State aid - United Kingdom

Aid C 46/2002 (ex N 56/2001) - CDC Group plc

Invitation to submit comments pursuant to Article 88(2) of the EC Treaty

(2002/C 223/03)

(Text with EEA relevance)

By means of the letter dated 2 July 2002, reproduced in the authentic language on the pages following this summary, the Commission notified United Kingdom of its decision to initiate the procedure laid down in Article 88(2) of the EC Treaty concerning the abovementioned aid.

Interested parties may submit their comments within one month of the date of publication of this summary and the following letter, to: European Commission Directorate-General for Competition

State Aid Registry

B - 1049 Brussels Fax (32-2) 296 12 42.

These comments will be communicated to United Kingdom. Confidential treatment of the identity of the interested party submitting the comments may be requested in writing, stating the reasons for the request.

SUMMARY

1. DESCRIPTION

By letter dated 17 January 2001, registered 19 January 2001, the United Kingdom authorities notified the scheme "CDC Group plc" to the Commission pursuant to Article 88(3) EC. The legal basis of the scheme is the CDC Act 1999. Responsible for the scheme and its implementation is the Department for International Development.

The overall purpose of the scheme is to support the UK Government's international development policy. According to the UK, most foreign investment in developing countries is focused on only a few of the richer developing countries. It is believed that financial sectors in poorer countries are underdeveloped and that official and market information about investment opportunities and potential returns is inadequate.

The CDC Group plc (CDC) is the UK Government's main instrument for investing in the poorer countries. By transforming CDC into a public private partnership, the UK authorities seek to encourage private investment flows to the poorer countries. CDC is expected to remedy the market failure by demonstrating that commercial returns are available from such investments. The Government has therefore imposed an operating framework on CDC, according to which it is required to make 70 % of new investments (by aggregate value) in poorer developing countries(1) over a rolling five-year period and to seek to make at least half of new investments in Sub-Saharan Africa and South Asia.

Up to 75 % of the shares of CDC will be offered to private investors. There will be open competition and full publicising of the CDC investment opportunity. It is proposed to grant CDC investment company status, although CDC does not meet all the technical requirements of an investment company as set out in the Companies Act. The main implication is that CDC will enjoy an exemption from tax on income and chargeable gains derived from its investment activities in the same way that investment companies do. Investors in CDC will pay tax according to their own circumstances. The UK authorities argue that if CDC is not tax efficient, private investors will not support the partnership.

Moreover, the UK authorities submit that nobody knows how long it will take to obtain the demonstration effect, but it is expected to take more than 10 years. Therefore, they claim that they would not be able to attract private investors if the Commission's initial approval were limited to 10 years. The measure has therefore been notified for an unspecified period.

The tax revenue forgone by the State is estimated at about GBP 50 million (about EUR 80 million) per year.

2. ASSESSMENT AND THE COMMISSION'S DOUBTS

The Commission finds that the measure fulfils all the requirements of Article 87(1) of the EC Treaty, and that the measure therefore constitutes State aid. The tax revenue forgone by the State constitutes a loss of State resources, the aid favours a certain undertaking, and the tax treatment which follows from the investment company status is an advantage for CDC, because it would not have been able to attract any private capital without it. Finally, it is the Commission's constant position that when the State intervenes to create a new player on the international financial markets, there is an effect on the investment flows between Member States.

The Commission has assessed the compatibility of the aid with the common market. It finds that the objective of the aid is in line with Article 177 of the EC Treaty, which states that Member States should foster the sustainable economic and social development of the most disadvantaged developing countries.

The further assessment was made with reference to the Commission Communication on State aid and risk capital(2). The notified aid contains a number of positive elements, notably that it serves to remedy a market failure, that it is proportionate, and that CDC will make equity investments and be profit driven. It is also the intention that the majority of the capital of CDC should be private.

The Commission has doubts as regards the compatibility with the common market of an aid scheme with an unspecified duration for the following reasons:

- the Commission does not, in principle, approve fiscal non-quantifiable State aid for an unlimited period of time,

- the Commission finds that it is appropriate to review State aid schemes regularly in order to ascertain whether the aid is still necessary in view of market developments. It cannot be excluded that the market for ethical investment funds will develop, so that the aid to CDC distorts competition and affects trade between Member States to a significantly greater extent than it does now,

- the Commission does not find the arguments put forward by the UK authorities convincing enough to deviate from its practice. In particular, the Commission is not convinced that an approval initially limited to 10 years in itself would reduce significantly the willingness of private investors to invest in CDC,

- regular renotifications of aid schemes leading to Commission decisions, which are published, give all parties concerned transparency as to aid in force,

- the European Council meeting in Barcelona on 15-16 March 2002 renewed its call to the Member States to reduce the overall level of State aid. The request for a time limit is in line with this policy,

- an indefinite tax exemption would appear to be difficult to reconcile with the principles of the EU and OECD initiatives to curb harmful tax competition,

- several countries in which CDC may invest are currently candidate countries negotiating accession to the EU.

TEXT OF THE LETTER

"The Commission wishes to inform the United Kingdom that, having examined the information supplied by your authorities on the aid referred to above, it has decided to initiate the procedure laid down in Article 88(2) of the EC Treaty.

1. PROCEDURE

By letter dated 17 January 2001, registered 19 January 2001, the United Kingdom authorities notified the aid 'CDC Group plc' to the Commission pursuant to Article 88(3) EC. By letters dated 19 March 2001 and 17 May 2001, the UK authorities stated that they intended to submit further information. The information was submitted by letter dated 5 June 2001, registered on 8 June 2001. A meeting between representatives of the Commission and the UK authorities was held on 11 July 2001. Following this meeting, the UK authorities submitted further information by letter dated 18 September 2001, registered on 21 September 2001. By letters dated 23 November 2001 and 24 January 2002, the UK authorities wrote that they intended to submit more information. The latest information was submitted by letter dated 29 May 2002, registered on 7 June 2002.

2. DETAILED DESCRIPTION OF THE MEASURE

2.1. Aim of the scheme

The overall purpose of the scheme is to support the UK Government's international development policy, which aims to reduce by one half the proportion of people living in extreme poverty by 2015. For this to be achieved, the economic growth of developing countries must be greater than population growth.

Although foreign investment in developing countries has increased significantly in the last few years, most of it, according to the UK authorities, is focused on only a few of the richer developing countries. In 1997 over 90 % went to middle income countries and over 50 % to only five countries. Sub-Saharan Africa and South Asia received less than 4 % of all private flows to developing countries in 1997(3).

It is believed that financial sectors in poorer countries are underdeveloped and that official and market information about investment opportunities and potential returns is inadequate. According to the UK authorities, foreign investors' fears of the risks are exaggerated. These fears cause under-investment in such countries. In particular, equity investments are relatively under-utilised. The UK authorities seek to encourage private investment flows to the poorer countries and to demonstrate that commercial returns are available from such investments. This should help to correct investors' perceptions of the net return ratio in poorer countries. Increasing investment will also promote economic growth and stability and thereby lower the risks for investors.

2.2. CDC Group plc

The CDC Group plc is the UK Government's main instrument for investing in the poorer countries. The purpose of CDC, as written in its Memorandum, is to maximise the creation and long-term growth of viable businesses in developing countries, especially poorer countries, to achieve attractive returns to its shareholders and implement social, environmental and ethical best practice". Since its foundation in 1948, CDC has been present as an investor in developing countries with a special focus on poorer countries and territories in the Commonwealth. It currently has interests in over 50 countries.

In December 1999, CDC was transformed from a statutory corporation into a public limited company. As a next step, up to 75 % of the shares will be offered to private investors. There will be open competition and full publicising of the CDC investment opportunity, allowing investors from any Member State to participate in the venture. The Government will maintain at least 25 % of the shares. It will also hold a special share in CDC, consisting of one special rights redeemable preference share of GBP 1 in the capital of CDC, which allows it to control that CDC makes its investments in accordance with the UK development policy objectives.

When CDC was transformed in 1999, an operating framework for the company was put in place. Under the operating framework, CDC is required to make 70 % of new investments (by aggregate value) in poorer developing countries(4) over a rolling five year period and to seek to make at least half of new investments in Sub-Saharan Africa and South Asia. Through its special share in CDC, the UK Government is able to ensure that CDC complies with this operating framework. However, the Government does not intervene in the individual investment decisions taken by the CDC Board. Once the Government gives up its special share, CDC will no longer be bound by these objectives and will lose its investment company status (see also point 2.7 on the duration of the scheme).

2.3. Capital restructuring

CDC comes from a State sector background. Prior to CDC's transformation into a plc, there was no mechanism other than debt from the Government to provide funding to the statutory corporation. This debt carried no interest and was normally rolled over on maturity. At present CDC has an interim capital structure. CDC's new capital structure will have to accommodate the different parts of its portfolio:

- A lower risk portfolio of loans, which produces correspondingly low returns. At 31 December 1999 about 20 % of CDC's outstanding loans were loans to the public sector. They were removed from CDC's balance sheet in September 2000 by an arrangement which gives the Government the net benefit flowing from them. Public sector loans is a discontinued line of business for CDC.

- A higher risk higher return equity portfolio, which will be the focus of all CDC's new business.

CDC has assets of around GBP 600 million of loans to the private sector and about GBP 500 million of risk capital investments(5). This will be funded by a combination of equity and debt. Existing debt will be converted into equity. Approximately GBP 200 million of new debt will be structured so that the UK Government has the option to sell the debt. CDC also has the option to refinance it in the public debt market. The rate will be set on the basis of formal advice from an independent investment bank.

Under this scheme, the UK Government will sell shares in a smaller CDC. However, the UK authorities consider that the characteristics of this entity will be such that investors might pay a better price proportionately. When added to assets retained in public ownership, better value is likely to be secured overall.

2.4. Investment company status

For the period that the UK Government holds its special share and CDC is subject to the operating framework, the UK authorities propose to grant CDC investment company status, although CDC does not meet all the technical requirements of an investment company as set out in the Companies Act.

The UK authorities are able to ensure that CDC will carry out its intended role as an investor in developing countries by various means. These include the special share arrangements, a deed of covenant relating to CDC's implementation of the agreed investment policy and remedies available through the Companies Act for any non-compliance. The UK authorities state that they would not have the same possibilities to control other fully private operators claiming to have the same investment policy as CDC, and therefore wanting to benefit from the same tax benefits without answering to the definition of an investment company in the Companies Act. Consequently, the investment company status is only available to CDC.

Allowing CDC to have the status of an investment company will have three practical effects.

2.4.1. Tax treatment

The main benefit to CDC of the investment company status is the tax treatment. CDC will enjoy an exemption from tax on income and chargeable gains derived from its investment activities in the same way that investment companies do. CDC will remain liable to all applicable local taxes in the developing countries as at present. Investors in CDC will be liable to tax on their income and gains from CDC as normal, according to their own circumstances. Where CDC undertakes activity in the EU, this will be undertaken through a separate subsidiary and subject to tax in the normal way.

The proposed tax treatment arises from the decision to introduce private capital to CDC. It is generally accepted that for investment vehicles to serve their purpose, they should not impose any additional tax burdens on investors over and above what these investors would have on investments made directly by themselves. According to the UK authorities, this is illustrated by the fact that in all the major economies, investment funds are treated as tax exempt or tax transparent. In the UK and most other Member States certain tax reliefs are available to various types of collective investment vehicles. The UK authorities consider that if CDC is not tax efficient, private investors will simply not support the partnership.

The UK authorities considered whether CDC could meet the technical requirements of any of the existing UK tax efficient schemes. However, because of the nature of its investments and the countries in which it invests, the UK authorities found that CDC is not able to do so(6). The tailored tax treatment, which puts CDC on a par with other investment vehicles, is therefore considered a necessary part of the partnership.

The UK authorities estimate that the revenue foregone by the State amounts to about GBP 50 million (about EUR 80 million) per year.

2.4.2. Accounts

The second effect of the investment company status is that CDC will be permitted to prepare its accounts in the way that investment companies do, which is different from other companies. In particular, investment companies are allowed to reflect unrealised gains on investments in their accounts. Potential investors are likely to see and value CDC as an investment company, and will expect it to account in this way.

2.4.3. Distribution of profits

The third effect concerns distribution of profits. Companies other than investment companies can, broadly, only pay dividends from accumulated realised profits less accumulated realised losses, without distinction between revenue and capital. Thus, for example, if a company makes revenue profits, but capital losses, it may not be able to make a distribution. Investment companies can only pay dividends from accumulated realised revenue profits minus accumulated realised revenue losses, and so may be able to pay dividends even if they make capital losses. According to the UK authorities, it would not be possible to list CDC as an investment entity without the secure prospect of regular dividends to investors, and it is therefore important that CDC is able to make distributions in this way. However, CDC is under no obligation to distribute a minimum share of its annual income as dividends.

2.5. Investments made by CDC

All CDC's investments must be for the economic benefit of developing countries and at least 70 % of these investments must be for the poorer of those countries (defined as those with a GDP per capita of less than USD 1740 in 1996). CDC is also required to aim at making at least half of its new investments each year in sub-Saharan Africa and South Asia.

CDC is not allowed to invest in manufacture of military equipment, gambling, pornography, illegal drugs and tobacco. CDC's Articles of Association also require it to operate under business principles which reflect best practice in a number of areas - health and safety, corporate governance, environment and social issues.

CDC's investment decisions are taken on a commercial basis. This is of central importance for the demonstration effect. CDC will normally only make investments on the basis of business plans.

The UK Government's return on investment is not subordinated to that of the private investors in CDC.

2.6. Competition

The UK authorities believe that CDC does not have any direct competitors, due to its unique status as a public private partnership and its unique investment policy. According to them, CDC is a pioneering venture, and its main aim is to demonstrate that ethically sound investments in the poorer countries of the world can be commercially viable. The transformation of CDC into a public private partnership reflects the conviction of the UK Government that the terms of CDC's engagement in the market should be fully commercial and reflect no subsidy.

Looked at in total, the only entities who share CDC's developing country focus and have broadly similar aims are the multilateral and European Development Finance Institutions, such as the International Finance Corporation(7) (IFC) and the European Investment Bank (EIB). The UK authorities claim that all of these receive relief or benefits in some form. For instance, IFC and EIB are supranational bodies outside the tax system. These institutions tend to focus on loans rather than, as CDC now does, on equity investment (in some cases, they have limits on the equity they can take in a company), and they tend not to be driven by commercial profit targets. Furthermore, the real difficulty is in finding sufficient funds to invest in worthwhile projects rather than competing over particular projects.

However, CDC can face different competitors in specific instances at both the investor level (i.e. the level of obtaining investment funds from bodies in the EU) and investment level (i.e. the level of competition for attractive investment opportunities). Indirectly, competition at these levels could involve EU bodies. CDC will be competing at these two levels without subsidy and with tax applied in a way common for investment institutions in the EU.

2.6.1. Competition at the investor level (i.e. between investors in CDC and other investors)

At the investor level, CDC is likely to be of interest to more sophisticated investors who are able to assess the risks and rewards involved. These investors probably have an exposure to emerging markets, and seek portfolio diversification and exposure to the parts of the world in which CDC operates. Ethical investors may also find CDC's business principles attractive. Competitors to CDC in the market for funds are therefore likely to be emerging market investment funds, emerging market private equity firms and ethical funds. Less directly, competition could be represented by large multinational companies (quoted in the EU) who might raise funds to finance acquisitions in the countries where CDC operates.

The UK authorities furthermore explain that the great majority of those who will be competing with CDC for investors' funds are themselves able to take advantage of beneficial tax treatment. In three broad categories by being an approved investment trust, by being a limited partnership (which suffers no tax at the level of the entity) or by being resident outside the UK in a competitive tax jurisdiction. This is apparently the case particularly for emerging market investment funds and private equity funds, though trade investors can also benefit from tax relief by using offshore vehicles.

2.6.2. Competition at the investment level (i.e. between CDC and other bodies)

At the level of investment, CDC's aim is to acquire equity stakes in companies in developing countries and expand these investments through further growth (whether organic or by further acquisition). Alternative players may include trade players (for example, companies already involved in the industry into which CDC is buying), other venture capital funds, including development finance institutions, or entrepreneurs who have spotted a good opportunity.

The UK authorities have considered the investments made by CDC since March 1999, and found that only with regard to 15 % of the investments realised had CDC had competitors from within the EU. The UK authorities therefore claim that the extent to which CDC is competing with EU-based companies for investments is limited.

Finally, the UK authorities point out that the value of the tax exemption of GBP 50 million (about EUR 80 million) is very small in relation to the total foreign direct investment in developing countries, which was around GBP 100000 million (about EUR 160000 million) in 1997.

2.7. The duration of the scheme

The UK authorities submit that it is not possible to know the duration of the special fiscal regime in advance. The UK authorities argue that they want to demonstrate that profits can be made from investments in viable companies in the poorer developing countries and thereby influence the behaviour of private investors. To do so, they need to control the investment policy of CDC and make sure that it invests in the parts of the world to which they want to direct private investment flows. However, nobody knows how long it will take to obtain a demonstration effect. It will not be achieved within five or 10 years, as might be the case for a market failure to be remedied within the EU, but will take much longer. Therefore, it cannot be determined in advance when the Government will give up its special share and CDC will lose its investment company status and tax exemption.

As regards the possibility to limit the period covered by the notification to 10 years, and then renotify the aid should it still be needed, the UK authorities submit that investors would not want to invest in CDC, if there was a risk that the Commission would not approve the aid a second time after 10 years.

However, the UK authorities consider that an over-subscription to the shares offered for sale would be an indication that the market failure is less severe and less long-term than they currently believe. Thus, if the part sales of the shares in CDC were to be significantly over-subscribed as a result of the proposed State aid, the UK Government would review the policy implications of that for the public-private partnership. The UK would communicate the results of any such review to the Commission, in addition to the annual report that the CDC, in compliance with the Companies Act, will provide. Moreover, the UK commits to keep the Commission informed of any changes to the notified measure.

3. ASSESSMENT

3.1. Presence of State aid under Article 87(1) of the EC Treaty

Article 87(1) EC states that any aid granted by a Member State or through State resources in 'any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, insofar as it affects trade between Member States, be incompatible with the common market'.

The notification covers two aspects of the transformation of CDC from a statutory corporation to a public private partnership.

3.1.1. Capital restructuring

The measures foreseen in order to prepare CDC for the transformation into a public private partnership can be summarised as follows:

- those of CDC's loans that were granted to public bodies are transferred to the State, since this activity is discontinued,

- CDC's existing debt to the Government is converted into equity,

- new debt is injected on commercial terms.

The Commission finds it conceivable that a private market economy investor would carry out all of these measures. The transfer of the loans granted to the public sector is a natural consequence of the streamlining of CDC's activities. CDC will now focus exclusively on the private sector. This transfer is therefore no different from any shifting of activities between members of a company group. The assessment might have been different had CDC continued to grant loans to the public sector, with the State only taking over the bad loans. Moreover, since CDC paid no interest to the Government, it makes more sense for the government to convert its loans to equity, and so stand a chance of receiving a return on investment. Finally, the new debt is injected on commercial terms, as established by an independent investment bank.

The Commission finds that the capital restructuring of CDC does not confer any advantage on the company within the meaning of Article 87(1) EC and therefore it does not constitute aid.

3.1.2. Investment company status

The UK authorities will grant CDC an exemption from tax on income and chargeable gains derived from its investment activities. This exemption is estimated to result in an annual loss of revenue for the State of GBP 50 million (about EUR 80 million). However, to the extent that the shareholders are UK companies the tax burden is shifted to them (they would not have been liable to tax if CDC had not been granted investment company status). It cannot be assumed that the tax they pay will fully compensate the State for the loss of tax revenue from CDC. In any case, it is only the net loss of tax revenue (which cannot be calculated) and not the GBP 50 million (about EUR 80 million) that can be considered as a loss of State resources within the meaning of Article 87(1) EC.

The UK authorities will only confer investment company status on CDC. Other potential private investment organisations with an ethical objective similar to that of CDC will not be allowed to benefit from a similar treatment. Therefore, the measure favours a certain undertaking.

Irrespective of its investment focus, it is an advantage for CDC to be granted investment company status enabling it to enjoy the tax benefit. Without it, CDC would not be able to attract private investors for any kind of investment. It is also an advantage for CDC that the majority of private investments focusing on developing countries and originating in the UK will have to go through CDC. Not many, if any, proper investment companies are likely to invest in the third world for the same reasons why CDC does not fit into any of the structures foreseen for investment companies. This has a positive effect on the flow of capital to CDC.

As regards the effect on trade between Member States, it is the Commission's constant position that when the State intervenes to create a new player on the international financial markets, this has an effect on the investment flows between Member States. In any case, the impact on Community trade is not disputed (see points 2.6.1 and 2.6.2 above). Therefore, the measure is considered to affect trade between Member States, albeit to a limited extent in this case in view of the specific investment focus of CDC.

Consequently, the Commission considers at this stage that the tax treatment resulting from the investment company status which CDC will enjoy, and which enables it to attract private capital, is covered by Article 87(1) EC.

3.2. Compatibility of the aid with Article 87(3)(c) of the EC Treaty

The Commission has assessed the compatibility of the aid with the common market based on Article 87(3)(c) EC, which allows for aid to facilitate the development of certain economic activities or of certain economic areas, where such aid does not adversely affect trading conditions to an extent contrary to the common interest.

- According to Article 177 of the EC Treaty, Community policy in the sphere of development cooperation, which shall be complementary to the policies pursued by Member States, shall foster the sustainable economic and social development of the developing countries, and more particularly, the most disadvantaged among them. Thus, as long as the UK Government maintains its special share and controls that CDC invests in accordance with its operating framework, the scheme is entirely in line with the Community development policy.

- In view of the fact that the objective of CDC is to invest in creating and growing long-term viable businesses, the Commission also refers to the communication on State aid and risk capital(8). As regards the applicability of the communication, it is important to note that it was designed against the background of the Community objective of supporting small and medium-sized enterprises, thereby increasing employment opportunities in the European Union. The measure concerned in this case has been designed with a different Community objective in view, namely the sustainable economic and social development of the poorer developing countries. The communication is therefore only used as guide in the overall assessment of the scheme. The Commission finds the following positive elements of the measure to be relevant:

- The factors which the Commission recognises as causing market failure are imperfect or asymmetric information and high transaction costs. The Commission also recognises that there are particular difficulties in regions qualifying for assistance under Article 87(3)(a) and (c) (points VI.3 and VI.4 of the communication). The Commission appreciates that these difficulties are even more acute in developing countries.

- The Commission accepts the data provided by the UK authorities as regards the distribution of private capital flows to developing countries as proof of a failure of the market to provide sufficient capital to the majority of developing countries (point VIII.2 of the communication).

- CDC operates as an investment organisation focusing on the poorer developing countries. The investment company status enables CDC to offer private investors conditions comparable to those offered by other investment organisations. Without the investment company status, CDC would not be able to attract private capital. Therefore, the Commission finds that the measure is just sufficient to ensure that market investors provide capital and that it results in investment decisions being taken on a commercial basis and on terms as close as possible to those which would prevail in the normal economy.

Moreover, the rationale of the scheme is that CDC one day will be able to attract private capital for investments in developing countries and be viable without the special tax treatment. Until that happens, there is a transitional period, during which the UK Government controls that CDC complies with the UK development policy goals. The benefit which CDC has from the measure compensates for the lower profits it will make as a result of having to take a public policy objective into account, and not being able to take investment decisions exclusively on the basis of profit considerations. For example, without the particular focus on poorer developing countries, CDC could have invested more in middle income developing countries and potentially made better returns.

Consequently, the measure can be considered to be proportionate to the presumed market failure it is devised to meet, and to ensure that any distortion is minimised (point VI.6 of the communication). There will also be open competition and full publicising of the CDC investment opportunity, allowing investors from any EU Member State to participate in the venture. This also minimises the distortion of competition between investors and is therefore a positive element.

- The Commission specifically identified fiscal incentives to investors to undertake risk capital investment as a form of aid capable of meeting the criteria set out in section VIII of the communication (point VII.1(e) of the communication).

- It is a positive element that CDC will make equity investments (point VIII.3 of the communication).

- The whole objective of CDC is to be profit driven. In this context, it is a positive element that the UK Government intends to sell up to 75 % of the shares in CDC to private investors. Within the limits of the operating framework, this capital is invested on a commercial basis directly in the equity of the target enterprises. The investment decisions are taken by the CDC Board. The State does not take part in the investment decisions beyond controlling that investments are made within the limits of the operating framework (point VIII.3 of the communication).

- CDC has no sectoral focus, and only excludes certain sectors for ethical reasons. This is a positive element (point VIII.3 of the communication).

- Normally, investments will be made on the basis of business plans (point VIII.3 of the communication).

- It is unlikely that CDC will be eligible for any other State aid, e.g. since it is not an SME, will not undertake investments in environmental protection and is not located in an assisted area. Therefore, there is no real risk of cumulation with other aid measures. This is a positive element.

The UK authorities will submit detailed annual reports to the Commission, and in addition they will also submit the results of any review of the scheme which the UK authorities will carry out in case a significant over-subscription to the shares of CDC indicates that the market conditions have changed and therefore also the necessity of the scheme as notified. This is important, as risk capital is an area of rapid development (point IX of the communication).

Any further benefit foreseen for CDC once the Government no longer holds its special share are to be notified to the Commission before implementation.

3.3. The Commission's doubts concerning the duration of the scheme

The Commission, nevertheless, has doubts as regards the compatibility with the common market of this aid for the following reasons:

- the Commission does not, in principle, approve fiscal non-quantifiable State aids for an unlimited period of time,

- the granting of State aid should not be seen as a permanent solution, but as a temporary measure, which aims to address specific problems. The ultimate goal should be to obtain a fully functioning market without State intervention. The Commission finds that it is appropriate to review State aid schemes regularly in order to ascertain whether the aid is still necessary in view of market developments,

- it is stated in point IX of the communication on State aid and risk capital that risk capital investment is an area of rapid development in the Community economy. This is one of the reasons why the period of application of the communication is limited to five years and why the Commission reserves the right to adjust its approach during that period. CDC does not carry out the kinds of risk capital investments foreseen in the communication, but the Commission cannot exclude that the market for ethical investment funds will develop so that the aid to CDC will distort competition and affect trade between Member States to a significantly greater extent than it does now,

- the Commission does not find the arguments put forward by the UK authorities to be convincing enough to deviate from its practice to require all State aid cases to be limited in time with a possibility of renotification and prolongation. In particular, the Commission is not convinced that an approval initially limited to 10 years in itself would reduce, significantly, the willingness of private investors to invest in CDC,

- if schemes were open-ended neither the Commission nor other Member States would know which aid schemes were still in operation in a particular Member State. Therefore, regular renotifications of aid schemes leading to Commission decisions, which are published, provide transparency,

- the European Council meeting in Barcelona on 15-16 March 2002 renewed its call to the Member States to reduce the overall level of State aid. The request for a time limit is in line with this policy,

- an indefinite tax exemption would appear to be difficult to reconcile with the principles of the EU and OECD initiatives to curb harmful tax competition,

- several countries in which CDC may invest are currently candidate countries negotiating accession to the EU. The Commission doubts that CDC will be able to continue investing in these countries once they have become members of the European Union.

In the light of the foregoing considerations, the Commission, acting under the procedure laid down in Article 88(2) of the EC Treaty, requests the United Kingdom to submit its comments and to provide all such information as may help to assess the aid, within one month of the date of receipt of this letter. It requests your authorities to forward a copy of this letter to the potential recipient of the aid immediately.

The Commission wishes to remind the United Kingdom that Article 88(3) of the EC Treaty has suspensory effect, and would draw your attention to Article 14 of Council Regulation (EC) No 659/1999, which provides that all unlawful aid may be recovered from the recipient."

(1) "Poorer developing countries" are those classified as "low income" by the World Bank in 1998, and those classified as "lower middle income" by the World Bank in 1998 and that are below the weighted mean of GNP per capita for lower middle income countries. The definition also includes 11 countries for which the World Bank does not currently collect GNP data.

(2) OJ C 235, 21.8.2001, p. 3.

(3) Source: UNCTAD World Investment Report. The numbers refer to world FDI, which mainly comes from OECD countries. In 2000, Africa's share of FDI in developing countries was still about 4 % (0,8 % of all FDI).

(4) 'Poorer developing countries' are those classified as 'low income' by the World Bank in 1998, and those classified as 'lower middle income' by the World Bank in 1998 and that are below the weighted mean of GNP per capita for lower middle income countries. The definition also includes 11 countries for which the World Bank does not currently collect GNP data.

(5) Figures submitted at the time of notification.

(6) The UK authorities submitted credible explanations of why CDC cannot fulfil the requirements of the following existing structures: investment trust, venture capital trust, unit trusts/open-ended investment companies, pension fund pooling scheme, partnership or limited partnership.

(7) IFC is part of the World Bank Group, and has 175 member countries.

(8) OJ C 253, 21.8.2001, p. 3.