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OFT and State aid action plan

This entry was added to http://www.reckon.co.uk/headlines-franckblog on 23 November 2005
Full blog table of contents available at Contents | viewpoint: Franck.

The Office of Fair Trading wants to get involved in the analysis of the compatibility of State aid with Article 87 of the EC Treaty. This article reviews the OFT's proposals.

The European Commission's State aid action plan consultation (19 pages, PDF) published in June 2005 suggested some changes to the way in which the Article 87 restrictions on State aid within the European Union are applied, including a revision and consolidation of block exemptions and guidelines. It also said that the Commission "will, when relevant, strengthen its economic approach to State aid analysis".

The OFT has now submitted two responses to this consultation, both of which read like bids to get involved in the economic analysis of State aid cases.

The OFT's first bid was a short document suggesting that the OFT could offer advice to the Commission, and that the system should be reformed so as "to ensure that aid that poses a significant risk to competition are [sic] prohibited and aid that does not pose a risk is approved". That seemed rather different from the requirements of the EC Treaty as interpreted by the courts, but was perhaps sufficiently vague to be reconciled with them; and the offer by a UK State body to advise the European Commission on its assessment of UK State aid proposals seemed strange but essentially harmless.

The OFT's second bid provides lengthy details on both points. It makes specific proposals for the OFT's involvement in the process and for the nature of the analysis, both of which seem to me to be completely misguided.

On the OFT's phase one proposals

The OFT's proposals for the substantive assessment of State aid notifications by the European Commission appear to boil down to the following:

The phase one process and associated guidelines seem to be a straightforward extension of the current guidelines under Article 87(3). There would be greater use of "market failure" terminology as a way of describing the objectives of State aid, in particular aid granted for economic development purposes under Article 87(3)(c). This seems in line with what I understood to be the purpose of the European Commission's State aid action plan.

However, using the same phase one/phase two terminology as for merger control might give false impressions about the likely timescales involved. And I suspect that in many cases figuring out whether there is aid within the meaning of Article 87(1) is the difficult part, and that it is false to suggest that the analysis can consider in turn Article 87(1), block exemptions, guidelines and Article 86(2)/Article 87(3). But this is mere terminology and I did not notice any specific proposals on timescales in the OFT document.

There are some details of the OFT's phase one proposals that I am not convinced about. For example, I doubt that tests such as "aid below 25 per cent of the cost of new activity" are generally appropriate (or even sufficiently well defined to be useful), even if they can work reasonably well as proxies in specific cases (as is currently the case under the environmental or cinema aid guidelines).

The OFT also suggests that market definition is a useful or necessary form of analysis in phase one, but its discussion (paragraphs 4.45-4.52) seems to envisage an assessment of the economic effect of the aid à la phase two, rather than the application of simple phase one guidelines.

But the OFT document does not really provide enough information on its ideas for its phase one to permit any useful commentary.

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On the phase two analysis of State aid schemes

Where there is a major problem with the OFT's proposals is in phase two, and specifically in the nature of the work to be done to assess proposed State aid schemes under Article 87(3) (or probably Article 86(2), although the OFT is strangely quiet about public services in its discussion of the "phase two assessment").

This is how the OFT describes the purpose of the phase two analysis (paragraphs 5.2-5.3):

Phase one sifts out subsidies that are unlikely to distort competition significantly. Proposed State aid that is subject to further analysis is considered likely to have a significant impact on competition. This proposed state aid could still be approved however, for one of two reasons:

– although the sift characteristics indicated the potential for significant competition effects, there are other characteristics of the state aid and market that offset these, hence the state aid is not likely to have a significant effect on competition and as such can be approved, or

– the distortion to competition from the state aid, although significant, is outweighed by the benefits in the European common interest.

It is the role of the phase two assessment to consider whether state aid should be approved on either of these grounds.

This statement is so obviously at odds with Article 87 case law that I cannot understand how the OFT's board allowed it to be published. The text quoted above says that aid which does not significantly distort competition can be approved with no further ado. Philip Morris (State aid) amongst many others confirms that this is wrong: even a purely hypothetical and insignificant effect is sufficient for aid to be State aid within the meaning of Article 87(1), and it is clear from the text of Article 87 that some more ado is required to approve such aid. At the very least, some reason within the scope of Article 87(2) or (3) or elsewhere in the Treaty (e.g. Article 86(2) or sectoral policy objectives) must be identified. (This does not arise in the case of de minimis aid as the Commission has taken the view that there is no potential effect on trade between EU member states, as noted in Annex B of the OFT document).

Thus, the first leg of the OFT's test would approve aid that is not actually compatible with the EC Treaty. This could occur, for example, if the phase two analysis had failed to consider a potential effect on competition because it considered it unlikely to occur, or because the analysts did not think of a particular way in which the market might develop. The authors of the EC Treaty and the judges who confirmed its meaning were obviously wiser to the risk of "pretence of knowledge" than OFT economists.

As to the second leg of the OFT's test, it merely refers us to the "European common interest" as the guide to decide whether aid is compatible.

The "common interest" gets a mention in Article 87(3)(c) and (d), where it qualifies a justification for State action as follows (the two paragraphs have slightly different words):

where such aid does not [adversely] affect trading conditions [and competition] to an extent [that is] contrary to the common interest.

I think this is the same as the "interests of the Community" in Article 86(2) where the qualification is expressed as follows:

The development of trade must not be affected to such an extent as would be contrary to the interests of the Community.

A full discussion of these clauses deserves an article to itself, but in broad terms my understanding is that these qualifications restrict the justifications for State aid — and for other derogations to the competition rules in the case of Article 86(2) — by excluding any State policies for economic development, heritage, public service and other such objectives that would be incompatible with the Treaty. In the context of public services, this complements (and arguably duplicates) Article 86(1). For Article 87(3)(c) and (d), it may go further, for example by preventing a cultural policy that discriminates on the basis of nationality to be used as a justification for State aid, even if the particular form of discrimination was by itself (absent State aid) compatible with the Treaty.

But this interpretation of the "common interest" is obviously not the same as the OFT's.

Instead the remainder of section 5 of the OFT's document goes on to describe a form of analysis inspired by merger control, involving the selection of a counterfactual (what would happen if the aid was not granted) and the description of any lessening or adverse effects on competition that might arise from the aid, compared to that counterfactual.

There is not the slightest acknowledgement of the need to identify a justification for the aid in terms of the provisions of the Treaty, and therefore nothing on the legitimacy of the objectives used as justification or the proportionality of the aid to its objectives.

In fact, the OFT's proposed phase two approach is very reminiscent of UK Competition Commission inquiries under the Fair Trading Act 1973 or the Enterprise Act 2002. It would involve a comprehensive review of what is going on, where there is competition, and how certain things — a merger, a regulation or other market feature, here a State aid — might affect how markets work. In these UK inquiries, the Competition Commission is then asked to make a pronouncement as to whether the things under review operate against the public interest, or (in its more modern incarnations) whether there is a substantial lessening of competition or an adverse effect on competition.

Given these precedents and the considerable debate in the UK about the exact nature of the test and the role of ministers in these inquiries, it is interesting to see the OFT suggesting a "common interest" test for State aid, whereas the public interest test in the UK is only ever used in cases where the final decision rests with someone other than the Competition Commission (such as a Government minister accountable to Parliament or a regulator operating under specific statutory duties).

Given this, and the lack of any detail about what would actually be done if the OFT's proposed approach were adopted, it seems that the OFT believes that some sages sitting in Brussels (or London?) should be responsible for deciding whether some French or Slovak State aid scheme is in the European common interest, having reviewed information about its effects on markets and competition.

It seems to me that the OFT's proposed approach rests on a complete misconception of EC State aid control.

The EC Treaty specifies certain classes of purposes which might justify State aid, limits their scope by reference to the interests of the Community, and limits the aid itself by the application of the principle of proportionality: any aid must be kept to the minimum necessary to achieve the legitimate purposes. It is accepted that applying these rules will require some degree of judgement by the European Commission (controlled by the courts). But the important point is that the power to determine the objective of State aid policy rests with individual Member States, and the role of the European Commission is limited to detecting aid that is not justified by the stated objectives, or objectives that would conflict with the Treaty.

Consider a semi-hypothetical example of French State aid to French cinema. The European Commission is not asked to decide whether French cinema is worth supporting. It is told by France that it is worth supporting; it checks that the objective is expressed in a manner compatible with the Treaty (e.g. French-language movies rather than movies made by French passport holders); and it checks whether there are ways of achieving the specific objectives of any proposed scheme that would involve less aid that the scheme put forward by France. If these hurdles are cleared then the aid is approved.

The OFT's approach, by contrast, would boil down to telling some hypothetical wise man what the foreseeable effects of the aid scheme on competition on various cinema and other markets might be, and asking him to decide whether the aid is OK, taking account of how much good French cinema might do to the "European common interest". There would be no attempt at revealing the specific objectives of the scheme, and no attempt at applying any notion of proportionality.

The OFT's proposed approach would therefore give a completely inappropriate level of discretion to the European Commission to interfere in many areas of national policy through State aid control, whilst at the same time reducing the rigour with which the need for each element of aid is examined, thus failing to achieve the "less and better targeted aid" aim of the State aid action plan.

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On the OFT's involvement

My main reason to be concerned about the OFT's attempt at advising anyone on State aid control is obviously that the OFT's document is so misguided about the nature and purpose of this control.

As as a proposal for advisory services, the OFT's bid fails at the first hurdle: "understanding the requirement".

Perhaps recognising the weakness of its offer in a competitive market, the OFT suggests that it should be automatically retained to help UK aid providers make submissions to the European Commission on the compatibility of their aid schemes (and to interfere in the design of these schemes).

But there seems to be no reason to believe that the structures currently established by the UK Government to provide advice to UK aid providers, dare I say complemented by consultancies, are failing to deliver this task. Organisations such as the DTI and the Scottish Executive State aid unit specialise in State aid clearances and can be expected to understand Article 87, and therefore to provide more useful advice to providers than the OFT. And consultancies can provide additional assistance in specific industries or types of cases, in the cases where this is required. Why does the OFT want to upset this market?

It is also worrying to see the OFT diverting its energy away from its true duties in an attempt at taking over other people's jobs.

I may have criticised the OFT in this blog before, for dereliction of its duty to enforce Article 81. And whilst I have not yet had an opportunity to comment on its actual competition law enforcement work, I notice that the National Audit Office, albeit in its typical understated tone, says that it is not that good.

I think that some people in Fleetbank House should try to do their real jobs better instead of telling the rest of Government and the whole European Union how to run their affairs.

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Declaration of interest: Reckon LLP offers advisory services in the application of the State aid rules. But we try to apply the law as it is rather than invent some new regime, and are therefore probably not in the same market as the OFT.

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Entry added by Franck Latrémolière on 23 November 2005

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Last changed by Franck at 8:52 PM on Wednesday 7 December 2005.

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Reckon Open "OFT and State aid action plan | viewpoint: Franck" 2005-12-07T20:52:50