The EU State Aid Sudoku on the Banking Sector : how the establishment of the Banking Union impacts on the taxpayers’ contribution to the restructuring of credit institutions

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University of Amsterdam

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MASTER THESIS

2014-2015

The EU State Aid Sudoku on the Banking Sector:

How the establishment of the Banking Union impacts on

the taxpayers’ contribution to the restructuring of credit i nstitutions.

Name: Christos Chrysostomou

Student Number: 10840044

Supervisor: Professor René Smits

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4.1 Single Resolution Fund ...p. 32-34 4.2 Single Resolution Fund under State Aid Control...p. 34-37 4.3 Direct recapitalization instrument as a complement to the Banking Union ....p. 33-35 4.4 Preconditions for the application of the direct recapitalization instrument ...p. 35-37 Preliminary findings ...p. 37-40

Chapter V: Conclusion...p. 40-43

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List of abbreviations

BRRD: Bank Recovery and Resolution Directive DGS: Deposit Guarantee Schemes

ECB: European Central Bank

ESM: European Stability Mechanism EU: European Union

EUR : euro (currency)

GDP: Gross Domestic Product SRB: Single Resolution Board SRF: Single Resolution Fund

SRM: Single Resolution Mechanism SSM: Single Supervisory Mechanism

TEC: Treaty establishing the European Community TFEU: Treaty on the Functioning of the European Union

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Chapter I

Introduction

Since the outset of the global financial crisis in 2008 the member states of the European Union have granted a significant amount of financial assistance to their credit institutions. This was considered necessary “in order to restore confidence and the proper functioning of the financial sector”1

. The absence of a common fiscal backstop at the European Union (hereafter “EU”) level that could stand as a lender of financial assistance to credit institutions forced the member states of the EU to rely upon the legal provisions of State aid2 in order to rescue and restructure their credit institutions. The granting of State aid to credit institutions mainly takes the form of recapitalization and state guarantees. To this end, the Commission set out “the broad [temporary] framework within which the State aid compatibility of recapitalization and guarantee schemes, and cases of application of such schemes, could be rapidly assessed”3.

This process could be considered in the broader context of the term ‘bank resolution’ which refers “to the stabilization, restructuring as a going concern and orderly winding up as a gone concern of some or all of failing bank’s business”4

. Thus, member states engage “in resolution strategies that involve a high financial risk for the official sector”5

and, by extension, a considerable burden on the taxpayers. Resolution strategies involve “a full range of tools deployed by authorities to restructure and facilitate the orderly winding up of a failing bank”6

.

During the years 2008 and 2011, “EU Member States granted over EUR 1,6 trillion of State aid to the financial sector, equivalent to 13% of total EU GDP”7. The amount of State aid to banks increased and reached EUR 4,5 trillion until 20128. This situation implies that under the Temporary Framework for State aid to banks, the taxpayers assumed an unfair burden-sharing in relation to private stakeholders. The burden burden-sharing in the case of the banking

1

Council Conclusions - Ecofin Council o f 7 October 2008, 13930/08 (Presse 284), p. 1

2

The core provisions of the Treaty on the Functioning of the European Union (TFEU) on State aid are a rtic les 107 TFEU, 108 TFEU, 109 TFEU (e x. A rtic les 87 TEC, 88 TEC, 89 TEC)

3

Council Conclusions - Ecofin Council o f 7 October 2008, 13930/08 (Presse 284), p. 3

4

Grünewa ld, S., The Resolution of Cross-Border Bank ing Crises in the European Union, A legal study from the

perspective of Burden Sharing, International Banking and Finance Law Series, Wolters Kluwer 2014, p. 14

5

Ibid, p. 32

6

Ibid, p. 15

7

Bacon, K., European Union Law of State aid, Oxford University Press 2013, 2nd ed., p. 400

8

A Roadmap towards a Ban king Union, Co mmunicat ion fro m the Co mmission to the European Pa rlia ment and the Council COM/2012/0510 final, p. 3

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4 sector and especially in the case of a bank failure refers to the allocation of losses or “burdens” among different stakeholders through some sort of collective proceeding9

.

The massive capital injections to the ailing banks contributed, inter alia, to the augmentation of the public debt of several member states in the EU. In 2010, the global financial crisis turned into a debt crisis affecting mainly the Eurozone member states. The situation led to a vicious circle between credit institutions and their sovereigns. In order to address this situation, it was considered indispensable to create a Banking Union for the Eurozone member states. The creation of the Banking Union attempts to complete the economic and monetary union and to ensure that taxpayers will no longer foot the bill when banks face difficulties10.

In the meantime, there occurred an adaptation11 of the Temporary Framework on State aid rules in the banking sector in order to provide new rules on burden sharing between taxpayers and private stakeholders during the restructuring and allocation of losses of a failing credit institution. The adaptation of the Temporary Framework seeks to set more stringent criteria for the request of public financial support. It does so mainly by introducing the bail- in tool. The Banking Union is based on three pillars: the Single Supervisory Mechanism (hereafter “SSM”), the Single Resolution Mechanism (hereafter “SRM”) and the Deposit Guarantee Schemes (hereafter “DGS”). Participating members of the Banking Union are all the euro area member states as well as those non-euro area member states that would like to join in12. Under the Banking Union, the decision for the resolution of a credit institution is transferred to the euro area level and, specifically, to the Single Resolution Board (hereafter “SRB”), which is in charge of the Single Resolution Fund (hereafter “SRF”). The SRF consists of bank levies and provides financial assistance during the resolution of credit institutions. Should an extra amount of money be required, there is a possibility of direct recapitalization through the European Stability Mechanism (hereafter “ESM”). The recent developments

9_{Grünewa ld, S., The Resolution of Cross-Border Bank ing Crises in the European Union, A legal study from the}

perspective of Burden Sharing, International Banking and Finance Law Series, Wolters Kluwer, 2014, p. 52

10

Eu ropean Co mmission Statement, April 2014 http://europa.eu/rapid/press -release_STATEMENT

-14-119_en.htm

11

It refe rs to the so-called “2013 Banking Co mmun ication”, Co mmunication fro m the Co mmission on the application, fro m 1 August 2013, of State aid rules to support measures in favor of banks in the context of the financial crisis (‘Ban king Co mmunication’) ( (2013/C 216/01)

12

According to article 2 o f the SSM Regulation ‘partic ipating Me mber State’ means a Me mber State whose currency is the euro or a Me mber State whose currency is not the euro which has established a close cooperation in accordance with Article 7”, Council Regulation (EU) No 1024/2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning polic ies relating to the p rudential supervision of credit institutions

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5 under the Banking Union aim to minimize the reliance on State aid for the resolution of credit institutions and to break the vicious circle between banks and their sovereigns.

The adaptation of the Temporary Framework on State aid rules in the banking sector as well as the creation of the Banking Union raised new challenges regarding the sequence in which several stakeholders are invited to contribute to the restructuring of a credit institution. Considering the aforementioned developments, the thesis poses the research question on how

the establishment of the Banking Union impacts on the taxpayers’ contribution to the restructuring of credit institutions.

For the purposes of the present thesis we construct the concept of "taxpayer" as follows: the "taxpayer" is a natural person or a legal entity, other than a credit institution entitled to DGS benefits, whose place of residence is one of the States which participate in the Banking Union. As such, the States are principally those already participating in the Eurozone and also, potentially, those member states of the EU which would like to form a part of the Banking Union. Under the definition of "taxpayer" as forged above, those natural persons or legal entities having deposits which exceed EUR 100.000 or having shares in the bank which is under resolution are not embedded within the definition.

More specifically, deposits exceeding EUR 100.000 do not constitute part of the covered deposits and, therefore, are subject to bail- in during the restructuring of a cred it institution. The term ‘covered deposits’ refers to “the part of eligible deposits that does not exceed the coverage level laid down in Article 6 of the DGS Directive”13. According to the latter, “the Member States shall ensure that the coverage level for the aggregate deposits of each depositor is EUR 100.000 in the event of deposits being unavailable”14. Since deposits exceeding EUR 100.000 are not included in the term ‘covered deposits’, they cannot be excluded from a bail- in pursuant to the BRRD15 and the SRM Regulation16.

13_{Article 2 (1) (5) of the Directive 2014/ 49/ EU of the European Parlia ment and of the Council o f 16 April 2014}

on deposit guarantee schemes

14_{Ibid, A rtic le 6 (1)} 15

According to article 44 (2) of the BRRD, “Resolution authorities shall not e xe rcise the write down or conversion powers in re lation to the fo llo wing liabilities, whether they are governed by the la w of a Me mber State or of a third country: (a) covered deposits ” Directive 2014/59/EU of the European Parlia ment and of the Council establishing a fra me work fo r the recovery and resolution of cred it institutions and investment firms and amending Council Directive 82/ 891/ EEC, and Directives 2001/ 24/ EC, 2002/47/ EC, 2004/ 25/EC, 2005/56/ EC, 2007/36/ EC, 2011/ 35/ EU, 2012/ 30/ EU and 2013/36/ EU, and Regulat ions (EU) No 1093/2010 an d (EU) No 648/2012, 15 May 2014

16

According to article 27 (3) of the SRM Regulation “The following liabilit ies, whether they are governed by the law of a Me mber State or of a third country , shall not be subject to write-down or conversion: (a ) covered deposits;” Regulation (EU) No 806/ 2014 of the European Parlia ment and of the Council o f 15 Ju ly 2014 establishing uniform ru les and a uniform p rocedure for the resolution of c redit institutions and certain

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6 The concept only comprises those "taxpayers" who have limited connection to the credit institution at stake: their deposits are either null or do not exceed the aforementioned threshold of the DGS Directive. Taxpayers are defined as such based on the fact that they pay taxes and social contributions. In order for its reasoning to get more clarity, the present thesis addresses taxpayers in relation to credit institutions on the sole basis of their fiscal liability. The inclusion of the liability of social contributions in the definition of “taxpayer” follows the EU law, which understands contributions as taxes. Social contributions are only partially insulated from the bail- in tool. Only liabilities for pension benefits that do arise from collective bargaining agreements shall not be subject to bail- in17.

Another point is related to the exclusion of credit institutions18 from the concept of "taxpayer". One shall admit that credit institutions do pay taxes and contribute to the fiscal consolidation. More specifically, a special fiscal contribution is set up under the SRM Regulation19. However, we do not include those entities in the "taxpayer" concept. This is justified to a certain extent, by the fact that the objective of the directive at stake is to shift resolution costs from taxpayers to credit institutions.

The followed research method is conducted from an internal perspective and consists of a description of the relevant legal texts adopted in the framework of the Banking Union, t he related Commission’s decisions on the restructuring of banks within the revised EU State aid guidelines on the banking sector as well as the well- established case- law regarding the main principles of State Aid Law. In order to reach our conclusion to the aforementioned research question, the thesis is based on the following structure.

In principle, it was considered necessary to provide a definition of State aid since the latter constitutes the means by which member states granted financial support to their ailing banks during the financial crisis. Generally, the provision of State aid is prohibited. However,

investment firms in the fra me work of a Single Resolution Mechanism and a Single Resolution Fund and amending Regulation (EU) No 1093/ 2010,

17_{According to artic le 44 (2) of the BRRD “ Resolution authorities shall not e xe rcise the write down or}

conversion powers in relation to the following liab ilities whether they are governed by the law of a Member State or of a third country: (g) a liab ility to any one of the following: (i) an e mp loyee, in relat ion to accrued salary, pension benefits or other fixed re munerat ion, e xcept for the variable co mponent of re muneration that is not regulated by a collective bargaining agree ment.

18

Credit institution means an undertaking the business of which is to take deposits or other repayable funds fro m the public and to grant cred its for its own account”, Article 4 (1), Regulation (EU) No 575/2013 of the European Parlia ment and of the Council of 26 June 2013 on prudential require ments for cred it institutions and investment firms and A mending Regulation (EU) No 648/ 2012

19

“Partic ipating Me mber States re main co mpetent to levy the contributions fro m the entities located in their respective territories in accordance with Directive 2014/59/EU and this Regulation. By means of the Agree ment, the participating Me mber States will assume the obligation to t ransfer to the Fund the contributions that they raise at national leve l in accordance with Directive 2014/59/ EU and this Regulation, SRM Regulat ion, rec ital 20

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7 article 107 TFEU lays down specific exceptions to the general rule. Therefore, the provis ion of State aid is subject to State aid Control by the Commission. The Commission’s policy under the Temporary Framework provides us with information on the allocatio n of burden sharing between taxpayers and private stakeholders (Chapter II).

This preliminary outcome functions as a tool in order to identify whether the allocation of burden sharing has changed during the adaptation of the Temporary Framework. Accordingly, the establishment of the Banking Union for the Euro zone member states aims,

inter alia, to minimize the reliance on State aid for the purpose of providing financial support

to the banks. Thus, by relying on the BRRD as well as on the Regulations that have been adopted in the context of the Banking Union, we identify the sequence of measures for the restructuring of a failing or likely to fail bank with a focus on the allocation of burden sharing between taxpayers and private stakeholders (Chapter III).

From this point of view, it was considered necessary to include the newly established SRF that will serve as a means for the granting of financial support during the restructuring of banks. Since the granting of financial assistance might favor certain banks and distort competition, we proceed with an examination of the relation between State aid rules and the SRF. The same applies for the possibility of receiving direct recapitalization through the ESM, for which certain preconditions must be fulfilled in order to be applicable (Chapter IV). By considering the above- mentioned structure, the thesis leads to the conclusion that although the Banking Union comprises several safety nets so as to avoid the reliance on State aid, the latter is still required under certain circumstances. In addition, these circumstances might be of such relevance that would probably entail a considerable burden o n taxpayers during the restructuring of a credit institution.

Chapter II

Coordinated State Aid Framework in the absence of a common fiscal

backstop at the EU level

2.1 Article 107 TFEU – Legal basis

The absence of a common fiscal backstop at the EU level created significant difficulties during the rescue and restructuring of credit institutions. In financial terms a backstop “refers

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8 to a type of insurance or last resort support”20 if private or public resources that have been raised from open markets prove to be insufficient. The inexistence of such a common safety net at the EU level led many member states of the EU to provide state support to their banks via taxpayers’ money in order to safeguard financial stability. As stated by the Commission “taxpayers in the end have to finance State aid and there are opportunity costs to it. By giving aid to undertakings means taking funding away from other policy areas”21

.

From the very beginning of the financial crisis, a rticle 107 TFEU (ex. article 87 EC Treaty) has been the legal basis for the granting of massive capital injections from member states to ailing banks. In particular, member states introduced financial support schemes for the financial sector by undertaking recapitalization measures and by providing guarantees so as to address core capital problems and liquidity problems respectively.

The provisions of EU competition law also apply to the banking sector. This is what the Court held in the Züchner case. The legal issue in the Züchner case concerned the imposition of a service charge by a banking undertaking on the transfer of a sum of money and its compatibility with articles 85 and 86 of the EEC Treaty (now articles 101 and 102 TFEU). The Court rejected the allegation of the defendants that banking undertakings “must be considered as undertakings entrusted with the operation of services of general economic interest" within the meaning of Article 90 (2) (now article 106 (2) TFEU) and thus are not subject, pursuant to that provision, to the rules on competition in Articles 85 and 86 of the Treaty”22

.

2.2 Definition of State Aid

As already mentioned, member states introduced financial support schemes in order to provide State aid to their ailing banks. In principle, the provision of State aid is generally prohibited under the TFEU. According to article 107(1) TFEU, “any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favoring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the internal market”23. However, the prohibition of the granting of State aid is subject to exceptions

20

Schoenma ker, D., On the need for a fiscal back stop to the bank ing system in: Research Handbook on Crisis Management in the Banking Sector. Edward Elgar Publishing, Forthcoming, Dece mber 2015 [online]

21

Eu ropean Co mmission, State aid Action Plan: Less and Better Targeted State aid” COM(2005) 107 final, para 8

22

Case C-172/80 Gerhard Züchner v Bayerische Vereinsbank AG. [1981] ECR 2021, para . 6

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9 provided in article 107(2) and (3) TFEU24. These exceptions state the circumstances under which State aid can be considered compatible with the internal market.

In order to be able to identify whether an aid is subject to the provisions of State aid under the TFEU, it is imperative to provide a definition thereof. This issue is of particular significance since State aid measures are subject to State aid control and require prior notification to the Commission. The relation between State aid rules and granting public financial support to a credit institution has acquired particular relevance in the case of provision of aid through the SRF and the ESM. The provision of aid through the SRF and the possibility of granting direct recapitalization via the ESM constitute aid provided at the supranational level and might circumvent the implementation of State aid rules25.

Article 107 (1) TFEU lays down the criteria for the qualification of an aid as State aid. In brief, these elements concern: first, the granting of aid by a Member State to the beneficiary undertaking; second, that the aid must be originated by State resources; third, the granting of aid must “confer an economic advantage upon the recipient, which he would not have gained in the course of a “normal” business”26

. Last but not least, the given aid must benefit certain products or undertakings and its granting must distort or threatens to distort competition and can affect the trade between Member States.

Despite the wording of article 107 (1) TFEU which refers to “any aid granted by a Member State or through State resources”, these two preconditions must be interpreted as cumulative, rather than as an alternative. In other words, for an aid to be classified as State aid, the measure must constitute Stare resource, whether directly or indirectly, and it must be imputable to the State27.

The issue concerning the cumulative or alternative implementation of the two preconditions was clarified by the Court in the Preussen Elektra case. This case concerned a law that required certain regional electricity distribution undertakings to purchase, at a fixed minimum price, electricity from renewable energy sources. As an offset to this purchase, the suppliers of electricity had to compensate the distribution undertakings for the additional costs. However, the Court held that since there had not been any transfer of state resources, the aid

24

See belo w under section 2.3, Chapter II

25

For a fu rther analysis of the re lation between State aid control and the granting of financial support via the SRF and the ESM, see below under section 4.2 and 4.4 respectively, Chapter IV.

26

Haucap, J., & Sch walbe, U., Economic principles of State aid Control, Discussion Paper, Düsseldorf Institute for Co mpetition Economics (DICE), April 2011, p. 2 [online]

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10 could not be qualified as State aid28. In the meantime, the Court clarified that “the distinction made in that provision between aid granted by a Member State and aid granted through state resources does not signify that all advantages granted by a State, whether financed through State resources or not, constitute aid”. The main intention of that provision was to “bring within that definition both advantages which are granted directly by the State and those granted by a public or private body designated or established by the State ”29.

An aid can be ascribed to a Member State when it is granted by “central, regional or local government bodies and by a private body established or appointed by the state to administer certain resources, even if they originate from private sources30. In the case C-482/99 France

v. Commission (Stardust Marine) concerning the granting of aid by two subsidiaries of a

publicly owned bank to a company whose main business developed in the pleasure boat market, the Court was confronted with the issue of whether a granting of aid originated from state resources must be considered imputable to the State only because of the mere fact that the measure was adopted by a public undertaking.

In this case, the Court reaffirmed the well-established case-law of the ECJ that for advantages “to be capable of being categorized as aid within the meaning of Article 87(1) EC, they must, first, be granted directly or indirectly through State resources and, second, be imputable to the State”31

. It further added that “the mere fact that a public undertaking is under State control is not sufficient for measures taken by that undertaking, such as the financial support measures in question here, to be imputed to the State”32. The aid is considered to be imputable to a State when there is some form of government decision33. In his opinion in case C-482/99

France v. Commission, Advocate General Jacobs stated that the measure must be the result of

the action of the Member State concerned and ultimately imputable to public authorities34. According to the second condition, the granting of State aid must originate through state resources. The form of aid instruments might differ in nature. In particular, “the transfer of State resources may take many forms, such as direct grants, loans, guarantees, direct

28

Ibid, p. 62

29

Case C- 379/98 PreussenElektra AG v Schhleswag AG, [2001] ECR I- 2099, para. 58

30

Hancher, L., The general framework in: EU State aids, Sweet & Ma xwe ll 2012, p. 61

31

Case C- 482/ 99 French Republic v Commission [2002] ECR I-4397, para . 24

32

Ibid, pa ra. 52

33

Schiavo, G., Lo, State aids and Credit Institutions in Europe: What way forward?, Eu ropean Business La w Revie w 2014, p. 435 [online]

34

Opin ion of Advocate Genera l Jacobs in the Case C- 482/ 99 French Republic v Commission [2002] ECR I-4397, para . 54

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11 investment in the capital of enterprises and benefits in kind ”35. In the case of the banking sector, four categories of aid measures have been applied. These categories concern funding guarantees, liquidity measures, recapitalizations, and impaired asset relief measures. Among those measures, guarantees comprised the largest part of the State aid approved for the banking sector36.

Concerning state guarantees, it must be said that the aid arises even if there is no burden on state resources at that point. In other words, even if the state guarantee has not yet been called, it can still be qualified as State aid within the meaning of article 107(1) TFEU. In this situation, “the aid is granted at the moment when the guarantee is given, not when the guarantee is invoked nor when payments are made under the terms of the guarantee”37. Under these circumstances, by guaranteeing the liabilities of their banks, the State bears the risk for the payback of bank’s liabilities.

The granted aid must provide with an economic advantage the recipient undertaking which must be “unmarketlike in the sense of being a benefit that the undertaking would not have received in the normal course of events on the private market”38. In order to address this issue, the Commission has adopted the Market Economy Operator test that applies when there is a public injection to an undertaking. According to this test, for such an injection to be qualified as State aid “it is necessary to assess whether, in similar circumstances, a private investor of a comparable size operating in normal conditions of a market economy could have been prompted to make the investment in question”39.

Here, it could be argued that “the state would realize a significant return on its investment in the longer term” 40

by granting State aid to the ailing banks. However, such an acknowledgment of this argument does not “preclude the qualification of the sta te’s investment as aid. For the Commission, the relevant question is whether at the time of the relevant transaction market players could be found who were willing to deal under the same conditions as the public authorities”41.

35_{Co mmun ication fro m the Co mmission, Draft Co mmission Notice on the notion of State aid pursuant to}

Article 107(1) TFEU para. 53

36

Between 1 October 2008 and 1 October 2014, the Co mmission authorized a total aid of EUR 3 892.6 billion (29.8 % of EU GDP in 2013) for guarantees on liabilit ies.

37

Co mmission Notice on the application of Articles 87 and 88 of the EC Treaty to State aid in the form o f guarantees (2008/ C 155/ 02), point 2.1

38

Bacon, K., European Union Law of State aid, Oxford University Press 2013, p. 31

39

Co mmun ication fro m the Co mmission, Draft Co mmission Notice on the notion of State aid pursuant to Article 107(1) TFEU para. 77

40

Gillia ms, H., Stress testing the regulator: review of State aid to credit institutions after the collapse of

Lehman, European La w Revie w 2011, p. 6 [online]

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12 In the light of the financial crisis, where the banks faced an unprecedented difficulty to find financial support by means of loans from private market operators, state intervention “was considered by the Commission as an advantage to the credit institution as no comparable private investor could be found in the market”42. The Commission’s approach is confirmed by the presumption of State aid that exists when “impaired assets are purchased or insured at a value above the market price, or where the price of the guarantee does not compensate the State for its possible maximum liability under the guarantee ”43.

In addition, article 107 (1) TFEU comprises further requirements. Specifically, article 107(1) TFEU requires that the state measure must favor “certain undertakings or the production of certain goods”. Thus, not all measures which favor economic operators fall under the notion of aid, but only those which grant an advantage in a selective way to certain undertakings or categories of undertakings or to certain economic sectors”44.

Furthermore, article 107(1) TFEU requires that state support must have an effect on competition and trade. In contrast to articles 101 and 102 TFEU that require an appreciable effect on trade and competition, the Commission, in the case of article 107 (1) TFEU, is not obliged to “establish that the measure in question can appreciably affect competition or inter-state trade”45

. Regarding the notion of effect on trade, the existence of such an effect does not depend on the fact that the undertaking offers services outside the State46. What the Court held in the Altmark case was that “where a Member State grants a public subsidy to an undertaking, the supply of transport services by that undertaking may for that reason be maintained or increased with the result that undertakings established in other Member States have less chance of providing their transport services in the market in that Member State”47. 2.3 State Aid Control under the Temporary Framework

In principle, it has to be mentioned that the “European State aid rules did not contain specific rules for rescue and restructuring State aid to credit institutions”48. Prior to the financial

42

Schiavo, G., Lo, State aids and Credit Institutions in Europe: What way forward?, Eu ropean Business La w Revie w 2014, p. 437 [online]

43

Co mmun ication fro m the Co mmission on the treatment of impa ired assets in the Commun ity banking sector (2009/ C 72/ 01) point 15

44

Co mmunicat ion fro m the Co mmission, Draft Co mmission Notice on the notion of State aid pursuant to Article 107(1) TFEU, para . 118

45

Hancher, L., The general fra mework in: EU State aids, Sweet & Maxwell 2012, p. 100

46

Ibid, p. 100

47

Case C-280/00 Alt mark Trans and Regierungspräsidium Magdeburg [2003] ECR I- 7747, para . 78

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13 crisis, those credit institutions that were confronted with difficulties could benefit “from State aid for rescue and restructuring under the general non- sectoral principles set out in the Rescue and Restructuring Guidelines, applying Article 107(3) (c) TFEU”49.50

This meant that in the case of the banking sector, the granting of State aid was assessed under the neutral, not sector-specific soft law and that banking undertakings “were treated in the same way as undertakings from other sectors”51

. This assessment reflects the Commission’s initial approach that the financial crisis could not disturb the entire economy of a Member State”.

For instance, in its decision regarding the granting of State aid as a rescue aid to the German commercial bank WestLB, the Commission considered article 87 (3) (b) EC (now article 107 (3) (b) TFEU), not the appropriate legal basis for the assessment of the granting of State aid to the bank. The Commission was not convinced that “the systemic effects that might result from the bankruptcy of WestLB could have reached a size constituting "a serious disturbance in the economy" of Germany within the meaning of Article 87 (3) (b). It further argued that “this case seems rather to be based on individual problems, and thus requires tailor made remedies, which can be addressed under the rules for companies in difficulties”52

. The Commission proceeded with the introduction of a Temporary Framework for State aid to credit institutions to address the systemic nature of the global financial crisis. After the fall of Lehman Brothers it was visible that the financial crisis could provoke serious disturbance in the economy of a single member state while the fall of a European systemic bank could worsen the entire internal market with severe collateral damage in other economic sectors53. According to the Temporary Framework, the legal basis for the gra nting of state support would not be “Article 107 (3) (c) TFEU but Article 107 (3) (b) TFEU which permits aid ‘to remedy serious disturbances in the economy of a Member State”54

.

By establishing this temporary framework, the Commission “made it clear that it would not apply the Rescue and Restructuring Guidelines as such but instead work with the ‘general

49

According to artic le 107(3)(c) TFEU “The following may be considered to be co mpatib le with the internal ma rket : c ) a id to fac ilitate the development of ce rtain economic activit ies or of ce rtain econo mic a reas, where such aid does not adversely affect trading preconditions to an extent contrary to the common interest”

50

Bacon, K., European Union Law of State aid, Oxford University Press 2013, p. 400

51

Arthold, C., Financial Sector in: EU State aids, Sweet & Ma xwe ll 2012, p. 621

52

Co mmission Decision of April 30, 2008 in State aid case NN 25/ 2008 (e x. CP 15/08) WestLB risk shield, Germany, para . 42

53

Arthold, C., Financial Sector in: EU State aids, Sweet & Ma xwell 2012, p. 649

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14 principles’ underlying them”55

.Thus, it “shifted away from its fundamentally critical stance towards those very rescue and restructuring aid measures, which in its Rescue and Restructuring Guidelines it described as one of the most distortive types of State aid”56. The restructuring aid was considered a permissible type of aid for the credit institutions.

Against this background, four Communications were adopted by the Commission indicating the Commission’s methodology to assess state support measures in the banking sector57

. These Communications concern the 2008 Banking Communication, the Recapitalization Communication, the Impaired Assets Communication and the Restructuring Communication58. Recently, the Commission adopted the 2013 Banking Communication59 that replaced the 2008 Banking Communication while it contains significant changes on “substantive aspects of the assessment of the various types of crisis aid ”60

.

The 2008 Banking Communication aimed to provide guidance on recapitalization measures and liquidity assistance to the banks. In this context, the granting of State aid “has to be decided on at national level but within a coordinated framework and on t he basis of a number of EU common principles”61

. With regard to the legal basis for the adoption of State aid measures, the Commission recognizes the temporary character of article 107 (3) (b) TFEU. As it is stated in the 2008 Banking Communication, “where there is a serious disturbance of a Member State's economy along the lines set out above, recourse to Article 87(3)(b) is possible not on an open-ended basis but only as long as the crisis situation justifies its application”62.

55

Lehman, European La w Revie w, 2011, p. 12 [online]

56

Blaschczok, M., & Zimmer, D., The role of competition in European State aid control during the financial

mark et crisis, European Co mpetit ion Law Rev iew, p. 15 [online]

57_{Schiavo, G., Lo, State aids and Credit Institutions in Europe: What way forward? , Eu ropean Business La w}

Revie w [2014], p. 431 [online]

58_{Of the first four Co mmun ications, only the Restructuring Co mmun ication had an e xpiry date (31 Dece mbe r}

2010). The other Co mmun ications were indefin ite in application . To this end, the fifth Co mmun ication adopted by the Commission, the so called First Prolongation Co mmunication, e xtended the Restructuring Co mmunicat ion until 31 Dece mber 2011. In addit ion, in spite the fact that the rest of the Co mmun ications were indefinite in their application, it was considered appropriate that the Banking, Recapita lizat ion and Impaired Assets Commun ications should re ma in in place beyond 31 Dece mber 2011 due to the fact that the “requirements for State aid to be approved pursuant to Article 107(3)(b) will continue to be fulfilled beyond the end of 2011”, Co mmunication fro m the Co mmission on the application, fro m 1st

of January, 2012, of State aid rules to support measures in favor of banks in the context of the financial c risis C(2011) 8744 final

59

See belo w under section 3.2 in Chapter III

60

Bacon, K., European Union Law of State aid, Oxford University Press, 2013, p. 402

61

Co mmun ication fro m the Co mmission on the application of State a id ru les to measures taken in re lation to credit institutions in the context of the current global financia l c risis [2008] OJ C270/8 para . 3

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15 The examination of the granting of State aid to credit institutions under the provision of article 107 (3) (b) TFEU as well as the departure from the Re scue and Restructuring Guidelines, allowed the Commission to adopt a more flexible treatment of approval pre-requirements63. Beyond the approval of the restructuring aid as one of the various types of aid to the credit institutions, the Commission also shifts away from the maximum duration of the aid provided to credit institutions.

The Rescue and Restructuring Guidelines state that the “rescue aid offers a short respite, not exceeding six months”64. In contrast, the Temporary Framework increased the duration for a “period longer than six months and up to two years in principle”65

. Here it could be stated that the maximum duration went up to even five years in individual decisions of the Commission.

For instance, Finland notified a guarantee scheme for bank funding in Finland. Under this scheme, a state guarantee was available for the issuance of new short and medium term debts. The scheme needed to include covered bonds that enable the credit institutions to obtain lower cost of funding in order to grant mortgage loans. According to the allegations of the Finnish Government, “a well- functioning mortgage bonds market, which consists to a large extent of fixed rate loans with a maturity of five years, is crucial to the whole financial industry in Finland”66. Thus, the Commission considered that an exceptional coverage of long term covered bonds up to 5 years could be sufficiently justified since it aimed to stabilize the financial system and not to create additional distortions67.

In parallel, with regard to the granting of State aid to the recipient bank, “the amount and intensity of the aid must be limited to the strict minimum”. This reflects the principle of necessity that implies contribution by the beneficiary in order to limit distortions of competition and to address moral hazard68. Moral hazard may occur where “one entity (the principal) does not know how another (the agent) will b ehave in the feature, and the dealings between the two entities incentivize the agent to take action that will be to the detriment of

63

Blaschczok, M., & Zimmer, D., The role of competition in European State aid control during the financial

mark et crisis, European Co mpetit ion Law Rev iew, E.C.L.R. 2011, 32(1), 9-16, p. 15 [online]

64

Co mmission Co mmunication, Co mmunity Gu idelines on State a id for Rescuing and Restructuring Firms in difficulty (2004/ C 244/02) para. 15

65

66

N 567/ 2008, Guarantee scheme for banks' funding in Fin land, para. 23

67

Ibid, pa ra. 40

68

Co mmission communicat ion on the return to viability and the assessment of restructuring measures in t he financia l sector in the current crisis under the State aid rules, 2009/ C 195/ 04, para. 22

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16 the principal”69

. In other words, moral hazard is a “situation in which a party insulated from risk behaves differently from the way in which it would behave if it were fully exposed to the risk”70

.

In the case of the banking sector, “the risk of moral hazard could be heightened because governments might engage in excessive injections of public money”71 followed by the banks’ incentives “to abstain from properly assessing risks in future lending and other investments”72. As a result, such risk might generate excess returns, otherwise, if things turn out badly, the state steps in and picks up the tab73 due to the fact that the latter stands as the guarantor for the ailing banks.

The Rescue and Restructuring Guidelines set an appropriate restructuring contribution by the aid beneficiary of at least 50%. Of course, lower contribution might be considered justifiable under the Rescue and Restructuring Guidelines which provide that “in cases of particular hardship, which must be demonstrated by the Member State, the Commission may accept a lower contribution”74

. According to the Temporary Framework concerning the banking sector, “a substantial private participation to the costs of the restructuring”75

of the aid beneficiary is required. This implies that the Restructuring Communication does not provide for a specific level of contribution. Thus, the contribution by the beneficiary might be lower than 50 %.

More specifically, the Restructuring Communication mentions that since “the credit institution has received State aid, the Member State should submit a viability plan or a more fundamental restructuring plan”76. Yet, the restructuring aid must be accompanied by an adequate burden sharing between the beneficiary credit institution and the Member State. If

69_{Ahlborn, C., & Picc inin, D., The Great Recession and other mishaps: the Commission’s Policy of}

restructuring aid in a time of crisis in: Research Handbook on European State aid La w, Edwa rd Elgar

Publishing, 2011, p.135

70

Arthold, C., Financial Sector in: EU State aids, Sweet & Maxwell 2012, p. 657

71_{De watripont, M., et. a l., The role of State aid control in improving bank resolution in Europe, Bruegel Policy}

Contribution, 2010, p. 2 [online]

72

Co mmun ication fro m the Co mmission on the treatment of impa ired assets in the Commun ity banking sector (2009/ C 72/ 01), para. 36

73

Milne, A., & Whalley, E., Bank Capital Regulation and Incentives for Risk -Tak ing, Cass Business School Research Paper. 2001 p. 6 [online]

74

75

76

Co mmission communicat ion on the return to viability and the assessment of restructuring measures in the financia l sector in the current crisis under the State aid rules, (2009/C 195/04) para. 4

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17 the beneficiary cannot provide an ex ante contribution at the time of rescue, this should be addressed at a later stage of the implementation of the restructuring plan77.

Such contribution might include the sale of assets or the “prohibition on payment of dividends and coupons on outstanding subordinated debt, with a view to limit the misuse of aid”78

. The Commission considered that it was not appropriate to set fixed thresholds concerning burden-sharing ex ante in the context of the systemic crisis that was present79. In that time, the Commission held that it was of utmost significance that the ability of the credit institutions gained access to private capital and returned to normal market conditions80.81 A further relaxation on the Commission’s policy during the adoption of the Temporary Framework concerns “the rule that rescue aid can only be granted to ‘undertakings in difficulty’82

. The 2004 Rescue and Restructuring Guidelines define the firms in difficulty as those that are unable “to stem losses which, without outside intervention by the public authorities, will almost certainly condemn it to going out of business in the short or medium term”83. Under the Temporary Framework, even a fundamentally sound credit institution may benefit from a rescue aid if it experiences liquidity problems84. According to the 2008 Banking Communication the establishment of a recapitalization scheme could be used “to support credit institutions that are fundamentally sound but may experience distress because of extreme conditions in financial markets”85.

This Commission’s flexible approach is illustrated, inter alia, in its Decision with regard to the recapitalization of KBC Group NV by the Belgian authorities. There, the Commission remarks that “in the case of KBC, the current capital base can absorb the losses and still stay above the regulatory capital requirements. Therefore, KBC has no solvency problem in the strict regulatory sense”86. However, as it states later on, the KBC current capital surplus is at

77

Ibid, pa ra. 7

78_{Gebski, S., Co mpetition First? Application of State aid Rules in the Bank ing Sector, Co mpetition Law}

Revie w, p. 110 [online]

79_{Co mmission communicat ion on the return to viability and the assessment of restructuring measures in the}

financia l sector in the current crisis under the State aid rules, (2009/C 195/04) para. 24

80_{Ibid, pa ra. 24} 81

An enhanced burden sharing has been launched in the recent 2013 Banking Co mmu nication, see further analysis in section 3.2 Chapter III

82

83

84

85

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18 its lowest level in 5 years and recapitalization is required to raise its capital to reassure financial markets”87.

Preliminary findings:

The inexistence of a common fiscal backstop at the EU level led many member states of the EU to grant massive capital injections to their banks by means of staid aid. To this end, the Commission introduced a Temporary Framework for State aid to credit institutions in order to address the systemic nature of the global financial crisis. This Temporary Framework allowed the Commission to depart from its prior approach concerning the granting of State aid to firms in difficulty and adopted a more softened approach during the examination of the granting of State aid to credit institutions. In this framework, the Commission refrained from setting an ex ante burden sharing between the beneficiary banks and the member state. However, the lack of adequate tools at Union level to deal effectively with unsound or failing credit institutions and investment firms enforced member states to save those institutions using taxpayers’ money88

. Eventually, the fiscal position of the government was weakened and this led to a vicious circle between banks and the sovereign debt.

Chapter III

Complex burden- sharing between taxpayers and credit institutions

3.1 The vicious circle between banks and the sovereign debt

Since the crisis started in 2008, member states of the European Union have tried to overcome the systemic fragility of their banking systems by granting financial assistance to their banks by means of State aid. As a result, the public debt of the EU member states augmented, inter

alia, due to the massive capital injections from state resources to ailing banks. In 2010 the

crisis turned into a debt crisis which affected mainly those countries that shared the euro as a single currency and were even more interdependent89.

This situation led to a vicious circle between banks and sovereign debt that can be explained as follows. In the absence of a supranational banking resolution mechanism, member states 87 Ibid, pa ra. 9 88 BRRD, Rec ital 1 89

“More than 75% of all state assistance (around €4 trillion) fro m 2008 to 2012 in the European Union has been used by euro-area countries, which have on average provided more State aids to local banks than the rest of the European Union”, Valiante, D., Framing Banking Union in the Euro Area, Centre for European Policy Studies Working Docu ment, No. 388/February 2014, p. 9 [online]

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19 are responsible for rescuing their ailing banks90. As far as the euro area is concerned, the creditworthiness of the Eurozone governments is priced by financial markets according to their actual fiscal capacity, taking into account the lack of a central bank backstop91. As a result, the fiscal position of the relevant member state is weakened. In parallel, domestic banks are confronted with weaker balance sheets due to the fact that they hold a considerable share of the debt issued by their domestic government. This implies that any doubt regarding sovereign solvency immediately affects domestic banks92.

In June 2012, the Heads of State and Governments highlighted that it was “imperative to break the vicious circle between banks and sovereigns”. Moreover, they further stated that “the Commission will present Proposals on the basis of Article 127(6) TFEU93

for a single supervisory mechanism”94. The setting- up of a Banking Union will place “the banking sector on a more sound footing and restore confidence in the Euro as part of a longer term vision for economic and fiscal integration”95

. In this direction, it was considered imperative to move responsibility for potential financial support - and the associated banking supervision - to a shared level in order to reduce the financial fragmentation, weaken the vicious loop in many countries96 and “detach government budgets from the balance sheets of individual banks”97. Therefore, “in view of the close links and interactions between Member States whose currency is the euro, the banking union should apply at least to all euro area Member States”98.

3.2 Adaptation of the Temporary Framework on State Aid Control

The announcement for the launch of the Banking Union was followed by an adaptation of the temporary framework on State aid control under the 2013 Banking Communication. The adaptation aimed “to ensure a smooth passage to the future regime under the Commission’s

90

Merle r, S., & Pisani-Ferry, J., Hazardous tango: sovereign-bank interdependence and financial stability in the

euro area, Banque de France, Financia l Stability Review, No. 16, 2012, p. 2 [online]

91_{Va liante, D., Framing Bank ing Union in the Euro Area , Centre for European Po licy Studies Working}

Document, No. 388/February 2014, p. 6 [online]

92_{Merle r, S., & Pisani-Ferry, J., Hazardous tango: sovereign-bank interdependence and financial stability in the}

euro area, Banque de France, Financia l Stability Review, No. 16, April 2012, p. 2 [online]

93

According to Article 127 (6) TFEU “The Council, act ing by means of regulations in acco rdance with a special legislative procedure, may unanimously, and after consulting the European Parlia ment and the European Central Bank, confer specific tasks upon the European Central Ban k concerning policies re lating to the prudential supervision of credit institutions and other credit institutions with the e xception of insurance undertakings”.

94

Eu ro Area Su mmit Statement - 29 June 2012 -

95

A Road map towards a Banking Union, Co mmunicat ion fro m the Co mmission to the European Parlia ment and the Council COM/2012/0510 final, p. 3

96

Goyal, R., et. al., A Bank ing Union for the Euro Area, IMF Staff Discussion Note 2013, p. 6 [on line]

97

Smits, R., Is my money safe at European bank s?, Capital Markets La w Journal 2014, p. 139 [online]

98

Council Regulation No 1024/2013 of 15 October 2013 conferring specific tasks on the European Central Ban k concerning policies relat ing to the prudential supervision of credit institutions, Recital 11

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20 Proposal for a directive for the recovery and resolution of credit institutions by providing more clarity to markets”99

. At the same time, the adaptation of the Communications sought to ensure “more decisive restructuring and stronger burden-sharing for all banks in receipt of State aid in the entire single market100.

The latter was considered necessary for two reasons. First, the Commission did not set ex

ante thresholds for own contribution. Second, until then member states did not generally go

beyond the minimum requirements set by State aid rules with regard to ex ante burden sharing. Thus, creditors were not required to contribute to rescuing credit institutions for reasons of financial stability101.

The 2013 Banking Communication replaced the 2008 Banking Communication that introduced article 107(3) (b) TFEU as a potential legal basis for the granting of State aid to credit institutions. Of course, the new Communication does not alter the legal basis for the granting of State aid since “the requirements for the application of article 107(3) (b) TFEU to State aid in the financial sector continue to be fulfilled”102. In addition, the 2013 Banking Communication adapts and complements the Recapitalization and Impaired Asset Communications while it provides more detailed guidance on burden sharing by shareholders and subordinated creditors with regard to the Restructuring Communication103.

Of utmost significance under the new Banking Communication is the establishment of the principle that “no recapitalization or asset protection measure can be granted without prior authorization of a restructuring plan”104

. This more stringent approach by the Commission aims to ensure that the amount of aid is more accurately calibrated while the taxpayer avoids a higher final bill105. This reflects the idea of having more conditionality for the acceptance of bailouts/recapitalization plans with public money106.

In particular, the aforementioned principle applies in cases of recapitalizations and impaired asset measures. In contrast, liquidity support and guarantees on liabilities can be notified to

99

Co mmun ication fro m the Co mmission on the application, fro m 1 August 2013, of State aid rules to support measures in favour of banks in the context of the financial crisis (‘Banking Co mmunication’) (2013/C 216/01), para. 13 100 Ibid, pa ra. 13 101 Ibid, pa ra. 17 102 Ibid, pa ra. 6 103 Ibid, pa ra. 24 104 Ibid, pa ra. 24 105 Ibid, pa ra. 23 106

De watripont, M., European Banking: Bailout, bail-in and State aid control, International Journal of Industrial Organizat ion, 34(2014), p. 42 [online]

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21 the Commission as rescue aid before the approval of a restructuring plan107. The difference lies in the nature of recapitalizations and impaired asset measures. These measures are mainly irreversible and cannot be easily undone108. If the bank’s problems have not been identified properly at an early stage, a possible bankruptcy at a later stage will lead to the sacrifice of the given public injection. To avoid such a situation, the granting member state must demonstrate that the aid provided is limited to the minimum necessary109. To this end, it must submit a capital raising plan to the Commission containing the appropriate measures taken by the bank and the potential burden sharing measures by the shareholders and subordinated creditors of the bank110.

Burden-sharing by shareholders and subordinated creditors is required when the bank does not meet the minimum regulatory capital requirements and is unable to restore the capital position on its own111. Burden sharing by shareholders and subordinated creditors can take the form of either a conversion into Common Equity Tier 1 or a write-down of the principal of the instruments112. This refers to the so called bail- in tool. This tool constitutes a statutory power that enables resolution authorities to “eliminate or dilute existing shareholders, and to write-down or convert any contractual contingent capital instruments that have not already been converted to equity, subordinated debt, and unsecured senior debt”113. In other words, “the term ‘bail-in’ as opposed to the term ‘bail-out’, signifies that the absorption of losses will preferably not be externally sourced by ‘outsiders (i.e., by Governments), but will rather be for the account of ‘insiders’, being shareholders and (certain categories) of creditors”114

. The 2013 Banking Communication envisages two scenarios for burden-sharing. In the case that a credit institution does not meet the minimum regulatory requirements, State aid can only be authorized after equity, hybrid capital and subordinated debt have fully contributed to offset any losses115. In the case of the second scenario, where the credit institution meets the

107_{Co mmun ication fro m the Co mmission on the application, fro m 1 August 2013, of State aid rules to support}

measures in favour of banks in the context of the financia l crisis (‘Banking Co mmunicat ion’) (2013/C 216/ 01), para. 56 108_{Ibid, pa ra. 28} 109 Ibid, pa ra. 29 110 Ibid, pa ra. 29 111 Ibid, pa ra. 43 112 Ibid, pa ra. 41 113

Bossu, W., et al., From Bail-out to bail-in: Mandatory Debt restructuring of systemic credit institutions, IMF Staff Discussion Note 2012 p. 6 [online]

114

Serière V., De., Bail-in: Some Fundamental Questions in: Recovery and Resolution: A conference book, Eleven International Publishing 2014, p. 154

115

Co mmunicat ion fro m the Co mmission on the application, fro m 1 August 2013, of State aid rules to support measures in favor o f banks in the context of the financial crisis (‘Ban king Co mmunication’) (2013/C 216/01), para. 44

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22 minimum capital requirements but a capital shortfall is identified, the Commiss ion indicates that the subordinated debt must be converted into equity before the granting of State aid116. This implies that under the second scenario “the write-down of debt is not contemplated”117

. In addition, with regard to the required contribution, the Banking Communication does not consider the contribution from senior debt holders as a mandatory component of burden sharing under State aid rules118. In the case that the capital raising and burden sharing measures do not suffice to cover the capital shortfall, the latter can in principle be covered by public recapitalization, impaired asset measures or a combination of the two119.

A capital shortfall can be identified in a “capital exercise, stress-test, asset quality review or an equivalent exercise at Union, euro area or national level, where applicable confirmed by the competent supervisory authority”120

. The SSM Regulation states in its transitional provisions that in view of the assumption of its tasks, the ECB may require the national competent authorities to provide the former with all relevant information in order to carry out a comprehensive assessment, including a balance-sheet assessment, of the credit institutions concerned121. The ECB assumed “banking supervision tasks in November 2014 in its role within the Single Supervisory Mechanism (SSM)”122. To this end, the ECB conducted a comprehensive assessment of 130 banks123. This comprehensive assessment comprises two components. First, the asset quality review which constitutes assessment of the accuracy of the carrying value of banks’ assets. In other words, it consists of a “health check of the banks that will be subject to direct supervision by the ECB”124

. Second, the stress test that provides a “forward-looking examination of the resilience of banks’ solvency to two hypothetical scenarios”125. The stress-test constitutes a “prudential exercise to address banks’ ability to withstand weaker economic conditions”126

. As already stated, the goal of the exercise “is to

116_{Ibid, pa ra. 43}

117_{Bruzzone, G., & Cassella, M., & Micossi S., Bail-in provisions in State aid and Resolution Procedures: Are}

they consistent with systemic stability?, Centre for European Policy Studies (CEPS) 2014, page 5 [online]

118_{Co mmunicat ion fro m the Co mmission on the application, fro m 1 Aug ust 2013, of State aid rules to support}

measures in favor o f banks in the context of the financial crisis (‘Ban king Co mmunication’) (2013/C 216/01), para. 42 119 Ibid, pa ra. 49 120 Ibid, pa ra. 28 121

Article 33 (4) of the Council Regulation (EU) No 1024/ 2013 of 15 October 2013 confe rring specific tasks on the European Central Bank concerning policies re lating to the prudential supervision of credit institutions

122

Aggregate Report on the comprehensive assessment, European Central Bank, October 2014, page 13

123 Ibid, p. 20 124 Ibid, p. 2 125 Ibid, p. 3 126_{Ibid, p. 3}

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23 help prevent further burdens on taxpayers by strengthening the resilience of the financial sector to future crises”127

.

Recently, the Commission approved the granting of State aid to a bridge bank that was established for the orderly resolution of Banco Espirito Santo S.A (BES). Due to high impairment and contingency costs related to the Espirito Santo Group, the Portuguese authorities proceeded with the resolution of the bank128. However, the absence of a private buyer in the market enforced the authorities to create a bridge bank in order to sa feguard the financial system in Portugal129. The Commission recognized that, due to the specificities of credit institutions and in the absence of mechanisms allowing for the resolution of credit institutions without threatening financial stability, the ordinary insolvency procedure might not be the appropriate130. To this end, state measures may be considered as compatible aid as soon as they subject to compliance with the requirements specified in the 2013 Banking Communication with regard to the burden sharing measures131. Thus, all shareholders and subordinated creditors left in the bad bank and will contribute to the maximum possible extent while they will not benefit from the State aid provided132.

Concerning the bridge bank named Novo Banco, selected assets and liabilities were transferred to it from Banco Espirito Santo S.A. while the remaining BES became the bad bank133. To this end, the Portuguese authorities proceeded with the transfer of the State guaranteed bonds of BES to the bridge bank134.135 The bridge bank was further capitalized by the Resolution Fund. Due to the insufficiency of the latter to provide adequate share capital to the bridge bank, the Resolution Fund was further financed via levies from the banking sector and “a loan financed from the State budget as foreseen in Portuguese Law nr. 83-C/2013 of 31 December”136

. Novo Banco “is per definition a temporary institution with the goal to sell all its assets”137

.

127_{Ibid, p. 13}

128_{State aid SA. 39250 (2014/N), Portugal, Resolution of Banco Espirito Santo, S.A, C(2014) 5682 fina l, para 1} 129 Ibid, pa ra. 3 130 Ibid, pa ra. 68 131 Ibid, pa ra. 68 132 Ibid, pa ra. 89 133 Ibid, pa ra. 33 134 Ibid, pa ra. 31 135

“The state guaranteed bonds were issued by BES under the Portuguese Guarantee Sche me approved by the Co mmission in case NN60/2008”. State aid SA. 39250 (2014/N), Portugal, Resolution of Banco Espirito Santo, S.A, C(2014) 5682 final, para. 32

136

Ibid, pa ra. 58