EN Official Journal of the European Union L 17/1

EFTA SURVEILLANCE AUTHORITY DECISION

No 28/09/COL

of 29 January 2009

amending, for the sixty-eighth time, the procedural and substantive rules in the field of State aid by introducing three new chapters on the application of State aid rules to measures taken in relation to financial institutions in the context of the current global financial crisis, on the recapitalisation of financial institutions in the current financial crisis: limitation of aid to the minimum necessary and safeguards against undue distortions of competition, and on the temporary framework for State aid measures to support access to finance in the current financial and economic crisis

THE EFTA SURVEILLANCE AUTHORITY (1),

Having regard to the Agreement on the European Economic Area (2), in particular to Articles 61 to 63 and Protocol 26 thereof,

Having regard to the Agreement between the EFTA States on the establishment of a Surveillance Authority and a Court of Justice (3), in particular to Article 24 and Article 5(2)(b) thereof,

Whereas under Article 24 of the Surveillance and Court Agreement, the Authority shall give effect to the provisions of the EEA Agreement concerning State aid,

Whereas under Article 5(2)(b) of the Surveillance and Court Agreement, the Authority shall issue notices or guidelines on matters dealt with in the EEA Agreement, if that Agreement or the Surveillance and Court Agreement expressly so provides or if the Authority considers it necessary,

Recalling the Procedural and Substantive Rules in the Field of State Aid adopted on 19 January 1994 by the Authority (4),

Whereas, on 13 October 2008, the European Commission (5) adopted a Communication relating to ‘The application of State aid rules to measures taken in relation to financial institutions in the context of the current global financial crisis’ (6),

Whereas, on 5 December 2008, the Commission adopted a Communication entitled ‘The recapitalisation of financial institutions in the current financial crisis: limitation of aid to the minimum necessary and safeguards against undue distortions of competition’ (7),

Whereas, on 17 December 2008, the Commission adopted a Communication entitled ‘Temporary Community Framework for State aid measures to support access to finance in the current financial and economic crisis’ (8),

Whereas these Communications are also of relevance for the European Economic Area,

Whereas uniform application of the EEA State aid rules is to be ensured throughout the European Economic Area,

Whereas, according to point II under the heading ‘GENERAL’ at the end of Annex XV to the EEA Agreement, the Authority, after consultation with the Commission, is to adopt acts corresponding to those adopted by the Commission,

Having consulted the Commission,

Recalling that the Authority has consulted the EFTA States by letters to Iceland, Liechtenstein and Norway on 19 January 2009 on the subject,

HAS ADOPTED THIS DECISION:

Article 1

The State aid Guidelines shall be amended by introducing three new chapters on the application of State aid rules to measures taken in relation to financial institutions in the context of the current global financial crisis, on the recapitalisation of financial institutions in the current financial crisis: limitation of aid to the minimum necessary and safeguards against undue distortions of competition, and on the temporary framework for State aid measures to support access to finance in the current financial and economic crisis. The three chapters are contained in Annex I, II and III to this Decision.

Article 2

Only the English version is authentic.

Done at Brussels, 29 January 2009. For the EFTA Surveillance Authority Per SANDERUD President Kurt JÄGER College Member

(1) Hereinafter referred to as the Authority.

(2) Hereinafter referred to as the EEA Agreement.

(3) Hereinafter referred to as the Surveillance and Court Agreement.

(4) Guidelines on the application and interpretation of Articles 61 and 62 of the EEA Agreement and Article 1 of Protocol 3 to the Surveillance and Court Agreement, adopted and issued by the Authority on 19 January 1994, published in the Official Journal of the European Union (hereinafter referred to as OJ L 231 of 3.9.1994, p. 1), and EEA Supplement No 32 of 3.9.1994 p. 1. The Guidelines were last amended on 17 December 2008. Hereinafter referred to as the State aid Guidelines. The updated version of the State aid Guidelines is published on the Authority’s website: http://www.eftasurv.int/fieldsofwork/fieldstateaid/state_aid_guidelines

(5) Hereinafter referred to as the Commission.

(6) OJ C 270, 25.10.2008, p. 8.

(7) OJ C 10, 15.1.2009, p. 2.

(8) OJ C 16, 22.1.2009, p. 1.

ANNEX I The application of State aid rules to measures taken in relation to financial institutions in the context of the current global financial crisis (1) 1. INTRODUCTION (1) The global financial crisis has intensified markedly and has now impacted heavily on the EEA banking sector. Over and above specific problems related in particular to the US mortgage market and mortgage-backed assets or linked to losses stemming from excessively risky strategies of individual banks, there has been a general erosion of confidence in the past months within the banking sector. The pervasive uncertainty about the credit risk of individual financial institutions has dried up the market of interbank lending and has consequently made access to liquidity progressively more difficult for financial institutions across the board. (2) The current situation threatens the existence of individual financial institutions with problems that are a result of their particular business model or business practices whose weaknesses are exposed and exacerbated by the crisis in the financial markets. If such institutions are to be returned to long-term viability rather than liquidated, a far reaching restructuring of their operations will be required. Under the prevailing circumstances, the crisis equally affects financial institutions that are fundamentally sound and whose difficulties stem exclusively from the general market conditions which have severely restricted access to liquidity. Long-term viability of these institutions may require less substantial restructuring. In any case however, measures taken by an EFTA State to support (certain) institutions operating within its national financial market may favour these institutions to the detriment of others operating within that EFTA State or in other EEA States. (3) The ECOFIN Council on 7 October 2008 adopted Conclusions committing to take all necessary measures to enhance the soundness and stability of the banking system in order to restore confidence and the proper functioning of the financial sector. The recapitalisation of vulnerable systemically relevant financial institutions was recognized as one means, among others, of appropriately protecting the depositors’ interests and the stability of the system. It was further agreed that public intervention has to be decided on at national level but within a coordinated framework and on the basis of a number of EU common principles (2). On the same occasion the Commission offered to shortly issue guidance as to the broad framework within which the State aid compatibility of recapitalisation and guarantee schemes, and cases of application of such schemes, could be rapidly assessed. (4) Given the scale of the crisis, now also endangering fundamentally sound banks, the high degree of integration and interdependence of European financial markets, and the drastic repercussions of the potential failure of a systemically relevant financial institution further exacerbating the crisis, the Authority recognises that EFTA States may consider it necessary to adopt appropriate measures to safeguard the stability of the financial system. Due to the particular nature of the current problems in the financial sector such measures may have to extend beyond the stabilisation of individual financial institutions and include general schemes. (5) While the exceptional circumstances prevailing at the moment have to be duly taken into account when applying the State aid rules to measures addressing the crisis in the financial markets the Authority has to ensure that such measures do not generate unnecessary distortions of competitions between financial institutions operating in the market or negative spill over effects on other EEA States. It is the purpose of this Chapter to provide guidance on the criteria relevant for the compatibility with the EEA Agreement of general schemes as well as individual cases of application of such schemes and ad hoc cases of systemic relevance. In applying these criteria to measures taken by EFTA States, the Authority will proceed with the swiftness that is necessary to ensure legal certainty and to restore confidence in financial markets. 2. GENERAL PRINCIPLES (6) State aid to individual undertakings in difficulties is normally assessed under Article 61(3)(c) of the EEA Agreement and the Chapter on aid for rescuing and restructuring firms in difficulty of the State aid Guidelines (3) (hereinafter ‘R&R guidelines’) which articulates the Authority’s understanding of Article 61(3)(c) of the EEA Agreement for this type of aid. The R&R guidelines are of general application, while foreseeing certain specific criteria for the financial sector. (7) In addition, under Article 61(3)(b) of the EEA Agreement the Authority may allow State aid ‘to remedy a serious disturbance in the economy of an EC Member State or an EFTA State’. (8) The Authority reaffirms that, in line with the case law and the Commission’s decision making practice (4), Article 61(3)(b) of the EEA Agreement necessitates a restrictive interpretation of what can be considered a serious disturbance of an EFTA State’s economy. (9) In the light of the level of seriousness that the current crisis in the financial markets has reached and of its possible impact on the overall economy of EEA States, the Authority considers that Article 61(3)(b) is, in the present circumstances, available as a legal basis for aid measures undertaken to address this systemic crisis. This applies, in particular, to aid that is granted by way of a general scheme available to several or all financial institutions in an EFTA State. Should the EFTA State’s authorities responsible for financial stability declare to the Authority that there is a risk of such a serious disturbance, this shall be of particular relevance for the Authority’s assessment. (10) Ad hoc interventions by EFTA States are not excluded in circumstances fulfilling the criteria of Article 61(3)(b) of the EEA Agreement. In the case of both schemes and ad hoc interventions, while the assessment of the aid should follow the general principles laid down in the R&R guidelines adopted pursuant to Article 61(3)(c) of the EEA Agreement, the current circumstances may allow the approval of exceptional measures such as structural emergency interventions, protection of rights of third parties such as creditors, and rescue measures potentially going beyond 6 months. (11) It needs to be emphasised, however, that the above considerations imply that the use of Article 61(3)(b) of the EEA Agreement cannot be envisaged as a matter of principle in crisis situations in other individual sectors in the absence of a comparable risk that they have an immediate impact on the economy of an EFTA State as a whole. As regards the financial sector, invoking this provision is possible only in genuinely exceptional circumstances where the entire functioning of financial markets is jeopardised. (12) Where there is a serious disturbance of an EFTA State’s economy along the lines set out above, recourse to Article 61(3)(b) of the EEA Agreement is possible not on an open-ended basis but only as long as the crisis situation justifies its application. (13) This entails the need for all general schemes set up on this basis, e.g. in the form of a guarantee or recapitalization scheme, to be reviewed on a regular basis and terminated as soon as the economic situation of the EFTA State in question so permits. While acknowledging that it is currently impossible to predict the duration of the current extraordinary problems in the financial markets and that it may be indispensable in order to restore confidence to signal that a measure will be extended as long as the crisis continues, the Authority considers it a necessary element for the compatibility of any general scheme that the EFTA State carries out a review at least every six months and reports back to the Authority on the result of such review. (14) Furthermore, the Authority considers that the treatment of illiquid but otherwise fundamentally sound financial institutions in the absence of the current exceptional circumstances should be distinguished from the treatment of financial institutions characterized by endogenous problems. In the first case, viability problems are inherently exogenous and have to do with the present extreme situation in the financial market rather than with inefficiency or excessive risk-taking. As a result, distortions of competition resulting from schemes supporting the viability of such institutions will normally be more limited and require less substantial restructuring. By contrast, other financial institutions, likely to be particularly affected by losses stemming for instance from inefficiencies, poor asset-liability management or risky strategies, would fit with the normal framework of rescue aid, and in particular need a far-reaching restructuring, as well as compensatory measures to limit distortions of competition (5). In all cases, however, in the absence of appropriate safeguards, distortions of competition may be substantial from the implementation of guarantee and recapitalization schemes, as they could unduly favour the beneficiaries to the detriment of their competitors or may aggravate the liquidity problems for financial institutions located in other EEA States. (15) Moreover, in line with the general principles underlying the State aid rules of the EEA Agreement, which require that the aid granted does not exceed what is strictly necessary to achieve its legitimate purpose and that distortions of competition are avoided or minimized as far as possible, and taking due account of the current circumstances, all general support measures have to be: — well-targeted in order to be able to achieve effectively the objective of remedying a serious disturbance in the economy, — proportionate to the challenge faced, not going beyond what is required to attain this effect, and — designed in such a way as to minimize negative spill over effects on competitors, other sectors and other EEA States. (16) The observance of these criteria in compliance with the State aid rules and the fundamental freedoms enshrined in the EEA Agreement, including the principle of non-discrimination, is necessary for the preservation of the proper functioning of the internal market. In its assessment, the Authority will take into account the following criteria to decide upon the compatibility of the State aid measures enumerated below. 3. GUARANTEES COVERING THE LIABILITIES OF FINANCIAL INSTITUTIONS (17) The principles set out above translate into the following considerations as regards guarantee schemes protecting liabilities established by way of a declaration, legislation or contractual regime, it being understood that these considerations are of a general nature and need to be adapted to the particular circumstances of every individual case. 3.1. Eligibility for a guarantee scheme (18) A significant distortion of competition may arise if some market players are excluded from the benefit of the guarantee. The eligibility criteria of financial institutions for coverage by such a guarantee must be objective, taking due account of their role in the relevant banking system and the overall economy, and non-discriminatory so as to avoid undue distortive effects on neighbouring markets and the internal market as a whole. In application of the principle of non-discrimination on the grounds of nationality, all institutions incorporated in the EFTA State concerned, including subsidiaries, and with significant activities in that EFTA State should be covered by the scheme. 3.2. Material scope of a guarantee—types of liabilities covered (19) In the present exceptional circumstances, it may be necessary to reassure depositors with financial institutions that they will not suffer losses, so as to limit the possibility of bank runs and undue negative spill over effects on healthy banks. In principle, therefore, in the context of a systemic crisis, general guarantees protecting retail deposits (and debt held by retail clients) can be a legitimate component of the public policy response. (20) As regards guarantees going beyond retail deposits, the selection of the types of debt and liabilities covered must be targeted, to the extent practicable, to the specific source of difficulties and restricted to what can be considered necessary to confront the relevant aspects of the current financial crisis, as they could otherwise delay the necessary adjustment process and generate harmful moral hazard (6). (21) In the application of this principle, the drying-up of interbank lending due to an erosion of confidence between financial institutions may also justify guaranteeing certain types of wholesale deposits and even short and medium-term debt instruments, to the extent such liabilities are not already adequately protected by existing investor arrangements or other means (7). (22) The extension of the coverage of any guarantee to further types of debt beyond this relatively broad scope would require a closer scrutiny as to its justification. (23) Such guarantees should not, in principle, include subordinated debt (tier 2 capital) or an indiscriminate coverage of all liabilities, as it would merely tend to safeguard the interests of shareholders and other risk capital investors. If such debt is covered, thereby allowing expansion of capital and thus of lending activity, specific restrictions may be necessary. 3.3. Temporal scope of the guarantee scheme (24) The duration and scope of any guarantee scheme going beyond retail deposit guarantee schemes must be limited to the minimum necessary. In line with the general principles set out above, taking into account the currently unpredictable duration of the fundamental shortcomings in the functioning of financial markets, the Authority considers it a necessary element for the compatibility of any general scheme for the EFTA State to carry out a review every six months, covering the justification for the continued application of the scheme and the potential for adjustments to deal with evolution in the situation of financial markets. The results of this review will have to be submitted to the Authority. Provided that such regular review is ensured, the approval of the scheme may cover a period longer than six months and up to two years in principle. It may be further extended, upon the Authority’s approval, as long as the crisis in the financial markets so requires. Should the scheme permit guarantees to continue to cover the relevant debt until a maturity date later than the expiry of the issuance period under the scheme, additional safeguards would be necessary in order to prevent excessive distortion of competition. Such safeguards may include a shorter issuance period than that allowed in principle under the present Chapter, deterrent pricing conditions and appropriate quantitative limits on the debt covered. 3.4. Aid limited to the minimum—private sector contribution (25) In application of the general State aid principle that the amount and intensity of the aid must be limited to the strict minimum, EFTA States have to take appropriate steps to ensure a significant contribution from the beneficiaries and/or the sector to the cost of the guarantee and, where the need arises, the cost of state intervention if the guarantee has to be drawn upon. (26) The exact calculation and composition of such contribution depends on the particular circumstances. The Authority considers that an adequate combination of some or all of the following elements (8) would satisfy the requirement of aid being kept to the minimum: — the guarantee scheme must be based on an adequate remuneration by the beneficiary financial institutions individually and/or the financial sector at large (9). Bearing in mind the difficulty of determining a market rate for guarantees of this nature and dimension in the absence of a comparable benchmark, and taking into account the potential difficulties in the current circumstances for beneficiaries to bear the amounts that might properly be charged, the fees charged for the provision of the scheme should come as close as possible to what could be considered a market price. Appropriate pricing mechanisms reflecting the varying degree of risks and the beneficiaries’ different credit profiles and needs, will be important contributions to the proportionality of the measure; — if the guarantee has to be activated, a further significant private sector contribution could consist in the coverage of at least a considerable part of the outstanding liabilities incurred by the beneficiary undertaking (if it continues to exist) or by the sector, the EFTA State’s intervention being limited to amounts exceeding this contribution; — the Authority recognizes that beneficiaries may not immediately be able to pay an appropriate remuneration in its entirety. Therefore, in order to complement or partially substitute the preceding elements, EFTA States could consider a claw back/better fortunes clause that would require beneficiaries to pay either an additional remuneration for the provision of the guarantee as such (in case it does not have to be activated) or to reimburse at least a part of any amounts paid by the EFTA State under the guarantee (in case it needs to be drawn upon) as soon as they are in a position to do so. 3.5. Avoidance of undue distortions of competition (27) Given the inherent risks that any guarantee scheme will entail negative effects on non-beneficiary banks, including those in other EEA States, the system must include appropriate mechanisms to minimize such distortions and the potential abuse of the preferential situations of beneficiaries brought about by a state guarantee. Such safeguards, which are also important to avoid moral hazard, should include an adequate combination of some or all of the following elements (10): — Behavioural constraints ensuring that beneficiary financial institutions do not engage in aggressive expansion against the background of the guarantee to the detriment of competitors not covered by such protection. This can be done, for example by: i. restrictions on commercial conduct, such as advertising invoking the guaranteed status of the beneficiary bank, on pricing or on business expansion, e.g. through the introduction of a market share ceiling (11), ii. limitations to the size of the balance-sheet of the beneficiary institutions in relation to an appropriate benchmark (e.g. gross domestic product or money market growth (12)), iii. the prohibition of conduct that would be irreconcilable with the purpose of the guarantee such as, for example, share repurchases by beneficiary financial institutions or the issuance of new stock options for management, — Appropriate provisions that enable the EFTA State concerned to enforce these behavioural constraints including the sanction of removing the guarantee protection from a beneficiary financial institution in case of non-compliance. 3.6. Follow-up by adjustment measures (28) The Authority considers that, in order to avoid distortions of competition to the maximum extent possible, a general guarantee scheme needs to be seen as a temporary emergency measure to address the acute symptoms of the current crisis in financial markets. Such measures cannot, by definition, represent a fully-fledged response to the root causes of this crisis linked to structural shortcomings in the functioning of the organization of financial markets or to specific problems of individual financial institutions or to a combination of both. (29) Therefore, a guarantee scheme needs to be accompanied, in due course, by necessary adjustment measures for the sector as a whole and/or by the restructuring or liquidation of individual beneficiaries, in particular for those for which the guarantee has to be drawn upon. 3.7. Application of the scheme to individual cases (30) Where the guarantee scheme has to be called upon for the benefit of individual financial institutions it is indispensable that this emergency rescue measure aimed to keep the insolvent institution afloat, which gives rise to an additional distortion of competition over and above that resulting from the general introduction of the scheme, is followed up as soon as the situation of the financial markets so permits, by adequate steps leading to a restructuring or liquidation of the beneficiary. This triggers the requirement of the notification of a restructuring or liquidation plan for recipients of payments under the guarantee which will be separately assessed by the Authority as to its compliance with the State aid rules (13). (31) In the assessment of a restructuring plan, the Authority will be guided by the requirements: — to ensure the restoration of long-term viability of the financial institution in question, — to ensure that aid is kept to the minimum and that there is substantial private participation to the costs of the restructuring, — to safeguard that there is no undue distortion of competition and no unjustified benefits deriving from the activation of the guarantee. (32) In this assessment, the Authority can build on the experience gathered in the application of State aid rules to financial institutions in the past, having regard to the particular features of a crisis that has reached a dimension to qualify as a serious disturbance of the economy of EEA States. (33) The Authority will also take into account the distinction between aid measures necessitated exclusively by the current bottleneck in access to liquidity in relation to an otherwise fundamentally sound financial institution, as opposed to assistance provided to beneficiaries that are additionally suffering from structural solvency problems linked for instance to their particular business model or investment strategy. In principle, assistance to the latter category of beneficiaries is likely to raise greater concerns. 4. RECAPITALISATION OF FINANCIAL INSTITUTIONS (34) A second systemic measure in response to the ongoing financial crisis would be the establishment of a recapitalisation scheme which would be used to support financial institutions that are fundamentally sound but may experience distress because of extreme conditions in financial markets. The objective would be to provide public funds so as to strengthen the capital base of the financial institutions directly or to facilitate the injection of private capital by other means, so as to prevent negative systemic spill overs. (35) In principle, the above considerations in relation to general guarantee schemes apply, mutatis mutandis, also to recapitalisation schemes. This holds true for: — objective and non-discriminatory criteria for eligibility, — the temporal scope of the scheme, — limitation of the aid to the strict necessary, — the need for safeguards against possible abuses and undue distortions of competition, bearing in mind that the irreversible nature of capital injections entails the need for provisions in the scheme which allow the EFTA State to monitor and enforce the observance of these safeguards and to take steps avoiding undue distortions of competition, where appropriate, at a later stage (14), and — the requirement for recapitalisation as an emergency measure to support the financial institution through the crisis to be followed up by a restructuring plan for the beneficiary to be separately examined by the Authority, taking into account both the distinction between fundamentally sound financial institutions solely affected by the current restrictions on access to liquidity and beneficiaries that are additionally suffering from more structural solvency problems linked for instance to their particular business model or investment strategy and the impact of that distinction on the extent of the need for restructuring. (36) The particular nature of a recapitalisation measure gives rise to the following considerations. (37) Eligibility should be based on objective criteria, such as the need to ensure a sufficient level of capitalisation with respect to the solvency requirements that do not lead to unjustified discriminatory treatment. Evaluation of the need for support by the financial supervisory authorities would be a positive element. (38) The capital injection must be limited to the minimum necessary and should not allow the beneficiary to engage in aggressive commercial strategies or expansion of its activities or other purposes that would imply undue distortions of competition. In that context the maintenance of enhanced minimum solvency requirement levels, and/or limitation to the total size of the balance sheet of the financial institution will be evaluated positively. The beneficiaries should contribute as much as possible in the light of the current crisis through their own means including private participation (15). (39) Capital interventions in financial institutions must be done on terms that minimise the amount of the aid. According to the instrument chosen (e.g. shares, warrants, subordinated capital, …) the EFTA State concerned should, in principle, receive rights, the value of which corresponds to their contribution to the recapitalisation. The issue price of new shares must be fixed on the basis of a market-oriented valuation. In order to ensure that the public support is only given in return for an appropriate counterpart, instruments such as preferred shares with adequate remuneration, will be regarded positively. Alternatively the introduction of claw back mechanisms or better fortunes clauses will have to be considered. (40) Similar considerations will apply to other measures and schemes aimed at tackling the problem from the financial institutions’ asset side, that would contribute to the strengthening of the institutions’ capital requirements. In particular, where an EFTA State buys or swaps assets this will have to be done at a valuation which reflects their underlying risks, with no undue discrimination as to the sellers. (41) The approval of the aid scheme does not exempt EFTA States from submitting a report to the Authority on the use of the scheme every six months and individual plans for the beneficiary undertakings within 6 months from the date of the intervention (16). (42) As in the case of guarantee schemes but having regard to the inherently irreversible nature of recapitalisation measures, the Authority will carry out its assessment of such plans in such a way as to ensure the coherence of the overall results of recapitalisation under the scheme with those of a recapitalisation measure taken outside such a scheme according to the principles of the R&R guidelines, taking into consideration the particular features of a systemic crisis in the financial markets. 5. CONTROLLED WINDING-UP OF FINANCIAL INSTITUTIONS (43) In the context of the current financial crisis an EFTA State may also wish to carry out a controlled winding-up of certain financial institutions in its jurisdiction. Such a controlled liquidation, possibly carried out in conjunction with a contribution of public funds, may be applied in individual cases, either as a second step, after rescue aid to an individual financial institution when it becomes clear that the latter cannot be restructured successfully, or in one single action. Controlled winding-up may also constitute an element of a general guarantee scheme, e.g. where an EFTA State undertakes to initiate liquidation of the financial institutions for which the guarantee needs to be activated. (44) Again, the assessment of such a scheme and of individual liquidation measures taken under such a scheme follows the same lines, mutatis mutandis, as set out above for guarantee schemes. (45) The particular nature of a liquidation measure gives rise to the following considerations. (46) In the context of liquidation, particular care has to be taken to minimise moral hazard, notably by excluding shareholders and possibly certain types of creditors from receiving the benefit of any aid in the context of the controlled winding-up procedure. (47) To avoid undue distortions of competition, the liquidation phase should be limited to the period strictly necessary for the orderly winding-up. As long as the beneficiary financial institution continues to operate it should not pursue any new activities, but merely continue the ongoing ones. The banking licence should be withdrawn as soon as possible. (48) In ensuring that the aid amount is kept to the minimum necessary in view of the objective pursued, it needs to be taken into account that the protection of financial stability within the current financial turmoil may imply the necessity to reimburse certain creditors of the liquidated bank through aid measures. The choice of criteria for the selection of the types of liabilities for this purpose should follow the same rules as in relation to the liabilities covered by a guarantee scheme. (49) In order to ensure that no aid is granted to the buyers of the financial institution or parts of it or to the entities sold, it is important that certain sales conditions are respected. The following criteria will be taken into account by the Authority when determining the potential existence of aid: — the sales process should be open and non-discriminatory, — the sale should take place on market terms, — the financial institution or the government, depending on the structure chosen, should maximise the sales price for the assets and liabilities involved, — in case it is necessary to grant an aid to the economic activity to be sold, this will lead to an individual examination according to the principles of the R&R guidelines. (50) Where the application of these criteria leads to the finding of aid to buyers or to sold entities, the compatibility of that aid will have to be assessed separately. 6. PROVISION OF OTHER FORMS OF LIQUIDITY ASSISTANCE (51) In dealing with acute liquidity problems of some financial institutions, EFTA States may wish to accompany guarantees or recapitalisation schemes with complementary forms of liquidity support, with the provisions of public funds (including funds from the central bank). Where an EFTA State/central bank reacts to a banking crisis not with selective measures in favour of individual banks, but with general measures open to all comparable market players in the market (e.g. lending to the whole market on equal terms), such general measures are often outside the scope of the State aid rules and do not need to be notified to the Authority. The Authority considers for instance that activities of central banks related to monetary policy, such as open market operations and standing facilities, are not caught by the State aid rules. Dedicated support to a specific financial institution may also be found not to constitute aid in specific circumstances. Following the Commission’s decision-making practice (17), the Authority considers that the provision of central banks’ funds to the financial institution in such a case may be found not to constitute aid when a number of conditions are met, such as: — the financial institution is solvent at the moment of the liquidity provision and the latter is not part of a larger aid package, — the facility is fully secured by collateral to which haircuts are applied, in function of its quality and market value, — the central bank charges a penal interest rate to the beneficiary, — the measure is taken at the central bank’s own initiative, and in particular is not backed by any counter-guarantee of the state. (52) The Authority considers that in the current exceptional circumstances a scheme of liquidity support from public sources (including the central bank) where it constitutes aid, can be found compatible, according to the principles of the R&R guidelines. Provided that the regular review of such a liquidity scheme every six months is ensured (18), the approval of the scheme may cover a period longer than six months and up to two years, in principle. It may be further extended, upon the Authority’s approval, in the event that the crisis in the financial markets so requires. 7. RAPID TREATMENT OF STATE AID INVESTIGATIONS (53) When applying the State aid rules to the measures dealt with in this Chapter in a manner that takes account of prevailing financial market conditions, the Authority, in co-operation with the EFTA States, should ensure both that they achieve their objective and that the related distortions of competition both within and between EEA States are kept to a minimum. In order to facilitate this cooperation and to provide both EFTA States and third parties with the necessary legal certainty on the compliance of the measures undertaken with the EEA Agreement (which is a significant component of restoring confidence to the markets), it is of paramount importance that EFTA States inform the Authority of their intentions and notify plans to introduce such measures as early and comprehensively as possible and in any event before the measure is implemented. The Authority is committed to ensuring the swift authorisation of aid measures upon receipt of complete notifications. (1) This Chapter corresponds to the Communication from the Commission—The application of State aid rules to measures taken in relation to financial institutions in the context of the current global financial crisis, OJ C 270 25.10.2008, p. 8. (2) The ECOFIN Council conclusions enumerate the following principles: — interventions should be timely and the support should in principle be temporary, — Member States will be watchful regarding the interests of taxpayers, — existing shareholders should bear the due consequences of the intervention, — Member States should be in a position to bring about a change of management, — the management should not retain undue benefits—governments may have inter alia the power to intervene in remuneration, — legitimate interest of competitors must be protected, in particular through the State aid rules, — negative spill-over effects should be avoided. (3) The Guidelines on aid for rescuing and restructuring firms in difficulties were adopted by the Authority with Decision No 305/04/COL of 1 December 2004. (4) Cf. in principle joined cases T-132/96 and T-143/96 Freistaat Sachsen and Volkswagen AG v Commission [1999] ECR II-3663, paragraph 167. Confirmed in Commission Decision 98/490/EC in Case C 47/96 Crédit Lyonnais (OJ L 221, 8.8.1998, p. 28), point 10.1, Commission Decision 2005/345/EC in Case C 28/02 Bankgesellschaft Berlin (OJ L 116, 4.5.2005, p. 1), points 153 et seq. and Commission Decision 2008/263/EC in Case C 50/06 BAWAG (OJ L 83, 26.3.2008, p. 7), point 166. See Commission Decision in Case NN 70/07 Northern Rock (OJ C 43, 16.2.2008, p. 1), Commission Decision in Case NN 25/08 Rescue aid to WestLB (OJ C 189, 26.7.2008, p. 3), Commission Decision of 4 June 2008 in Case C 9/08 SachsenLB, not yet published. (5) It being understood that the exact nature and timing of the restructuring to be carried out may be affected by the present turmoil in the financial markets. (6) The limitation of the amount of the guarantee available, possibly in relation to the balance sheet size of the beneficiary may also be an element safeguarding the proportionality of the scheme in this respect. (7) Such as, for example, covered bonds and debt and deposits with collateral in government bonds or covered bonds. (8) This is a non-exhaustive list of tools contributing to the objective of keeping the aid to the minimum. (9) E.g. through an association of private banks. (10) This is a non-exhaustive list of tools contributing to the objective of avoiding undue distortions of competition. (11) The retention of profits in order to ensure adequate recapitalization could also be an element to be considered in this context. (12) While safeguarding the availability of credit to the economy notably in case of recession. (13) As a matter of principle, the Authority considers that in the event of payments having to be made to beneficiary financial institution, the payment has to be followed within six months by a restructuring plan or a liquidation plan, as the case may be. In order to facilitate the work of the EFTA States and the Authority, the Authority will be prepared to examine grouped notifications of similar restructuring/liquidation cases. The Authority may consider that there is no need to submit a plan for the pure liquidation of an institution, or where the size of the institution is negligible. (14) According to the principles of the R&R guidelines. (15) The upfront provision of a certain contribution may need to be supplemented by provisions allowing the imposition of additional contributions at a later stage. (16) In order to facilitate the work of the EFTA States and the Authority, the Authority will be prepared to examine grouped notifications of similar restructuring cases. The Authority may also consider that there is no need to submit a plan relating to a pure liquidation of the institution, or where the size of the residual economic activity is negligible. (17) See for instance Northern Rock (OJ C 43, 16.2.2008, p. 1). (18) The principles set out above in point 24 would apply to this review.

ANNEX II The recapitalisation of financial institutions (1) in the current financial crisis: limitation of aid to the minimum necessary and safeguards against undue distortions of competition (2) 1. INTRODUCTION (1) The EFTA Surveillance Authority’s (hereinafter ‘the Authority’) Guidelines of 29 January 2009 on The application of State aid rules to measures taken in relation to financial institutions in the context of the current global financial crisis (3) (‘the Guidelines on financial institutions’) recognize that recapitalisation schemes are one of the key measures that EFTA States (4) can take to preserve the stability and proper functioning of financial markets. (2) The ECOFIN Council of 7 October 2008 and the Eurogroup meeting of 12 October 2008 addressed recapitalisation in a similar spirit by concluding that ‘Governments commit themselves to provide capital when needed in appropriate volume while favouring by all available means the raising of private capital. Financial institutions should be obliged to accept additional restrictions, notably to preclude possible abuse of such arrangements at the expense of non beneficiaries’, and ‘legitimate interest of competitors must be protected, in particular through the State aid rules.’ (3) Until December 2008, the Commission approved recapitalisation schemes in three Member States, as well as individual recapitalisation measures, in line with the principles laid down in the so-called Banking Communication (5). Recapitalisation, notably in the form of ordinary and preferred shares, has been authorized, subject in particular to the introduction of market-oriented remuneration rates, appropriate behavioural safeguards and regular review. However, as the nature, scope and conditions of recapitalisation schemes currently being envisaged vary considerably, both Member States and potential beneficiary institutions have called for more detailed guidance as to whether specific forms of recapitalisation would be acceptable under State aid rules. In particular, some States envisage the recapitalisation of banks, not primarily to rescue them but rather to ensure lending to the real economy. The present Guidelines provide guidance for new recapitalisation schemes and opens the possibility for adjustment of existing recapitalisation schemes. Common objectives: Restoring financial stability, ensuring lending to the real economy and dealing with the systemic risk of possible insolvency (4) In the context of the current situation in the financial markets, the recapitalisation of banks can serve a number of objectives. First, recapitalisations contribute to the restoration of financial stability and help restore the confidence needed for the recovery of inter-bank lending. Moreover, additional capital provides a cushion in recessionary times to absorb losses and limits the risk of banks becoming insolvent. Under current conditions, triggered in particular by the collapse of Lehman Brothers, fundamentally sound banks may require capital injections to respond to a widespread perception that higher capital ratios are necessary in view of the past underestimation of risk and the increased cost of funding. (5) Second, recapitalisations can have as objective to ensure lending to the real economy. Fundamentally sound banks may prefer to restrict lending in order to avoid risk and maintain higher capital ratios. State capital injection may prevent credit supply restrictions and limit the pass-on of the financial markets’ difficulties to other businesses. (6) Third, State recapitalisation may also be an appropriate response to the problems of financial institutions facing insolvency as a result of their particular business model or investment strategy. A capital injection from public sources providing emergency support to an individual bank may also help to avoid short term systemic effects of its possible insolvency. In the longer term, recapitalisation could support efforts to prepare the return of the bank in question to long term viability or its orderly winding-up. Possible competition concerns (7) With these common objectives in mind, the assessment of any recapitalisation scheme or measure must take into account possible distortions of competition at three different levels. (8) First, recapitalisation by one EFTA State of its own banks should not give those banks an undue competitive advantage over banks in other EEA Member States. Access to capital at considerably lower rates than competitors from other EEA Member States, in the absence of an appropriate risk-based justification, may have a substantial impact on the competitive position of a bank in the wider single European market. Excessive aid in one EFTA State could also prompt a subsidy race among EEA Member States and create difficulties for the economies of other States in the EEA which have not introduced recapitalisation schemes. A coherent and coordinated approach to the remuneration of public capital injections, and to the other conditions attached to recapitalisation, is indispensable to the preservation of a level playing field. Unilateral and uncoordinated action in this area may also undermine efforts to restore financial stability. (‘Ensuring fair competition within the EEA’) (9) Secondly, recapitalisation schemes which are open to all banks within an EFTA State without an appropriate degree of differentiation between beneficiary banks according to their risk profiles may give an undue advantage to distressed or less-performing banks compared to banks which are fundamentally sound and better-performing. This will distort competition on the market, distort incentives, increase moral hazard and weaken the overall competitiveness of European banks (‘Ensuring fair competition between banks’) (10) Thirdly, public recapitalisation, in particular its remuneration, should not have the effect of putting banks that do not have recourse to public funding, but seek additional capital on the market, in a significantly less competitive position. A public scheme which crowds out market-based operations will frustrate the return to normal market functioning. (‘Ensuring a return to normal market functioning’) (11) Any proposed recapitalisation has cumulative competitive effects at each of these three levels. However, a balance must be struck between these competition concerns and the objectives of restoring financial stability, ensuring lending to the real economy and dealing with the risk of insolvency. On the one hand, banks must have sufficiently favourable terms of access to capital in order to make the recapitalisation as effective as necessary. On the other hand, the conditions tied to any recapitalisation measure should ensure a level playing field and, in the longer-term, a return to normal market conditions. State interventions should therefore be proportionate and temporary and should be designed in a way that provides incentives for banks to redeem the State as soon as market circumstances permit, in order for a competitive and efficient European banking sector to emerge from the crisis. Market-oriented pricing of capital injections would be the best safeguard against unjustified disparities in the level of capitalisation and improper use of such capital. In all cases, EFTA States should ensure that any recapitalisation of a bank is based on genuine need. (12) The balance to be achieved between financial stability and competition objectives underlines the importance of the distinction between fundamentally sound, well-performing banks on one hand and distressed, less-performing banks on the other. (13) In its assessment of recapitalisation measures, whether in the form of schemes or support to individual banks, the Authority will therefore pay particular attention to the risk profile of the beneficiaries (6). In principle, banks with a higher risk profile should pay more. In designing recapitalisation schemes open to a set of different banks, EFTA States should carefully consider the entry criteria and the treatment of banks with different risk profiles and differentiate in their treatment accordingly (see Annex 1). Account needs to be taken of the situation of banks which face difficulties due to the current exceptional circumstances, although they would have been regarded as fundamentally sound before the crisis. (14) In addition to indicators such as compliance with regulatory solvency requirements and prospective capital adequacy as certified by the national supervisory authorities, pre-crisis CDS spreads and ratings should, for example, be a good basis for differentiation of remuneration rates for different banks. Current spreads may also reflect inherent risks which will weaken the competitive situation of some banks as they come out of the general crisis conditions. Pre-crisis and current spreads should in any event reflect the burden, if any, of toxic assets and/or the weakness of the bank’s business model due to factors such as overdependence on short-term financing or abnormal leverage. (15) It may be necessary, in duly justified cases, to accept lower remuneration in the short term for distressed banks, on the assumption and condition that in the longer term the costs of public intervention in their favour will be reflected in the restructuring necessary to restore viability and to take account of the competitive impact of the support given to them in compensatory measures. Financially sound banks may be entitled to relatively low rates of entry to any recapitalisation, and correspondingly significantly reduced conditions on public support in the longer term, provided that they accept terms on the redemption or conversion of the instruments so as to retain the temporary nature of the State’s involvement, and its objective of restoring financial stability/lending to the economy, and the need to avoid abuse of the funds for wider strategic purposes. Recommendations of the Governing Council of the European Central Bank (ECB) (16) In the Recommendations of its Governing Council of 20 November 2008, the European Central Bank proposed a methodology for benchmarking the pricing of State recapitalisation measures for fundamentally sound institutions in the Euro area. The guiding considerations underlying these Recommendations fully reflect the principles set out in this introduction. In line with its specific tasks and responsibilities, the ECB placed particular emphasis on the effectiveness of recapitalisation measures with a view to strengthening financial stability and fostering the undisturbed flow of credit to the real economy. At the same time, it underlined the need for market-oriented pricing, including the specific risk of the individual beneficiary banks and the need to preserve a level playing field between competing banks. (17) Although the EFTA States are not members of the ECB, the Authority welcomes its Recommendations which propose a pricing scheme for capital injections based on a corridor for rates of return for beneficiary banks which, notwithstanding variations in their risk profile, are fundamentally sound financial institutions. This document aims to extend guidance to conditions other than remuneration rates and to the terms under which banks which are not fundamentally sound may have access to public capital. (18) In addition, while acknowledging that the current exceptional market rates do not constitute a reasonable benchmark for determining the correct level of remuneration of capital, the Authority is of the view that recapitalisation measures by EFTA States should take into account the underestimation of risk in the pre-crisis period. Without this, public remuneration rates could give undue competitive advantages to beneficiaries and eventually lead to the crowding out of private recapitalisation. 2. PRINCIPLES GOVERNING DIFFERENT TYPES OF RECAPITALISATION (19) Closeness of pricing to market prices is the best guarantee to limit competition distortions (7). It follows that the design of recapitalisation should be determined in a way that takes the market situation of each institution into account, including its current risk profile and level of solvency, and maintains a level playing field by not providing too large a subsidy in comparison to current market alternatives. In addition, pricing conditions should provide an incentive for the bank to redeem the State as soon as the crisis is over. (20) These principles translate into the assessment of the following elements of the overall design of recapitalisation measures: objective of recapitalisation, soundness of the beneficiary bank, remuneration, exit incentives, in particular with a view to the replacement of state capital by private investors (8), to ensure the temporary nature of the State’s presence in banks’ capital, safeguards against abuse of aid and competition distortions, and the review of the effects of the recapitalisation scheme and the beneficiaries’ situation through regular reports or restructuring plans where appropriate. 2.1. Recapitalisations at current market rates (21) Where state capital injections are on equal terms with significant participation (30 % or more) of private investors, the Authority will accept the remuneration set in the deal (9). In view of the limited competition concerns raised by such an operation, unless the terms of the deal are such as to significantly alter the incentives of private investors, in principle there does not appear to be any need for ex ante competition safeguards or exit incentives. 2.2. Temporary recapitalisations of fundamentally sound banks in order to foster financial stability and lending to the real economy (22) In evaluating the treatment of banks in this category, the Authority will place considerable weight on the distinction between fundamentally sound and other banks which has been discussed in paragraphs 12 to 15. (23) An overall remuneration needs to adequately factor in the following elements: (a) Current risk profile of each beneficiary (10); (b) Characteristics of the instrument chosen, including its level of subordination; risk and all modalities of payment (11); (c) Built-in incentives for exit (such as step-up and redemption clauses); (d) Appropriate benchmark risk-free rate of interest. (24) The remuneration for state recapitalisations cannot be as high as current market levels (about 15 %) (12) since these may not necessarily reflect what could be considered as normal market conditions (13). Consequently, the Authority is prepared to accept the price for recapitalisations of fundamentally sound banks at rates below current market rates, in order to facilitate banks to avail themselves of such instruments and to thereby favour the restoration of financial stability and ensuring lending to the real economy. (25) At the same time, the total expected return on recapitalisation to the State should not be too distant from current market prices because (i) it should avoid the pre-crisis under-pricing of risk, (ii) it needs to reflect the uncertainty about the timing and level of a new price equilibrium, (iii) it needs to provide incentives for exiting the scheme and (iv) it needs to minimise the risk of competition distortions between EEA States, as well as between those banks which raise capital on the market today without any State aid. A remuneration rate not too distant from current market prices is essential to avoid crowding out recapitalisation via the private sector and facilitating the return to normal market conditions. Entry level price for recapitalisations (26) In the ‘Recapitalisation Communication’ (14), the Commission described methods to determine the entry level price for recapitalisations. The Authority will apply the methods described below in a similar manner, taking into account that the EFTA States are outside the Eurosystem. The Commission considers that an adequate method to determine the price of recapitalisations is provided by the Eurosystem recommendations of 20 November 2008. The remunerations calculated using this methodology represent in the view of the Eurosystem an appropriate basis (entry level) for the required nominal rate of return for the recapitalisation of fundamentally sound banks. This price may be adjusted upwards to account for the need to encourage the redemption of state capital (15). The Commission considers that such adjustments will also serve the objective of protecting undistorted competition. (27) In line with the Eurosystem recommendations, the required rate of return by the government on recapitalisation instruments for fundamentally sound banks—preferred shares and other hybrid instruments—could be determined on the basis of a ‘price corridor’ defined by: (i) the required rate of return on subordinated debt representing a lower bound, and (ii) the required rate of return on ordinary shares representing an upper bound. This methodology involves the calculation of a price corridor on the basis of different components, which should also reflect the specific features of individual institutions (or sets of similar institutions) and of EFTA States. The Commission has established that the application of the methodology by using average (mean or median) values of the relevant parameters (government bond yields, CDS spreads, equity risk premium) determines a corridor with an average required rate of return of 7 % on preferred shares with features similar to those of subordinated debt and an average required rate of return of 9,3 % on ordinary shares relating to Euro area banks. As such, this average price corridor represents an indicative range. (28) The Authority will accept a minimum remuneration based on the above methodology for fundamentally sound banks. This remuneration is differentiated at the level of an individual bank on the basis of different parameters: (a) the type of capital chosen (16): the lower the subordination, the lower the required remuneration in the price corridor; (b) appropriate benchmark risk-free interest rate; (c) the individual risk profile at national level of all eligible financial institutions, (including both financially sound and distressed banks). (29) EFTA States may choose a pricing formula that in addition includes step-up or payback clauses. Such features should be appropriately chosen so that, while encouraging an early end to the State’s capital support of banks, they should not result in an excessive increase in the cost of capital. (30) The Authority will also accept alternative pricing methodologies, provided they lead to remunerations that are higher than the above methodology. Incentives for State capital redemption (31) Recapitalisation measures need to contain appropriate incentives for state capital to be redeemed when the market so allows (17). The simplest way to provide an incentive for banks to look for alternative capital is for EFTA States to require an adequately high remuneration for the state recapitalisation. For that reason, the Authority considers it useful that an add-on be generally added to the entry price determined (18) to incentivise exit. A pricing structure including increase over time and step-up clauses will reinforce this mechanism to incentivise exit. (32) If an EFTA State prefers not to increase the nominal rate of remuneration, it may consider increasing the global remuneration through call options or other redemption clauses, or mechanisms that encourage private capital raising, for instance by linking the payment of dividends to an obligatory remuneration of the State which increases over time. (33) EFTA States may also consider using a restrictive dividend policy to ensure the temporary character of state intervention. A restrictive dividend policy would be coherent with the objective of safeguarding lending to the real economy and strengthening the capital basis of beneficiary banks. At the same time, it would be important to allow for dividend payment where this represents an incentive to provide new private equity to fundamentally sound banks (19). (34) The Authority will assess proposed exit mechanisms on a case-by-case basis. In general, the higher the size of the recapitalization and the higher the risk profile of the beneficiary bank, the more necessary it becomes to set out a clear exit mechanism. The combination of the level and type of remuneration and, where and to the extent appropriate, a restrictive dividend policy, needs to represent, in its entirety, a sufficient exit incentive for the beneficiary banks. The Authority considers, in particular, that restrictions on payment of dividends are not needed where the level of pricing correctly reflects the banks’ risk profile, and step-up clauses or comparable elements provide sufficient incentives for exit and the recapitalisation is limited in size. Prevention of undue distortions of competition (35) The Guidelines on financial institutions stresses, in point 35, the need for safeguards against possible abuses and distortions of competition in recapitalisation schemes. Point 38 of the Guidelines on financial institutions requires capital injections to be limited to the minimum necessary and not to allow the beneficiary to engage in aggressive commercial strategies which would be incompatible with the underlying objectives of recapitalisation (20). (36) As a general principle, the higher the remuneration the less there is a need for safeguards, as the level of price will limit distortions of competition. Banks receiving state recapitalisation should also avoid advertising it for commercial purposes. (37) Safeguards may be necessary to prevent aggressive commercial expansion financed by State aid. In principle, mergers and acquisitions can constitute a valuable contribution to the consolidation of the banking industry with a view to achieving the objectives of stabilising financial markets and ensuring a steady flow of credit to the real economy. In order not to privilege those institutions with public support to the detriment of competitors without such support, mergers and acquisitions should generally be organised on the basis of a competitive tendering process. (38) The extent of behavioural safeguards will be based on a proportionality assessment, taking into account all relevant factors and, in particular, the risk profile of the beneficiary bank. While banks with a very low risk profile may require only very limited behavioural safeguards, the need for such safeguards increases with a higher risk profile. The proportionality assessment is further influenced by the relative size of the capital injection by the State and the reached level of capital endowment. (39) When EFTA States use recapitalisation with the objective of financing the real economy, they have to ensure that the aid effectively contributes to this. To that end, in accordance with national regulation, they should attach effective and enforceable national safeguards to recapitalisation which ensure that the injected capital is used to sustain lending to the real economy. Review (40) In addition, as indicated in the Guidelines on financial institutions (21), recapitalisations should be subject to regular review. Six months after their introduction, EFTA States should submit a report to the Authority on the implementation of the measures taken. The report needs to provide complete information on: (a) the banks that have been recapitalised, including in relation to the elements identified in point 12 to 15, Annex 1, and an assessment of the bank’ business model, with a view to appreciating the banks’ risk profile and viability; (b) the amounts received by those banks and the terms on which recapitalisation has taken place; (c) the use of the capital received, including in relation to (i) the sustained lending to the real economy and (ii) external growth and (iii) the dividend policy of beneficiary banks; (d) the compliance with the commitments made by EFTA States in relation to exit incentives and other conditions and safeguards; and (e) the path towards exit from reliance on State capital (22). (41) In the context of the review, the Authority will assess, amongst others, the need for the continuation of behavioural safeguards. Depending on the evolution of market conditions, it may also request a revision of the safeguards accompanying the measures in order to ensure that aid is limited to the minimum amount and minimum duration necessary to weather the current crisis. (42) The Authority recalls that where a bank that was initially considered fundamentally sound falls into difficulties after recapitalisation has taken place, a restructuring plan for that bank must be notified. 2.3. Rescue recapitalisations of other banks (43) The recapitalisation of banks which are not fundamentally sound should be subject to stricter requirements. (44) As far as remuneration is concerned, as set out above, it should in principle reflect the risk profile of the beneficiary and be higher than for fundamentally sound banks (23). This is without prejudice to the possibility for supervisory authorities to take urgent action where necessary in cases of restructuring. Where the price cannot be set to levels that correspond to the risk profile of the bank, it would nevertheless need to be close to that required for a similar bank under normal market conditions. Notwithstanding the need to ensure financial stability, the use of State capital for these banks can only be accepted on the condition of either a bank’s winding-up or a thorough and far-reaching restructuring, including a change in management and corporate governance where appropriate. Therefore, either a comprehensive restructuring plan or a liquidation plan will have to be presented for these banks within six months of recapitalisation. As indicated in the Guidelines on financial institutions, such a plan will be assessed according to the principles of the rescue and restructuring guidelines for firms in difficulties, and will have to include compensatory measures. (45) Until redemption of the State, behavioural safeguards for distressed banks in the rescue and restructuring phases should, in principle, include: a restrictive policy on dividends (including a ban on dividends at least during the restructuring period), limitation of executive remuneration or the distribution of bonuses, an obligation to restore and maintain an increased level of the solvency ratio compatible with the objective of financial stability, and a timetable for redemption of state participation. 2.4. Final remarks (46) Finally, the Authority takes into account the possibility that banks’ participation in recapitalisation operations is open to all or a good portion of banks in a given EFTA State, also on a less differentiated basis, and aimed at achieving an appropriate overall return over time. Some EFTA States may prefer, for reasons of administrative convenience for instance, to use less elaborated methods. Without prejudice to the possibility for EFTA States to base their pricing on the methodology above, the Authority will accept pricing mechanisms leading to a level of a total expected annualised return for all banks participating in a scheme sufficiently high to cater for the variety of banks and the incentive to exit. This level should normally be set above the upper bound referred to in paragraph 27 for Tier 1 capital instruments (24). This can include a lower entry price and an appropriate step-up, as well as other differentiation elements and safeguards as described above (25). (1) For the convenience of the reader, financial institutions are referred to simply as ‘banks’ in this document. (2) These Guidelines correspond to the Commission’s Communication ‘The recapitalisation of financial institutions in the current financial crisis: limitation of aid to the minimum necessary and safeguards against undue distortions of competition.’, issued on 5 December 2008 (C(2008) 8259 final), hereinafter ‘the Recapitalisation Communication’. (3) These Guidelines correspond to the Commission’s Communication on ‘The application of State aid rules to measures’ taken in relation to financial institutions in the context of the current global financial crisis, published in the OJ C 270, 25.10.2008, p. 8. (4) In these Guidelines the EFTA States refers to Norway, Iceland and Liechtenstein. (5) See Commission decision of 13 October 2008 in case N 507/2008 Financial Support Measures to the banking Industry in the UK (OJ C 290, 13.11.2008, p. 4), Commission decision of 27 October 2008 in case N 512/2008 Support measures for financial institutions in Germany (OJ C 293, 15.11.2008, p. 2) and Commission decision of 19 November 2008 in case N 560/2008 Support measures for the credit institutions in Greece, Commission decision of 12 November 2008 in case N 528/2008 the Netherlands, Aid to ING Groep N.V, Commission decision of 25 November 2008 in case NN 68/2008 on Latvian State support to JSC Parex Banka. (6) See Annex 1 for more details. (7) See point 39 of the Guidelines on financial institutions. (8) All the references to exit incentives or incentives to redeem the State in this document have to be understood as aiming at the replacement of State capital by private capital to the extent necessary and appropriate in the context of a return to normal market conditions. (9) See for example Commission decision of 27 October 2008 in case N 512/2008 Support measures for financial institutions in Germany, point 54. (10) See Annex 1 for more details. (11) For example, a number of parameters increase or decrease the value of preferred shares, depending on their exact definition, such as: convertibility into ordinary shares or other instruments, cumulative or non-cumulative dividends, fixed or adjustable dividend rate, liquidation preference before ordinary shares, participation or not in earnings above dividend rate paid to ordinary shares, put option, redemption clauses, voting rights. The Authority will use the general classification of capital instrument among the different regulatory categories as a benchmark (e.g. core/non core, Tier 1/Tier 2). (12) Reference is made to Commission Communication on the recapitalisation of financial institutions in the current financial crisis, footnote 10. (13) Current levels of remuneration may also reflect present relatively high demand for Tier 1 capital, as banks move away from what is now perceived as the undercapitalised business model of the past, combined with relatively small supply and high market volatility. (14) See footnote 2, paragraphs 26 and following. (15) See points 5 to 7 of the ECB Governing Council recommendations on the pricing of recapitalisations of 20 November 2008. (16) Such as ordinary shares, non-core Tier 1 capital, or Tier 2 capital. (17) Taking into account the type of recapitalisation instrument and its classification by supervisory authorities. (18) This is all the more important as the method presented above may be affected by under pricing of risk before the crisis. (19) Taking into account these considerations, restrictions on the payment of dividends could for example be limited in time or to a percentage of the generated profits, or linked to the contribution of new capital, (for example by paying out dividends in the form of new shares). Where the redemption of the State is likely to occur in several steps, it could also be envisaged to foresee the gradual relaxation on any restriction on dividends in tune with the progress of redemption. (20) Given the objectives of ensuring lending to the real economy, balance sheet growth restrictions are not necessary in recapitalisation schemes of fundamentally sound banks. This should in principle apply also to guarantee schemes, unless there is a serious risk of displacement of capital flows between EEA Member States. (21) See points 34 to 42 of the Guidelines on financial institutions. In line with the Guidelines on financial institutions, individual recapitalisation measures taken in conformity with a recapitalisation scheme approved by the Authority do not require notification and will be assessed by the EFTA Surveillance Authority in the context of the review and the presentation of a viability plan. (22) Taking into account the characteristics of the recapitalisation instrument. (23) See paragraph 28 on the extended price corridor implying increased rates of remuneration for distressed banks. (24) The Commission has so far accepted recapitalisation measures with a total expected annualised return of at least 10 % for Tier 1 instruments for all banks participating in a scheme. For EEA States with risk-free rates of return significantly divergent from the Eurozone average such a level may need to be adapted accordingly. Adjustments will also be necessary in function of developments of the risk-free rates. (25) See, as an example of a combination of a low entry price with such differentiation elements, the Commission decision of 12 November 2008 in case N 528/2008 the Netherlands, Aid to ING Groep N.V where for the remuneration of a sui generis capital instrument categorized as core Tier 1 capital a fixed coupon (8,5 %) is coupled with over-proportionate and increasing coupon payments and a possible upside, which results in an expected annualised return in excess of 10 %. ANNEX 1 Pricing of equity Equity (ordinary shares, common shares) is the best known form of core Tier 1 capital. Ordinary shares are remunerated by uncertain future dividend payments and the increase of the share price (capital gain/loss), both of which ultimately depend on the expectations of future cash flows/profits. In the current situation, a forecast of future cash flows is even more difficult than under normal conditions. The most noticeable factor, therefore, is the quoted market price of ordinary shares. For non-quoted banks, as there is no quoted share price, EFTA States should come to an appropriate market-based approach, such as full valuation. If assistance is given in the issuance of ordinary shares (underwriting), any shares not taken up by existing or new investors will be taken up by the EFTA State as underwriter at the lowest possible price compared to the share price immediately prior to the announcement of placing an open offer. An adequate underwriting fee should also be payable by the issuing institution (1). The Authority will take into account the influence that previously received State aid may have on the share price of the beneficiary. Indicators for the assessment of a bank's risk profile In evaluating a bank's risk profile for the purpose of the appreciation of a recapitalisation measure under State aid rules, the Authority will take into account the bank's position in particular with respect to the following indicators: (a) Capital adequacy: The Authority will value positively the assessment of the bank's solvency and its prospective capital adequacy as a result of a review by the national supervisory authority; such a review will evaluate the bank's exposure to various risks (such as credit risk, liquidity risk, market risk, interest rate and exchange rate risks), the quality of the asset portfolio (within the national market and in comparison with available international standards), the sustainability of its business model in the long term and other pertinent elements; (b) Size of the recapitalisation: The Authority will value positively a recapitalisation limited in size, such as for instance no more than 2 % of the bank's risk weighted assets; (c) Current CDS spreads: The Authority will consider a spread equal or inferior to the average as an indicator of a lower risk profile; (d) Current rating of the bank and its outlook: The Authority will consider a rating of A or above and a stable or positive outlook as an indicator of a lower risk profile. In the evaluation of these indicators, account needs to be taken of the situation of banks which face difficulties due to the current exceptional circumstances, although they would have been regarded as fundamentally sound before the crisis, as shown, for instance, by the evolution of market indicators such as CDS spreads and share prices. Table 1 Types of capital (1) See for example, Commission decision of 13 October 2008 in case N 507/2008 Financial Support Measures to the banking Industry in the UK, at point 11, Commission decision of 27 October 2008 in case N 512/2008 Support measures for financial institutions in Germany, at point 12.