Market Economy Investor Principle

Prof P. Nicolaides

Theme: State acting as investor

Investor = faces risk [ assumes/minimises risk exposure]

Shareholder/private investor [acquisition of assets]

Facilitator of private investment [i.e. risk-capital formation]

Creditor [protecting own assets]

Guarantor of 3rd party risk

Vendor/operator [sale of public assets, privatisation]

Purpose of MEIP

To identify when investment decisions of public authorities contain elements of state aid, because

the state cannot be prevented from investing => principle of neutrality with regard to system of property

ownership [Article 345]

private undertakings cannot be prevented from receiving state capital

=> principle of equality between public and private undertakings

Source of funding

State aid

State State resources

Public undertakings or agencies of State

Funds controlled by the State

Actions imputed to State

C-482/99, France v Commission (Stardust Marine): imputability shown by directives, supervision, etc; C-83/98, France v Commission (Ladbroke)]: public control of funds

EU funds

Undertakings

MEIP benchmark: Two principles

Private investor guided by prospect of long-term profitability [as for a holding company] and takes into account all risks & costs to itself + all benefits to third parties

Private investor ignores: social, regional or sectoral policy considerations fate of assets/workers after sale any tax receipts or social costs image of public body or region [although see T-565/08 , Corsica Ferries]

Cont.

PI carries out ex ante study on profitability of project

PI compares return on project with other similar projects

PI takes into account all possible options & effects does not wilfully ignore options or relevant information

PI never gives away anything for nothing

Roles of state

There is difference between obligations of state as shareholder and as public authority

Public authority acting as PI ignores even its own obligations as public authority [see T-268/08, Bank Burgenland]

Shareholder normally liable for debt up to liquidation value of assets

Public authority normally concerned about cost of redundancies, payment of unemployment benefits, aid for restructuring, impact on industrial activity and infrastructure, etc. [C-278/92, Hytasa]

A classification

PIP applies in following situations:

participation in capital, granting of loans, offering of guarantees, sale of goods or services, payment of insurance premia, reimbursement of salary charges

PIP does not apply to following situations:

public subsidies, tax exemptions, reduction of social insurance contributions, charges related to dismissal of workers, unemployment benefits and other social benefits, industrial restructuring, public loans under unusual terms, preparation of industrial parks

[T- 156/04, EDF]

When & why does public holding cause problems?

When funds are contributed in circumstances that would be

unacceptable to a private investor operating under normal

market conditions

Because, then recipients obtain advantage they would not

otherwise enjoy under normal market conditions

Note, concept of aid is objective according to its effects, not

motives: Injection of capital to remedy effects of fraud or

mismanagement does not make Art 107 inapplicable [but see

SA.31296 on capital injection in public water & sewage company,

KWL, in Leipzig]

What is the investment horizon of a private investor?

Profitability in the medium to long term

Distinction between short-term and long-term-term

[parent company may tolerate temporary losses of subsidiary in

order to maintain synergies, protect corporate image or

redirect activities of subsidiary]

Not accepted that governments can forecast better

Commission may not use hindsight - considers prospects at

point of investment

Important to identify comparable situations between public and

private investments

The importance of right time framework

C-482/99, France v Commission

ECJ annulled Comm. Dec. 2000/513 on injection of K from Crdit Lyonnais subsidiary into Stardust Marine, inter alia, because K was invested in tranches during a period of several years while Commission examined prospects at a particular point in time

It follows that investment motive must be related to each amount at every instance of investing

And is assessed on prevailing conditions

But in certain cases separate measures may be considered a single measure [C-399/10 P, Bouygues v Commission (France Telecom)]

Cont.

T-11/95 BP v Commission: Mere fact that undertaking has received state aid does not mean that other K injections do not satisfy MEIP

=> Commission has to assess each separate measure

MEIP applies to all transactions between state & same firm

ING v Commission, T-33/10 NL injected capital in ING and then accepted change in the

terms of its remuneration [ING paid back earlier at lower rate]

Commission: Capital injection was state aid. Therefore, change in terms of remuneration was also state aid. Moreover, the change lowered remuneration. Therefore, state lost revenue [from EUR 15/share to EUR 10/share]

GC: Each transaction has to be assessed individually on basis of available information

Commission failed to consider whether a PI would have accepted a lower, but an earlier & certain return instead of a higher but later & uncertain return

Confirmed by C-224/12 P, Commission v The Netherlands

What is the risk tolerance of a PI?

Commission accepts wide margin of judgment; acts when public investment is beyond reasonable doubt

Risk assessed against market rates for comparable assets and situations

The higher the risk, the higher the expected return

The larger the sacrifice [e.g. no voting rights for large amounts of investment], the larger the expected reward

Losses in early years are OK provided measures taken to eliminate them & compensate in terms of higher profits later on

What are the expectations of a PI?

Planned restructuring & expected productivity improvements must be reasonable; i.e. no claimed huge increases in profit

In case of doubt whether investment is reasonable, Commission expects proof that funds could be raised in capital markets - hunches must be proven

Return must be commensurate to benefits enjoyed by recipient company

PI aims for long-term and takes into account ALL effects

T-565/08, Corsica Ferries V Commission

GC annuls Comm Dec 2009/611 which had found that 1) sale of SNCM for a negative price of EUR 158 mn and 2) aid to individuals (employees) were not state aid

Commission accepted French arguments that a PI would take into account negative publicity and social upheaval from liquidation

GC: PI may indeed take such issues into consideration [C-305/89, Italy v Commission]

But Commission did not show objectively how a PI would act

No quantification of probability and amount of future benefits for MS

Cont.

Commission was wrong to find that the aid to individuals was not state aid on grounds that it was not linked to legal or contractual obligations of SNCM [i.e. no relief for SNCM]

There could be state aid indirectly because it made it easier for workers to leave SNCM

But Commission was right in finding that a concomitant investment of EUR 8.75 mn by CGMF was not state aid [principle of concomitance]

Which market benchmark?

Private investor must obtain return at least equal to average of the market for same type of investment [e.g. in terms of amount, rights, etc.] and risk

Average return is only analytical tool -- it is not automatic criterion -- it must be adjusted in light of all available info and factors

Benchmarks

Private investor

provides equity financing whenever NPV of expected future cash flows [dividends] plus capital gains adjusted for risk opportunity cost

Private vendor/operator

seeks highest possible price or best terms for sale or renting of assets [price market price or NPV of future net income generated by assets]

Private guarantor

covers risk with sufficient premium or security [premium income or disposal value of security expected loss]

Private creditor

seeks to maximise recoverable assets & chooses least costly option [C-271/13 P, Rousse Industry v Commission: choice between bankruptcy & amicable arrangement]

A check list [Citynet Amsterdam, 2008/730]

Are all other investors market investors? Yes

Do investments by private investors have real economic significance and are free from aid? Yes [each invests in proportion to shareholding]

Are investments identical? Yes

Are all investments concomitant? Yes [yes, pre-investments by municipality to be paid back and did not change risk of project for the others]

Do public authority & other investors have relationships outside the project? No

Is there a reasonable business plan? Yes [verified by independent consultant]

Commission investigation of partnership in Trento

SA.33063: Public-private partnership to build broadband network in province of Trento

State acts as PI when:

There is significant participation of PI

Or, there is sound business plan showing adequate return on investment

In this case, Italy argues that low return is irrelevant because investment is pari passu

However, private partner has exclusive supply agreement with PPP

How is capital injection assessed? [in healthy & troubled firms]

Recipient in financial trouble?

Yes No

Return comparable to market rates?

No

No aid

Comparable private investment?

Aid No aid

Compatible with IM if it complies with relevant Guidelines

In case of R&R Firm must attain

profitability

Could firm obtain amounts

on K market?

No Yes Yes

Capital injection: no presumption of aid [comparable investment actually made]

Capital contribution from public funds satisfies PI test if it is

made at same time as a significant capital contribution by a

private investor and in comparable circumstances

[T-296/97, Alitalia v Commission]

Comparable: similar size and conditions

But there may be aid where private investments occur only

after public investments [T-358/94, Air France; T-20/03,

Kahla]

Capital injection in case of restructuring

Two-stage assessment

I: Is investment the least costly option, including non-intervention?

No

II: Is solution the least costly recovery option?

Yes No

Compatible Incompatible

Excludes social costs of liquidation from possible

non-intervention but includes privately borne

redundancy costs

Yes Separation of roles of state as public authority and as share holder State acts as

private investor

Private creditor: Debt write-off

Assets

Debt secured unsecured

Creditor A does not write-off

Creditor B writes-off debt

Maximum write-off

No PI grants unsecured loans to firm in difficulty There is state aid if in court-supervised restructuring, state is more generous than other creditors C-480/98 ES v Comm (Magefesa)

But

Closure

PI does take into account the cost of closure before deciding whether to wind up a company

PI ignores costs borne by the State and all debts [e.g. unsecured loans] that do not have to be repaid after closure or costs of cleaning pollution for which it has no liability

Public authority may not include in cost of closure loans previously granted as aid by itself

[C-334/99, Germany v Commission] [C-278/92, Spain v Commission (Hytasa)]

Cont.

ECJ: Creditor weighs recovered amount v future amount after restructuring & takes into account [see also T-152/99, HAMSA]:

Status [preferential or not]

Security

Chances of return of debtor to viability

Amounts

But if there is no agreed restructuring, creditor weighs proceeds from insolvency v proceeds from procedure for recovery of debt

Where there are several methods for recovery, creditor must consider all of those methods

Commission did not analyse all possible methods

MEIP v Altmark

Often there is confusion about MEIP and Altmark [because in both there is no SA]

However, the logic is contradictory

Under MEIP, state seeks to obtain return

Under Altmark, state expends resources

Summary

Source of funds: Public?

Investment in healthy firm

Investment in troubled firm

Supply/sale of products/assets

Recovery of assets

Yes No

Yes No

Yes No

Yes No N

O

A I D

Adequate return?

At market rates?

At best rate/terms?

With private investor?

AID Exempted if:

there is restructuring plan and/or fits in categories of exemption

Case study: Valencia film studios

Commission Decision 2013/126 [SA.22668]

Use of CAPM: Re = Rf + (Rm Rf)

Rf = 10-year govt bond (2004) = 4.1%

(Rm Rf) = 6.8% - 9.3% [academic study]; Comm takes 6.8%

= 1.59 [comparison with similar studios]

=> Re = 0.041 + 0.068*1.59 = 14.9%

[Commission rejects of 0.395 proposed by ES]

IRR [based on business plan of studios] = 5.74%

NPV of projected cash flows at discount rate of 14.9% =

= EUR 132 mn

Sensitivity analysis

- 132

5.74%