Invitation to submit comments pursuant to Article 1(2) in Part I of Protocol 3 to the Agreement between the EFTA States on the Establishment of a Surveillance Authority and a Court of Justice on State aid with regard to the Icelandic Housing Financing Fund from payment of a state guarantee premium
Date: 2009-03-19
Institutions: EFTA Surveillance Authority
Subjects: EFTA, Iceland, State aid, bonus payment, control of State aid, guarantee, real estate credit, services of general interest, tax exemption

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NOTICES CONCERNING THE EUROPEAN ECONOMIC AREA

EFTA SURVEILLANCE AUTHORITY

Invitation to submit comments pursuant to Article 1(2) in Part I of Protocol 3 to the Agreement
between the EFTA States on the Establishment of a Surveillance Authority and a Court of Justice
on State aid with regard to the Icelandic Housing Financing Fund from payment of a state guarantee
premium

(2009/C 64/09)

By means of Decision No 406/08/COL dated 27 June 2008, reproduced in the authentic language on the
pages following this summary, the EFTA Surveillance Authority initiated proceedings pursuant to Article 1(2)
in Part I of Protocol 3 of the Agreement between the EFTA States on the Establishment of a Surveillance
Authority and a Court of Justice. The Icelandic authorities have 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
Registry
Rue Belliard 35
1040 Brussels
BELGIQUE/BELGIË

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

SUMMARY

The Housing Financing Fund (hereafter referred to as ‘the HFF’), which operates on the Icelandic mortgage
market, is a State institution governed by public law. As such, it enjoys, under the general principles of
Icelandic public law, a State guarantee on all its obligations without any special legal provision to that effect.

This guarantee existed before the EEA Agreement entered into force on 1 January 1994. The guarantee as
such will not be dealt with under the current procedures concerning new aid but under the procedures for
existing aid. The current procedure deals with the fact that the HFF is exempted from paying a guarantee
premium which other undertakings organised in a similar way as the HFF are obliged to pay. By Act
No 121/1997 and later amendments (Act No 70/2000 and Act No 180/2000) such institutions are charged
guarantee premiums. The current premium is 0,0625 % per quarter on outstanding commitments.

In the preliminary view of the EFTA Surveillance Authority (hereinafter referred to as ‘the Authority’) the
HFF's exemption from paying a guarantee premium amounts to State aid in the meaning of Article 61(1) of
the EEA Agreement. Moreover, the Authority doubts that this exemption is compatible with the Agreement.
Derogations provided for in Articles 61(2) and (3) do not seem to be applicable. Neither can the Authority
see that Article 59(2) of the EEA Agreement would be applicable to the general loan scheme operated by
the HFF.

While certain lending for house financing may be defined to be a service of general economic interest in the
meaning of Article 59(2) and therefore possibly eligible for aid, the Authority's preliminary view is that the
general loan system of the HFF is too broadly set up to comply with the conditions of Article 59(2). The

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Authority has not been presented with any information that would give it reason to believe that the market
would not be able to provide for housing finance on manageable terms in general. Under the general loan
scheme of the HFF loans are available to anyone irrespective of income and assets and irrespective of cost
and size limitations of the dwelling to be financed. Loans may also be granted anywhere irrespective of
whether local housing finance may be readily available or not.

To the extent the Authority's preliminary views are upheld in the final decision, unlawful aid will need to be
recovered.

The decision to open proceedings is without prejudice to the final decision of the Authority.

Any interested party is invited to submit comments to the Authority within one month of the publication
of the Decision in the Official Journal of the European Communities and the EEA Supplement thereto.

EFTA SURVEILLANCE AUTHORITY DECISION

No 406/08/COL

of 27 June 2008

to initiate the formal investigation procedure with regard to the relief of the Icelandic Housing
Financing Fund from payment of a State guarantee premium

THE EFTA SURVEILLANCE AUTHORITY (1),

(Iceland)

Having regard to the Agreement on the European Economic Area (2), in particular to Articles 59, 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 thereof,

Having regard to Article 1(2) of Part I and Articles 4(4) and 6 of Part II of Protocol 3 to the Surveillance
and Court Agreement (4),

Having regard to the Authority's Guidelines (5) on the application and interpretation of Articles 61 and 62
of the EEA Agreement,

Having regard to the Authority's Decision No 195/04/COL of 14 July 2004 on the implementing provisions
referred to under Article 27 of Part II of Protocol 3 (6),

Having regard to the Authority's Decision No 405/08/COL of 27 June 2008 close the formal investigation
procedure with regard to the Icelandic Housing Financing Fund (7),

Whereas:

I. FACTS

1. Procedure

By letter dated 28 September 2007 (Event No 442805), the Authority requested information from the
Icelandic authorities regarding State guarantees and the obligation to pay a State guarantee premium under
the Act on State Guarantees. By letter from the Icelandic Mission to the European Union dated 24 October
2007, forwarding the letter from the Icelandic Ministry of Finance of the same date, received and registered
by the Authority on 25 October 2007 (Events No 448739 and 449598), the Icelandic authorities responded
to this request.

(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) Hereinafter referred to as Protocol 3.
(5) 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 and EEA Supplement No 32
of 3 September 1994. The Guidelines were last amended on 19 December 2007. 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/guidelines/

(6) Published in OJ C 139, 25.5.2006, p. 57 and EEA Supplements No 26 of 25 May 2006.
(7) Not published yet. The non-confidential full text of the Decision will be available at:

www.eftasurv.int/fieldof work/fieldstateaid/stateaidregistry/

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The case was subject to discussions between the representatives of the Authority and the Icelandic Govern-
ment on 7 September 2007 in Brussels and on 29 October 2007 in Reykjavik as well as between the repre-
sentatives of the Authority and the complainant, the Icelandic Financial Services Association, in a meeting
on 6 March 2008 in Brussels.

2. Description of the relevant Icelandic law provisions

2.1. Introduction

The Housing Financing Fund (hereafter referred to as the HFF) is a State institution governed by public law,
cf. Article 4 of the Housing Act No 44/1998 (lög um húsnæðismál). As such, it enjoys, under the general
principles of Icelandic public law, a State guarantee on all its obligations without any special legal provision
to that effect. The same applied to its predecessor, the State Housing Agency, and the State Building Fund
and the Workers' Housing Fund operated by the Agency as well as the State Housing Board, cf. Act
No 97/1993 on the State Housing Agency (lög um Húsnæðisstofnun ríkisins).

On 1 January 1999, the Housing Act No 44/1998 entered into force. Under the terms of the Housing Act,
the Housing Financing Fund replaced the former State Housing Agency and took over its predecessor's obli-
gations. Furthermore, the State Building Fund and the Workers' Housing Fund were merged and taken over
by the HFF (1).

2.2. Act No 37/1961 on State Guarantees, as amended by Act No 65/1988

Act No 68/1987 introduced an obligation to pay a guarantee premium to the State for State guarantees that
were not subject to the risk premium. Article 8 of the Act No 37/1961 on State Guarantees (lög um ríkisá-
byrgðir), as subsequently amended by Act No 65/1988 on State Guarantees,
(lög um breyting á lögum
nr. 37/1961, um ríkisábyrgðir, með síðari breytingum) required banks, credit funds, financial institutions, enter-
prises and other such entities that, according to law, enjoy a State guarantee whether through the ownership
of the State or other reasons, to pay a guarantee premium to the State as regards their commitments
towards foreign entities. In contrast, no similar premium was imposed on domestic commitments at the
time of the entry into force of the EEA Agreement in Iceland on 1 January 1994.

The premium was set at 0,0625 % per quarter on the principal of foreign commitments based on their
average for each period, cf. paragraph 2 of Article 8. Loans for which a risk premium had been paid, certain
export guarantees and commitments due to credit balance in domestic currency accounts did not constitute
basis for calculation of the guarantee premium, cf. paragraph 2 of Article 9 of the Act.

In its submission of 24 October 2007, the Icelandic Government has claimed that the State Housing
Agency was not liable to pay a guarantee premium under the terms of the Act No 37/1961 on State Guar-
antees. The Government did not, however, present arguments as to why the general obligation should not
also cover the State Housing Agency. The Authority does not dispute the statement of the Icelandic Govern-
ment that the Agency in fact never paid any premium as it did not have any foreign commitments.
However, this does not change the fact that according to the Act, the Agency would have been liable for the
premium in the event of undertaking foreign commitments. Hence, the Authority is of the preliminary
opinion that the obligation to pay a guarantee premium did indeed apply to any foreign financial commit-
ments that the State Housing Agency might have had.

2.3. Act No 121/1997 on State Guarantees

On 22 December 1997, a new Act on State Guarantees No 121/1997 was adopted. This Act, which entered
into force on 1 January 1998, extended the obligation to pay a premium also to cover domestic commit-
ments. Paragraphs 1 and 2 of Article 6 of the Act stated:

‘Banks, credit funds, financial institutions, enterprises and other such entities that according to law enjoy or have
enjoyed the guarantee of the Treasury, whether through the ownership of the State or for other reasons shall pay a
guarantee premium on their State-guaranteed commitments. …

The guarantee premium according to paragraph 1 shall amount to 0,0625 % per quarter on the principal of
foreign commitments subject to the premium and 0,0375 % per quarter on the principal of the average of domestic
commitments during each payment period, cf. Article 8. The proceeds shall accrue to the Treasury.’ (2).

(1) For more information on this aspect and the continuity of activities, see the Authority's Decision No 405/08/COL.
(2) Translation of the Act available at the website of the Ministry of Finance.

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Article 7 of Act No 121/1997 provides for an exemption from the general obligation to pay a premium
pursuant to Article 6 of the Act. In its original form paragraph 1 of Article 7 read as follows:

‘Credits on which a risk premium has been paid cf. Article 4, housing bonds issued by the Housing Bond Division
of the State Housing Agency, commitments in lieu of deposits in deposit accounts of deposit money banks and
government-guaranteed export guarantees as well as the Central Bank of Iceland are exempt from payment of the
guarantee premium cf. Article 6.’ (emphasis added)

The State Housing Agency had other commitments than those relating to housing bonds issued by the
Housing Bond Division of the Agency. It therefore seems to follow from an a contrario interpretation of
Article 7 that the main rule on the payment of a fee was applicable to such activities. The same goes for the
other public bodies operating on the basis of Act No 97/1993: the State Housing Board, the State Building
Fund and the Workers' Housing Fund.

The Icelandic Government has, however, in its letter of 24 October 2007, submitted that as regards commit-
ments other than housing bonds, the levying of the guarantee fee ‘was based on questionable legal basis’.
According to the Government, due to their social character, the State Building Fund and the Workers'
Housing Fund, operated by the Agency, were never intended to pay a guarantee premium under the Act. In
this respect, the Government refers to a memorandum of 16 October 1998 by the Minister of Social Affairs
as well as a report of a working group of June 1999 on the collection of a guarantee premium of the debts
of the State Building Fund and the Workers' Housing Fund and the HFF (1). The conclusion of the working
group's report was that it was arguable that the commitments of the State Building Fund and Workers'
Housing Funds fell outside the scope of Article 6 of Act No 121/1997. In arriving at that conclusion, the
working group stated that the funds were of a social character which justified that they were operated under
the responsibility of the State and were dependant on State contributions as well as always having been
operated with a negative interest margin. Furthermore, the report referred to the general comments to the
bill, which became Act No 121/1997, whereby distinction was made between funds in ‘commercial’ opera-
tion and those with a social role.

For the reasons set out below, the Authority questions this legal reasoning:

— first, according to Article 6 of the Act:

‘Banks, credit funds, financial institutions, enterprises and other such
entities that according to law enjoy or have enjoyed the guarantee of the Treasury, whether through the ownership of
the State or for other reasons shall pay a guarantee premium on their State-guaranteed commitments’. Even
assuming, hypothetically, that HFF was not considered a ‘bank, credit fund, financial institution or enterprise’
the wording ‘any other entities’ seems to indicate that the provision covers all bodies enjoying a State guar-
antee, irrespective of operating form. Furthermore, it was considered necessary to explicitly exempt the
commitments related to the Housing Bond Division, cf. Article 7 of the Act,

— second, as will be shown below in point 2.4, the preparatory works to Act No 70/2000 contain several
statements which indicate that the Act was based on the premise that the HFF was indeed, at that time,
subject to the guarantee premium on other commitments than those related to the housing bonds,

— third, a specific provision in the 2001 Supplementary Budget Act was inserted to cancel the debts
relating to unpaid premiums the HFF had accrued under Act No 121/1997 until the entry into force of
Act No 70/2000 (2). Such a provision would hardly have been necessary if the HFF and its predecessors
had never been subject to the premium,

— fourth and finally, as far as the Authority can understand, the comments referred to by Iceland
concerning the distinction between funds in commercial operation on the one hand, and those with a
social role on the other, did not relate to the issue of whether or not a guarantee premium should be
collected for commitments enjoying a State guarantee. Rather, they indicate that the legislator was of the
opinion, that when it came to granting a Fund a State guarantee, it was of importance whether the Fund
in question was operated on a commercial or social basis.

In any event, as already indicated, in the 2001 Supplementary Budget Act, a provision was inserted to
cancel the debts related to unpaid premiums the HFF had accrued until the entry into force of Act
No 70/2000. It therefore seems that the HFF, either was never liable to pay the fee or retroactively was
exempted from it. Thus, in either situation the HFF was from the start, or with retroactive effect, exempted
from the main rule in Act No 121/1997 on State Guarantees that State bodies enjoying a guarantee should
pay a premium for it.

(1) Skýrsla starfshóps um innheimtu ábyrgðargjalds af skuldum Byggingarsjóðs ríkisins, Byggingarsjóðs verkamanna og Íbúða-

lánasjóðs.

(2) Item 1.4 of Article 4 of the Supplementary Budget Act amending Article 7 of the Budget Act, which grants various permis-
sions to the Minister of Finance provided as follows: ‘To abolish guarantee premiums pursuant to Article 6 of Act No 121/1997
on State Guarantees levied on the House Financing Fund until the entry into force of Act No 70/2000 which exempts the Fund from
the payment of the premium.’.

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2.4. Act No 70/2000 amending Act No 121/1997

By Article 1 of Act No 70/2000 which entered into force on 26 May 2000, Article 7 of the Act
No 121/1997 was amended and is currently as follows:

‘Credits on which a risk premium has been paid cf. Article 4, commitments in lieu of deposits in deposit accounts
of deposit money banks and government-guaranteed export guarantees as well as the … the Housing Financing
Fund … are exempt from payment of the guarantee premium cf. Article 6.’

The bill, which subsequently became Act No 70/2000 did not originally include a proposal to exempt all
obligations of the HFF guaranteed by the State from the guarantee premium. It was originally foreseen only
to exempt the HFF's obligations taken over from the State Building Fund and the Workers' Housing Fund
upon the entry into force of Act No 44/1998. Indeed, in the bill, it was stated that the exemption for the
obligations deriving from the housing bonds (cf. Article 7 of the Act) was based on the fact that the
Housing Bonds Division collected an interest margin of 0,35 % of mortgage instruments guaranteeing
commitments relating to housing bonds. Other commitments of the HFF were not supposed to be exempted
from the payment obligation of the guarantee premium as no money was put aside in a reserve fund to
meet losses connected with lending on that basis (1).

However, during the Parliamentary procedure, the bill was changed so that the exemption covered all the
obligations of the HFF:

‘During the procedure before the Committee it was specifically examined that the bill presupposes that a premium
will still be paid on some of the loans taken by the Housing Financing Fund such as loans, which the Fund takes
to finance additional
loans and loans for rental apartments. … Having regard to the above, the Committee
proposes to amend the bill so that all the obligation of the Housing Financing Fund will be exempt from the
premium.’ (2) (emphasis added)

Therefore, as approved by Alþingi, the Act No 70/2000 amending Act No 121/1997 extended the exemp-
tion from the payment of a guarantee premium and covered all the obligations of the HFF. As a conse-
quence, the HFF has not been paying a guarantee premium on its commitments, foreign as well as domestic,
to the State Treasury.

2.5. Act No 180/2000 amending Act No 121/1997

In its judgment in State Debt Management Agency, the EFTA Court held that the difference in the amount of
the State guarantee premium due under the provisions of the Act on State Guarantees was in breach of
Article 40 EEA, as it was made dependant on whether the obligations were of domestic or foreign char-
acter (3). Following this judgment, the Act on State Guarantees was amended. By Act No 180/2000, which
entered into force on 11 January 2001, the difference between foreign and domestic commitments was
abolished for the purpose of calculation of the State guarantee premium. As from Act No 180/2000, the
premium has been set at 0,0625 % per quarter irrespective of the origin of the commitments. Due to the
above-mentioned exceptions pertaining to HFF, these changes did not apply to HFF.

II. ASSESSMENT

3. State aid within the meaning of Article 61(1) EEA and the classification of such aid as new or

existing

3.1. The aid elements of the Icelandic system of implicit State guarantees

Article 61(1) of the EEA Agreement reads as follows:

‘Save as otherwise provided in this Agreement, any aid granted by EC Member States, EFTA States or through
State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain
undertakings or the production of certain goods shall, in so far as it affects trade between Contracting Parties, be
incompatible with the functioning of this Agreement.’

(1) The original Icelandic text is as follows: ‘Aðrar skuldbindingar Íbúðalánasjóðs eru hins vegar ekki undanþegnar gjaldskyldu þar sem

ekki er lagt fé í varasjóð til að mæta útlánatöpum vegna lánveitinga á grundvelli þeirra.’.

(2) Opinion of the Economic and Commerce Committee of Alþingi, the Authority's unofficial translation.
(3) Case E-1/00 State Debt Management Agency [2000-2001] EFTA Court Report, p. 8.

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For a measure to be classified as State aid within the meaning of Article 61(1) of the EEA Agreement, it
must be granted by the State or through State resources, confer an advantage on the recipient undertaking,
be selective and thereby distort or threaten to distort competition and be liable to affect trade between the
Contracting Parties. Before examining each of these conditions in turn, the Authority makes the following
remarks concerning the scope of the present decision to open the formal investigation procedure:

As any other undertaking organised as a public institution, the HFF enjoys an implicit State guarantee in the
same manner as did the predecessors of the HFF from the start of their operations in the 1950's, cf. Act
No 42/1957. The HFF pays neither a market based premium for the guarantee, nor the premium laid down
in Act No 121/1997 on State Guarantees.

The implicit State guarantee for this type of public undertaking was at the outset granted without any obli-
gation to pay a premium. However, Icelandic system for implicit State guarantees was changed in 1987.
From this point in time, a guarantee premium was to be paid for foreign commitments, but not for domestic
ones. The original State guarantee scheme, with the changes introduced in 1987, thus predates the EEA
Agreement.

The Icelandic system relating to implicit guarantees was changed again as of 1 January 1998 when a general
obligation to pay a guarantee premium was also introduced as regards domestic commitments. Considering
the size of the premium the Authority finds it unlikely that the guarantee premium removed aid contained
in the original guarantee scheme. Therefore, in the Authority's preliminary opinion, the original guarantee
scheme still contains State aid. The State aid element will generally be the difference between the appropriate
market price for the guarantee provided and the price paid for that measure according to Act No 121/1997
on State Guarantees (1). This possible aid element will follow from the implicit guarantee in force since
before the entry into force of the EEA Agreement, and would constitute existing aid. It will therefore be
assessed separately following the procedures regarding existing aid.

Hence, the present decision to open the formal investigation procedure only relates to severable changes to
the Icelandic system of implicit guarantees made after 1994 which would give a particular advantage to
HFF (2). Indeed, only such changes could be classified as new aid (3).

With Act No 121/1997, Iceland introduced a premium for banks, credit funds, financial institutions, enter-
prises and other such entities that enjoy a State guarantee in respect of domestic commitments. The activities
of the Housing Bonds Division were exempted from a guarantee premium both on domestic and foreign
commitments from the entry into force of the Act. As regards other operations of the HFF, they were
exempted from the premium by Act No 70/2000. In the 2001 Supplementary Budget Act the accrued
unpaid premium for these activities was cancelled. Therefore, either from the beginning, or retroactively, the
other operations of the HFF were exempted from this generally applicable guarantee premium. Indeed,
according to Iceland itself, HFF has never paid any premium under the Act.

As HFF has, as a matter of fact, never paid any premium for the guarantee it enjoys, Iceland has in its letter
of 24 October 2007 argued that the factual situation for HFF has remained the same over the years regard-
less of the introduction of the general premium with effect for other undertakings. Moreover, as the exemp-
tions in the Act pertaining to HFF merely maintained the status quo in relation to that particular undertaking,
Iceland is of the opinion that exemptions cannot constitute new aid.

In the Authority's view, it is not relevant for the assessment of the classification of the aid as new or existing
whether or not the Act, as a matter of fact, changed the situation of HFF as regards the payment of guar-
antee premium. What is decisive is that the new Act introduced a new system where, for the first time, the
HFF was being treated more favourably than provided for under the general rule for undertakings benefiting
from the implicit State guarantee. It is therefore the Authority's preliminary opinion that any advantage to
HFF following from the exemption granted to the Housing Bond Division introduced by Article 7 of Act
No 121/1997 would constitute new aid. The same would apply to the exemption/relief from paying the
premium relating to other operations of the HFF, cf. Act No 70/2000 amending Act No 121/1997, as well
the 2001 Supplementary Budget Act (4).

(1) It could be questioned whether a guarantee covering the totality of a company's financial obligations exists on the market.

It might therefore be difficult to establish a market premium for the guarantee in the present case.

(2) Joined Cases T-195/01 and T-207/01 Government of Gibraltar v Commission [2002] ECR II-2309, paragraph 111.
(3) Hence, these changes are not dealt with in the context of Decision No 185/06/COL to open the formal investigation proce-
dure, partly because the rules in the State Guarantees Act were only briefly discussed in that opening decision, partly
because the Icelandic authorities, in the above-mentioned letter of 24 October 2007, did not answer in the affirmative that
the aid questions pertaining to HFF's exemption from the premium should be dealt with within that procedure.

(4) In any event, the argumentation of the Icelandic authorities builds on the premise that HFF was never subject to a premium
de jure. In contrast, it would not be sufficient that HFF never actually paid the fee, and that the legal obligation to do so was
later cancelled, as such cancelling of a debt would in itself constitute aid. As illustrated above under point I.2.3, the
Authority is not convinced that this premise is fulfilled in the case at hand.

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3.2. Economic advantage

Exempting the HFF from payment of the guarantee premium provides a financial advantage to that under-
taking as the corresponding costs of the premium are not covered by the HFF. This advantage amounts to
what the HFF would have had to pay each time on its commitments under the applicable rate of the guar-
antee premium.

The advantage following from the non-payment of the State guarantee premium can be determined as
follows:

1; exemption (either originally or ex post facto) from payment of State guarantee premium amounting to
0,0625 % per quarter of the value of foreign commitments relating both to housing bonds and other
commitments in the period from 1 January 1998 to date;

2. exemption (either originally or ex post facto) from payment of State guarantee premium amounting to
0,0375 % per quarter of the value of domestic commitments relating both to housing bonds and other
commitments in the period from 1 January 1998-10 January 2001;

3. exemption from payment of State guarantee premium amounting to 0,0625 % per quarter of the value

of all HFF's domestic commitments in the period from 11 January 2001 to date.

In its letter of 24 October 2007, Iceland seems to be of the opinion that the HFF does not enjoy any real
advantage as it levies a margin on the general loans it issues. Iceland submits that the Housing Bonds Divi-
sion of the State Housing Agency and subsequently the HFF were subject to a special regime which entailed
paying a ‘special State guarantee fee’, raised in the form of an interest margin, into a special reserve fund.
According to Article 21 of the Act No 97/1993 (see subsequently Article 28 of the Housing Act), the
Housing Bonds Division was permitted to claim an interest margin to cover its operating expenses and esti-
mated losses from outstanding loans (1). On that basis, the Icelandic Government has stated that the exclu-
sion of the housing bonds from the general system of Act No 121/1997 was based on the fact that the risk
associated with the guarantee was no longer borne by the State.

The Authority has doubts about this reasoning. The system provided for by the levying of an interest margin
does not entail that the HFF pays a premium for the State guarantee it has on commitments related to
housing bonds. Rather, it required the borrowers to pay higher interest rates to the HFF. The money raised
by the levying of the interest margin was set aside in a special reserve fund. As far as the Authority has been
able to ascertain, this fund is merely a part of the HFF. The Authority cannot see that charging borrowers
higher interest rates and setting that aside in an in-house fund can be equated with paying a State guarantee
premium pursuant to Act No 121/1997.

In conclusion, the Authority takes the preliminary view that the exemption from the guarantee premium
does give the HFF an advantage in the sense of Article 61(1) EEA. Whether any advantages could be offset
by public service obligations imposed on HFF will be addressed below.

3.3. Presence of State resources

HFF is exempted from the payment of a guarantee premium to the State Treasury otherwise applicable to all
undertakings pursuant to Article 6 of Act No 121/1997. By exempting the HFF from paying a guarantee
premium to it, the State foregoes revenues which would have normally to be paid to the State. The exemp-
tion therefore contains State resources. Similarly, to the extent HFF was originally liable to pay a guarantee
premium, but later relieved of that obligation with retroactive effect, such ex post facto exemption would also
imply a drain of State resources.

3.4. Selectivity

As outlined above, the HFF is according to Article 7 of Act No 121/1997 exempted from paying a guarantee
premium pursuant to Article 6 of the Act. The main rule according to Act No 121/1997 is that every entity
enjoying a State guarantee is subject to the guarantee premium provided for in Article 6. Those exempted
are obligations that are subject to the higher risk premium pursuant to Article 4 of the Act, the HFF, the
Central Bank of the Iceland and the Student Loan Fund.

Consequently, under Article 7 of the Act, it is only the HFF and the two other public institutions that are
exempt from paying a premium to the State for being granted State guarantees. The aid measure therefore
appears to be selective.

(1) The Minister of Social Affairs was to determine the level of the interest margin having obtained the proposal of the State
Housing Board. On the basis of that Article, the Minister decided by Regulation No 540/1993 of 28 December 1993,
amending Regulation No 467/1991, to charge an interest margin of up to 0,25 %. By Regulation of 11 October 1994, the
Minister raised the ceiling of the interest margin to 0,35 %.

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The State Guarantees Act links the payment of a premium to the existence of a guarantee issued by the
State. Moreover, it seems to be intended to (partly) compensate the State for the risk it undertakes by being
the guarantor. On that basis, the Authority does not view the Act on State guarantees as a tax measure. The
Authority has therefore not found it necessary to discuss whether the exemption pertaining to HFF would
have been within the logic or nature of a tax system.

3.5. Effect on trade between Contracting Parties

The HFF provides services on the market for housing mortgage loans, i.e. long-term house financing for resi-
dential accommodation. Aid granted to HFF may make it more difficult for banks in the EEA to enter the
Icelandic housing mortgage market. Also markets related to the mortgage market, such as other financial
markets may be affected (1). The aid therefore seems to affect trade between the Contracting Parties.

3.6. Altmark conditions

In the Altmark judgment, the European Court of Justice held that provided that the following conditions are
cumulatively fulfilled, a measure does not confer an advantage on the beneficiary and, thus, does not qualify
as state aid in the meaning of Article 87(1) of the EC Treaty, corresponding to the provision of Article 61(1)
of the EEA Agreement:

— first, the recipient undertaking must actually have public service obligations to discharge, and the obliga-

tions must be clearly defined,

— second, the parameters on the basis of which the compensation is calculated must be established in
advance in an objective and transparent manner, to avoid conferring an economic advantage which may
favour the recipient undertaking over competing undertakings,

— third, the compensation cannot exceed what is necessary to cover all or part of the costs incurred in the
discharge of public service obligations, taking into account the relevant receipts and a reasonable profit
for discharging those obligations,

— fourth, where the undertaking which is to discharge public service obligations in a specific case, is not
chosen pursuant to a public procurement procedure which would allow for the selection of the tenderer
capable of providing those services at the least cost to the community, the level of compensation needed
must be determined on the basis of an analysis of the costs which a typical undertaking, well run and
adequately provided with means so as to be able to meet the necessary public service requirements,
would have incurred in discharging those obligations, taking into account the relevant receipts and a
reasonable profit for discharging the obligations (2).

With regard to the first condition, i.e. the definition of public service obligations discharged to the HFF, it is
highly doubtful, in light of the EFTA Court's judgment, that the general loans system of the HFF as defined
today fulfils the criteria for qualifying as a service of general economic interest (3).

Concerning the second condition, the Court of First Instance of the European Communities (hereinafter ‘the
CFI’) recalled in BUPA (4) that the Member States have wide discretion not only when defining a public
service mission but also when determining the compensation for the costs, which calls for an assessment of
complex economic facts. In the same ruling, the CFI also held that the second Altmark condition requires
that the Community institutions must be in a position to verify the existence of objective and transparent
parameters, which must be defined in such a way as to preclude any abusive recourse to the concept of a
public service on the part of the Member State. The Icelandic Government has so far not demonstrated to
the Authority that a methodology exists for calculation of public service compensation to the HFF. More-
over, to the Authority's knowledge, the Icelandic Government did not establish in advance the criteria on
the basis of which the compensation for public service activities of the HFF was to be determined.

With regard to the third Altmark condition, the CFI found in BUPA that a public service compensation
system which operates independently of receipts does not require a strict interpretation of this criterion, in
particular as regards taking into account the relevant receipts for discharging public services (5). Nevertheless,
as the aid measure in question benefits the entirety of the operations of the HFF, it cannot be established at
this stage whether the level of compensation is limited to what is necessary to cover all or part of the costs
incurred in the discharge of properly limited public service obligations.

(1) See also, Case E-9/04 The Bankers' and Securities' Dealers Association of Iceland v the Authority, [2006] EFTA Court Report,
page 42, paragraphs 80-81. Furthermore, in its recent Concluding Report on the Retail Banking Sector Inquiry (page 67) the
Authority concluded that tying of different retail banking products is a common practice of financial institutions across
EEA. In particular, in the above-mentioned report, the Authority underlined bundling of current accounts and other
products such as mortgages or loans.

(2) Case C-280/00 Altmark Trans GmbH [2003] ECR I-7747, paragraphs 89-93.
(3) Case E-9/04 The Bankers' and Securities' Dealers Association of Iceland v the Authority, cited above, page 42, paragraph 79.
(4) Case T-289/03 BUPA v Commission, judgment of 12 February 2008, not yet reported, paragraph 214.
(5) Case T-289/03 BUPA v Commission, cited above, paragraph 241.

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Furthermore, with regard to the fourth condition set forth in Altmark, the HFF has neither been chosen by
way of a public procurement procedure nor did the Icelandic authorities determine the level of compensa-
tion by way of a comparison between the HFF and a privately run efficient operator as a reference under-
taking. As held by the CFI in BUPA, the purpose of the fourth Altmark condition is to ensure that the
compensation does not entail the possibility of offsetting any costs that might result from inefficiency on
the part of the beneficiary undertaking (1).

In conclusion, it cannot be established, in the Authority's view, that the four cumulative Altmark conditions
are fulfilled.

3.7. Conclusion with regard to state aid character of the measure in question

In light of the above, it is the Authority's preliminary conclusion that exempting HFF from paying a guar-
antee premium pursuant to Article 7 of Act No 121/1997 on State Guarantees, with subsequent amend-
ments, involves State aid within the meaning of Article 61(1) of the EEA Agreement. Furthermore, it is the
Authority's preliminary opinion that any such aid would constitute new aid.

4. Procedural requirements

Pursuant to Article 1(3) of Part I of Protocol 3 to the Surveillance and Court Agreement, ‘the EFTA Surveil-
lance Authority shall be 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 Icelandic authorities did not notify the Authority of the above-mentioned measures in the form of
exemption of the HFF from payment of the guarantee premium. The Authority therefore concludes that
Iceland has not respected its obligations pursuant to Article 1(3) of Part I of Protocol 3 to the Surveillance
and Court Agreement.

5. Compatibility of the aid

5.1. Possibilities to declare aid for housing purposes compatible

Article 61(1) of the EEA Agreement sets out that state aid as a principle is prohibited. Article 61(2)
and 61(3) provide, however, for certain exceptions from this general prohibition.

The derogations in Article 61(2) of the EEA Agreement do not seem to be applicable to the aid in question,
which is not designed to achieve any of the aims listed in this provision. In particular, the aid measure
involved cannot be considered to fulfil the conditions of derogation specified in Article 61(2)(a) of the EEA
Agreement, namely aid having a social character, granted to individual consumers and without discrimina-
tion related to the origin of the product concerned.

Likewise, the derogations in Article 61(3) of
the EEA Agreement do not apply to the aid measure
under investigation. In particular, the aid measure is not granted with the aim of promoting or facilitating
the economic development of certain areas or of certain economic activities. Thus, the derogations in
Article 61(3)(a) and (c) of the EEA Agreement in conjunction with the Regional Aid Guidelines are not
applicable in this case.

Furthermore, the aid measure under investigation is not given to promote the execution of an important
project of common European interest or to remedy a serious disturbance in the economy of Iceland, there-
fore Article 61(3)(b) of the EEA Agreement does not apply.

The aid in question is not linked to any investment, but reduces the costs which HFF would normally have
to bear in the course of pursuing its day-to-day business activities and is consequently to be classified as
operating aid. Operating aid is normally not considered suitable to facilitate the development of certain
economic activities or of certain regions as provided for in Article 61(3)(c) of the EEA Agreement, unless it
is specifically envisaged by the Authority's Guidelines, which is not the case here.

Aid for housing purposes may, however, be declared compatible with the EEA Agreement on the basis of
Article 59(2). That would be the case if the aid would be limited to provision of services of general
economic interest and if the other conditions of Article 59(2) of the EEA Agreement would be fulfilled.

(1) Case T-289/03 BUPA v Commission, cited above, paragraph 249.

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Article 59(2) of the EEA Agreement reads:

‘Undertakings entrusted with the operation of services of general economic interest or having the character of a
revenue-producing monopoly shall be subject to the rules contained in this Agreement, in particular to the rules on
competition, in so far as the application of such rules does not obstruct the performance, in law or in fact, of the
particular tasks assigned to them. The development of trade must not be affected to such an extent as would be
contrary to the interests of the Contracting Parties.’

Compliance with Article 59(2) of the EEA Agreement requires the fulfilment of the following conditions:

— that the aid is a compensation for the provision of services of general economic interest,

— that the undertaking receiving the aid is entrusted to provide such services,

— that the aid is necessary, and not more than necessary, to carry out the entrusted tasks, and

— that the aid does not affect trade against the interest of the Contracting Parties to the Agreement.

5.2. General remarks with regard to the concept of services of general economic interest

The concept of service in the general economic interest means, among other things, that the State assigns
‘particular tasks’ to an undertaking (1). In order to qualify for classification as service of general economic
interest, a service must have certain characteristics, the most important of which is that the service in ques-
tion cannot be provided in the same manner on the market and that the service should be clearly
defined (2). States may take account of objectives pertaining to their national policy when defining the
service of general economic interest which they entrust to certain undertakings (3).

As an exception to the main rule in Article 59(1) of the EEA Agreement, the concept of ‘services of general
economic interest’ must be interpreted restrictively (4) and applies only to activities of direct benefit to the
public. Still, States remain free, in principle and where no common policy is established, to designate which
services they consider to be of general economic interest and to organize these services as they see fit,
subject to the rules of the EEA Agreement and the specific conditions laid down in Article 59(2) of the EEA
Agreement (5). Thus, the competence to define such services lies with the States, subject to scrutiny by the
Authority. This scrutiny must essentially be conducted on a case-by-case basis. In such an assessment, the
nature of the undertaking entrusted with the service is not of decisive importance, nor whether the under-
taking is entrusted with exclusive rights, but rather the essence of the service deemed to be of general
economic interest and the special characteristics of this interest that distinguish it from the general economic
interest of other economic activities (6).

5.3. Services of general economic interest in the field of social housing

The EFTA Court gave some guidance on how to assess the extent of the HFF's activities in light of the
requirements of Article 59(2) of the EEA Agreement. The Court primarily addressed the issue of whether
the Authority should have been in doubt whether the general loans scheme of HFF was operated in compli-
ance with Article 59(2) of the EEA Agreement. The Court ruled that the Authority should have been in
doubt and consequently should have opened the formal State aid investigation procedure. (This was based
on the implicit, but non-verified, assumption that the aid in question was new aid.) While the Court did not
address whether the general loan category fulfilled the conditions of Article 59(2) of the EEA Agreement,
the Court's judgment raised issues of doubt in relation to:

— whether the HFF scheme fulfilled all conditions relating to services of general economic interest in

Article 59(2),

— whether the derogation from the State aid rules was proportionate, and

— whether the scheme affected the development of trade contrary to the interest of the Contracting Parties.

(1) See for example: Case 10/71 Muller [1971] ECR 723; Case 127/73 BRT [1974] ECR 313; Case 7/82 GVL [1983] ECR 483;

Case C-393/92 Almelo [1994] ECR I-1520; Case C-266/96 Corsica Ferries [1998] ECR I-3949.

(2) Communication from the Commission — Services of General Interest in Europe (OJ C 17, 19.1.2001, p. 7), see para-

graph 14.

(3) Case E-9/04, The Bankers' and Securities' Dealers Association of Iceland v the Authority, cited above, paragraph 67.
(4) See Case C-242/95 GT-Link A/S [1997] ECR I-4449, paragraph 50; Case T-260/94 Air Inter [1997] ECR II-147, para-

graph 135; Case C-159/94 Commission v France [1997] ECR I-5815, paragraph 53.

(5) See in this context for example: Services of General Interest, cited above, paragraph 22; Case T-106/95 FFSA [1997]
ECR II-229, paragraph 192. As stated by Advocate General Léger in his opinion in Case C-438/02 Krister Hanner [2005]
ECR I-4551, paragraph 139: ‘… it falls to the Member States to define the content of their services of general economic interest and,
in so doing, they enjoy considerable leeway since the Court and the Commission will intervene only in order to penalise manifest errors of
assessment’.

(6) Case E-4/97 Norwegian Bankers' Association v the Authority, [1998] EFTA Court Report page 38, paragraph 47.

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In relation to the first issue the Court stated inter alia:

‘[…] The HFF general loans system is intended to promote security and equal rights as regards housing in Iceland
by providing loans on manageable terms to the general public throughout the territory of Iceland and thereby foster
private home ownership. This goes beyond the normal economic interest of operators in the financial sector. A
service with this objective may qualify as a service of general economic interest justifying State aid, provided that the
service fulfils the requirements laid down in Article 59(2) EEA.’ (1).

When the EFTA Court later turned to the questions on proportionality, it held, inter alia, that:

‘[…] as long as it is not established that the effect of the low interest rate on HFF general loans is completely
neutralised by an increase in housing prices, the HFF general loan scheme must be considered suitable to meet its
aim.’ (2).

And moreover:

‘The Court does not find it doubtful that the State aid provided to the HFF system did not go beyond what is
necessary in the case at hand to allow the HFF to cover expected losses and operate the general loans system under
economically acceptable conditions [ …] This does not mean, however, that the general loans system as operated by
the HFF is necessarily compatible with the EEA Agreement.’ (3).

Then the Court went on to, inter alia, state that:

‘[…] it is necessary to address the question of whether the conditions under which the loans were granted did not
go beyond what was necessary for HFF to perform the tasks entrusted to it. The Court recalls that the ultimate aim
of the State's intervention in lending services through the general loans scheme is to foster private home ownership
in Iceland through lending on “manageable terms”. A service rendered with such an objective may, as has been
stated above, be considered legitimate under Article 59(2) EEA. However, ESA has to make sure that public inter-
vention does not, in reality, pursue other goals than those defined by Icelandic law or exceed what is necessary to
achieve the defined goal.

In that regard, the Court notes that unlike the cost and size limitations practiced by the Norwegian Husbanken in
Case E-4/97 Husbanken II, the HFF's relative and absolute lending caps do not limit the subsidised lending
scheme to dwellings which fulfil certain criteria. They only limit the amount one may borrow from the HFF for any
dwelling, regardless of the value or size of that dwelling. There is no limit as to how big or valuable a dwelling
may be and still be eligible for a general loan under the HFF scheme; there are only limits to how much the HFF
may grant as a general loan.

Moreover, the HFF general loans scheme is not limited to the financing of one unit of residential housing for each
borrower. This means that in principle the system may provide financing for houses or apartments built or
purchased for investment purposes. In 2004, a general limit of two units was introduced. As the Government of
Iceland has pointed out, there may be social policy reasons why certain persons need to own more than one unit.
The provision of more than one loan to the same person has not, however, been made dependent on that person
fulfilling any criteria relating to such reasons.

These features mean that in principle the HFF general loans scheme provides subsidised financing, up to a certain
limit, for any house or apartment regardless of size and value, and also for construction or purchase of residential
units for investment purposes. The scheme is not formally limited to assisting the average citizen in financing his or
her own dwelling. Even if it may be so that few people have in fact exploited these features of the system, they raise
questions under Article 59(2) EEA. The Court recalls in this context that the HFF scheme is intended to promote
security and equal rights as regards housing by providing loans on manageable terms.’ (4).

( a ) M a n a ge a b l e te r m s

The EFTA Court did not rule out per se that State intervention in lending services through general loans,
which pursues the objective of fostering private home ownership through lending on ‘manageable terms’
might be considered legitimate under Article 59(2) of the EEA Agreement. In this respect, the EFTA Court
clarified that the Contracting Parties enjoy a margin of discretion in deciding what ‘manageable terms’
should mean in relation to a housing financing scheme which qualifies as a service of general economic
interest (5).

(1) Case E-9/04 The Bankers' and Securities' Dealers Association of Iceland v the Authority, cited above, paragraph 68.
(2) Case E-9/04 The Bankers' and Securities' Dealers Association of Iceland v the Authority, cited above, paragraph 71.
(3) Case E-9/04 The Bankers' and Securities' Dealers Association of Iceland v the Authority, cited above, paragraph 73.
(4) Case E-9/04 The Bankers' and Securities' Dealers Association of Iceland v the Authority, cited above, paragraphs 76 to 79.
(5) Case E-9/04 The Bankers' and Securities' Dealers Association of Iceland v the Authority, cited above, paragraph 71.

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In the view of the Authority, the concept of ‘manageable terms’ cannot be understood in any absolute or
isolated manner. While noting the Court's view that there should be a margin of discretion to decide what is
manageable, the concept has to relate to certain general parameters of the national economy. What is
manageable in a rich country may not be manageable in a less prosperous one. In a well-functioning market
without a particular skewed distribution of income, it would appear reasonable to assume that the market
interest rates on mortgages would be ‘manageable’ for the population at large. Excluding that public activity
itself is distorting the market, to the extent the market is not well functioning there could be a reason for
government measures to provide for loans on ‘manageable terms’.

It was confirmed in the EFTA Court's judgment that the commercial banks were only able to match the
interest rate of HFF's general loans from August 2004 onwards (1). In its Decision No 185/06/COL, the
Authority requested up-dated information on the development on the Icelandic mortgage market, in order
to assess to what extent commercial banks had offered mortgage secured loans on terms the Icelandic State
would consider as manageable. While some information has been provided the Authority would require up-
dated information in this respect as there are indications that the state of the market has changed recently.
The amount of mortgage loans, especially from the commercial banks has fallen considerably (2).

A connected, but separate, issue is whether the market would be able to develop satisfactorily if it would
operate under conditions without any State aid distorting the competitive situation of the respective lenders.
Up till now, the Authority has not been presented with any arguments or factual information that give it
reason to believe that this should be the case.

( b ) S o c i a l e l e m e n t

The general loan scheme of the HFF is not limited to those below certain income and/or assets thresholds
but is available to everyone irrespective of those elements and as the EFTA Court has pointed out, without
any cost and size limitations on the dwellings. Furthermore, the general lending system is also open to
others than individuals, for example building contractors may qualify for loans under that system.

In the Court's words, the ‘lending caps do not limit the subsidised lending scheme to dwellings which fulfil certain
criteria’ and ‘there is no limit as to how big or valuable a dwelling may be and still be eligible for a general loan under
the HFF scheme; there are only limits to how much the HFF may grant as a general loan’ (3).

Moreover, the EFTA Court pointed out that the scheme provided for construction or purchase of individual
units for investment purposes, and it was not formally limited to assisting the average citizen in financing of
his or her house. The rules have now been changed and Article 21 of the Regulation No 522/2004, as
subsequently amended, provides that lending from the HFF is limited so that an individual can only own
one property carrying a mortgage from the Fund. However, the Board of the Fund may set rules providing
for exemption from this requirement. On 10 August 2006, the Board passed such rules. The Icelandic
authorities are requested to explain these exemptions and their application and how the HFF monitors that
residential housing financed by the HFF's loans is actually used for purposes of being the applicant's own
dwelling.

In a letter received by the Authority on 14 June 2007, the Icelandic Government argued that there were no
grounds for questioning the compatibility of the general lending scheme with the EEA Agreement. In light
of the observations of the EFTA Court, quoted above, the Authority is of the preliminary opinion that the
Icelandic Government has not demonstrated that the current general loan scheme is in compliance with
Article 59(2) of the EEA Agreement. Moreover, the Commission's practice regarding social housing shows
that the Commission has only accepted systems of social housing, which contained limitations as to who
could qualify for loans under the system.

In 2001, the Commission adopted a decision with regard to a guarantee for borrowings of the Irish Housing
Finance Agency (hereinafter referred to as the HFA) (4). At the time of this decision, the HFA was itself

(1) Case E-9/04 The Bankers' and Securities' Dealers Association of Iceland v the Authority, cited above, paragraph 74.
(2) See e.g.

http://www.mbl.is/mm/frettir/innlent/2006/04/27/samdrattur_i_ibudalanum_bankanna/ and
http://www.mbl.is/mm/vidskipti/frettir/2008/05/26/verulegur_samdrattur_i_ibudalanum_bankanna/
(3) Case E-9/04 The Bankers' and Securities' Dealers Association of Iceland v the Authority, cited above, paragraph 77.
(4) Decision of 3 July 2001 in State aid N 209/01 — Ireland — Guarantee for borrowings of the Housing Finance Agency, SG
(2001) D/289528. The Commission has also dealt with two Swedish schemes regarding social housing which it considered
compatible aid on the basis of Article 87(3)(c) of the EC Treaty. In the first case (Commission Decision of 24 June 2003 in
State aid N 40/03 — Sweden — Measures to promote certain house building, C(2003) 1762 fin) a State support in the
form of a VAT tax exemption was granted to constructions in certain areas of Stockholm, Gothenburg and Malmö. The
scheme was restricted to rented dwellings measuring up to 70 m2 and student accommodation at college and university
sites with a maximum size of 25 m2 with additional ceilings on the aid level per dwelling. The rent for both types of dwell-
ings was regulated. In the second case (Commission Decision of 7 March 2007 in State aid N 798/06 — Sweden —
Support for construction of special housing for elderly people, C(2007) 652 fin) the scheme was targeted to benefit elderly
people who were not able to continue living independently. The scheme provided direct grant support to special housing
for elderly. According to the conditions of the scheme, the size of the apartment could not exceed 35 m2 per one-person
apartment and 50 m2 per two-persons apartment with additional support to 15-20 m2 for common space (used for
example for meals, hobbies, group activities). The maximum aid intensity was 10 % of actual construction costs.

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not empowered to extend loans. Its objective was to raise funds at the best rate on the capital markets
which were then advanced to local authorities to be used by them for social housing financing. In this case,
social housing was defined as provision of housing for the most socially disadvantaged households, and in
particular those which due to their economic circumstances were unable to fund their own housing require-
ment at socially acceptable conditions through recourse to commercial lenders. This objective was entrusted
to local authorities who operated social housing programmes such as general mortgage finance, the opera-
tion of a share ownership scheme, and affordable housing schemes aimed at providing low cost housing, a
rental subsidy scheme and miscellaneous grant schemes for elderly and disabled persons. The eligibility for
social housing loan finance was assessed according to the following limitations: (i) need must be established;
(ii) income and loan ceilings; (iii) households which seek to avail of schemes unavailable in the private sector
(this had to be proved by the applicant by attaching letters of rejection from two private sector mortgage
lenders); and (iv) only households which are mentioned on local authority housing lists. Thus, the Commis-
sion accepted that the operations of the Agency could be regarded as services of general economic interest
for the purposes Article 86(2) of the EC Treaty.

The Authority also refers to a case concerning the financing of activities of Dutch Housing Corporations
which is still pending before the Commission. In 2005, DG Competition sent an Article 17(2) letter, inviting
the Dutch authorities to make appropriate changes to the system. DG Competition has, inter alia, criticised
the broad scope of definition of services of general economic interest provided by the Housing Corporations.
In particular,
it was not considered acceptable that, whereas the priority to rental housing is given to
persons that have difficulties in finding suitable housing, the activities in question are not restricted to
socially disadvantaged persons. Therefore, DG Competition was of the opinion that the possibility to let
dwellings to persons with a higher income or to enterprises must be regarded as a manifest error in the defi-
nition of a service of general economic interest. Moreover, this concern was not removed by the proposed
solution of the Dutch authorities to limit the maximum value of the dwellings to be rented out which
would be then defined as ‘social housing’. In the preliminary view of DG Competition, the definition of
public service activities of Housing Corporations was to have a direct relation to socially disadvantaged
households and not only be linked to the maximum value of the property (1).

Furthermore, the Icelandic Government referred to the fact that the Authority, in its decision in the Norwe-
gian Husbanken case, accepted loans that were not limited to those qualifying under certain income and
assets criteria but limited the size of the of house/apartment being acquired. Iceland has argued that the
Norwegian limit should not be regarded as being universal and that the situation in Iceland would justify a
higher limit. The Authority will, at this stage, not pass judgment on whether only imposing a size limitations
would be sufficient to ensure compliance with Article 59(2) of the EEA Agreement as it observes that
currently the HFF system operates without any limitations as to the size of house/apartment that may
qualify for loans under the general system.

In light of all of the above, it is the preliminary view of the Authority that the general loan scheme of the
HFF does not pursue a sufficiently restricted social objective.

( c ) Te r r i t o r i a l c o h e s i o n

As regards the element of territorial cohesion, the Authority is aware of the particular situation of certain
regions in Iceland, where the market for mortgage loans might be of such a nature that commercial provi-
ders do not have incentives to offer mortgage loans. Such a situation might justify exceptional treatment of
certain territories as regards the conditions for eligibility of loans (2). Currently, the general loans scheme of
the HFF is operated without any criteria related to territorial cohesion.

In its Decision No 185/06/COL it was the Authority's opinion that SFF had not submitted any tangible
evidence during the EFTA Court proceedings, which demonstrated that the commercial banks had offered
loans on ‘manageable terms’ outside the Reykjavik area during the period between 1999 and August 2004.
In response to the Authority's request for information the SFF and the Icelandic Government submitted
conflicting evidence as to the extent the commercial banks had offered mortgage loans outside the Reykjavík
area and other more densely populated areas after August 2004. In light of the currently available informa-
tion the Authority cannot conclude that the loans provided by the commercial banks have not been offered
in rural areas as well, as far as the period after August 2004 is concerned.

(1) Letter dated 14 July 2005 from DG Competition to the Dutch authorities, 0/55413.
(2) See for example the differentiation of ceiling for the level of aid per dwelling according to the area in the Swedish Case

N 40/03, referred to above.

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5.4. Development of trade and the interest of the Contracting Parties

Article 59(2) of the EEA Agreement further requires an assessment of whether the specific service in ques-
tion affects the development of trade to an extent contrary to the interests of the Contracting Parties. The
Authority is charged with striking a balance between the right of Iceland to invoke the derogation and the
interest of the Contracting Parties to avoid distortions of competition and restrictions to the ‘four free-
doms’ (1).

This entails that it must be established that the performance of the service of general economic interest does
not disproportionately affect competition and the internal market. In light of the EFTA Court's conclusions
on this point (2), the Authority will have to assess to what extent the aid granted to the HFF could affect
other parts of the EEA internal market, in particular other financial markets, such as, for example, the
private lending market. However, as outlined above, the Authority is of the preliminary opinion that the
current lending scheme is not compatible with Article 59(2) as it is too widely defined. In light of that, the
Authority does not consider it necessary to assess whether the service affects the development of trade to an
extent contrary to the interest of the Contracting Parties. In any event, an amended scheme will have to
strike the right balance between the interests at stake.

Against the background of the various points referred to above, the preliminary view of Authority is that
the general loan scheme of HFF does not comply with all the conditions laid down in Article 59(2) of the
EEA Agreement.

5.5. Other loan categories of the HFF

In the discussion above regarding the compatibility of the aid, only the general loans category of the HFF
has been referred to. However, the exemption in Article 7 of Act No 121/1997, as amended, covers entire
operations of the HFF. Currently, the HFF is also providing loans for rental housing to municipalities, etc.
pursuant to Chapter VIII of the Housing Act. Furthermore, the Minister of Social Affairs has, on the basis of
Article 16 of the Housing Act, issued Regulation No 458/1999, with subsequent amendments, which lists
the other loan categories offered by the HFF, cf. Article 2 of the Regulation (3).

As outlined above, the Authority is of the preliminary opinion that the general loans scheme of the HFF is
incompatible with Article 59(2) EEA. Since the exemption from the guarantee premium benefits all the
operations of the HFF, it follows that this measure cannot be regarded as compatible aid on the basis of
Article 59(2). This is so even though the individual loan categories referred to above examined in isolation
might comply with the conditions laid down in that provision.

5.6. Conclusion with regard to compatibility

On the basis of the foregoing considerations, the Authority has doubts as to whether the guarantee
premium exemption in favour of the HFF can be regarded as compatible with the functioning of the EEA
Agreement.

6. Recovery

According to Article 14(1) in Part II of Protocol 3 to the Surveillance and Court Agreement, ‘[w]here negative
decisions are taken in cases of unlawful aid, the EFTA Surveillance Authority shall decide that the EFTA State
concerned shall take all necessary measures to recover the aid from the beneficiary (hereinafter referred to as a “recovery
decision”). The EFTA Surveillance Authority shall not require recovery of the aid if this would be contrary to a general
principle of EEA law’.

In other words, any unlawful aid which cannot be declared compatible with the State aid rules will be
subject to recovery. In case of recovery, it is the Authority's preliminary view that, in the case at hand, no
legitimate expectations could be invoked, which would preclude the recovery.

(1) See similar Case E-4/97 Norwegian Bankers' Association v the Authority, cited above, paragraph 70.
(2) Case E-9/04 The Bankers' and Securities' Dealers Association of Iceland v the Authority, cited above, paragraph 81.
(3) Article of Regulation No 458/1999, as amended, provides for the following categories: ‘1. Loans for the construction or
purchase of day-care institutions, service centres, homes and apartments specially designed for the needs of the elderly; 2. Loans for the
construction or purchase of communal housing for the disabled; 3. Special loans — loans to those with special needs; 4. Maintenance
loans; 5. Loans for major outdoor maintenance of redeemed apartments; 6. Loans or grants for technical innovations and other reforms
in the construction industry; 7. Loans for rental housing; 8. Loans for the construction or purchase of homes and day-care institutions
for children and young people.’.

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According to settled case-law, ‘[…] undertakings to which an aid has been granted may not, in principle, entertain a
legitimate expectation that the aid is lawful unless it has been granted in compliance with the procedure laid down in
that article. A diligent businessman should normally be able to determine whether that procedure has been followed’ (1).

Consequently, any unlawful aid which will ultimately be declared incompatible with the State aid rules will
be subject to recovery.

7. Conclusion

The Authority is of the preliminary opinion that the exemption from the guarantee premium in favour of
the HFF constitutes aid within the meaning of Article 61(1) of the EEA Agreement. Furthermore, the
Authority has doubts that this measure can be regarded as complying with Article 61(2) and (3) of the EEA
Agreement or with Article 59(2) of the EEA Agreement. Any unlawful aid which ultimately will be declared
incompatible with the State aid rules will be subject to recovery.

Consequently, and in accordance with Article 4(4) of Part II of Protocol 3 to the Surveillance and Court
Agreement, the Authority is obliged to open the procedure provided for in Article 1(2) of Part I of Protocol
3 of the Surveillance and Court Agreement. The decision to open proceedings is without prejudice to the
final decision of the Authority, which may conclude that the measure in question is compatible with the
functioning of the EEA Agreement.

In light of the foregoing considerations, the Authority, acting under the procedure laid down in Article 1(2)
of Part I of Protocol 3 to the Surveillance and Court Agreement, requests the Icelandic authorities to submit
their comments within one month of the date of receipt of this Decision.

In light of the foregoing consideration, the Authority requires that, within one month of receipt of this deci-
sion, the Icelandic authorities provide all documents, information and data needed for assessment of the
compatibility of the exemption from the payment of the guarantee premium in favour of the HFF. It requests
the Icelandic authorities to forward a copy of this decision to the potential aid recipient of the aid
immediately.

HAS ADOPTED THIS DECISION:

Article 1

The EFTA Surveillance Authority has decided to initiate the formal investigation procedure provided for in
Article 1(2) in Part I of Protocol 3 to the Surveillance and Court Agreement against Iceland regarding the
exemption of the Housing Financing Fund contained in the Act on State Guarantees to pay a premium on
the guarantee provided by the Icelandic State in its favour.

Article 2

The Icelandic authorities are requested, pursuant to Article 6(1) in Part II of Protocol 3 to the Surveillance
and Court Agreement, to submit their comments on the opening of the formal investigation procedure
within one month from the notification of this Decision.

The Icelandic authorities are required to provide within one month from the notification of this Decision all
documents, information and data needed for the assessment of the compatibility of the aid measure.

Article 3

Article 4

The Icelandic Government is requested to forward a copy of this Decision to the recipient of the potential
aid immediately.

(1) Case C-5/89 Commission v Germany [1990] ECR I-3437, paragraph 14; Case C-169/95 Spain v Commission [1997]

ECR I-135, paragraph 51.

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The EC Commission shall be informed, in accordance with Protocol 27(d) of the EEA Agreement, by means
of a copy of this Decision.

Article 5

Article 6

Other EFTA States, EC Member States, and interested parties shall be informed by the publishing of this
Decision in its authentic language version, accompanied by a meaningful summary in languages other than
the authentic language version, in the EEA Section of the Official Journal of the European Union and the EEA
Supplement thereto, inviting them to submit comments within one month from the date of publication.

This Decision is addressed to the Republic of Iceland.

Article 7

Article 8

Only the English version is authentic.

Done at Brussels, 27 June 2008.

For the EFTA Surveillance Authority

Per SANDERUD

President

Kurt JAEGER

College Member