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June 29, 2016

In February 2016, the European Commission (EC) published a study setting out an evaluation of its various restructuring aid decisions on the subsequent viability of the aided (non-financial) firms. The aim of the study was to assess the EC’s effectiveness in sanctioning state-sponsored restructuring plans for firms in financial distress (excluding banks), while ensuring that the adverse effects on competition arising from the aid were minimized. In the context of state aid entering the wider public lexicon — given financial distress in such industries as steel and calls for governments to intervene in support of "national treasures" in need — the study provides useful insights into the effectiveness of the solutions and, in turn, to the scope of the competition rules themselves. Note that this study was published prior to the recent Brexit vote (i.e., the vote of the U.K. to exit the EU), however, its comments still hold for all Member States until any such exit.

European state aid rules
State aid is considered to arise where a state’s resources are used to assist — giving a selective advantage to — one or more economic undertaking(s). Amongst other instruments, state aid could, for example, include:

  • Direct grants
  • Debt write-offs
  • Loans
  • State guarantees
  • Tax deferments

Under European rules, if the assistance could affect trade between Member States and could be expected to distort (or have the potential to distort) competition, then it has to be notified to the EC for approval.  Where the conditions hold, and where de-minimus thresholds and other exemptions do not apply, the EC must sanction the aid before it can be granted.[1]

European state aid rules are both complex and constantly evolving, and the EC is particularly strict in its application of them.[2] This is because the EC considers financial distress to be an important signal of failures to make optimal use of resources and that exit from markets plays a pivotal role in ensuring more efficient economic outcomes. As a result, simply propping up a firm with no real prospect of its imminent return to viability and its ability to compete effectively is not an option open to Member States’ governments. 

Un-notified measures later investigated and found to be incompatible with European rules may need to be withdrawn or recovered, which could in turn have serious consequences for the aid recipients.  Indeed, in the case of European steelmakers this year, the EC adopted a final negative decision in respect of Belgium requiring it to recover €211 million of aid granted to companies within the Duferco group, and opened a formal investigation into aid measures granted by Italy to Ilva, amounting to some €2 billion.[3] Unlike in the case of bank bailouts following the financial crisis, the EC does not necessarily consider that steelmakers may be able to return to viability.

Assessing the Economic Effects of State Aid
Determining the extent to which measures may or may not impinge on the competitive landscape in a particular market is a non-trivial exercise. The EC considers such issues as:

  • Whether the aid is the minimum necessary
  • If it is appropriate to the issue at hand
  • Which alternatives are available
  • The extent to which the benefits of the aid would outweigh the negative effects on competition in the markets under consideration.[4]

An EC commissioned study, the results of which were published in February of this year, sought to assess the EC’s ex-ante (i.e., prior to, based on forecasts) assessments of restructuring plans against subsequent market outcomes. Through data analyses and a series of case studies and interviews, the authors came to some noteworthy findings:[5]

  • Some 68 percent of the all the firms had improved their performance when assessed in terms of profits before taxes, with 61 percent showing improvement when looking at returns on capital employed.
  • Of the companies assessed, 52 percent were still active in their original market, 23 percent were active but had been acquired by other companies, 13 percent were going through insolvency proceedings and 12 percent were bankrupt.
  • Between 14 percent to 18 percent difference in survival probabilities was found between aid receiving firms and a control group, with survival model analyses showing aid receiving firm lifecycles increasing by approximately 8 to 15 years.
  • The authors found no evidence of major competition distortions arising from the aid, with market share effects not being seen as sufficient to constitute a distortion and with compensatory measures proving sufficient to prevent distortions.

Performance improvements of the order of magnitude noted here are remarkable. Even more so, however, is the notion of no corresponding distorting effect on competition. By providing state aid that would ostensibly have prevented firms from market exit, one would imagine a series of counterfactuals with competition effects being at least sufficiently measurable in some material respects.

Put another way, while the results might suggest the EC has done extraordinarily well in meeting its objectives, they might equally point to the EC having been overly prudent in sanctioning potentially welfare-enhancing restructuring plans. The EC might be choosing only to approve support in those very limited instances where the case for doing so is, for all intents and purposes, unequivocal. 

A recent article in The Economist highlights just such a potential weakness in EC state aid rules, with that author suggesting that overly restrictive state aid regulations might currently be preventing the Italian authorities from setting up a government-backed plan to protect itself against an imminent banking crisis with the risk of contagion (i.e., with better Italian banks at risk from the weaknesses of others).[6]

Adhering as strictly as possible to rules that protect competition in markets is not only admirable but is, and always should be, of paramount importance. Effective competition drives innovation, provides consumers with choice and ensures the right price and quality for customers, both today and in the future. Notwithstanding this, where a market fails or where there is a real risk of potential irremediable failure, protecting competition in the long-term might in certain cases warrant some form of intervention. In these instances,market design could be a potential underwriter of competitive forces. Finding the right balance, however, is where the true art lies, and where competition authorities and the EC must take on the unenviable title of artist, irrespective of how the resulting masterpieces might be judged by observing critics or galleries. 

[1] Note that these rules currently apply to all Member States, and will continue to apply to the U.K. until such times as future arrangements are made in light of its expected exit from the EU.

[2] The EC’s experience over the years has led it to develop a detailed set of regulations and guidelines for the approval of state aid, which can in the main be met through two routes: compliance with a set of approved mechanisms or approval from the EC for the specific scheme in question. The list of activities falling under the EC’s General Block Exemption Regulation (GBER) has itself grown steadily over the years — extending, for example, from such areas as regional aid and measures for environmental protection, through to aid related to heritage conservation.

[3] See “Statement by Commissioner Vestager on EU state aid rules in the steel sector and Commission state aid decisions concerning Duferco in Belgium and Ilva in Italy”; Brussels, January 2016.

[4] The EC would also look to the market economy investor principle (MEIP), via which it would consider whether the transaction was on an equivalent basis to that likely to be observed under normal market conditions. The principle of neutrality when assessing aid means that any meeting the MEIP would not be deemed to confer an ‘advantage’ to a firm involved.

[5] See “Ex-post evaluation of the impact of restructuring aid decisions on the viability of aided (non-financial) firms, Final Report”; European Commission (with the study undertaken by the following consortium: WIFO, SPI, Ecorys, ZEW and Idea Consult), February 2016.

[6] See “Banks and state aid: The rule of flaw. Italy has been flirting with a banking crisis—and Brussels is partly to blame”; The Economist, May 2016.