State Aid Matters October 2008

State intervention in the credit crunch: New communication on emergency measures for financial institutions, and other options

Never before has the role of the State in securing, stimulating or even saving theeconomy been put in such sharp focus. Late last year when the tremors began we saw the rescue of Northern Rock in the UK. This was a big deal at the time but has been dwarfed since. Other European rescue plans for banks began to emerge and since early September the banking sector is universally acknowledged to be in crisis.  Inter bank lending has dried up due to the erosion of confidence, with the result that liquidity is frozen and even fundamentally businesses everywhere are faced with potential cashflow difficulties that are capable of leading to insolvencies that would not happen were normal credit flows in operation.

No time to lose!
Obviously the various governments of the EU are determined to do whatever is necessary to prevent a meltdown. First the Irish government decided to guarantee deposits and debt instruments in certain banks, and now several Member States (including the UK) have followed with various measures, to such extent that the European Commission has compiled a rolling table of different measures across the EU. What has differentiated these steps from ordinary aid plans has been the urgency required. Where even 24 hours of delay can make the difference between a run on a bank or comparative safety, governments have had to work 24 hour days to come up with plans they believe will work. Balancing this with the pan-European State aid discipline designed to maintain competition across the EU is very difficult.

The Commission notes that the treatment of illiquid but otherwise fundamentally sound financial institutions should be distinguished from the treatment of financial institutions that are in difficulties through poor asset liability management or risk strategies. The traditional rules for State intervention to support failing firms (i.e. the latter scenario) are contained in the Commission’s 2004 Guidelines on aid for rescuing and restructuring firms in difficulty (“the R&R Guidelines”). These guidelines have been used for some notable rescue plans over the years to the likes of Alstom, British Energy and latterly Northern Rock. However, the Commission has realised that the sudden need to help fundamentally sound institutions that are suffering through the general situation does not necessarily sit well with the R&R Guidelines, and marks uncharted waters in State aid terms. Thus the Commission has moved very quickly to publish on 13 October 2008 a new emergency “Communication on the application of the State aid rules to measures taken in relation to financial institutions in the context of the current financial crisis” (“the Communication”), which broadly sets out new parameters for State intervention during the current crisis.