Invitation to submit comments pursuant to Article 1(2) in Part I of Protocol 3 to the Surveillance and Court Agreement concerning aid measure — State guarantee in favour of deCODE Genetics in relation to the establishment of a drug development department (SAM 030.02.006 — Iceland)
Date: 2003-12-18
Institutions: EFTA Surveillance Authority
Subjects: EFTA Court, Iceland, State aid, control of State aid, medicinal product

C 308/22

EN

Official Journal of the European Union

18.12.2003

EFTA SURVEILLANCE AUTHORITY

Invitation to submit comments pursuant to Article 1(2) in Part I of Protocol 3 to the Surveillance
and Court Agreement concerning aid measure — State guarantee in favour of deCODE Genetics in
relation to the establishment of a drug development department (SAM 030.02.006 — Iceland)

(2003/C 308/09)

By means of Decision 139/03/COL of 16 July 2003, reproduced in the authentic language on the pages
following this summary, the EFTA Surveillance Authority initiated proceedings pursuant to Article 1(2) of
Protocol 3 of the Surveillance and Court Agreement concerning the above mentioned aid measure. The
Icelandic Government has been informed by means of a copy of the decision.

The EFTA Surveillance Authority hereby gives the EFTA States, EU Member States and interested parties
notice to submit their comments on the measure in question within one month from the publication of
this notice to:

EFTA Surveillance Authority
Rue de Trèves/Trierstraat 74
B-1040 Brussels

The comments will be communicated to the Government of Iceland. Confidential treatment of the identity
of the interested party submitting the comments may be requested in writing, stating the reasons for the
request.

SUMMARY

Procedure

the Icelandic Government
By letter dated 27 May 2002,
notified, pursuant
to Article 1(3) of Protocol 3 to the
Surveillance and Court Agreement, a proposal to provide a
guarantee to deCODE Genetics Inc. (US) in connection with
a research and development project which the company
intends to undertake in the field of biotechnology in Iceland.

In the course of the investigation, the Icelandic Government
submitted an expert report on the estimation of the net grant
equivalent of the planned aid and informed the Authority that
the Icelandic Government had decided to request deCODE
Genetics Inc. (US) to pay an annual guarantee fee amounting
to [. . .] (*) % of the nominal value of the bonds.

In September 2002, the Authority received a complaint against
the proposed State aid in favour of deCODE Genetics. The
complainant
guarantee
constituted incompatible State aid. The complainant argued,

the proposed State

argued that

(*) Business secret — deleted figures.

in particular, that the project would have to be qualified as
‘pre-competitive development’. As
the proposed aid
granted for the notified project would exceed the permissible
aid ceiling of 25 % of eligible costs. The complainant inter alia
also claimed that due to recent development within the
company, it was unlikely that the proposed State aid would
contribute to the European industry's competitiveness.

such,

In December 2002, the Authority awarded a contract to an
external expert, concerning the evaluation of the notified R & D
the R & D Guidelines. The external expert
project under
delivered his final report on 10 April 2003.

In a letter dated 9 May 2003, the Authority informed the
Icelandic Government of its doubts concerning the compati-
bility of the notified aid for R & D projects which had not been
clearly identified. It also informed the Icelandic Government
sufficiently precise information
that, due to the lack of
regarding the individual R & D projects,
the Authority was
not in a position to verify that the proposed State aid would
be in compliance with Article 61(3)(c) of the EEA Agreement,
in combination with the R & D Guidelines.

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Description of the aid measure — State guarantee

In May 2002, the Icelandic Parliament authorised the Ministry
of Finance to issue a guarantee to deCODE Genetics Inc. (US)
in relation to a bond amounting to USD 200 million. DeCODE
is a population genetics company working to identify the
genetic causes of common human diseases and to apply this
knowledge to discover novel means of treating, diagnosing and
preventing disease. DeCODE also provides drug discovery
typically major pharmaceutical or
services to third parties,
biotechnology companies. The proceeds of the bond would
be passed down to deCODE's wholly owned subsidiary,
deCODE erfðagreining ehf., located in Reykjavik and then be
utilised to establish a new department
for developing bio-
pharmaceutical products in Iceland.

The Icelandic authorities informed the Authority about the
main characteristics of
the bond and the State guarantee.
However, the terms of the bond, as well as the terms under
which the State guarantee would be issued, would only be
finally fixed after the Authority had approved the aid. The
Icelandic authorities informed the Authority that contrary to
what was initially notified, the bond would have a duration of
five years (instead of the initially foreseen seven years). The
bond could be converted into deCODE stock in the event
In
that
the
addition, deCODE would have the right
conversion price.
If the bonds were converted into stocks,
they would be regarded as paid up and the State guarantee
would lapse.

the shares would exceed USD 18.

the price of

to reduce

the price of

the time the proposed guarantee was notified to the
At
Authority,
the company's stocks was in the
range of USD 5 per share. Since then, the share price havs
fallen to below USD 2 per share and they are currently traded
at around USD 3.5 per share.

The R & D project, the financing of which should be secured
through the notified State guarantee, consists of the estab-
lishment of a new drug development department based on
research carried out by deCODE in population genomics and
genealogy-based genetic research.

DeCODE uses population genomics to discover how genetic
factors contribute to the cause of diseases. DeCODE's access
to an extensive genealogical database and associated bioin-
formatics is the core of DeCODE's approach to identifying
human disease genes and associated drug targets. deCODE
hopes that working with the Icelandic population puts it in a
position to accelerate the discovery and development of new
proprietary diagnostic and therapeutic products.

to the

According
information submitted, deCODE has
successfully isolated genes related to specific diseases [. . .].
For certain drug targets, deCODE has concluded collaborative

in relation to
agreements with pharmaceutical companies
several of the disease genes discovered. DeCODE now wishes
to develop a portfolio of drug targets for in-house drug devel-
opment based on the results from its genetic research.

The R & D activities covered by the notified State support
‘target validation’ and ‘drug development’. The
consist of
Icelandic authorities explained that after a drug target for a
specific disease has been identified, the fundamental research
under the current project would start. Once deCODE succeeded
in identifying a disease gene it would conduct fundamental
research within the scope of the proposed project to define
molecular pathways in which the disease gene plays a role.
In the next phase of
the project, drug development really
begins. During this phase, research is carried out to identify
the drug leads (i.e. work on the initial chemicals which have
been identified during the screening assays phase and which
showed positive results in acting against the drug target).

Appreciation of the aid

According to an evaluation carried out by the expert in July
2002 on behalf of the Icelandic State, the State guarantee
would allow deCODE to borrow money on the market at
conditions more favourable than without the proposed State
guarantee. The Authority considers that it is reasonable to
the State guarantee would give deCODE a
assume that
financial benefit and strengthen deCODE's position in relation
to its competitors within the EEA. Consequently, the proposed
State guarantee is liable to distort competition and affect trade
between the Contracting Parties within the meaning of Article
61(1) EEA Agreement.

According to the Icelandic Government, the proposed State
guarantee would be compatible under Article 61(3)(b) of the
EEA Agreement, according to which ‘aid to promote the
execution of an important project of common European
interest’ may be considered to be compatible with the func-
tioning of the EEA Agreement. According to relevant practice
of
this derogation may apply
particularly to ‘transnational projects of major qualitative and,
in principle, quantitative significance’. Since the proposed State
aid would benefit only the establishment of a drug devel-
opment department by deCODE, the Authority has doubts as
to whether the notified aid can be regarded as compatible with
Article 61(3)(b) of the EEA Agreement.

the European Commission,

The Authority has then assessed the aid according to Article
61(3)(c) of the EEA Agreement in conjunction with Chapter 14
of the Authority's State Aid Guidelines.
In line with point
14.2.1(1), 14.5.1 and 14.7 the Authority needs to assess the
scope and nature of the research activity, the aid intensity and
the incentive effect of the aid.

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Proposed State aid for specific R & D projects

The Authority has doubts as regards to the exact number of
target validation and drug discovery programmes which would
be carried out by deCODE under the R & D project for which
State support is sought.

According to the information submitted to the Authority,
taken a decision on which specific drug
deCODE has not
targets would be included in the project
for which State
support is sought. Given the lack of a decision on the part
of deCODE as well as the Icelandic authorities on which
specific R & D projects would be carried out, the Authority is
not in a position to ascertain that the proposed State aid would
be used to carry out a specific R & D project. The Authority
cannot therefore exclude that the proposed State aid could be
used by deCODE to cover running expenses with respect to the
establishment of a drug development department. Any such aid
not linked to a specific R & D project bears the risk of consti-
tuting operating aid.

The Authority has doubts as to whether State aid may be
approved with respect to R & D programmes which have not
been clearly identified as being included in the project (with
explicit reference to disease targets) and which may only later
materialise (possibly years after the request for State support
was submitted) and then be possibly included in the overall
R & D project.
In addition, the Authority has doubts as to
whether deCODE is willing and capable of carrying out the
R & D programmes (as regards both target validation and
drug discovery) which have been identified by the Icelandic
authorities as being candidates for drug development under
the envisaged research project.

As regards target validation, the Icelandic authorities submitted
that this can only start after a disease gene has been identified.
Disease genes with respect to which target validation work
should be carried out, have, however, only been established
for a certain number of diseases. The Authority has doubts
as to whether target validation could be carried out with
respect to diseases for which the disease genes have not yet
been identified and whether the costs related to this work can
be determined without having identified the disease gene.

As regards the drug discovery programmes, the Authority has
doubts as to whether deCODE would actually carry out drug
discovery with respect
to all drug discovery programmes
identified by the Icelandic authorities.

Incentive effect

Based on the information in the Authority's possession, and in
light of
the
Authority currently sees no reason to question the incentive
effect of the proposed Sate aid.

the evaluation made by the external expert,

indicates that

of research activity which is described in general terms will
actually be carried out with respect
to individual disease
programmes. The information submitted by the Icelandic auth-
orities rather
the
research activities may differ quite significantly, depending on
the disease target in question. Consequently, in the absence of
an individualised work plan for a specific programme,
the
Authority is not in a position to clearly identify the eligible
costs.

the nature and scope of

Permissible aid ceilings

individual R & D programmes,

Given the absence of verifiable information concerning the
is not
eligible costs for
possible for the Authority to ascertain that
the proposed
State aid respects the permissible aid ceilings. The various
concerns expressed above rather indicate that the proposed
State aid would exceed the permissible aid intensities.

it

Conclusions

The aid proposed for the project constitutes aid within the
meaning of Article 61(1) of
the EEA Agreement. The
Authority has doubts as to whether the notified aid may be
regarded as compatible with the functioning of
the EEA
Agreement, and in particular Article 61(3)(c), because the
information submitted by the Icelandic authorities does not
demonstrate that the conditions set out in Chapter 14 of the
Authority's State Aid Guidelines are fulfilled.

Consequently, and in accordance with Chapter 5.2 of
the
Authority's State Aid Guidelines, the Authority is obliged to
open the formal investigation procedure provided for in Article
1(2) of Protocol 3 to the Surveillance and Court Agreement
against the proposed State aid in the form of a guarantee in
favour of deCODE Genetics Inc.

I. FACTS

A. Procedure

Notification by the Icelandic Government

By letter from the Ministry of Finance dated 27 May 2002,
received and registered by the Authority on 30 May 2002
(Doc. No 02-4055-A),
the Icelandic Government notified,
pursuant to Article 1(3) of Protocol 3 to the Surveillance and
to provide a guarantee to
Court Agreement, a proposal
in connection with a research
deCODE Genetics Inc.
and development project which the company intends
to
undertake in the field of biotechnology in Iceland.

(US)

Eligible costs

In the absence of more detailed information, the Authority
cannot verify whether it is reasonable to expect that the kind

By letter dated 24 July 2002, the Authority acknowledged
receipt of the notification and requested additional information
to be submitted within one month from receipt of that letter
(Doc. No 02-5620-D).

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C 308/25

By letter from the Ministry of Finance dated 13 August 2002,
received and registered by the Authority on 19 August 2002
(Doc. No 02-6060-A), the Icelandic Government submitted a
report on the estimation of the net grant equivalent of the
planned aid (hereinafter referred to as the ‘[. . .] (**) Report’)
and informed the Authority that the Icelandic Government
had decided to request deCODE Genetics Inc. (US) to pay an
annual guarantee fee amounting to [. . .] % of the nominal
value of the bonds.

The Authority acknowledged receipt of this information by
letter dated 22 August 2002 (Doc. No 02-6078-D).

After several requests for an extension of the deadline (cf. letter
from the Ministry of Finance dated 6 September 2002, received
and registered by the Authority on 10 September 2002 (Doc.
No 02-6456-A); letter from the Ministry of Finance dated 4
October 2002, received and registered by the Authority on 7
from the
October 2002 (Doc. No 02-7176-A) and letter
Ministry of Finance dated 17 October 2002, received and
registered by the Authority on 18 October 2002 (Doc. No
02-7574-A)),
responded to the
questions raised in the Authority's letter of 24 July 2002, by
letter from the Ministry of Finance dated 30 October 2002,
received and registered by the Authority on 31 October 2002
(Doc. No 02-7905-A) and the letter from the Icelandic Mission
received and registered by the
dated 8 November 2002,
In
Authority on that
addition, the Authority was informed of certain amendments
to the initial notification.

same day (Doc. No 02-8063-A).

the Icelandic Government

By letter dated 25 November 2002 (Doc. No 02-8459-D), the
Authority acknowledged receipt of this information.
In this
letter, the Authority informed the Icelandic Government that
the notification could not be regarded as complete since the
final terms for the guarantee, the convertible bonds and the
security arrangements, were not then available. The Authority
that
further
it would
informed the Icelandic Government
engage an external expert in order to assess,
inter alia, the
qualification of the nature of the project, the suitability of
the project's budget, as well as the State aid's incentive effect
the
for the project
Authority's State Aid Guidelines (‘R & D Guidelines’).

in question in light of Chapter 14 of

In December 2002, the Authority awarded a contract to an
external expert concerning the evaluation of the notified R & D
project under the R & D Guidelines.

In February 2002,
the external expert submitted his draft
report. The expert's statements revealed the need for further
information.

By letter dated 10 February 2003 (Doc. No 03-808-D), the
to submit
Authority requested the Icelandic Government
additional
information. The Icelandic Government responded
to this request by letter dated 10 March 2003, received and
registered by the Authority on that same day (Doc. No
03-1443-A).

The external expert delivered his final report on 10 April 2003.

In a letter dated 9 May 2003 (Doc. No 03-2990-D),
the
Authority informed the Icelandic Government of its doubts

the notified aid for R & D
concerning the compatibility of
projects which had not been clearly identified.
It also
informed the Icelandic Government that, due to the lack of
sufficiently precise
individual
R & D projects, the Authority was not in a position to verify
the proposed State aid would be in compliance with
that
Article 61(3)(c) of the EEA Agreement,
in combination with
the R & D Guidelines.

information regarding

the

from the
in which the

Following this letter, several meetings were held between
representatives
and the
Authority
authorities presented
proposals of how the Authority's concerns could be allayed.
The arguments presented by the Icelandic Government were,
however, not regarded as dispelling the Authority's doubts.

Icelandic Government
Icelandic

Complaint

argued that

the proposed State

In September 2002, the Authority received a complaint against
the proposed State aid in favour of deCODE Genetics. The
complainant
guarantee
constituted State aid within the meaning of Article 61(1) of
the EEA Agreement. In the complainant's view, the proposed
State guarantee was incompatible with the functioning of the
EEA Agreement. In this respect, the complainant maintained
that the conditions as laid down in Article 61(3)(c) of the EEA
in combination with the R & D Guidelines were
Agreement,
in particular, that the
not fulfilled. The complainant argued,
project would have to be qualified as ‘pre-competitive devel-
opment’. As such, the proposed aid granted for the notified
project would exceed the permissible aid ceiling of 25 % of
eligible costs. The complainant also considered that
the
proposed State aid would not have the required incentive
effect.

the value of

In a further submission of May 2003, the complainant pointed
to, in his view, significant changes in the market which would
imply that
the State guarantee would have
increased significantly. The complainant also claimed that due
to recent development within the company, it was unlikely that
the proposed State aid would contribute to the European
industry's competitiveness.

B. Description of the aid measure — State guarantee

In May 2002, the Icelandic Parliament authorised the Ministry
of Finance to issue a guarantee to deCODE Genetics Inc. (US)
in relation to a bond amounting to USD 200 million. The
proceeds of the bond would be passed down to the wholly
owned subsidiary, deCODE erfðagreining ehf.,
located in
Reykjavik and then be utilised to establish a new department
for developing biopharmaceutical products in Iceland (1).

The Icelandic authorities informed the Authority about the
the bond and the State guarantee.
main characteristics of
However, the terms of the bond, as well as the terms under
which the State guarantee would be issued, would only be
finally fixed after the Authority would have approved the aid.

(1) Whereas the guarantee is proposed to be granted to deCODE
Genetics Inc. (US), proceeds from the State guaranteed bond will
go to deCODE ehf. (Iceland). The direct aid recipient and the aid
beneficiary are therefore two legally distinct entities.
In the
following, reference will be made to ‘deCODE’ without making a
distinction between the mother and the daughter company.

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The Icelandic authorities informed the Authority that contrary
to what was initially notified, the bond would have a duration
of five years (instead of the initially foreseen seven years). The
bond could be converted into deCODE stock in the event that
the price of the shares would exceed USD 18. In addition,
deCODE would have the right
to reduce the conversion
price. If the bonds were converted into stocks, they would be
regarded as paid up and the State guarantee would lapse.

the price of

the time the proposed guarantee was notified to the
At
Authority,
the company's stocks was in the
range of USD 5 per share. Since then, the shares price fell
to below USD 2 per share and is currently traded at around
USD 3,5 per share (2).

According to the Icelandic Government, deCODE would have
to pay a guarantee premium. Even though the exact amount
had not been finally decided upon, the notification was based
on the assumption of a possible guarantee premium of [. . .] %.

the proposed State guarantee,

The Icelandic Government asked an independent expert [. . .] to
evaluate the guarantee. The expert based its assessment of the
value of
inter alia, on the
the guarantee and the bond (this
preliminary terms of
assessment was based on a duration of the bond of seven
years and the payment of a guarantee premium) and the
financial information available about deCODE at the time of
the State guarantee was
the
determined by comparing the estimated cost of capital based
on a CAPM (3) analysis without the State guarantee, with the
estimate cost of debt based on the proposed State guarantee for
the USD 200 million bond. The expert came to the conclusion
that the value of the State guarantee (‘net grant equivalent’)
would be in the range between USD [. . .] and USD [. . .] (the
midpoint of this range being USD [. . .]).

assessment. The value of

C. Description of the aid beneficiary

DeCODE Genetics Inc. was incorporated in Delaware (US) in
1996. Its wholly owned subsidiary, deCODE erfðagreining ehf.
has its headquarters in Reykjavik. DeCODE is a population
genetics company working to identify the genetic causes of
common human diseases and to apply this knowledge to
discover novel means of treating, diagnosing and preventing
disease. DeCODE also provides drug discovery services to
third parties, typically major pharmaceutical or biotechnology
In addition to its genetics research and drug
companies.
discovery services, deCODE commercialises database services
and healthcare informatics products. With the acquisition of
MediChem Life Sciences Inc.
in March 2002, deCODE has
access to advanced drug discovery and development capa-
bilities.
in November 2000, deCODE acquired
Encode, to launch pharmacogenomics studies in Iceland and
to conduct clinical trials for new and existing therapeutics as a
Contract research organisation.

In addition,

The company has, according to the information provided in
the notification, around 600 employees worldwide (as of 31
December 2001) (4).

(2) Information from http://www.nasdaq.com/ (date 11 July 2003).
(3) Capital Asset Pricing Model.
(4) The Authority notes that the actual number of deCODE employees
in Iceland is not entirely clear, since the company had to lay off
around 200 employees worldwide in the autumn 2002.

According to the Annual Report for 2001, deCODE had an
annual turnover amounting to USD 31,5 million, a net loss of
USD 47,8 million and a balance sheet total of USD 256,4
million. Operating
R & D development
expenses
amounted to USD 71,8 million.

for

D. Description of the R & D project

1. Project description

(a) G e n e r a l o u t l i n e a n d o b j e c t i v e s

The R & D project, the financing of which should be secured
through the notified State guarantee, consists of the estab-
lishment of a new drug development department based on
research carried out by deCODE in population genomics and
genealogy-based genetic research.

DeCODE uses population genomics to discover how genetic
factors contribute to the cause of diseases. DeCODE's access
to an extensive genealogical database and associated bioin-
formatics is the core of deCODE's approach to identifying
human disease genes and associated drug targets. DeCODE
hopes that working with the Icelandic population puts it in a
position to accelerate the discovery and development of new
proprietary diagnostic and therapeutic products.

to the

According
information submitted, deCODE has
successfully isolated genes related to specific diseases [. . .].
For certain drug targets, deCODE has concluded collaborative
agreements with pharmaceutical companies
in relation to
several of the disease genes discovered.

DeCODE now wishes to develop a portfolio of drug targets for
in-house drug development based on the results from its
genetic research. DeCODE will continue its genetic research
to identify disease genes responsible for other diseases for
which it has already mapped genetic loci. This research is
not covered by the proposed State aid.

In the company's view,
the development of a portfolio of
several drug targets at any given time is necessary in order
in bringing even a few products to the
to be successful
market. Therefore, the scope of the overall R & D project for
which State support has been notified,
is not limited to the
R & D projects for which disease genes have already been
identified. The scope of the R & D project for which State
support is sought is therefore intended to cover also possible
future drug candidates which could be included at a later stage
depending on the progress made by deCODE in identifying
new disease genes.

‘target validation’ and ‘drug development’

The R & D activities covered by the notified State support
(for a
consist of
more detailed description of
see
below). Clinical research required to put new drugs on the
market will not be covered by the notified State support. The
envisaged State support project would only cover a period of 5
years up to the filing of an Investigatory New Drug filing with
the US Food and Drugs Administration or its equivalent in
other jurisdictions.

activities, please

these

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Based on the information submitted by the Icelandic auth-
orities, deCODE has identified at present [. . .] target validation
and [. . .] drug discovery programmes as being candidates for
research (so-called ‘initial programmes’). However, the overall
R & D project for which State support is sought consists of, in
total,
validation and [. . .] drug discovery
[. . .]
programmes.

target

(b) ‘ T a r g e t V a l i d a t i o n ’

The Icelandic authorities explained that after a drug target for a
specific disease has been identified, the fundamental research
under the current project would start. Once deCODE succeeded
in identifying a disease gene it would conduct fundamental
research within the scope of the proposed project to define
molecular pathways in which the disease gene plays a role
[. . .].

(c) ‘ D r u g d e v e l o p m e n t ’

In the next phase of
the project, drug development really
begins. During this phase, research is carried out to identify
the drug leads (i.e. work on the initial chemicals which have
been identified during the screening assays phase and which
showed positive results in acting against the drug target).

This phase can be divided into the following phases [. . .].

2. Eligible costs

the project

for which State support

According to the financial schedule submitted by the Icelandic
authorities,
is sought
comprises in total [. . .] R & D programmes ([. . .] target vali-
dation programmes and [. . .] drug discovery programmes). The
costs to be incurred in the first five years of the project (i.e. the
duration of
the project covered by the proposed State
guarantee) are estimated to amount to ISK 34 billion. Of this
amount,
ISK 20 billion (approximately USD 200 million,
based on a conversion rate of USD 1 = ISK 100) would be
raised through the issue of convertible bonds with the
proposed State guarantee. The remaining costs of the project
shall be financed by deCODE Genetics.

These overall cost estimates are broken down into operating
expenses, interest costs and investment costs. Operating costs
consist of personnel costs amounting to [. . .], chemicals and
consumables amounting to [. . .], contractor services amounting
to [. . .], and overhead expenses amounting to [. . .]. Net
and
interest
investments costs [. . .].

estimated to amount

costs were

to [. . .]

For the five-year period, the costs related to ‘target validation’
(which was regarded by the Icelandic authorities as funda-
mental research) were estimated to amount to [. . .], and for
‘drug development’ (which was regarded as industrial research)
[. . .].

Whereas personnel costs were in addition allocated to the
specific research programmes (i.e.
research into a specific
disease/drug candidate),
and further broken down with
respect to the specific activity within either target validation
or drug discovery, no such comparable cost allocation was

done for other cost items. Other costs were only allocated to
what was regarded by the Icelandic authorities to constitute
either fundamental or industrial research.

3. Incentive effect

According to the Icelandic authorities, the proposed aid has the
required incentive effect. In this respect, the Icelandic auth-
orities refer to the risks involved in the project which would
exceed those risks faced by other companies engaged in a more
conventional approach to drug discovery and development.

the project would be
In the Icelandic Government's view,
extremely ambitious
in scope and its aims. The project
would entail the creation of the world's first proprietary drug
discovery operation based largely upon fundamental research
in human genetics. What makes the project so ambitious is,
according to the Icelandic authorities, the aim of bringing a
steady stream of
the targets isolated and verified through
subsequent drug development and into clinical testing and to
sustain several projects at any one time at various stages of
development over a period of many years. Given the lack of
for successful drugs developed from population
precedent
genetics
in terms of
finance and time required to follow through such a project,
the Icelandic authorities consider the project to be extremely
ambitious.

research, and the large investment

As regards the comparison between the envisaged project and
deCODE's current activities, the Icelandic authorities informed
the Authority that the project would only extend to target
validation and drug development of disease targets that are
not currently a part of deCODE's ordinary business activities
(i.e. covering only those drug targets which are not subject to
collaborative arrangements with pharmaceutical companies).

Finally, and as regards the quantifiable factors as referred to in
point 14.7(2) of Chapter 14 of
the Authority's State Aid
Guidelines, the Icelandic authorities point to an increase in
R & D spending, based on current R & D spending amounting
to USD 71,8 million in 2001 and the projected R & D
spending over the first five years of the project. Furthermore,
and according to the amended notification, deCODE would
envisage recruiting up to 350 new employees to undertake
fundamental
research (compared to the
envisaged 300 additional employees referred to in the initial
notification). All
the 350 employees would be new staff
dedicated solely to the new research and development activity.

and industrial

II. APPRECIATION

A. State aid within the meaning of Article 61(1) of the
EEA Agreement

‘any aid
By virtue of Article 61(1) of the EEA Agreement,
through State
granted by EC Member States, EFTA States or
threatens to
resources in any form whatsoever which distorts or
the
or
distort
production of certain goods
in so far as it affects trade
shall,
between the Contracting Parties, be incompatible with the functioning
of this Agreement.’

favouring certain undertakings

competition by

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According to an evaluation carried out by the expert in July
2002 on behalf of the Icelandic State, the State guarantee
would allow deCODE to borrow money on the market at
conditions more favourable than without the proposed State
guarantee. The expert came to the conclusion that the aid
element contained in the proposed State guarantee would
(the average being [. . .]).
amount
to approximately [. . .]
Apparently not included in this evaluation,
is the guarantee
premium of [. . .] % (i.e. approximately [. . .] expressed in net
present value terms (5)). The financial benefit to deCODE after
taking into account
the payment of a guarantee premium
would consequently be reduced to [. . .] (the average being
[. . .]).

Without it being necessary at this stage to assess in more detail
whether the evaluation which was made in July 2002 would
still be valid, the Authority considers that it is reasonable to
assume that the State guarantee would give deCODE a financial
benefit and strengthen deCODE's position in relation to its
competitors within the EEA. Consequently,
the proposed
State guarantee is liable to distort competition and affect
trade between the Contracting Parties.

In light of these considerations, the Authority has concluded
that the proposed State guarantee constitutes aid within the
meaning of Article 61(1) of the EEA Agreement

B. Notification requirement and standstill obligation

Pursuant to Article 1(3) of Protocol 3 to the Surveillance and
‘[t]he EFTA Surveillance Authority shall be
Court Agreement,
informed, in sufficient time to enable it to submit its comments, of
any plans to grant or alter aid . . . The State concerned shall not put
its proposed measures into effect until the procedure has resulted in a
final decision’.

The Act authorising the Ministry of Finance to issue a
guarantee in favour of deCODE does not, in the Authority's
understanding, confer any right on deCODE with respect to the
guarantee. It is still for the Icelandic Government to take a
decision whether or not and,
if so, under which conditions
to issue a guarantee to deCODE. Since no such decision has
been taken, the Authority considers that the proposed State aid
has not yet been put into effect.

C. Compatibility of the aid measures

1. Assessment of the aid measure under Article 61(3)(b) of the EEA

Agreement

According to the Icelandic Government, the proposed State
guarantee would be compatible under Article 61(3)(b) of the
EEA Agreement.

By virtue of Article 61(3)(b) of the EEA Agreement,
promote

an important project

execution of

the

of

‘aid to
common

(5) The Authority's calculation of the net present value of the guarantee
premium is based on the reference rate of interest which was, as
from 1 January 2002, fixed for Iceland at 9,54 %.

European interest’ may be considered to be compatible with the
functioning of the EEA Agreement.

As stated in Chapter 14 of the Authority's State Aid Guidelines,
this provision has been applied in the field of R & D by the
European Commission, only in a limited number of cases.
According to relevant Commission practice,
this derogation
may apply particularly to ‘transnational projects of major quali-
tative and, in principle, quantitative significance’ (6). Aid granted for
a project the results of which only benefit a single undertaking,
without a co-operation with other companies in the EEA and
without a dissemination of the results, which would result in
the formulation of EEA wide industry standards as referred to
in the guidelines, would not seem to be covered by this
exemption.

Since the proposed State aid would benefit only the estab-
lishment of a drug development department by deCODE, the
Authority has doubts as to whether the notified aid can be
regarded as compatible with Article 61(3)(b) of
the EEA
Agreement.

2. Assessment of the aid measure under Article 61(3)(c) of the EEA

Agreement

to the competitiveness of

The Icelandic Government claimed that the proposed State
guarantee was justified under Article 61(3)(c) of
the EEA
Agreement. It would be in the common interest of the EEA
to strengthen the position of Europe in the field of biotech-
nology. According to the Icelandic Government, the aid would
provide a significant boost
the
European biotechnology industry by opening up a completely
new way of approaching genetic research. The reason for the
project being undertaken in Iceland was because of the unique
genetic pool of its inhabitants. This project would lead the way
to other companies in the EEA being able to build on this
foundation. This would provide the EEA an advantage in the
development of novel pharmaceutical products developed from
genetic and biotechnological research and would give the
European industry a competitive advantage compared to the
US.

Article 61(3)(c) of the EEA Agreement regards aid to facilitate
the development of certain economic activities, where such aid
trading conditions to an extent
does not adversely affect
contrary to the interests of
the Contracting Parties, as
compatible with the functioning of the EEA Agreement. Aid
granted for R & D activities is assessed under Chapter 14 of the
Authority's State Aid Guidelines.

According to point 14.2.1(1) of Chapter 14 of the Authority's
State Aid Guidelines,
‘The closer the R & D is to the market, the
more significant may be the distortive effect of the State aid. In order
to determine the proximity to the market of the aided R & D, the
EFTA Surveillance Authority makes a distinction between funda-
mental research,
industrial research and precompetitive development
activity.’

(6) See e.g. State aid case N 692/2001 — Germany.

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in each case will

According to point 14.5.1 of Chapter 14 of the Authority's
State Aid Guidelines,
‘The allowable intensity of aid will be
determined by the EFTA Surveillance Authority on a case-by-case
basis. The Authority's assessment
into
consideration the nature of the project or programme, overall policy
considerations relating to the competitiveness of European industry,
the risk of distortion of competition and the effect on trade between
the Contracting Parties. A general evaluation of such risks leads the
Authority to consider
research and industrial
research may qualify for higher levels of aid than precompetitive
development activities, which are more closely related to the market
introduction of R & D results and,
if aided, could therefore more
easily lead to distortions of competition and trade.’

fundamental

take

that

According to point 14.7 of Chapter 14 of the Authority's State
Aid Guidelines, ‘State aid for R & D should serve as an incentive for
firms to undertake R & D activities in addition to their normal
day-to-day operations. It may also encourage firms not carrying out
research and development to undertake such activities. Where this
incentive effect is not evident, the EFTA Surveillance Authority may
consider such aid less favourably than it usually does.’

Against this background, the Authority needs to assess the
scope and nature of the research activity, the aid intensity
and the incentive effect of the aid.

(a) P r o p o s e d S t a t e

a i d f o r

s p e c i f i c R & D

p r o j e c t s

The Icelandic Government notified the Authority of
the
intention to grant a State guarantee to deCODE Genetics in
relation to a bond amounting to USD 200 million. The
proceeds from the bond shall be used to finance deCODE's
project of establishing a biopharmaceutical research and devel-
opment department in Iceland [. . .].

According to the information submitted to the Authority,
taken a decision on which specific drug
deCODE has not
targets would be included in the project
for which State
support is sought. Given the lack of a decision on the part
of deCODE as well as the Icelandic authorities on which
specific R & D projects would be carried out, the Authority is
not in a position to ascertain that the proposed State aid would
be used to carry out a specific R & D project. The Authority
cannot, therefore exclude that the proposed State aid could be
used by deCODE to cover running expenses with respect to the
establishment of a drug development department. Any such aid
not linked to a specific R & D project bears the risk of consti-
tuting operating aid.

Furthermore, an assessment of the R & D projects benefiting
from the proposed State support under the R & D Guidelines is
difficult since the Icelandic authorities failed to submit detailed
work plans for specific R & D projects (in particular when it
comes to determining and evaluating the reasonableness of the
proposed R & D budget; see below).

According to the financial schedule submitted by the Icelandic
authorities, the overall project deCODE wants to embark upon,
consists of [. . .] target validation programmes and [. . .] drug
discovery programmes. However, the Authority also notes, that
out of the [. . .] target validation programmes and the [. . .]
target validation
drug discovery programmes, only [. . .]

programmes and [. . .] drug discovery programmes have been
clearly identified as possible candidates for research to be
carried out with the proposed State support. The remaining
programmes (i.e. [. . .] target validation programmes and [. . .]
drug discovery programmes) would possibly become part of
the project at a later stage.

As pointed out above, the Authority has doubts as to whether
State aid may be approved with respect to R & D programmes
which have not been clearly identified as being included in the
project (with explicit reference to disease targets) and which
may only later (possibly years after the request
for State
support was submitted) materialise and be possibly included
in the overall R & D project.

In addition, the Authority has doubts as to whether deCODE is
willing and capable of carrying out the R & D programmes (as
regards both target validation and drug discovery) which have
been identified by the Icelandic authorities as being candidates
for drug development under the envisaged research project.

Based on the description given by the Icelandic authorities,
target validation work can only start after a disease gene has
been identified. Disease genes with respect to which target
validation work shall be carried out under the project have,
however, only been identified for
[. . .] diseases [. . .]. As
regards other diseases mentioned by the Icelandic authorities
in the financial schedule for the project [. . .], the information
submitted shows that even though genetic loci have been
mapped/candidate genes identified, a disease gene has not
been discovered yet. The Authority has, therefore, doubts as
to whether target validation could be carried out with respect
to diseases for which the disease genes have not yet been
identified.

it

is the nature of

Furthermore, based on the explanations provided by the
Icelandic authorities,
the disease gene
which is determining for the scope and nature of research
work. Therefore, the Authority has doubts as to whether the
research work to be carried out by deCODE with respect to a
specific disease target, and thus the costs related to this work,
can be determined without having identified the disease gene.

In addition, the Authority has doubts as to whether deCODE
would actually carry out drug discovery with respect to all drug
discovery programmes identified by the Icelandic authorities
[. . .]. These doubts result from information about deCODE's
financial performance in 2002, according to which, drug
discovery work for Myocardial Infarct and Hypertension may
not be necessary (cf. deCODE Genetics Annual report (SEC
form 10-K) presented on 15 April 2003:
in our drug
discovery work on our findings in myocardial infarction and hyper-
tension, we believe we may be able to bypass much of the drug
discovery process and enter directly into phase II clinical trials as
early as mid-2003.’).

‘. . .

Against this background, the Authority has doubts as regards
to the exact number of target validation and drug discovery
programmes which would be carried out by deCODE under the
R & D project for which State support is sought. Based on the
concerns raised above, eligible research projects might be
limited only to [. . .] target validation programmes and [. . .]
drug discovery programmes.

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(b) A s s e s s m e n t o f

t h e t y p e o f r e s e a r c h

According to the initial notification, the project for which State
support is sought consists of elements of fundamental research
(‘target validation’) and industrial research (‘drug discovery’).

nature and intensity those faced by other companies in the
same industry. Individual target validation and drug discovery
programs comprised in deCODE's project were not ‘extremely
ambitious’ as compared to other programs foreseen or being
performed by other companies in the same industry.

According to the external expert, ‘target validation’ qualifies as
‘fundamental research’. This activity is designed to increase
scientific and technical knowledge about the diseases being
studied. It is primarily linked to understanding some of the
mechanisms involved in disease initiation and progression
and is not necessarily leading to the development of new
commercial products. According to the external expert, this
activity is very much upstream in the R & D process, and
there is a significant risk that it may not lead to the identifi-
cation of drug targets and the development of new products,
processes or services. Time-to-market may be greater than 10
years.

As regards ‘Drug Development’, the external expert considers
that phases 1-4 [. . .] could be classified as ‘industrial research’.
On the other hand, phases 5 and 6 [. . .] would qualify as
‘pre-competitive development
the
objective of phases 5 and 6 is to create initial prototypes of
drugs that provide a strong basis for patent filing and that will
direct the development of new products.

activity’.

In his

view,

The Authority sees no reason to deviate from this assessment
as regards ‘target validation’ and parts of ‘drug development’.
However,
the Authority has doubts as to whether certain
activities forming part of the ‘drug development’ (i.e. phases
5 and 6) can be qualified as ‘industrial research’ as claimed by
the Icelandic authorities (7).

(c) A s s e s s m e n t o f

t h e

i n c e n t i v e

e f f e c t o f

t h e a i d

The external expert agreed that the proposed State aid would
have an incentive effect, since a large proportion of deCODE's
project corresponds to a new activity (i.e.
large-scale drug
discovery effort performed by deCODE alone). According to
the external expert, the aid would indeed induce deCODE to
pursue new R & D activities that imply a considerable increase
in R & D spending. The proposed aid would permit deCODE to
widely expand the scope of its research to drug discovery and
drug development.

In the expert's view, the incentive effect of the aid specifically
relied on the fact that the aid would allow deCODE to embark
upon a large-size drug development program, in particular to
hire a large number of scientists and to secure high financial
is
input. The project exceeded in risk and ambition what
normally done by other companies in the same industry,
strictly because of the large number of simultaneous research
programs, especially if considering that deCODE would invest
heavily and immediately in activities (drug development) for
which the company has previously not demonstrated success.
On the other hand,
the risks
associated with the individual
target validation and drug
discovery programs planned by deCODE, do not exceed in

the expert pointed out

that

(7) According to the external expert, activities related to phases 5 and 6
qualify as ‘pre-competitive development’. As such,
they could
benefit from aid up to 25 % of eligible costs. It would, however,
appear that the notified aid should not cover ‘pre-competitive devel-
opment’ activities.

Based on the information in the Authority's possession, and in
light of
the
Authority currently sees no reason to question the incentive
effect of the proposed Sate aid.

the evaluation made by the external expert,

(d) A s s e s s m e n t o f

t h e e l i g i b l e c o s t s

The information submitted by the Icelandic Government does
not allow the Authority to determine the exact amount of
eligible costs given that
the R & D programmes have not
been clearly identified by the Icelandic authorities and given
that no detailed work plan has been submitted which could
have been used as a basis for evaluating the reasonableness of
the proposed R & D budget.

The Icelandic authorities have merely described in abstract
terms the kind of activities that need to be carried out in the
context of target validation and drug discovery, without spec-
ifying the kind of activities that will actually be carried out
with respect to individual programmes.

It is the kind of activity which will be carried out by deCODE
which will determine the eligible costs for a specific R & D
programme. In the absence of more detailed information, the
Authority cannot verify whether it is reasonable to expect that
the kind of research activity which is described in general
terms will actually be carried out with respect to individual
information submitted by the
disease programmes. The
Icelandic authorities
the nature and
indicates
rather
scope of the research activities may differ quite significantly,
depending on the disease target in question. Consequently, in
the absence of an individualised work plan for a specific
programme,
in a position to clearly
identify the eligible costs.

the Authority is not

that

Even though the external expert was able to provide the
Authority with average figures concerning the personnel
required for target validation and drug discovery activities in
general, the Authority cannot, due to the uncertainties referred
to above, exclude the possibility that
the requirements for
individual programmes may differ substantially from these
average figures. In this context, the Authority also notes that,
according to the external expert,
regarding
required personnel as well as other cost items were overstated.

the estimates

In addition to the lack of detailed information as referred to
above, the exact determination of the eligible costs has not
been possible because the Icelandic Government has not
allocated all cost items to specific R & D programmes (most
cost
items have only been shared between fundamental
research and industrial research without being allocated to
individual R & D programmes or activities)
and because
certain cost items have not been properly justified (in particular
building costs).

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Official Journal of the European Union

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Icelandic

authorities have only
regards personnel

submitted detailed
The
costs. Based on the
information as
information submitted,
is not possible to allocate other
cost items to individual research programmes and activities
within each programme.

it

The Authority also notes that the Icelandic authorities have not
provided a satisfactory explanation concerning the extra-
ordinary building expenses which are
supposed to be
incurred in the first two years of the project [. . .].

(e) A s s e s s m e n t
c e i l i n g s

o f

t h e

p e r m i s s i b l e

a i d

individual R & D programmes,

Given the absence of verifiable information concerning the
eligible costs for
is not
possible for the Authority to ascertain that
the proposed
State aid respects the permissible aid ceilings. The various
concerns expressed above rather indicate that the proposed
State aid would exceed the permissible aid intensities.

it

ISK 34 billion was based on [. . .]

In this respect, the Authority observes that the project's budget
target validation
of
programmes (for which a budget of ISK [. . .] was foreseen)
and [. . .] drug discovery programmes (for which a budget of
ISK [. . .] was foreseen). In the following, the Authority would
like to illustrate the effects of a limitation of the scope of the
R & D project on the budget and thus the permissible aid. The
figures presented are based on average cost figures for target
validation and drug development programmes, respectively,
and do not necessarily reflect the exact consequences of a
limitation of the eligible R & D projects on the budget.

If the R & D projects which can be regarded as sufficiently
concrete would be limited to those clearly identified by the
Icelandic authorities as being candidates for the project (i.e.
[. . .] target validation programmes and [. . .] drug discovery
programmes), the budget would be reduced as regards target
validation to approximately ISK [. . .] and as regards drug
discovery to approximately ISK [. . .].
in addition, as
pointed out above by the Authority, eligible R & D projects
would be limited to [. . .]
target validation and [. . .] drug
discovery programmes,
the budget would be reduced as
regards target validation to approximately ISK [. . .] and as
regards drug discovery to approximately ISK [. . .]. It is also
noted that building costs amounting to ISK [. . .] have not been
properly justified by the Icelandic authorities. Any such costs
would therefore, based on the information currently available,
not be included in the eligible costs. Finally, it is noted that,
according to the external expert, personnel costs, in particular,
were overestimated.

If

Whereas costs regarding target validation could benefit as
fundamental research from 100 % aid intensity,
the costs
regarding drug discovery were regarded by the external
expert, only to a certain extent, as falling within the definition
of industrial research, for which the permissible aid intensity is
50 %. The
regarded as
remaining activities which were
pre-competitive development could only benefit from 25 % aid.

Taking all this into account, it appears that the proposed State
guarantee, with an estimated aid element amounting to USD
[. . .], or on average USD [. . .] (which at a conversion rate of
100 would amount to ISK [. . .]), may exceed substantially what

could, based on the information currently available to the
Authority, be regarded as permissible.

p r o g r a m m e ,

t h e n a t u r e o f

(f) A s s e s s m e n t o f
o r
j e c t
c o n s i d e r a t i o n s
p e t i t i v e n e s s o f E u r o p e a n i n d u s t r y ,
r i s k o f d i s t o r t i o n o f
t h e
C o n t r a c t i n g P a r t i e s

t h e p r o -
p o l i c y
c o m -
t h e
c o m p e t i t i o n a n d
t h e

o v e r a l l
t o

b e t w e e n

r e l a t i n g

e f f e c t

t r a d e

t h e

o n

In its view,

to lead to any

research. According

The Icelandic Government took the view that the proposed aid
was unlikely
significant distortion of
the relevant market was that of
competition.
biotechnological
Icelandic
to
Government, the biotechnological research market was ‘wide
open and not as easily prone to distortion as the phar-
maceutical product market’, given the extremely high level of
risk and lack of investment across the EEA. It is further main-
tained that the market for biotechnological research was ‘a
growth market with the bounds
exploitation on the open
market in a worldwide context almost limitless’.

the

for

According to the external expert, deCODE's project concerns a
large number of common diseases that are targeted by virtually
all biotech companies (especially if they are initially genomic
companies) and bio-pharmaceutical
companies worldwide.
Some of deCODE's direct competitors (i.e. genomic firms
including Millenium, Celera, HGS, Myriad Genetics, Lexicon
genetics and Incyte) have been, or are in the process of,
moving into the therapeutic business.

In the external expert's view, the market potentially affected by
the proposed aid is that of drugs that will reach clinical phases
and will be best positioned to be acquired by big phar-
maceutical companies. With the expectation of 200 drugs to
be derived from genomic targets and considering not more
than 10-20 players in the market which will be able to
the market size would appear to be
develop these drugs,
rather
for
each
approximately 10 % of the market. The grant equivalent of
report
the proposed aid as
amounting to USD [. . .], would represent, according to the
external expert,
revenues or
available cash for most of deCODE's direct competitors.
Based on the market size and the aid intensity, the external
expert considered the risk for distortive effects of the proposed
aid to be significant.

calculated by the

[. . .] of either

the one-year

allowing

struggle

expert's

limited,

player

to

the

to sustain the development of

In addition to gaining operational and strategic advantages over
its competitors, deCODE would be able to attract investors that
investing significantly in other
might no longer consider
European drug discovery companies, a situation that may last
for a significant period of time. Human resources and facilities
available
emerging
biomedicine sector in Iceland (basically in the Reykjavik area)
were obviously limited. There is a significant number of
companies that are emerging in this sector.
In particular,
there were at
least 5 emerging pharmaceutical companies
that employ 30-150 people and that develop activities in the
field of therapeutics (noticeably production of generics, and
design of drug delivery systems). When deCODE is allocated
the emerging biomedicine companies in
the proposed aid,
Iceland may
in attracting
investors, qualified personnel,
and in accessing relevant
facilities.

serious difficulties

encounter

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Official Journal of the European Union

18.12.2003

In light of the external expert's comments in this respect, the
Authority has doubts as to whether the propose State aid in
favour of deCODE would risk distorting competition and trade
to an extent contrary to the common interest.

D. Conclusions

The aid proposed for the project constitutes aid within the
meaning of Article 61(1) of
the EEA Agreement. The
Authority has doubts as to whether the notified aid may be
regarded as compatible with the functioning of
the EEA
Agreement, and in particular Article 61(3)(c), because the
information submitted by the Icelandic authorities does not
demonstrate that the conditions set out in Chapter 14 of the
Authority's State Aid Guidelines are fulfilled.

Consequently, and in accordance with Chapter 5.2 of
the
Authority's State Aid Guidelines, the Authority is obliged to
open the formal investigation procedure provided for in Article
1(2) of Protocol 3 to the Surveillance and Court Agreement
against the proposed State aid in the form of a guarantee in
favour of deCODE Genetics Inc.

The Icelandic Government is invited to submit its comments to
this decision.

The Icelandic Government is further requested to submit all
information necessary to assess
the
proposed State guarantee with the functioning of the EEA
Agreement.

the compatibility of

HAS ADOPTED THIS DECISION:

1. The Authority opens the formal

investigation procedure
pursuant to Article 1(2) of Protocol 3 to the Surveillance
and Court Agreement against the proposed State guarantee
in favour of deCODE Genetics Inc.

2. The Icelandic Government

is invited, pursuant

to point
the Authority's State Aid
5.3.1(1) of Chapter 5 of
Guidelines,
to the present
comments
its
decision within two months from receipt of the present
decision.

to submit

3. The Icelandic Government

requested to submit all
is
information necessary to enable the Authority to examine
the compatibility of the proposed State aid under Article
61(3)(c) of
in combination with
Chapter 14 of the Authority's State Aid Guidelines, within
two months from receipt of the present decision.

the EEA Agreement,

4. The Icelandic Government is invited to notify without delay
the

the initiation of

the potential aid beneficiary of
proceedings.

5. Other EFTA States, EC Member States and interested parties
shall be informed by the publishing of this decision in the
EEA Section of the Official Journal of the European Union and
the EEA Supplement
inviting them to submit
comments within one month from the date of publication.

thereto,

6. This decision is authentic in the English language.

The Icelandic Government is reminded not to put the proposed
State aid into effect.

Done at Brussels, 16 July 2003

The Icelandic Government is invited to notify without delay the
potential aid beneficiary of the initiation of the proceedings.

Finally, the Authority would like to point out that the decision
to open the formal investigation procedure is without prejudice
to the final decision (cf. point 5.2(2) of Chapter 5 of the
Authority's State Aid Guidelines).

For the EFTA Surveillance Authority

Einar M. BULL

Hannes HAFSTEIN

President

College Member