COMMISSION DECISION of 20 May 1998 concerning aid granted by France to the Crédit Lyonnais group (notified under document number C(1998) 1454) (Only the French text is authentic) (Text with EEA relevance) (98/490/EC)

THE COMMISSION OF THE EUROPEAN COMMUNITIES,

Having regard to the Treaty establishing the European Community, and in particular Articles 92 and 93 thereof,

Having regard to the Agreement on the European Economic Area, and in particular Articles 61 and 62 thereof,

Having, in accordance with the abovementioned Articles, given the interested parties notice to submit their observations (1),

Whereas:

1. INTRODUCTION

Crédit Lyonnais (CL) is a publicly owned financial group operating in the banking sector. Since 1992 it has experienced considerable difficulties which led the State in 1994 to grant it aid in the form of a capital increase and the creation of a hive-off vehicle for property assets worth about FRF 40 billion. In 1995 other assets were hived off amounting to a total of approximately FRF 190 billion (2), the losses being covered by State guarantee. These measures were the subject of Decision 95/547/EC, in which the Commission decided on 26 July 1995 to approve on certain conditions the State aid in question, provided that the net cost to the State did not exceed FRF 45 billion (3). In response to CL's deteriorating financial situation, the French authorities, in September 1996, submitted a plan to grant emergency aid totalling nearly FRF 4 billion in order to avoid serious adverse effects. On 25 September 1996 the Commission decided to approve the emergency aid and at the same time to initiate the Article 93(2) procedure (4) with regard to the other recovery measures recommended to CL. In that context it would examine the compatibility of any restructuring measure in the light of all the relevant information - including that on which Decision 95/547/EC was based and the obligations imposed by that Decision on France - and of any new facts, including the failure to meet certain conditions, the new arrangements proposed and the additional compensating measures.

The same day, Mr Van Miert, Member of the Commission, sent a letter to the French Minister, M. Arthuis, informing him of the inevitable difficulties associated with examination of the new restructuring plan for the bank, given the extremely large amount of aid already authorized by the Commission, and that it was therefore not possible to predict the final outcome of the case. The French authorities replied to the letter notifying the initiation of the Article 93(2) procedure in the following letters:

- that of 8 November 1996, attached to which were an analysis of the first recovery plan, the consolidated accounts of CL and the Consortium de Réalisations (CDR) at June 1996, a note on CL's management and internal auditing systems and a note on the partial securitization of the loan to the Etablissement Public de Financement et de Restructuration (EPFR);

- that of 23 May 1997, enclosing inter alia CL's draft annual report for 1996;

- that of 31 July 1997, in which the French authorities submitted the restructuring plan for the bank as requested by the Commission when the present procedure was initiated.

Other letters were sent by Mr Van Miert to the French authorities, in particular that of 25 June 1997 explaining to them the Commission's concern about the delay in the transmission of the new restructuring plan for the bank, and that of 16 October 1997 explaining the principles on which the Commission would base a decision. On 31 March 1998 the Minister for Economic, Financial and Industrial Affairs, M. Strauss-Kahn, wrote to Mr Van Miert informing him of new measures which the French State was ready to take with a view to securing conditional approval for the aid to CL. On 2 April, having obtained the Commission's approval, Mr Van Miert wrote to M. Strauss-Kahn setting out the conditions which, in the Commission's view, would make it possible to regard the aid in question as compatible with the common interest. On 6 April, as a supplement to that letter, Mr Van Miert wrote to M. Strauss-Kahn informing him of the reasons why the undertakings made in the letter from the French Minister dated 31 March could not be regarded by the Commission as sufficient to secure a positive decision. On 24 April M. Strauss-Kahn wrote to Mr Van Miert again, repeating the position of the French authorities, emphasizing the constraint on the bank's viability and challenging the amount of aid calculated by the Commission. On 4 May M. Strauss-Kahn wrote to Mr Van Miert a third time, proposing additional compensating measures to offset the distortive effect of the aid. In three separate letters to Mr Van Miert dated 13 May, M. Strauss-Kahn set out all the undertakings made by the French authorities.

In evaluating the CL restructuring plan, the Commission decided to base its analysis on advice from the internationally reputed merchant bank Lehman Brothers (the Commission's consultant bank), which, in connection with the bank's viability, was instructed to examine the restructuring plan submitted by the French authorities and to propose any changes which it thought necessary. The Commission's consultant bank was also asked to assess the new compensating measures proposed by the French authorities and to examine additional ones if necessary. The CL restructuring plan was submitted to the Commission at the end of July 1997. The Commission's consultant bank carried out a thorough, detailed analysis and submitted its report, which is confidential, in November 1997. The French authorities and CL were able to consult the report and did not challenge its principal conclusions.

Mr Van Miert gave an oral progress report on the case to the Commission at its meetings on 25 November 1997 and 28 January, 25 February, 18 March, 31 March and 6 May 1998.

The Commission also consulted a group of 'wise men`, former governors of central banks, to discuss the various problems associated with the case and the possible consequences of the failure of a large bank.

The observations of third parties are set out in section 5.

The measures examined here in connection with the increase in the aid approved by the Commission in Decision 95/547/EC and the Decision of 25 September 1996 comprise:

- the defrayal by the State of the additional losses of the Consortium de Réalisations (CDR) through the mechanism of a participating loan ('prêt participatif`) from the Etablissement Public de Financement et de Restructuration (EPFR) to CDR;

- EPFR's carrying costs and additional losses, including the 'neutralization` of the loan from CL to EPFR from 1997 to 2014;

- the abandonment of the zero-coupon bond provided for in the 1995 business plan and Decision 95/547/EC, the discounted income from which had been deducted from the approved aid;

- a number of measures likely to contain additional aid components, in particular a possible capital increase.

2. BACKGROUND

2.1 Aid to CL in 1994 and 1995

After almost five years of rapid growth, CL recorded losses in 1992 (FRF 1,8 billion) and 1993 (FRF 6,9 billion). These were very heavy losses in proportion to CL's own funds, and its solvency ratio - the ratio of own funds to risk-adjusted assets - would have fallen below the 8 % legal minimum if the French authorities, acting at the request of the authority responsible for supervising the French banking system (the Commission Bancaire), had not taken financial support measures in 1994, essentially consisting of a capital increase of FRF 4,9 billion and the underwriting by the State of the risks attached to about FRF 42,7 billion of non-performing property assets transferred to a special hiving-off company (Omnium Immobilier de Gestion, OIG). At the beginning of 1995 it became clear that CL would be recording further losses which would threaten its solvency; the French State put together a new rescue package, involving the setting-up of another special hive-off vehicle consisting of, firstly, CDR, a hiving-off consortium for taking over CL's compromised assets, including those which had already been transferred to OIG, and secondly of a holding company (SPBI), responsible for financing the hiving-off and controlled by the main shareholders in CL (the Government, Thomson-CSF and CDC). CDR is a wholly owned, non-consolidated subsidiary of CL. SPBI was subsequently transformed (by the Law of 28 November 1995) into a public administrative institution, EPFR, which enabled it to qualify for an unlimited State guarantee in respect of all the risks and costs associated with the commitments transferred to CDR, including carrying costs. The setting-up of this vehicle limited CL's accounting loss for 1994 to FRF 12,1 billion.

According to the plan communicated by the French authorities and approved by Decision 95/547/EC, CDR purchased nearly FRF 190 billion of assets from CL, including those hived off in 1994, to which were attached FRF 55 billion in liabilities. The net value of the hived off assets, therefore, would be about FRF 135 billion. All the assets concerned were to be sold or liquidated. At least 50 % of them were to be sold within three years, and 80 % within five years if market conditions allowed. In the case of the banking subsidiaries transferred to CDR, the healthy part of these banks was either to be sold to third parties or taken back before 31 December 1995 by CL, with the result that at the end of financial 1995 CDR would no longer contain any active banking structure.

To enable it to buy the CL assets, CDR received a participating loan of FRF 135 billion from EPFR, with the possibility of increasing it to FRF 145 billion through an additional tranche of FRF 10 billion. The arrangement was financed by CL through a non-participating loan up to a maximum of FRF 145 billion. With this, EPFR was able to grant the participating loan of FRF 135 billion to CDR and should have been able to buy long-term zero-coupon bonds amounting to FRF 10 billion. The bond transaction would have enabled EPFR to earn an income initially estimated in 1995 at about FRF 35 billion by the end of 2014, thus allowing it to absorb the balance of the losses which will be recorded at that time in CDR.

The maturity date for both the CL loan to EPFR and EPFR loan to CDR is 31 December 2014. The CL loan will be repaid early as the assets are sold, in step with the amounts received, provided however that the repayments from CDR to EPFR are greater than the annual interest charged on the CL loan. The annual rate of interest applicable was initially fixed at 7 % in 1995 and at 85 % of the money market rate (MMR) from 1996. The participating loan granted to CDR is partly amortized at the end of each financial year: EPFR receives a repayment equal to the amount of the sales during the year and, if capital losses are incurred on the sales, it abandons the claim (by activating the guarantee) to the extent of the losses incurred by CDR.

Through the mechanism of the participating loan, CDR's losses are borne by EPFR and hence in the last resort by the State, up to a maximum of FRF 135 billion. However, the State guarantee was not subjected to a ceiling by Parliament when it adopted the Law of 28 November 1995 setting up EPFR, and is therefore de facto unlimited, even if in the extreme case the hive-off should make losses whose total exceeds the amount of the participating loan. Thus CL is covered by the State for the repayment of its loan to EPFR, which makes it possible for CDR not to be consolidated either prudentially or for accounting purposes within the CL group. This mechanism has enabled CL to record reduced provisions and losses and to comply with the statutory solvency ratio. The diagram below shows the main features of the arrangement.

As a quid pro quo, EPFR is entitled to the income from a 'better fortunes` clause in respect of CL. Thus it receives a contribution of 34 % of CL's net consolidated result, group share (prior to the entry in the accounts of the contribution and the appropriation from the financial year to the fund for general banking risks and prior to French corporation tax) plus 26 % of the fraction of that result exceeding 4 % of the consolidated capital and reserves, group share.

COMPOSITION OF THE HIVE-OFF VEHICLE

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Recapitalisation STATE Budget allocations

CREDIT LYONNAIS Loan FRF 135 billion EPFR Additional tranche of FRF 10 billion for the zero coupon Loan 145 bill Losses Wholly owned sub. CDR ring-f. Contrib. net assets FRF 135 bill HIVE-OFF

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The CL restructuring plan submitted to the Commission in 1995 contained several measures concerning strategy redefinition, the sale of subsidiaries, cost reduction and risk management and control. These measures should have enabled CL to make a profit from 1995 on. By the end of 1999 CL should have recorded a return on its equity of 12,4 %. Under the better fortunes clause, its contribution to the cost of the hive-off vehicle should have been a total of FRF 6 136 million nominal over the period 1995-99.

2.2 Decision 95/547/EC

In Decision 95/547/EC the Commission conditionally approved the aid granted by the French State to CL during 1994 and 1995, regarding it as compatible with the common market under Article 92(3)(c) of the EC Treaty and in particular with the Community guidelines on State aid for rescuing and restructuring firms in difficulty (5). The substantive provisions of the Decision are reproduced below:

'Article 1

The aid contained in the recovery plan for Crédit Lyonnais in the form of a capital increase of FRF 4,9 billion, the underwriting of the risks and costs associated with the assets transferred to the hiving-off structure (up to a maximum of FRF 135 billion) and tax concessions inherent in the "better fortunes" clause, the total net cost of which to the State, taking into account the revenue accruing to the State, is estimated at a maximum of FRF 45 billion, is hereby declared to be compatible with the common market and with the EEA Agreement under point (c) of Article 92(3) of the EC Treaty and point (c) of Article 61(3) of the EEA Agreement.

Article 2

The aid referred to in Article 1 is authorized subject to France meeting the following conditions and commitments:

(a) it must ensure that all the recovery measures and all the arrangements provided for under the scheme described in Article 1 are implemented;

(b) it must not amend the conditions laid down in the recovery plan, except with the Commission's prior agreement. At all events, the "better fortunes" clause may be transferred no earlier than at the time of the privatization of Crédit Lyonnais, and only at the market price; that price will be verified by independent assessments;

(c) it must ensure, given the size of the estimated overall cost of the scheme to the State of FRF 45 billion, that the commercial capacity of Crédit Lyonnais is reduced by means of a cut of at least 35 % in its commercial operations abroad, including its European banking network, by the end of 1998 in accordance with the commitments given by France in its letter of 18 July 1995. If that objective cannot be achieved by the deadline set without causing substantial losses that require the shareholder in question to provide further financial assistance in order in particular to ensure compliance with the Community solvency ratio, the Commission undertakes to examine the possibility of extending that deadline. If the costs of the scheme, estimated at FRF 45 billion, are exceeded, it will be necessary to re-examine the scale of the reduction in the commercial operations of Crédit Lyonnais as accepted by the abovementioned letter;

(d) it must prevent Crédit Lyonnais from benefiting from a carry-over of tax losses in respect of the 1994 tax loss covered by the capital increase of FRF 4,9 billion;

(e) it must prevent Crédit Lyonnais from repurchasing hived-off industrial and commercial assets, except at the price at which the assets were transferred to CDR or at the market price if that is higher than the price at which the assets were transferred to CDR, and at all events subject to an overall limit of FRF 5 billion;

(f) it must prevent Crédit Lyonnais from sharing in any of the proceeds of sales from CDR;

(g) it must achieve a separation between CDR and Crédit Lyonnais as regards their managers, their administration and the system of monitoring and supervising the management of the hived-off assets;

(h) it must ensure that the committees responsible for managing the hived-off assets are independent of Crédit Lyonnais;

(i) it must eliminate any possibility of a carry-over of residual tax losses for years prior to 1995 for Crédit Lyonnais if, at the time of privatization, the "better fortunes" clause is transferred;

(j) it must ensure that Crédit Lyonnais uses the proceeds of sales to restructure non-performing assets and activities;

(k) it must ensure that Crédit Lyonnais pays to SPBI the levy sums in accordance with the "better fortunes" clause;

(l) it must pay to SPBI the proceeds of privatizing Crédit Lyonnais, particularly those deriving from the sale of the shares currently held by SPBI, and ask Parliament to endorse payment to SPBI of the proceeds of privatizing the remaining shares.

Article 3

The Commission has taken account of the French authorities' statement that their firm objective is to privatize Crédit Lyonnais and that the anticipated recovery should enable it to be ready for privatization within five years. Any deferment of privatization beyond five years will have to be notified to the Commission.

Article 4

The French authorities must cooperate fully in monitoring compliance with this Decision and must submit the following documents to the Commission every six months as from 1 March 1995:

(a) a detailed report on the application of the plan, together with the reports presented to Parliament;

(b) the balance sheets, profit and loss accounts, and reports of the directors of the companies involved in the hiving-off operation, namely OIG, CDR, SPBI and Crédit Lyonnais;

(c) a list of the hived-off assets that are liquidated or sold, with details of selling prices, the names of purchasers, and the names of the banks to which the selling instructions have been given;

(d) a detailed list of abandonments of CDR claims to be set against the participating loan granted by SPBI;

(e) a detailed list of the banking assets sold by Crédit Lyonnais outside the hive-off vehicle, with an evaluation, based on objective and verifiable criteria, of the reduction in its commercial operations abroad;

(f) detailed figures for Crédit Lyonnais's contributions to the hive-off vehicle in the form of a levy or dividends.

The Commission may ask for these documents and the implementation of the plan to be assessed by means of special audits.

Article 5

This Decision is addressed to the French Republic.`

As a supplement to this decision it should be pointed out that, in its letter of 18 July 1995, France undertook to ensure that CL reduced its commercial presence in Europe outside France by 50 % in balance-sheet terms by the end of 1998, on the same conditions as in Article 2(c).

2.3 Emergency aid

In late September 1996 the French authorities submitted further aid for CL, amounting to nearly FRF 4 billion, to the Commission. In order to prevent considerable losses for CL and the deterioration of its rating, which could have had negative consequences for other financial institutions, the French authorities declared that emergency aid measures were necessary, namely:

- emergency aid which was designed to preserve the liquidity position and the solvency of the institution and which related to 1995 and 1996;

- restructuring aid which was designed to facilitate the recovery of CL beyond 1996 and which would not be implemented before the Commission had taken a final decision in its respect.

The proposed measures consisted in altering the conditions attaching to the loan from CL to EPFR, so as to 'neutralize the weight of the past in CL's accounts`. Since the results in the other activities were less good than forecast, the interest arrangements on the loan, according to the French authorities, imposed a net burden on CL of FRF 3 billion in 1996, 2,7 billion in 1997 and 2,5 billion in 1998. The calculation took into account the difference between the rate for the loan to EPFR (85 % of MMR) and the weighted average rate for the CL refinancing secured by the corresponding liabilities.

Initially and at 25 September 1996 these measures were to be implemented in respect of 1995 (retroactively, through incorporation of exceptional proceeds in 1996) and 1996. Subsequently, and subject to the Commission's final decision, they could possibly be introduced for the whole term of CL's loan to EPFR, in the form of restructuring aid.

The proposed changes were designed to compensate CL fully for the burden of the said loan. Thus it was planned that the rate of interest on the loan should offset the cost to CL of collecting the funds necessary to finance the loan. Consequently, the French authorities decided to increase the rate of interest from 7 % to 7,45 % in 1995 and from 85 % of MMR to 5,84 % in 1996. In particular, in respect of 1996, the French authorities did not confine themselves to cancelling the 15 % subsidy on the rate for the original loan so that CL would be remunerated at the MMR level, but they also proposed to increase the rate on the loan beyond the MMR by a percentage that would offset CL's higher refinancing cost caused by its long-term liabilities. The increase compared with MMR was about 2 %. The changes in respect of 1995 and 1996 would have the effect of giving CL an advantage of FRF 3 560 million, which was to be sufficient to prevent any liquidity and confidence problem for the bank in 1996.

As the French authorities have admitted, part of the plan approved by the Commission in 1995 has never been implemented. This is the FRF 10 billion part of the FRF 145 billion loan from CL to EPFR enabling the latter to issue long-term zero-coupon bonds which would have earned it an income of FRF 35 billion nominal by 2014, or FRF 7,8 billion discounted. The French authorities planned therefore to abolish this part of the plan. As with the other measures described above, the change was first introduced on 25 September 1996, in respect of 1996, in the form of a suspension of the operation. Subsequently, and in accordance with the Commission's final decision, the change would be proposed by the French authorities for the following years, in the form of restructuring aid.

Implementation of the zero-coupon operation would have had the result of further increasing the above-mentioned losses of CL by imposing on it an annual burden of carrying additional outstanding loans of FRF 10 billion, at an interest rate not covering its refinancing cost.

The French authorities also affirmed, when submitting their request for emergency aid, that such aid was not sufficient to sustain the definitive recovery of CL, since the new redundancy programme and the shedding of retail banking activity outside France, provided for in the measures submitted, involved substantial provisions and capital losses in respect of several non- or poorly performing subsidiaries (a capital loss of about FRF 6.5 billion). For this reason, the French authorities proposed to effect a capital injection, probably when the 1996 accounts were closed, 'for an amount exceeding those capital losses`. The Commission had, in 1996, estimated the possible amount of such an additional transaction at FRF 8-10 billion.

On 26 September 1996 the Commission therefore decided to approve the emergency aid and to initiate the procedure with regard to the other measures concerning CL. It announced that, as part of the procedure, it would examine the compatibility of any restructuring measure concerning CL on the basis of all the relevant information - including that on which Decision 95/547/EC had been based and the obligations which that Decision had imposed on France - plus any new facts - including failure to satisfy certain conditions, the new arrangements proposed and the additional compensating measures.

It should also be emphasized that the approval of the emergency aid for 1995 and 1996 has in no way prejudged the present decision, with the result that France's and CL's obligations concerning the introduction of the zero-coupon bond and the financing of the loan to EPFR, as defined in Decision 95/547/EC, have remained unaltered as from 1 January 1997.

2.4 Background to the examination of the supplementary restructuring aid for CL

In its examination of the supplementary aid for CL, the Commission takes account of the fact that it has already approved the aid granted by France to CL in 1994 and 1995, regarding it as compatible with the common market under Article 92(3)(c) of the EC Treaty and in particular with the Community guidelines on State aid for rescuing and restructuring firms in difficulty (6).

As the guidelines affirm, 'aid for restructuring raises particular competition concerns as it can shift an unfair share of the burden of structural adjustment and the attendant social and industrial problems on to other producers who are managing without aid and to other Member States. The general principle should therefore be to allow restructuring aid only in circumstances in which it can be demonstrated that the approval of restructuring aid is in the Community interest`. Thus, 'aid for restructuring should therefore normally only need to be granted once`.

The Commission finds that to the substantial amount of aid accepted in 1995 further aid is now being added on an unprecedented scale. In the September 1996 Decision initiating the procedure, the Commission noted that the considerations presented lead inevitably to the conclusion that such supplementary aid can be regarded as compatible with the State aid rules of the EC Treaty only if serious, substantial quid pro quos are provided. These should be made both inside and outside France, in retail banking and in CL's other areas of activity. The Commission assessment of the compatibility of the supplementary aid will also depend on the extent to which it exceeds the amount approved in 1995. Consequently, the Commission must ensure that such aid is not declared compatible, if at all, without a particularly substantial contribution from CL, which takes account of the circumstances in which the French authorities submitted these aid measures to the Commission, the scale of the supplementary aid compared with the FRF 45 billion authorized by Decision 95/547/EC, and the recurrent nature of the aid. It will ensure in particular that CL makes compensating arrangements proportionate to the exceptional nature and size of the aid it has been granted. Such arrangements must not be limited to businesses which are no longer part of the bank's strategic priorities but must also relate to businesses whose sale may compensate for the damage caused to competitors by the aid, and everything which is not strictly necessary to the viability of CL's core business.

3. DESCRIPTION OF CL AND ITS RECENT PERFORMANCE

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CL is a banking group engaged in various areas of financial intermediation. Its business includes retail and wholesale commercial banking, merchant banking, third-party asset management, leasing, factoring and insurance. At the end of 1997 CL employed 50 789 people, slightly less than two thirds of them in France. Its balance sheet total then stood at FRF 1 499 billion, FRF 692 billion of which related to activity in France (46,2 %) and FRF 474 billion to activity in Europe excluding France (32 %). After buying up Thomson's shareholding in December 1996, the French State held 78,05 % of the capital and 96,01 % of the voting rights in CL (including the shares held by EPFR). The Caisse des Dépôts et Consignations, a publicly-owned specialist credit institution, held 3,7 % of the capital and 3,99 % of the voting rights. The rest of the capital (18,25 %) consisted of non-voting preference shares quoted on the stock exchange. The breakdown of CL's functions and the number of its establishments in France and abroad at the end of 1997, plus the geographical distribution of some of its key financial elements are given in the tables below.

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CL's activities are organized by function and grouped in a number of directorates, i.e. French business (DCAF), European business outside France (DCAE), other international business outside Europe (DCAI), capital markets (DCMC), management and relations with institutional investors (DGRI), financial engineering and asset and project financing (IFAP), and miscellaneous. DCAF is the main division in the group, since it contributes nearly half of CL's consolidated income and one third of its net profit (excluding holding and intra-group adjustments). Table 3 below gives the contribution of each directorate to certain group financial aggregates in 1996.

Table 3 shows that, compared with weighted commitments and capital allocated, the result for European activities was very modest in 1996, whereas the opposite is true for other international business. French business, for its part, produced substantial gross revenue, but its net result was not so high, in particular on account of overheads and the high level of risks and asset-related losses. The situation evolved significantly in 1997 (see below).

Since the first aid was granted in 1994, CL has undertaken a major restructuring of its organization and all its activities. The restructuring has covered strategy, operations and finance.

CL has abandoned its aspiration to become a universal bank on a world scale. While retaining this objective in France, where it is at once a personal bank, a bank for small and medium-size firms, a bank for large firms and institutional investors, an insurance bank, and a business and merchant bank, in the rest of the world CL has reduced its commercial presence, as constrained by Decision 95/547/EC, by disposing of foreign banking subsidiaries specializing in retail operations, in Europe (CLBN, Credito Bergamasco and Woodchester), in Latin America (Banco Frances e Brasileiro) and in Africa. Since 1 January 1995 international sales have concerned 17,9 % of the assets in that field, which corresponds to about FRF 171,2 billion, of which FRF 136,1 billion in Europe and FRF 35,2 billion in the rest of the world (principally in Latin America). By contrast, it has maintained and reorganized its wholesale and capital market banking business throughout the world. It has also set up alliances with specialist partners, acquiring a pre-eminent role on their markets (in particular with Allianz in non-life insurance and Cetelem in France in consumer credit).

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From the operations standpoint, two main courses of action have been followed. First, the portfolio has been improved, having benefited from the transfer to CDR of FRF 190 billion of largely non-performing assets and from the introduction of more efficient instruments for the control, management and monitoring of risks and of suitable management and internal auditing systems. The ratio for the coverage of doubtful debts by provisions was increased to 65 % in 1997. Secondly, a major effort has been made to reduce overheads. Successive redundancy programmes have reduced staff from 59 323 in 1995 to 50 789 in 1997 and total labour costs over the same period from FRF 20,6 billion to FRF 19,8 billion. Staff numbers have fallen by 14,4 % (7) compared with 1995, a much bigger reduction, even assuming a constant range of business, than that achieved by CL's principal French competitors. A further decline in staff numbers is expected in 1998 as part of the implementation of the third redundancy programme, which envisages a reduction of 5 000 jobs in 1996-98. Measures to retain customer loyalty and safeguard net receipts from banking (NRB) have been taken to halt the decline in the latter recorded in 1996.

Financial restructuring has been slower. Compared with the plan submitted to the Commission in 1995, CL has not managed to achieve the objectives it had set itself, for several reasons. On the liabilities side, CL has continued to be saddled with its long-term liabilities contracted several years ago, whose rate conditions have become increasingly burdensome compared with the gradual

decline in market rates. CL's credit rating has remained particularly low and unfavourable compared with the strategy pursued by the bank. Despite the recent improvement in its operational performance, CL's debt rating, as attributed by the international rating agencies, is currently BBB+ (Standard & Poor's) and A3 (Moody's), defined as adequate capacity to pay interest and repay principal, but with great sensitivity to changing economic circumstances (8). This compares with the ratings of AA-/Aa3 for Société Générale and A+/Aa3 for BNP, the two private French banks of roughly comparable size to CL, and with the generally higher ratings of the other publicly-owned banks. A rating in the range AAA-A- (S & P) or Aaa-A3 (Moody's) is normally a necessary condition for the long-term viability of a bank, in particular so that it can finance itself under competitive conditions on markets. The rating also reflects CL's weak capitalization compared with the functions exercised and with the extensiveness of its activities, which are subject to changes in economic circumstances throughout the world. The solvency ratio went up from 8,4 % in 1995 to 9,3 % (in 1997) and its tier one from 4,4 % to 4,8 %. Although these ratios are normally quite sufficient for an average bank, they remain below what the markets normally require for banks which claim to pursue a broad strategy such as that of CL. In January 1998 Moody's placed all CL notes under surveillance on account of the bank's exposure to Asia and of the uncertainty surrounding approval of the aid plan by the Commission.

Despite these difficulties on the liabilities side, the main problems for CL lie with its assets, on account of the delayed repayment of the loan to EPFR, which hampers its operation, and also of the decline in its market shares in 1995-96 (halted in 1997). A further factor was the unfavourable economic situation in those years, which explains the inadequacy of the NRB and the results - the reasons behind the rescue aid approved by the Commission in 1996.

On the assets side it will also be noted that the return on the claims portfolio declined automatically as a result of the fall in market rates and of the greater competition associated with the disintermediation on the more sophisticated levels of the financial markets and with technological progress and the integration of markets. The decline in interest income (interest receivable less interest payable) has been progressively offset by the increase in commissions on securities and on third-party asset management. The loan to EPFR is still at a high nominal level (more than FRF 100 billion), and its remuneration, which is lower than the market rates (85 % of MMR), has affected the bank's accounts, which led to the granting of the emergency aid in 1996.

Table 4 provides a financial and operational analysis of CL over the period 1994-97.

It should be stressed that CL's accounts in 1995 and 1996 include the neutralization of the loan to EPFR. Similarly, the 1997 accounts were drawn up by the bank on the assumption that the Commission would approve the neutralization of the loan. After the results were announced on 19 March 1998, the Commission made it known, through a statement by Mr Van Miert, that the inclusion in the bank's results of the aid relating to the neutralization in 1997 of the loan to EPFR was premature and had not yet been approved, that the Commission could not anticipate the present decision and that therefore, pursuant to the State aid rules, it was unlawful at this stage. Without this aid in 1997 - it amounted to more than FRF 3 billion - the bank would have recorded a loss. Despite this reservation, the results, as presented, are comparable to those for 1996 and 1995, which contained similar aid, and give an important indication of the trend of CL's activities.

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The table shows that after a very noticeable fall in 1995, the bank's net receipts from banking stabilized in 1996 and recovered appreciably in 1997. The noticeable rise in NRB in 1997 is due, firstly, to a significant increase in commissions (+ 11,5 %, assuming constant consolidation limits) resulting from the high level of activity on financial markets in 1997. Commissions now account for 33,8 % of CL's NRB and have increased in all the major activities of the bank, both in France (where they have gone up from FRF 6,6 billion to FRF 7,1 billion) and internationally. Secondly, lending activity was steady in 1997: outstanding loans grew in Europe (+ 11 %, assuming a comparable range of activity) and in the rest of the world (+7,6 %). The rise in Europe is due to the marked increase in loans from the BfG and a sterling exchange effect (+ 20 %). The figure for the rest of the world includes a dollar effect (+ 14 %). Capital market operations and the operations of the other foreign subsidiaries, notably in the United States and Asia, made a considerable positive contribution to the bank.

According to the bank, CL's market shares in France, after the fall recorded in 1995-96, stabilized, both in the granting of loans and in the collection of resources.

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In 1997 there was a rapid improvement in the profitability of CL's commercial banking in France: NRB France remained stable on account of the slight fall in outstanding loans to customers (- 2,6 %, excluding securitization) and the erosion of rate margins (intermediation margin, debtor rates less creditor rates), but the control of overheads in connection with activity in France, which fell by 1,4 %, was a favourable factor, as was the fall in provisions resulting from better risk control. The level of provisions for commercial banking activities in France fell considerably in 1997 compared with 1996, from FRF 3,7 billion, or about 1 % of weighted assets, to less than FRF 2 billion, thus making possible an improvement in the result (the pre-tax result went up by FRF 2 billion).

Overheads for the group as a whole have fallen significantly since 1995, as a result in particular of the reduction in staff numbers and total staff costs. The operating ratio has thus been reduced from 84,7 % to 76 %. However, it is still particularly high in France (about 82 %), a level which has to be compared with that of the bank's main French competitors (approximately 70-72 %). By contrast, international overheads increased appreciably in 1997. The overall result is that the operating ratio (ratio of overheads to NRB) is falling slowly despite the rise in NRB. This is much better than forecast for 1997 in the plan (80 %), but CL is still a long way from the ratio of its main competitors and from the objective it set itself (ratio of 70 % in 2000).

Provisions reached a total of over FRF 8 billion in 1997, i.e. twice as much as forecast. The increase is due mainly to the exceptional provision of FRF 3 billion for Asia. Compared with 1996, provisions (excluding Asia) are declining, falling from FRF 5,7 billion to FRF 5,1 billion. They are nevertheless FRF 1 billion higher than was forecast in the plan and have increased, on a constant activity basis, as a result in particular of a substantial provision for risk-countries of FRF 900 million in 1997 (further to a provision of FRF 333 million already made in 1996).

The bank's net result increased appreciably in 1997 but is difficult to interpret in view of the size of the non-recurrent exceptional items (neutralization of the loan to EPFR, provision for Asia, capital gains from sales). The solvency ratio (Cooke ratio), taking account of the improvement in the results (positive effect on the numerator, after allocation of the result) and of the stability of the weighted assets (the denominator in the ratio) is increasing appreciably, rising from 4,6 % to 4,8 % (tier one) and from 8,7 % to 9,3 % (overall solvency ratio).

The results now available show that CL's recovery is still fragile and its profitability insufficient to provide a return on equity of the level which a private shareholder would normally expect. Without the emergency aid approved by the Commission in 1996, the bank's results would still be negative. It should also be remembered that without the neutralization of the loan (anticipated and, in accordance with the State aid rules, unlawful at this stage), CL would still have recorded losses in 1997.

On this basis alone, therefore, the Commission cannot conclude that the recent trend of the bank's activity shows that it has returned to profitability and viability. It is essential in this respect to examine the restructuring plan submitted by the authorities in July 1997 (see below).

4. ANALYSIS OF THE PROGRESS MADE IN IMPLEMENTING THE MEASURES PROVIDED FOR IN DECISION 95/547/EC

In Decision 95/547/EC the Commission subjected the aid to a series of conditions, the implementation of which is examined below. The most important conditions are:

(a) full implementation of the restructuring plan submitted to the Commission;

(b) a 35 % cut in the bank's commercial presence outside France in balance sheet terms;

(c) introduction of the EPFR loan and the zero-coupon bond;

(d) payment of the better fortunes clause;

(e) payment of the dividends from CL to the State as shareholder;

(f) use of the proceeds of sales for restructuring purposes;

(g) abolition of the carry-over of tax losses relating to the aid.

(a) Implementation of the restructuring plan submitted to the Commission

Since the approval by the Commission in July 1995 of the aid plan for CL, including the protocol between the French State and CL of 5 April 1995 concerning the hive-off vehicle, the French authorities have sent the Commission several amendments to the protocol, some of them in order to comply with Decision 95/547/EC (separation of CL and CDR) and with the Commission's Decision of September 1996 (emergency aid). Attention is drawn here to Amendment No 9 of 6 May 1997, which adapted the arrangements for the repayment of the participating loan by CDR to EPFR by doing away with the obligation on CDR to repay in advance each year to EPFR a sum corresponding to the sums collected from the assets less sums made available to controlled companies, operating expenses and interest owing to EPFR. Since the date of the amendment, CDR must submit each year to EPFR a multiannual financing and cash-flow plan, under which it repays in advance to EPFR, on 30 June, an amount equal to its estimated available cash flow at that date less one sixth of the sale proceeds set out in the budget for the year in progress.

The same amendment introduced a guarantee from EPFR to CDR making it easier for the latter to obtain external financing up to a limit of FRF 10 billion. The amount of the additional drawdowns under EPFR credit which CDR can make from 1 January 1998, up to a limit of FRF 10 billion, is reduced by the amount of the guarantees in existence at the date of each drawdown. The changes reflect CDR's increased cash-flow needs, which were a factor behind the delayed repayments of the participating loan and, consequently, of the loan from CL to EPFR.

On 16 December 1997 the French authorities informed the Commission of the reform of the structures for supervising CDR presented to the Finance Committee of the National Assembly by the Minister, Mr Strauss-Kahn. According to the French authorities, the reform was necessary in order to correct the defects in the previous arrangements, in particular:

- the fact that liquidation was the sole objective, and the binding nature of the timetable;

- the fact that CDR was not made sufficiently responsible;

- a plethora of supervisory bodies and procedures;

- political interference;

- uncertainty as to the outcome of lawsuits.

The reform is based on three principles: independent and responsible management, rigorous and effective supervision, and the State to be impartial and concerned to see justice. In practice this means that:

- in order to obtain the best value for them and optimize the financial result for the State, the assets will no longer be managed with a view simply to their liquidation;

- CDR will alone be responsible for the sell-off process, as part of a strategy to be reviewed each year, and profit-sharing arrangements will be introduced;

- internal control will be strengthened by the transformation of CDR into a company with a supervisory and management board, the assumption of the functions of the advisory committee by the supervisory board, the creation of a risks division, and the simplification of internal accounting arrangements and middle management structures;

- EPFR will exercise vis-à-vis CDR the prerogatives of the State as shareholder, in a supervisory function for which it may bring in outside experts;

- political interference is prohibited, and instances will be systematically referred to the courts, whose resources will be strengthened for the purpose.

The Commission supports the principle of a management which is keen to defend the asset-related interests of the State; this should have the effect of minimizing the aid granted by the State to CL through the hive-off vehicle. The Commission notes that CDR's operations during the 1996 and 1997 financial years have already shifted from a liquidation perspective and that, in particular, CDR has abandoned claims and effected recapitalizations, and granted fresh guarantees to its subsidiaries or their buyers, under conditions likely to include the grant of State aid to the beneficiaries of these transactions. The Commission stresses that the abandonment of the liquidation rationale makes it less likely that the original (indicative) timetable, whose target was that 80 % of the hived-off assets should be sold within five years (i.e. by the year 2000), will be complied with. The advantages which the authorities see in such non-liquidation management must be evaluated in the light of the increased carrying costs associated with extending the hiving-off of a number of assets. The authorities have not provided any evidence on this point to show that they are minimizing the aid in the process.

The Commission would point out that CDR's resources are state resources within the meaning of Article 92 of the Treaty, not only because CDR is the wholly owned subsidiary of a public undertaking but also because it is financed by a participating loan guaranteed by the State and because its losses are borne by the State. The Commission notes that such transactions do not qualify for any derogation exempting them from the obligations arising out of Articles 92 and 93 of the Treaty, and in particular that the French authorities and CDR cannot be exempted from such obligations under Decision 95/547/EC or under this Decision. It should be noted that CDR's operations with regard to its subsidiaries are deemed not to include any aid component only if they conform with the 'market economy investor` principle and that any injection of funds (or abandonment of claims) complies with this principle. In its communication to the Member States (9) concerning the principles to be applied to determine whether public intervention should be regarded as aid, the Commission considers that injections of capital into public undertakings contain elements of State aid if, in similar circumstances, a private investor, in view of the expected return on the contribution of funds, would not have made the capital injection in question. In a letter dated 16 October 1997 addressed to the Minister for Economic, Financial and Industrial Affairs, Mr Van Miert pointed out that CDR operations involving a recapitalization of its assets, a sale at a loss or a cancellation of debt were likely to include aid and should be notified to the Commission. Similarly, sales of CDR assets other than by open, transparent tendering procedures must also be notified to the Commission. Only operations definitely below the de minimis aid threshold of ECU 100 000 are exempt from this obligation.

The other aspects of the implementation of the restructuring plan submitted to the Commission in 1995 are examined below.

(b) Reduction of the bank's commercial presence outside France

In accordance with the undertakings given by France in the letter from the Minister, Mr Madelin, dated 18 July 1995, Decision 95/547/EC called for a reduction of at least 35 % in CL's commercial presence abroad, including the European banking network, by the end of 1998. The letter states that the reduction will have to be valued in balance sheet terms and that an international reduction of the magnitude of the above percentage represents a reduction of 50 % in the European network. The contribution of the international assets to the bank's total assets at the end of 1994 was FRF 960 billion, whereas the contribution of the European assets was equivalent to FRF 620 billion. Consequently, 35 % of the international assets corresponds to FRF 336 billion, of which FRF 310 billion are in Europe (= 50 % of CL's European assets outside France).

At 31 October 1997, CL had sold assets with a balance sheet value at 1 January 1995 of FRF 171,2 billion, or 17,9 % of international assets. The reduction is the result of sales of FRF 136,1 billion in Europe and FRF 35,2 billion in the rest of the world. The reduction in Europe corresponds to 22 % of European activities. Consequently, CL must still sell, by 31 December 1998, nearly FRF 174 billion of European assets in order to fulfil this obligation.

(c) Introduction of the loan to EPFR and the zero-coupon bond

In order to buy the FRF 135 billion of assets, net of liabilities, transferred from CL to the hive-off vehicle, CDR received a participating loan of FRF 145 billion from EPFR (of which FRF 10 billion were converted into an EPFR guarantee in for CDR borrowings from third parties). EPFR, for its part, obtained its finance from CL through a non-participating loan of FRF 145 billion. The two loans have a maturity date of 31 December 2014. The annual rate of interest applicable to the loan from CL to EPFR was originally set at 7 % in 1995, then at 85 % of the money market rate (MMR) from 1996 (10). Since the larger part of this loan (FRF 135 billion) has made it possible to finance the transfer of assets, the balance (FRF 10 billion) should have been used by EPFR to purchase zero-coupon bonds for the same amount, which would have enabled it to earn an income of FRF 35 billion (nominal) in 2014, which the Commission estimated in Decision 95/547/EC to be worth about FRF 8 billion in present value terms.

Several changes have been made to this plan. The loan from CL to EPFR has been set up, but only the first part relating to FRF 135 billion, which means that EPFR has not been able to set up the zero-coupon bond. Since the expected income for EPFR from the zero coupon had been deducted by the Commission from the gross aid to CL, the failure by CL to grant the FRF 10 billion loan to EPFR and the consequent failure to set up the zero-coupon bond constitute an additional cost to the State and additional aid to CL (compared with what was authorized in 1995), of an amount equal to the deduction of approximately FRF 8 billion calculated in 1995. Part of this aid, estimated at FRF 400 million and relating to the failure to set up the bond in 1995-96, was however approved by the Commission in its Decision of September 1996 concerning emergency aid for CL.

The same Decision approves other emergency aid of about FRF 3,5 billion deriving from the increase in the interest rate for the loan from CL to EPFR for 1995 (ex post facto) and 1996. The Commission also decided to initiate the procedure with regard to the application of this change in the years ahead.

Amendments to the 1995 protocol between the State and CL were made after it had been signed, in order to change other clauses that had been approved by the Commission. Thus, as regards the mechanism for financing the hive-off, the failure by EPFR to draw down FRF 10 billion from CL did not result in a reduction by a similar amount of the participating loan from EPFR to CDR, but in the transformation of this possibility of an additional drawdown by CDR into a guarantee for the same amount enabling it to borrow direct from third parties.

In addition, although progress on CDR sales is in keeping with the original objective of selling 80 % of the hived-off assets within five years and 50 % within three, the increase in the proceeds from sale to EPFR, and hence the repayment of the loan from CL, have been much slower and more limited than initially planned, since CDR has kept the bulk of these sale proceeds for financing its operating costs, the costs of carrying its assets (in particular the repayment of third-party liabilities), and for supporting certain hived-off assets in various forms (through recapitalizations, advances and abandonments of claims).

The delay in repayments and the unexpected trend of interest rates have had an effect on CL's accounts. The assets transferred to CDR were partly financed by long-term liabilities not transferred to the hive-off vehicle and contracted by the bank in its expansion phase (1988-93) at rates higher than the return on the EPFR loan after 1995 (85 % of MMR). From 1996 on, this should have entailed carrying costs for CL (projected at the time as FRF 2,1 billion in 1997, FRF 1,8 billion in 1998 and FRF 1,4 billion in 1999). In accordance with the intentions of the French authorities, this constituted a contribution from CL to the costs of the mechanism, and therefore to its own restructuring. The projections of the bank's net receipts from banking indicated in 1995 that CL would be fully able to support these costs. In reality, the delayed repayment of the loan to EPFR and the unexpected trend of market interest rates increased these costs. However, the increase would not have required emergency aid if CL had lived up to its NRB projections. It is therefore this latter element, namely the lower than forecast outturn of NRB, which is at the root of the emergency aid. In the 1996 decision, the Commission had concluded, on the basis of the data supplied by the French authorities, that the effect of the rate would have additional costs for CL of only FRF 1 billion over the three-year period 1996-98 (11).

(d) The better fortunes clause

The terms of the better fortunes clause have been applied correctly since the adoption of Decision 95/547/EC. However, under this clause, CL paid only FRF 6 million in 1995 and FRF 107 million in 1996, amounts which are well below the FRF 339 million and FRF 505 million initially scheduled for these two years, owing to the bank's performance, which was less good than originally forecast. The new plan submitted in July 1997 foresees, on the basis of a complete neutralization of the EPFR loan and the other assumptions concerning the sales of assets, an improvement in the bank's results from the year 2000 compared with the 1995 plan, and hence payments under the clause, if it is maintained.

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Such an improvement should compensate, subject to the clause being maintained, for the lack of initial payments. However, the plan submitted to the Commission in July 1997 (see below) leaves a question mark as to whether the clause will be kept or replaced by an alternative solution.

(e) Payment of dividends to the State as shareholder

As with the clause, the fact that CL has recorded results which are worse than forecast has reduced the dividend payments from CL to the State as shareholder and the value of the shares held by the latter, compared with the estimates initially used. The Commission would point out that in Decision 95/547/EC it estimated that the value of the State's share of CL's results was FRF 10 billion discounted. The following table shows the original projections and the revised estimates of CL's net, post-clause results.

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(f) Use of sale proceeds for restructuring purposes

CL stated that it used FRF 14,8 billion from the proceeds of sales to finance all the restructuring measures. The actual amount used was FRF 7,5 billion, the rest being invested in cash flow or in debt refinancing. It will be noted, however, that CL also invested nearly FRF 254 million abroad. These investments were small-scale and represent only 1,7 % of the proceeds from sales made since the beginning of 1995.

(g) Abolition of the carry-over of tax losses relating to the aid

In accordance with the principles of the guidelines on restructuring aid, the Commission obliged the French State to remove from CL the possibility of carrying over the tax loss associated with that part of its negative results covered by the 1994 capital increase of FRF 4,9 billion. The Commission also requested the French authorities to remove from CL the possibility, at the moment of privatization, of carrying over the other tax losses, if the better fortunes clause is transferred.

With regard to the first condition, CL stated that, in its view, this concerns only the 1994 losses corresponding to the capital increase financed by the State and the Caisse des Dépôts et Consignations (FRF 3,75 billion). The Commission would observe that in Decision 95/547/EC it considered that all the assistance from CL shareholders, including the Thomson group, in which the State had a majority holding, and whose resources are therefore state resources within the meaning of Article 92(1) of the EC Treaty, was to be regarded as State aid. Consequently, it confirms that this condition applies to the total amount of the capital increase (FRF 4,9 billion). The Commission also confirms that it is necessary to fulfil the second condition.

5. COMMENTS FROM THIRD PARTIES

5.1 Comments from third parties

As part of these proceedings, the Commission received comments from Société Générale (SG) and the UK authorities by letters dated 21 and 23 January 1997 respectively, which were forwarded to the French authorities. The latter replied by letters dated 10 and 27 February 1997. Other written comments were received on 19 May 1997 from the British Bankers' Association, on 2 July from Nederlandse Vereniging van Banken and on 26 August 1997 from Bundesverband deutscher Banken. The comments cannot, however, be taken into account as they were sent after the deadline for receipt of comments provided for in the Commission notice published in the Official Journal of the European Communities.

SG decided to refer to the Court of First Instance of the European Communities the Commission Decision of September 1996 approving emergency aid to CL, as it had already done with regard to Decision 95/547/EC.

As regards the additional restructuring aid covered by these proceedings, SG considers that it is not intended to facilitate the development of an activity within the meaning of Article 92(3)(c) of the Treaty, although it acknowledges that the sole prospect of the crisis that would be caused by the failure of CL justifies and indeed demands that the State, as both shareholder and guardian of the market place, take steps to reassure the depositors and intrabank creditors of this major institution.

SG takes the view that the Commission must require the French authorities to consider alternative solutions such as controlled liquidation and selling in blocks. This would be especially justified in view of the recurrent nature of the aid. Whilst its main argument is that the alternative solutions referred to above are the only outcome that complies with the Treaty, SG also considers that the Commission should compensate competitors for the damage caused them by requiring CL to sell not only all its foreign businesses (including those in the United States and South-East Asia, which are the most profitable), but also activities in France such as collective and individual third-party asset management, consumer credit and life insurance subsidiaries or certain sections of the retail network itself. Similarly, SG points out that the assistance provided by the French authorities and the Commission for the redundancies envisaged by CL would not constitute a binding condition for the grant of financial aid but rather an additional form of aid, as private banks would not receive such assistance and would thus be prevented from raising their profitability to the level of their European competitors.

Lastly, SG drew the attention of the Commission to the conditions of the future privatization of CL, in particular the plan to strengthen the solvency ratio before privatization to nearly 6 % in tier one (i.e. the 'hard` ratio of own funds in the narrow sense), which would seriously distort competition, in view of the effects in terms of the rating given by rating agencies and in comparison with the 1987 privatization of SG with a solvency ratio of only 3 %, which it was able to increase to 6% only ten years later.

The UK authorities support the Commission's in-depth investigation and note that the recurrent aid could generate future expectations of aid on the part of the bank's management, which could distort competition. They stress that CL should give serious and substantial quid pro quos which would involve all the activities of the bank not strictly necessary to the viability of its basic activity. For that reason, they suggest that future aid be staggered over time and that their approval should be subject to restructuring measures and compensating arrangements.

5.2 Comments from the French authorities and CL

By letter dated 6 December 1996 to the Commission, the Chairman of CL stated that he had informed the French Government of the prospects for 1996 very early that same year, and again in July, pointing out that a rapid decision was needed. He also disputed the reference date for the reduction in CL's commercial operations abroad, stating that the letter of 18 July 1995 from the Minister, Mr Madelin, forwarded to the bank only several months after it was sent to the Commission, did not fix a reference date at all and that the restructuring of the bank began at the end of 1993.

The French authorities commented on the letter from SG forwarded to them by the Commission, pointing out that they had fully assumed their twofold responsibility as shareholder and guardian, as acknowledged by SG when the emergency aid was notified. They disputed the analysis of SG and the UK authorities concerning the distorting effect of the emergency aid and the need for compensating measures, claiming that CL had been severely restricted in the 1995 plan and that refocusing on a more limited core of activity was provided for in the new restructuring plan. They nevertheless said that restructuring aid was needed, chiefly to neutralize the CL-EPFR loan, but also possibly to recapitalize the bank in order to ensure its viability, the amount of the increase being strictly in proportion to CL's financial requirements for rapid privatization. They also stated that, when considering methods of providing the bank with financial support, they would bear in mind that state resources should be granted in step with completion by the bank of the targets contained in its strategic plan.

5.3 Observations of the Commission on the comments submitted

The comments of third parties are examined in the following sections of this Decision.

The comments made by CL call for the following response from the Commission. As regards the date on which CL informed the French authorities of the deterioration of the bank's financial position and the need for assistance from the State, the Commission can only deplore the fact that the French authorities concealed the true position of the bank instead of meeting their obligation to provide the Commission with regular reports on the progress of the plan approved by it in July 1995. Although it may not alter the need for the aid approved by the Commission in September 1996, especially as the Commission could not completely rule out the risk of serious consequences for CL without aid, it is obvious that the French authorities should have notified the aid in question much earlier.

As regards the reference date for assessing the reduction in CL's commercial operations abroad, the Commission is unable on legal grounds to agree with the date suggested by CL, i.e. 1 January 1994. The French authorities did not notify the Commission in 1994 of the first instalment of State aid to CL; the restructuring plan was notified to the Commission, at its request, only in 1995 and only after a new aid plan had been set up. Nor can the fact that the terms of the letter from the Minister, Mr Madelin, of 18 July 1995 were officially communicated to CL only later be invoked against the Commission. The most appropriate legal basis for defining the date by which that obligation should have been fulfilled continues to be the letter of 18 July 1995 from Mr Madelin, in which the words 'd'ici fin 1998` (by the end of 1998) are unequivocal.

Accordingly, in order to assess the reduction in CL's commercial operations abroad, the Commission takes as reference the contribution at 31 December 1994 from the various geographical areas to the bank's total assets as shown in the annual report of CL, the balance sheet at the end of 1994 thus constituting the sole and last public, objective basis which can be taken into account.

6. THE RESTRUCTURING PLAN PRESENTED BY THE FRENCH AUTHORITIES IN JULY 1997

6.1 Chief characteristics of the plan

The plan submitted to the Commission in July 1997 was drawn up with a view to the gradual bringing in of new shareholders to CL, approved in principle by the State in the preceding plan approved by the Commission in 1995. The plan is based on a macro-economic environment characterized by an average growth in gross domestic product in France of 2,3 % and inflation of some 2 % a year. The strategy is based on two large centres of activity: on the one hand, a bank for private individuals, businesses and SMEs in France; on the other, in the main regions of the world, including France and Europe, a 'wholesale` bank for big businesses and institutions. The two large centres would continue to rely on CL's skills in market activities, financial engineering and third-party asset management, which the bank plans to retain.

The plan is built around the following hypotheses:

- total neutralization of the net costs of carrying the loan from CL to EPFR;

- sale of a substantial portion of the bank's retail operations in Europe;

- reinvestment in cash flow of the proceeds from the asset sales.

The strategy presented by the French authorities was relatively conservative in terms of growth, its chief aim being to restore the profitability of CL. Net receipts from banking (NRB) at consolidated level would, overall, stagnate in nominal terms as against the 1996 level (taking account of sales) and overheads would fall by nearly FRF 4 billion, so that the bank operating ratio (ratio of overheads to NRB) would drop from 79 % in 1996 to about 70 % in 2000, i.e. close to the level of CL's main French competitors, Société Générale and BNP. In practice, the plan provided for a recovery in net receipts from banking which, following a sharp dip forecast for 1997 (- 7 % in value, or nearly - 9 % in volume), should become stable by 1998 and rise in 1998 and 1999. Whilst the recovery would be appreciable in 1998 as regards the bank's activities in France, it would, because of the sales in the European network, be deferred to the end of the period for the group as a whole.

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An improvement in risk control, reflected in a reduction in the provisioning rate (12) from 0,78 % to 0,55 %, was to have made a significant contribution to the results. In particular, however, the bank had planned for two major variables to restore its margins and profitability:

(i) a very significant reduction in operating costs in France

For a universal bank like CL, having a domestic market is a considerable advantage and provides a relatively stable turnover. It is vital for the bank to be able to operate with the most performing operators on the French market in order to be able to produce the margins which improve its position in France as a reliable and strategic base point. Thus by the end of the plan, the anomaly of the bank's inability to produce satisfactory margins would be corrected: CL would again secure substantial profits on its domestic markets, especially at retail level, and obtain most of its cash flow from that source.

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The plan provides for several packages of measures aimed at the recovery of CL on the French market. An overall project to 're-engineer` the decision-making processes (projects with the title of 'challenges`) should lead to a radical restructuring of the bank's commercial activity and the information processing chain. New risk assessment tools will be set up for credit for SMEs. An agreement with Cetelem, a consumer credit specialist, will allow CL to expand its position on the consumer credit market, until now dominated by specialized establishments. Lastly, CL will launch telephone banking in order to improve contact with its retail customers.

The plan presented by the French authorities has a large number of social measures. The job cuts under the third redundancy programme, started in mid-1996 and finishing at the end of 1998, should involve some 5 000 persons, chiefly those in the bank's mainland network. The reductions will affect the network staff (3 140 persons) and operational units (1 860 persons). According to the plan submitted to the Commission, they were not intended to reduce the bank's commercial capacity significantly but essentially to cut operating costs and improve the operating ratio.

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Further reductions are planned after 1998, in 1999 and 2000, involving [ . . . ] persons, of whom [ . . . ] in the branches and [ . . . ] in the bank's functional units. All in all, the workforce would shrink by [ . . . ] in France compared with 1996 (and [ . . . ] at consolidated level, taking account of the sales of subsidiaries). The reductions would produce savings in staff costs of 9 % in France over the life of the plan, thus significantly cutting CL's charges and helping it return to profitability.

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The plan provides for rationalization of the network outlets in France, involving the closure of 243 loss-making branches in 1997 and 1998 (out of a total of 1 954 branches for retail customers in 1996), and the reorganization of business centres and retail outlets for business customers (see Table 12 below). Overall, the number of branches in the parent company in France would fall in the period 1996-2000 from 2 100 to 1 750, i.e. a reduction of some 17 %. On the basis, however, of information forwarded by CL to the Commission's consultant bank, it would seem that the total number of CL outlets in its French network should fall from 2 298 at the end of 1996 to 2 146 at the end of 2000, i.e. a reduction of only 6,6 %. The difference between the data supplied in July to the Commission and those sent by CL appears to be due to the scope of the commitments which, in CL's presentation, includes all CL's outlets in France, including the parent company and subsidiaries.

Together, these measures should help to improve profits in the French network. The bank's aim is to increase the net result of DCAF (central directorate for activities in France) from FRF 1 billion to FRF 4,3 billion by 2000. If it succeeds, CL will not only have restored the French network's contribution to the result, in proportion to the turnover produced, it will have made the activity in France one of the most profitable of the group.

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A sensitivity analysis conducted by CL showed that, if consumer credit were to grow twice as slowly as forecast, if the new measures to finance the NRB (for the DCAF) were to contribute twice as little as expected and the reduction in the provisioning rate was not as large as predicted, the contribution of the French network to the result would be reduced by half, but would still be positive.

(ii) neutralization of the loan to EPFR

The various sections of the 1995 CL rescue plan included a plan for CL to finance the hive-off by granting a soft loan of FRF 145 billion to EPFR. This below-market rate would thus enable the State, which would ultimately bear the final cost of the CDR debt write-off through EPFR, to reduce the financing cost of carrying the CL assets transferred to CDR.

As stated above, the plan provided that the CL loan to EPFR would be remunerated at 7 % in 1995 and then at 85 % of MMR (short-term money market rate) from 1996. The State benefited from this: for EPFR the benefit can be estimated annually on the basis of the differential between the short-term rate for the CL loan and the long-term rate for the refinancing it would have to obtain without the CL loan, i.e. currently some 2,5-3 % annually on the loan outstanding. In 1997, the benefit of the special scheme set up by the State was worth, in respect of the amount outstanding, some FRF 2,8-3,3 billion to EPFR. From CL's standpoint, however, the loan, which is partially secured with refinancing liabilities contracted at a higher rate and which preceded the 1995 hive-off, is penalizing and makes a negative contribution to its operating result, amounting to the differential between the borrowing rates for its loan refinancing liability and the lending rate for the loan. As a large part of CL's refinancing liabilities are fixed-rate liabilities, any cut in rates, taking account of the definition of the rate for the loan to EPFR, results in an increase in the net loan-carrying costs.

According to CL, from September 1995 to the end of 1996, it set up an instrument providing partial cover for the rate risk it was incurring on account of the structure of its loan refinancing liabilities. These 'swap` type hedging derivatives enabled the bank, it claims, to limit its carrying costs in 1995-96 to some FRF 670 million (i.e. only very partial cover for the rate risk incurred, as is clear from the amount of the neutralization subsequently necessary), which it took into account in calculating the cost of the rate for the emergency aid (relating to the loan to EPFR) for 1996, i.e. 5,84 %. In view of these considerations, and the very partial rate risk cover set up in 1995, it is clear however, that CL expected interest rates to develop differently, thus reducing its costs. Hence, the higher losses incurred by the bank on the loan granted to the hive-off are attributable to it in part, to the extent of the risk rate it contracted. At the end of 1997, the French authorities commissioned an independent firm to audit the transactions connected with the loan to EPFR, but they have not forwarded the results to the Commission.

As far as the Commission is aware, the bank has not had recourse to any methods of covering the rate risk on the loan to EPFR since the end of 1996, largely rendered meaningless by the fall in rates of more than two points since the adoption of Decision 95/547/EC.

In September 1996, when the emergency aid was notified, the French authorities asked for the complete neutralization of the effects of the CL loan to EPFR until 2014 through an increase in the interest rate from 85 % of MMR to a rate corresponding to the cost of refinancing CL (it was subsequently established in work done by the Commission's consultant bank that the rate would fluctuate between MMR + 2,5 at the start of the period to MMR + 0,2 at the end of the period). The request was confirmed in the plan presented to the Commission in July 1997. According to the French authorities, this measure should make it possible to draw a line below the past, as CL would no longer be penalized for the financial consequences of the expansion strategy that led it to the crisis of 1993-95.

In the view of the Commission, however, it in fact amounts to 'over-neutralization`, as the proposed increase in the rate takes it above the market rate and also compensates for initial errors in the cover against the rate risk on the CL loan to EPFR. On the basis of a scenario involving repayment of the loan and 'rate spread` data (the gap between the asset rate for the EPFR loan and the weighted average of the rates applicable to the refinancing liabilities) submitted by CL to the Commission's consultant bank, this component of the aid can be estimated at FRF 20,2 billion in the period 1997-2014 (by discounting future flows at the money market rate used to define the rate spreads in this scenario, i.e. 3,19 %). It is worth noting that the bank and the French authorities, using a long-term discounting rate, arrive at a different figure for the discounted aid relating to the neutralization, which they estimate at some FRF 17,2 billion over the period 1997-2014, using the same method (apart from the discounting rate applied), which was validated by the Commission's consultant bank. It should also be noted that, if the conventional hypotheses underlying that calculation were to change substantially, in particular the timetable for repayment of the CL loan to EPFR, the calculation of the neutralization aid would be invalid and would have to be revised on new bases. The Commission is not aware at the date of this Decision of any such changes and notes that the French authorities have retained their estimate based on similar underlying hypotheses.

At the request of the consultant bank, CL carried out a study on the sensitivity of the neutralization value of the CL-EPFR loan to an increase in interest rates. All other things being equal, the study shows that in the event of a 1 % rise in short-term rates (and of a 0,5 % increase in long-term rates), the cost of neutralizing the loan would vary by FRF 500 million from the FRF 17,2 billion calculated by the bank. The Commission therefore concludes, in view of the 0,3 % increase in MMR between mid-1997 and this Decision, that the conditions on the basis of which it estimated the cost of neutralizing the loan at FRF 20,2 billion at the end of 1997 are still valid.

In their letter of 31 March 1998, the French authorities propose to alter the mechanism by totally neutralizing the loan until 2000 (as in their preceding notification) and, from 2001 to 2014, by neutralizing it at a short-term rate (not specified, but possibly the PIBOR which, depending on market conditions, ranges from MMR to MMR + 0,2 %). The Commission has assessed the economic effects of the new proposal from the French authorities. The difference is small, i.e. (discounted to 31 December 1997) FRF 2,3 billion, the aid falling from FRF 20,2 billion to FRF 17,9 billion. The minimal difference is explained by the fact that CL incurs carrying costs on the loan to EPFR in respect of the portion exceeding MMR, chiefly in the period 1997-2001.

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In support of their proposal, the French authorities considered that if the carrying costs of the loan to EPFR were not neutralized, the bank's viability could be jeopardized owing to the possible reactions of its customers, the compensating measures and the rating agencies which could downgrade CL's rating. The French authorities also justified the measure on the ground that it should help to bring new shareholders to the bank.

The plan submitted by the French authorities to the Commission in July 1997 also considered another possibility: instead of the annual neutralization of the carrying costs of the EPFR loan, CL would be repaid in advance and would receive an adjustment for the discounted difference between the cost of the liabilities securing the EPFR refinancing (13) until they are extinguished and the cost of refinancing short-term liabilities. However, in subsequent discussions with the Commission, the French authorities made no further reference to that option. It is worth noting that, as stated above, the existing mechanism was relatively advantageous to the French Government as, throughout the period of the loan (potentially until 2014), it financed long-term applications (the carrying by EPFR of the participating loan to CDR) with resources obtained at a lower rate, i.e. at a short-term rate. The neutralization option has the advantage of being less expensive for EPFR than early repayment of the loan coupled with a long-term borrowing: in view of the gradual restructuring of the CL liabilities backing the loan, the rate of the loan after neutralization should gradually fall until it reaches PIBOR in 2004 or 2005. As the reference rate for the loan is still MMR, the State could thus continue, although the terms would not be as good, to bear the carrying costs of the hive-off at a rate similar to the short-term rate.

6.2 Measures presented by the French authorities in exchange for aid to CL

In addition to the restructuring of the French network, which includes branch closures described by the French authorities as compensating measures for aid to CL, the July 1997 plan includes the sale of most retail operations in Europe, including CL's largest subsidiary, Bank für Gemeinwirtschaft (BfG, Germany, of which it owns 50 % plus one share). The plan earmarks major provisions (FRF 4,4 billion) for the financial years 1998 and 1999 in anticipation of the negative impact, forecast in 1997, of the sale of BfG at a loss in 2000. The French authorities also proposed that the rigid timetable imposed in 1995 for completion of the compensating measures in the first aid plan (i.e. the sale of 50 % of the bank's assets in Europe by 31 December 1998) should be relaxed to avoid CL having to call on its shareholder to finance the erosion of own funds resulting from the sales. Strategic disinvestments would be staggered until 2000, sales being decided as and when financial circumstances permitted.

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The French authorities took the view that CL's decision to sell its subsidiaries before the introduction of the Euro deprived it of the opportunities afforded by a more integrated personal banking market in Europe and therefore constituted a substantial effort which released market shares for its competitors in Europe.

Outside France, once the bank had pulled out of retail banking in Europe, its strategy would be to refocus on the functions of credit for large firms, structured financing and financing of projects, capital markets, asset and flow management, private management and international trading. These would in future be organized as 'world lines` in order to provide better support for the bank's customers in their international transactions. The refocusing would reflect CL's move away from the 'universal` bank strategy abroad.

7. ASSESSMENT OF ADDITIONAL AID TO THAT APPROVED BY THE COMMISSION IN 1995

7.1 Uncertainty concerning the total amount of aid

The Commission having placed a ceiling of FRF 45 billion on the amount of aid approved in 1995, it is necessary to assess the amount of additional aid before determining its compatibility with the Treaty. It will be recalled that, in addition to the FRF 45 billion authorized in 1995, the Commission also authorized some FRF 4 billion in emergency aid in September 1996.

The costs incurred by the State and included in the total aid to CL are as follows:

- the recapitalization of CL in 1994 (i.e. FRF 4,9 billion), to which the French authorities envisaged, in the plan submitted to the Commission in July 1997, possibly adding a second recapitalization for an unspecified amount;

- the discounted losses of CDR borne by EPFR, which abandoned claims (with activation of guarantees) in respect of the participating loan of FRF 145 billion (of which FRF 10 billion were converted into a guarantee for CDR borrowings from third parties);

- the discounted carrying costs of the CL loan of FRF 135 billion to EPFR; these costs might rise if the CL loan is neutralized between 1997 and 2014, giving a discounted cost of some FRF 20 billion;

- the extra discounted carrying costs if EPFR exercises its right to draw on additional credit of FRF 10 billion which CL undertook to grant it from 1 January 1998;

- the extra discounted carrying costs which EPFR could incur if, in view of its cash flow, it had to borrow on the market in addition to its loan from CL.

All the hive-off costs are to be settled by the State by recapitalizing EPFR through budget allocations, whose amounts and timetable are not known at this stage but which are likely to be spread over the period of the CL loan to EPFR, until it matures in 2014, and through receipts from the better fortunes clause (14) and from the privatization of CL.

First of all, as is clear from the aid calculation set out below, some of the aid in question, especially the neutralization of the CL loan to EPFR for 1995-96 (approved by the Commission in September 1996 as part of the CL emergency measures) and its neutralization from 1997 (proposed by the French authorities), are an integral part of the costs of carrying the loan from CL to EPFR. The Commission nevertheless regards the neutralization of the loan as a specific aid: it is additional in relation to the plan approved in 1995, and its implementation would mean that CL would be relieved of a cost with an estimated discounted value of some FRF 20 billion over the period from 1997 (inclusive) to 2014. 'Neutralization`, as the French authorities interpret it, means that CL would be relieved of the net charges connected with the EPFR loan and that the discounted value of the bank would be immediately increased by the correction in proportion (15) to the discounted amount of the neutralization. The bank would thus benefit immediately from the future effects of the neutralization. The Commission therefore considers that the discounted value of the neutralization throughout the period 1997-2014 must be taken directly into account in full, as fresh aid to the bank. The Commission notes that the French authorities, in a letter dated 3 April 1998, appear to take the same approach to this point, and include the total value of the neutralization in their estimate of the amount of aid to CL.

There are further difficulties in assessing the amount of aid to CL owing to the specificities of the hive-off plan drawn up by the French authorities and to a number of uncertainties not clarified by the French authorities in the plan submitted to the Commission in July 1997.

The losses eventually borne by the hive-off and hence by the State are not yet known. The potential losses include one component, the losses of CDR, estimated at 31 December 1996 at FRF 100,2 billion. It is pointed out that the latter figure, presented on 1 July 1997 in the EPFR report to the Minister for Economic, Financial and Industrial Affairs and to the French Parliament, is not certified by the auditors of CDR. The French authorities, questioned on this matter by the Commission, indicated that they would be unable, in view of the specificity of the hive-off, to produce certified accounts for CDR. Only the losses already recorded by CDR and charged to EPFR by activating the guarantee on the participating loan, i.e. some FRF 45 billion at the end of 1996, could at the beginning of 1998, before the closure of the 1997 accounts, be regarded as certain, on the basis of the information available. At meetings held at the beginning of May 1998, the French authorities informed the Commission that the estimated additional losses of CDR in 1997 amounted to a further FRF 3 billion, i.e. a total loss of FRF 48 billion at end 1997. In view of the remaining assets (about FRF 80 billion, assets of FRF 110 billion having already been sold or wound up), the French authorities conclude that losses cannot be more than FRF 128 billion. The Commission agrees that part of the residual risk to EPFR in respect of CDR (the portion relating to its assets) diminishes as the asset sell-off plan progresses: by the end of 1997, 58 % of the gross assets transferred to CDR at 1 January 1995 had been sold.

The French authorities were unable, however, to make any undertaking concerning the maximum losses that might be incurred by CDR. The French Parliament had not put a ceiling on the nominal risk borne by EPFR, which granted a participating loan of FRF 145 billion to CDR (of which the latter used FRF 123,5 billion, plus FRF 10 billion taken from the loan facility and transformed into a guarantee), so that it covers all CDR losses, even if they reach or even exceed the amount of the participating loan, i.e. FRF 145 billion.

The risk borne by EPFR in respect of CDR exceeds its exposure to the assets initially transferred to the hive-off, for several reasons. Firstly, the 'backup` capital investments in the hived-off assets, the merits of which are not questioned by the Commission at this stage, increase CDR's exposure in respect of the recapitalized assets and hence the exposure of EPFR to CDR and the risk of losses by the hive-off (16). In spite of repeated requests to the French authorities, the Commission so far has only a very limited picture of these transactions (17). Even if, as the French authorities claim, the investments have the effect of cutting the hive-off losses, at this stage they mean an increase in the risk relating to the State guarantee. In addition, a number of off-balance sheet risks were transferred from CL to CDR in the form of guarantees on its subsidiaries or on assets not transferred to CDR when it was set up. Furthermore, CDR's consolidation limits were extended in 1996, the Commission being unable at that stage to determine whether the expansion significantly increased the risk exposure of CDR and EPFR: the extension of the consolidation limits in 1996 must be examined in the light of the risks to CDR of the new assets before their incorporation in the form of assets within the hive-off vehicle. Further losses have also emerged and could continue to increase, chiefly as a result of the rise in the number of legal proceedings initiated. By mid-1997, there were 75 such proceedings, of which 52 in France and 23 abroad. Several will probably result in damages being awarded to CDR and a consequent reduction in the cost of the hive-off. Others, however, in the event of an unfavourable outcome for CDR, will result in major off-balance sheet risks that are hard to forecast and may alter considerably over time. Furthermore, legal proceedings have a negative effect inasmuch as they make it more difficult to wind up or sell assets in dispute, by slowing up or indeed interrupting transactions.

Any slippage in the timetable for the sale of CDR's assets in relation to the original timetable for their transfer to the hive-off vehicle (sale of 50 % in three years and 80% in five years) increases management costs and operating losses for CDR. In addition, CDR's repayments to EPFR were slowed down owing to the fact that certain third-party liabilities (out of the liabilities of some FRF 60 billion transferred to CDR, in addition to the EPFR participating loan) were repaid by CDR more rapidly than the original five-year period, some of the liabilities having become due following the withdrawal of licences from its banking subsidiaries. In addition, there is the growing complexity of cases (the easiest assets to sell having already been disposed of), which will slow down foreseeable hive-off transactions and heighten the risk of capital losses. Furthermore, the abandonment in December 1997, when CDR was reformed, of the liquidation rationale may also have prolonged the hive-off management costs and hence the losses charged to the State via EPFR. The delays in selling CDR's assets do not directly affect its losses (apart from the increase in its operating costs charged as losses) but do, however, have the effect of prolonging uncertainty and increasing the nominal carrying costs of the hive-off as regards EPFR. Experience with this type of hive-off tends to show that, over time, the assets remaining in portfolio are of less good quality and become increasingly difficult to realize. Furthermore, the hived-off companies can incur heavy losses that will be charged to hive-off losses irrespective of the asset value of those companies.

Despite two letters sent to the French authorities on the subject (on 1 December 1997 and 5 February 1998), the Commission has not received any reply concerning a possible timetable for recapitalizations of EPFR by the State which would help to reduce the balance of the loan from CL to EPFR. It is pointed out that, according to a timetable based on conservative hypotheses presented by CL to the Commission's consultant bank, the balance of the loan could remain in the region of FRF 100 billion until the loan matures in 2014.

The carrying costs are not included in the calculation of CDR's losses. They too will be charged to EPFR and hence ultimately to the national budget. The costs to EPFR of carrying the hive-off will rise in proportion to delays in CDR's repayments to EPFR. In nominal terms (18), assuming that the loan-carrying costs cover the entire period in accordance with the timetable submitted by CL to the Commission's consultant bank (and excluding any further assumptions concerning EPFR's borrowings), and taking account of the neutralization of the loan planned by the French authorities, the carrying costs would, for the entire period of the scheme (1995-2014) amount altogether to almost FRF 100 billion, of which FRF 78 billion from 1 January 1997. The nominal costs would in the end be borne by the national budget and the taxpayer, like all the hive-off losses. Furthermore, the nominal value of the carrying costs is also sensitive to changing rates: a 1 % increase in MMR would also result in a nominal increase of FRF 13 billion. Such nominal sensitivity to rate trends would have benefited EPFR since 1995, due to the drop in short-term rates, if the CL loan had not been neutralized in 1995-96. But it could again have the opposite effect if rates harden (unless the loan is neutralized). The uncertainty concerning the amount of the carrying costs can nonetheless be partly eased by a discounting calculation which includes the discounted carrying costs and losses (see below).

The carrying costs have already risen in relation to the original estimates of 1995 as a result of two factors: first, CDR has carried out only a fraction of the participating loan repayments to EPFR originally provided for, so that EPFR has not been able to repay its loan from CL as soon as expected and current interest rates are higher than planned. Second, the State's recapitalizations of EPFR have been inadequate, so that the latter has accumulated interest arrears on its payments to CL which are charged as higher nominal carrying costs. Thus not only might EPFR fail to repay the principal of its loan from CL for several years, but its debts might rise if, as in the last two years, interest arrears accumulate owing to late or inadequate recapitalizations by the State. In its 1997 report (19), EPFR rings the alarm, pointing out that, if it receives only the repayments on its participating loan to CDR and payments from the State solely to cover interest arrears, it will have to run into debt to pay the interest on the loan from CL (because the interest is not capitalizable with the underlying loan). According to EPFR, its borrowing capacity for interest payments, capped at FRF 50 billion by the Law of 28 November 1995, could be used in full by 2002-04. It concludes that, in any event, it would be advisable to avoid financing irrecoverable losses by contracting a debt which would only add to the final bill (20).

It is clear that it is possible for the hive-off costs to spiral significantly, not only as regards CDR and its asset losses and off-balance sheet risks, but also as regards EPFR and its rising carrying costs. In its 1997 report, EPFR describes it as a 'snowball` effect which could result in the State bearing not only the 'primary` interest costs (those of the CL loan to EPFR) but also the interest on the additional loans contracted to pay the interest on the principal loan. If the fears of EPFR come about and it is compelled to borrow the necessary resources to service the CL loan, the carrying costs for the entire mechanism could spiral again. This could continue for as long as the State's recapitalizations of EPFR are insufficient, and especially if the loans to EPFR have to be concluded at medium- and long-term rates (about 4,5-5,5 % at the beginning of 1998) considerably higher than the service rate for the loan from CL (85 % of MMR, i.e. about 3 % at the beginning of 1998). For example, if in 2003 the amount outstanding on new loans contracted by EPFR totalled FRF 50 billion, the annual carrying cost of the hive-off could surge from FRF 2,9 billion (current estimated servicing of CL loan, excluding neutralization) to some FRF 4,4-5,5 billion, depending on whether EPFR refinances at short- or long-term rates.

In addition, the State now plans, following the decision to transfer to EPFR the stake in the holding company Artemis originally hived off to CDR, to give EPFR an asset-carrying role not originally provided for in the plan submitted to the Commission in 1995. The accounting or transfer losses could be attributed to EPFR. Accordingly, such capital losses would no longer be borne by CDR so that its estimated losses would be reduced by the amount of provisions in respect of Artemis; thus the transfer should not affect the hive-off as a whole.

The French authorities also intimated in the plan submitted in July 1997 that they might recapitalize CL afresh, without specifying the amount involved. If necessary, the Commission would have added such a recapitalization to its calculation of the total amount of aid in question. However, no further action was taken.

In Decision 95/547/EC, a number of factors were deducted from the total aid. The carrying cost of the zero-coupon bond was deducted and cannot be deducted from the new assessment of aid to CL, the French authorities having clearly confirmed by letter dated 31 March 1998 from the Minister for Economic, Financial and Industrial Affairs to Mr Van Miert that they planned to abolish the obligation to finance a zero-coupon bond. This accordingly increases by FRF 7,8 billion, compared with the 1995 plan, the estimated aid to CL, the latter being relieved of that obligation. Another factor, the discounted value of the receipts generated by the better fortunes clause, was deducted, as was the net book value of CL (after deduction of the clause). By letters dated 31 March and 3 May 1998 to Mr Van Miert, the Minister for Economic, Financial and Industrial Affairs formally stated that France undertook to transfer CL to the private sector before the end of 1999, and that the clause would be 'terminated`. In view of that undertaking and the approaching deadline, the Commission considers that the value of the State's holding in the bank (some 82 %) should be deducted from the gross aid rather than, as it did in 1995, deducting the sum of the clause and the net book value of the bank.

The French authorities, unlike the Commission which had calculated in 1995 that possible aid to CL totalled FRF 45