on a general scheme and aimed at preventing negative spill-over effects. There is no conflict with EU state aid law regarding retail deposit guarantees.^[44]

For all other types of guarantees^[45] to be assessed as compatible, compliance with certain requirements is obligatory. In principle, the necessary extent of safeguards, the amount of compensation and restrictions imposed on beneficiaries of the guarantee, depends on the initial risk factor of the covered liability. For example, if subordinate debt is to be covered, further restrictions are necessary than for the coverage of inter­bank lending or covered bonds.

iii. Time limitations

The scheme has to be reviewed every six months and a regular report must be submitted to the Com. Schemes may cover debt for a period no longer than two years. Further extensions are subject to the Corn’s approval.

iv. Private sector contribution and burden sharing

For the purpose of keeping distortions of competition to a strict minimum, the Com calls for Member States to ensure that the beneficiaries bear an adequate share of the costs triggered by guarantees and their potential activation.

Therefore, covered institutions should pay a charge as close as possible to a market price^[46] for the provision of the guarantee in order to compensate the state for the funding costs. The price should furthermore reflect the portfolio risk of the individual bank.^[47]

[...]

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^[1] See: news.bbc.co.uk/2/hi/business/7521250.stm for a brief chronology of the events, 20 October 2010.

^[2] By many, so-called “fair value accounting” (also pro-cyclical accounting) is considered responsible for the problems we are facing today. This principle, implemented in IAS 39 and FASB 157, allows mark-to-market valuation of assets. For further information on the discussion see: “The crisis and fair- value accounting”, The Economist, 20 September 2009; Wilfried Stadler, “Finanzmarktpolitische und regulatorische Ursachen der Finanzmarktkrise” (Financial and regulatory causation of the financial crisis), ecolex, 2009, pp. 104-109.

^[3] Residential Mortgage Backed Securities (RMBS) are financial products based on the value of housing loans. Typically, financial institutions pool single loans, group them according to their credit ratings into several tranches, transfer the loans to a trust which then issues bonds that are sold to by investors and other financial institutions.

^[4] Solvency ratios for EU-banks are determined in the Banking Directive, 2006/48 OJ L 177 [2006], p. 1-200, and the Capital Adequacy Directive, 2006/49/EC OJ L 177 [2006], p. 201-255, which implement the ideas of the Basel Consensus (Basel II) into EU-law. Banks are only able to maintain regulatory compliance by either raising additional capital or by deleveraging. In the initial stage of the meltdown, banks were able to raise capital on the market. Due to increasing distrust in the viability of banks, this source dried-up in Sept/Oct 2008.

^[5] Many experts blame pro-cyclical accounting provisions for the rapid widening of the crisis, e.g. FASB 157 for the US and IAS 39 for Europe. So called fair-value accounting forced banks to mark their securities to the market price. Thus, when the market price slumps due to external factors, as seen with RMBS, all institutions with like assets have to recognise losses.

^[6] Credit Default Swaps (CDS) are insurance contracts protecting against the risk of insolvency. Many investment banks were mayor players on the CDS market. Due to the CDS practice, one large-scale insolvency would trigger many more banks to fail. Moreover, CDS obligations are not adequately recognised on balance sheets, leading to even lesser confidence among bankers.

^[7] C/08/284, Immediate responses to financial turmoil, ECOFIN Council, 7 October 2008.

^[8] Ibid fn. 7.

^[9] Member States still enjoy exclusive competence on fiscal policy. EU-competition law can only function as a limiting framework with the objective of providing a level playing field.

^[10] Thomas van Rijn, “Die Rolle der Gemeinschaftsorgane während der Krise” (The role of Community institutions during the crisis), EuZW, 2009, p. 193.

^[11] Case N 61/2009, Anglo Irish Bank; In its decision, the Com considered that a mere change of ownership does not constitute state aid. Nationalisations are therefore not covered in this paper.

^[12] Luis Correia da Silva, “State aid and the banking crisis”, Oxera, available at: www.oxera.com/main.aspx?id=7860, 8 May 2009.

^[13] Banking Communication, para. 6.51.

^[14] All legal norms mentioned in the following, unless otherwise indicated, refer to the Treaty on the Functioning of the European Union (TFEU). Norms in brackets refer to the EC-Treaty, the legal foundation before the Treaty of Lisbon entered into force on 1 December 2009.

^[15] Vivien Rose, Peter Roth and Andrew Macnab, Bellamy & Child - European Community Law of Competition (Oxford University Press, 2010) pp. 217-259; Anastasia Tsakatoura, "State Aids in the EU Banking Industry", Inter-Lawyer Lex E-Scripta, available at: www.inter-lawyer.com/lex-e- scripta/articles/eu-banking-state-aid.htm, 8 May 2009.

^[16] Case 30/59 Steenkolenmijnen [1961] ECR 1; for an overview of relevant case law see: Paul Craig and Gràinne de Bùrca, EULaw (Oxford University Press, 4th Edition, 2008), p. 1070; With regard to financial aid for banks, e.g., every measure by a Member State that frees the beneficiary bank from the need register either a loss (write-downs) or a reserve for a possible loss would therefore constitute state aid.

^[17] Vivien Rose, Peter Roth and Andrew Macnab, Bellamy & Child - European Community Law of Competition (Oxford University Press, 2010), p. 1112.

^[18] This is particularly the case if, as we have seen during the ongoing crisis, a market has completely dried up and no transactions are made. In such a situation, almost every investment made by the state can be declared as state aid.

^[19] Case C-256/97, DMT[1999] ECR I-03913; Case C-303/88, Italy v. Commission [1991] ECR I-1433; Case C-42/93, Re State Aid to the Merco Company: Spain v Commission [1994] ECLR 134, 135-6; Braun and Kühling, “Article 87 EC and the Community Courts: From Revolution to Evolution”, Common Market Law Review, 2008, p. 468.

^[20] In the 1980s in a small case concerning Greece.

^[21] Joint Cases T-132/96 and T-143/96, [1999], Freistaat Sachsen and Volkswagen AG v Commission, ECR II-3663, para. 167; C 28/2002, Bankgesellschaft Berlin, OJ L116 [2005], p. 1; C 47/1996, Commission Decision on Crèdit Lyonnais [1995], OJ L308 pp. 92-119.

^[22] Art 108 (ex Art 88) outlines the Corn’s competence on state aid. Additionally, pursuant to ex Art 94 EC-T, the Council in Council Reg. 994/98, [1998] OJ L142/1 delegated power to the Com to adopt exemptions of Art 107. The Com uses this power frequently.

^[23] Paul Craig and Gràinne de Bùrca, EULaw (Oxford University Press, 4th Edition, 2008), p. 1130.

^[24] OJ C244 [2004] pp. 2-17, Communication from the Commission - Community guidelines on State aid for rescuing and restructuring firms in difficulty.

^[25] Nevertheless, the Com has always been aware of the vital importance of banks for the overall economy and has been more lenient when applying state aid rules to interventions in the banking sector; see, e.g., Case C 47/1996 Commission Decision on Crèdit Lyonnais, pp. 92-119.

^[26] R&R Guidelines, para. 4.

^[27] R&R Guidelines, para. 25.

^[28] Jestaedt in Martin Heidenhain (Edt.), European State Aid Law (Hart Publishing, 2010), p. 203; See the cases: Case NN 70/2007, Northern Rock; Case NN 25/2008, WestLB; Case NN 36/2008, Roskilde Bank; Case NN 44/2008, Hypo Real Estate; Case C9/2008, SachsenLB.

^[29] C/08/284, Immediate responses to financial turmoil, ECOFIN Council, 7 October 2008.

^[30] Jestaedt in Martin Heidenhain (Edt.), European State Aid Law (Hart Publishing, 2010), p. 205.

^[31] Thomas J. Doleys, “Managing State Aid in Times of Crisis: The Role of the European Commission”, ECPR Fifth Pan-European Conference on EU Politics, 2010, available at: jhubc.it/ecpr- porto/virtualpaperroom/084.pdf, 16 July 2010.

^[32] OJ C 270 [2008], p.8-14, 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 crisis.

^[33] OJ C 10 [2009], p. 2-10, Communication from the Commission - The recapitalisation offinancial institutions in the current financial crisis: limitation of aid to the minimum necessary and safeguards against undue distortion of competition.

^[34] OJ C 72 [2009], p. 1-22, Communication from the Commission on the Treatment of Impaired Assets in the Community Banking Sector.

^[35] OJ C 195 [2009], p. 9-20, 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.

^[36] Banking Communication, para. 2.9.

^[37] Banking Communication, para. 7.

^[38] E.g. solvency ratios or capital requirements. Compare with the Swedish guarantee scheme, Press Release IP/08/1600, IP09/186 and IP09/652.

^[39] For a compatible implementation see for example: Case N512/2008, Commission Decision on the rescue package for credit institutions in Germany, p. 2, point 3; In Case NN48/2008, Commission Decision on guarantee schemes for banks in Ireland, the Com first declined approval as only Irish banks were eligible for the guarantees.

^[40] The Com, in the Recapitalisation Communication, p. 4, names pre-crisis CDS-spreads and ratings as proper criteria for differentiation. Moreover, the size of toxic assets, the soundness of the banks’ business model and the dependence on short-term financing should determine the extent of safeguards and the remuneration for aid.

^[41] Regarding bad bank structures it is incorporated in the Impaired Asset Communication, para. 16, 30, 52 and 59.

^[42] Jestaedt in “European State Aid Law” (Edited by Martin Heidenhain), Hart Publishing, 2010, pp 203.

^[43] Scoreboard on State Aid, Spring 2010, p. 4, available at:

ec.europa.eu/competition/state_aid/studies_reports/studies_reports.html, 15 July 2010.

^[44] Press Release, “Kroes: state aid rules” part of the solution” to banking crisis”, European Parliament, 6 October 2008.

^[45] Namely wholesale deposits, short and medium-term debt instruments, bonds, inter-bank loans, etc.

^[46] The Com takes account of the fact, that such a guarantee might temporarily not be available on the market (or only at crisis-driven high prices) and the State is the last resort for the banks. The price will therefore almost every time be lower than the market price.

^[47] Mostly, this calculation is based on the institution’s respective CDS-spread and a fixed add-on of about 50 basis points. The charge further depends on the maturity of the covered debt. Under the Swedish scheme, e.g., guarantees for debt with a maturity of less than one year are subject to a fee of 0.5 % on an annual basis. Long-term debt is subject to additional add-ons. See Case N533/2008, Commission Decision on support measures for the banking industry in Sweden, for more information.