Seminar on JESSICA and State Aid Brussels 4

Seminar on JESSICA and State Aid Brussels, 4 May 2011 JESSICA: detailed economic assessment directly under TFEU Eglé Striungyté and Christian Harringa DG Competition, European Commission* * DISCLAIMER: The views expressed are purely those of the presenters and may not in any circumstances be regarded as an official position of the European Commission 1

Potential State aid beneficiaries Private investors in HF/UDFs receiving preferential treatment compared to public investment Project promoters (and other project investors) receiving sub-commercial equity, loans and guarantees HF/UDF managers receiving higher than market remuneration for investment management services 2

Assessment principles • Direct application of Art 107(3) TFEU: – For measures falling outside the scope of any existing rules; – Detailed economic assessment – effect-based balancing test of positive and negative effects. • Key assessment principles: – Targeting an objective of European common interest; – Well-designed (appropriate means, incentive effect, proportionality); – Limited effects on trade and competition. 3

Overall objectives • Overall objectives: – Tackling market failures (efficiency objective) which lead to economic underperformance and strengthening socio-economic cohesion (equity objective) in target urban areas • Supporting urban development projects (UDPs) that are in common EU interest, however not commercially attractive for market investors: – Efficiency objective: risk characteristics of UDP (high initial costs, long duration, uncertain revenues, etc) may lead to coordination problems, asymmetry of information and externalities, resulting in market failures; – Equity objective: UDPs that tackle socio-economic deprivation issues ( e. g. UDPs entailing public goods or/and with uncertain profitability due to location characteristics , urban planning constraints). 4

Funding architecture • The Holding Fund (optional): – Responsibilities: selection and investment in UDFs on behalf of public authorities; – Provides a mechanism for the diversification of investments in several types of UDFs and more efficient controls; – Economies of scale and a catalyst in the investment process. • The UDF: – Responsibilities: individual investment decisions in UDPs – Professional managers, performance incentives • Key parameters of HF/UDFs: – Size, legal and ownership structure, funding sources, investment policy, governance structure, etc. 5

Eligibility criteria (1) • Each UDP must form part of an integrated plan for sustainable urban development (IPSUD) – Excluding “single” unrelated projects • IPSUDs must be in line with the objectives of EU Strategic Guidelines, comprising i. a. : – The target urban area; – Analysis of urban socio-economic and environmental needs and demand for assets/services; – A coherent development plan (a multi-purpose, multi-sector approach); – A financially sustainable investment strategy; – Approval of responsible local authority. 6

Eligibility criteria (2) • Eligible beneficiaries i. a. : – Any size, multi-sectoral, not companies in difficulty, no State aid recovery. • Geographic requirements: – UDPs must be carried out in the target areas defined in the IPSUD. • Eligible activities and costs: – Investment activities and costs must reflect the nature of UDPs affected by market failures, initial investment (not replacement capital or buyouts) in line with SF Regulations. • Financial sustainability: – Projects must generate some returns to repay UDF investments (and other market investors at UDF or UDP level). 7

UDF non pari-passu investments • UDFs could provide sub-commercial equity/quasi-equity, loans and guarantees (entails State aid) to make projects economically sufficiently viable. • Examples of State aid in loans, guarantees and equity/quasi-equity: – Loans and guarantees at lower than market rates; – Equity/quasi-equity with non pari-passu risk sharing of the upside and/or downside between public and private investors, which could take the form of preferential returns for private investors and/or UDF taking a first loss position. 8

UDF investments: proportionality • General principle: – UDF sub-commercial investments (in any form) must be adjusted to the minimum necessary to limit State aid to investors both at UDP or UDF level • Conditions for estimated investment performance: – UDF may not invest at loss - at least an initial UDF investment value should be repaid based on estimated investment performance; – UDF sub-commercial investments may not result in higher than market returns on private investment (FRR) at UDF or project level. • Conditions for actual investment performance: – If the investment outperforms initial estimates, a profit-sharing mechanism must be in place to share the upside (beyond the FRR) proportionately; – If the investment underperforms compared to initial estimates, a losssharing mechanism must be in place to limit UDF first loss exposure. 9

Co-investors in UDPs • In order to limit State aid intervention and at the same time benefit as much as possible from market players’ intelligence, the UDF may not finance a UDP without market oriented co-financing sharing investment risks. • Co-financing must be significant, e. g. not smaller than 30% of a UDP. • Co-financing can take place at fund level or at the level of individual projects. • UDF managers (e. g. banks) are allowed to co-invest, applying arm’s length principle, subject to – Prior verification of non pari-passu investment conditions by Independent Experts and – Project reporting and evaluation following international accounting standards. 10

UDF decision-making (1): UDP selection • A fair and open selection procedure for potential UDPs has to be provided (e. g. publication on website, road show etc. ). In addition, a possibility to apply as UDP should be ensured over the UDF’s entire life cycle. • As part of individual due diligence of aided UDP applicants, UDF managers must establish a viability gap caused by market failures and/or socio-economic extra costs resulting in the non-financing of a UDP by the market (Necessity Test). • UDF managers have to verify and keep at Commission’s disposal sufficient proof of relevant market failures or socio economic extra costs. 11

UDF decision-making (2): Structuring UDP investment conditions • Investments into UDPs have to be based on a business plan and an ex-ante defined exit strategy. • UDF managers are expected to structure – preferential – investment conditions in a way that minimizes Staid to private investors resulting in a Fair Rate of Return. – Preferential option is to run a competitive process i. e. public tendering or appropriate negotiations with at least two potential co-investors, records thereof being kept at Commission’s disposal. – Where the competitive process is not possible ( e. g. only one potential investor, potential investor already owns essential asset such as piece of land), appropriate non pari-passu investments conditions have to be verified by an Independent Expert. – Independent Experts will use industry benchmarks adjusted to project specific investment risks when establishing appropriate advantages for private investors. 12

Requirements for Independent Experts • Independent experts (IEs) have industry and market knowledge as well as financial expertise related to a particular project. Potential IEs are accounting firms, real estate developers, investment banks, consultants, etc. • Holding funds or national authorities will carry out pre-selection procedure of eligible IEs. • IEs have to disclose all current relationships with UDF or potential UDP. • IEs, their employees or spouses shall not have any financial links with the UDF or the potential UDP. • A UDF shall not use the same IE too frequently, e. g. more than twice within a period of six months. • IEs will be liable for the accuracy of their expertise not only to the UDF, but also to the Holding fund and/or the National Authorities. 13

Requirements for UDF management • UDF managers have to be selected by means of an open tendering procedure (call for expression of interest, „in house rules“ apply) in order to exclude State aid to the management • UDF managers need a proven track record in the relevant sector of urban development. • Compliance with best practice rules and professional standards has to be ensured. • Management remuneration has to foresee an appropriate flexible success based component in order to incentivise profit oriented investment decisions and limit distortion of competition. 14

Other Requirements • Annual reporting obligation to the Commission, sufficient to verify compliance i. a. with State aid provisions. • Standardized information sheets (SIS) for UDPs beyond a certain size (e. g. EUR 5 million joint investment). • Individual notification of UDP larger than EUR 50 million • State aid approvals limited to 5 years – prolongation possible - in order to allow for adjustments after first lessons learned. 15

Notification documents • Key document - a concise description (free form): – objectives, set-up of the measure, investment instruments and conditions, eligibility criteria, investment decision-making and governance structure, etc. • Supporting documents - economic and market studies: – JESSICA feasibility studies and other studies justifying the need for public intervention in a target area (market failures, socio economic needs of deprived urban areas) • Supporting documents - funding agreements: – HF Funding Agreement (if exists) and/or the UDF Operating Agreement (draft or signed). 16

Contacts Paolo Cesarini Head of Unit, H 2 State aid: Cohesion, R&D&I and Enforcement DG Competition, European Commission Tel: +32 2 2951286 Paolo. Cesarini@ec. europa. eu 17