The European Commission's scrutiny of current state aid cases is taking place against mounting criticism of the procedures involved. On top of this, the Commission's public satisfaction with the existing policy sits uneasily with the groundswell building for changes. These could include the introduction of a state aid regulation, which would place scrutiny in the hands of the Council of Ministers, and the expansion of the market economy investor principle (MEIP).
The planned refinement of the MEIP, used to clear the Spanish government's second injection into Iberia in early 1996 (see box opposite), also highlights fears that the legally baseless first-time, last-time policy will crumble if carriers return, as Iberia did, for more state aid during the next economic downturn.
The French government's support for Air France continues to dominate the state aid debate despite its commitment to push ahead with privatisation at the end of the year. This reflects both the disquiet over the size of the FFr20 billion ($3.7 billion) state injection, cleared in 1994, and the allegations of abuses by the French carrier, which may yet return to haunt Air France and Brussels. 'Air France was not allowed to be a tariff leader on routes competing with us. We have proven that they have used lower fares but the Commission said that since they had addressed the matter it was okay,' says Ronald van der Maaten, vice president public affairs at KLM.
The Commission's clearance of the third and final tranche in full is not expected until March and will closely shadow the outcome of the most concerted challenge yet to Brussels' authority and the existing policy framework. The European Court of First Instance is due to rule by mid-year on a complaint brought by six European carriers, based on the alleged leniency of the conditions attached to the state injection and breaches of the conditions.
A separate complaint brought by Lufthansa covers Air France's alleged failure to meet criteria imposed before the payment of the third tranche, 20 per cent of which remains frozen pending the outcome of the complaint.
Air France received a blow in December when the European Court of Justice upheld the Commission's 1994 decision to block a FFr1.5 billion payment from state-owned Caisse des Depots. The carrier had until 17 February to lodge another appeal but was not expected to do so. This remains the only example of the Commission barring a state financial injection.
The other battleground is the Commission's investigation into what could amount to a L3,000 billion ($2 billion) injection into Alitalia by state holding company IRI. No decision is expected before April.
The Alitalia case also promises to reopen the debate over whether injections are tied to private sector investment and, eventually, privatisation. The Treaty of Rome forbids the Commission from distinguishing between public and private ownership, but Brussels has made implicit efforts to encourage member states to divest airline assets as part of approval. This was true in the second Iberia case, as well as the decision not to open a procedure for Sabena's second state injection, which was dictated by Swissair's decision to contribute over 60 per cent of the recapitalisation and take a 49.5 per cent stake.
The Italian government is following this approach, though no private investor has yet emerged. Alitalia's chairman, Fausto Cereti, argues that injections should be authorised if the funds can be recovered through privatisation. 'No obstacles should be imposed by the Commission to the restructuring when it is clearly orientated to the eventual privatisation of the airline,' he told a conference in Brussels organised by Forum Europe. Meanwhile, the Commission is also negotiating with the Spanish authorities over the payment of an additional Pta 20 billion to Iberia and continues to investigate the Greek government's breach of conditions attached to the restructuring of Olympic Airways in 1994.
These cases promise to stretch Commission policy to the limit, while providing an opportunity finally to set that policy in stone, even though the guidelines were only revised in 1995. '1997 can be the turnaround year for this policy,' says Thomas Kropp, general manager European affairs at Lufthansa. 'By the end of the year we would be pleased if Air France had fulfilled the undertakings [made to the Commission].'
Veteran critics of the Commission's actions in this arena concede that policy has moved on but still argue there is room for considerably more action. 'The Commission is a lot more thorough than they were four years ago,' says Tim Walden, head of government affairs at British Midland. However, in a letter to transport commissioner Neil Kinnock he says Brussels 'must take notice of the inadequacies of its earlier conditions and impose realistic - but beneficial - conditions on the granting of state aid'.
Conditions attached to aid have steadily toughened since the approval of Aer Lingus' state aid in 1994, which was followed by similar sanctions attached to aid for Olympic Airways and TAP Air Portugal. 'The conditions at the time were close to what we would have imposed ourselves,' says a senior Aer Lingus official. 'The caps on capacity in certain markets and on fleet growth were not an insurmountable burden. The rigour of the various audits to ensure that we were meeting the targets and not misusing the funds was a useful burden. The big downside was the focus it took off the marketplace [for three years].'
There is similar support from Rigas Doganis, Olympic's former chairman and chief executive and now professor of air transport at Cranfield University. 'The existing policy works well and enabled Olympic actually to turn itself around,' he says. Doganis contends that the conditions attached were right to prevent abuse of the funding while the post-transaction monitoring was similarly effective.
The scrutiny of state investment under Commission guidelines rather than a codified legal framework is seen by some observers as lying at the root of the politicisation. Calls for a more formal legal process involving the Council of Ministers have already led to work on a draft regulation, qualifying the guidelines introduced in 1995 and improving the rights of third parties. Philip Lowe, chef de cabinet at the transport directorate, concedes that these rights are effectively impeded by the slow procedures of the Court of First Instance, and says he wants them speeded up to allow the court to act as an appeal tribunal. But he warns involving the Council in any regulation of state aid could muddy the waters further 'as most member states have political interests in this area.'
Gerrit Schohe, an outspoken critic of the system and a partner at Feddersen Laule Scherzberg & Ohle Hansen Ewerwahn in Brussels, believes the problems run deeper. 'The Commission has too many roles and there are no checks and balances.'
Schohe describes current policy as 'bureaucratic and authoritarian', and says the Commission's concept of transparency excludes the Council and third parties and uses vague language.
While Schohe's remarks have drawn a frosty reception from Commission officials, he is not alone. 'If you have clear rules in EU law then they ought to be applied,' notes another competition lawyer. 'All that is publicly available are the guidelines but [the Commission doesn't] even need to issue these, just their interpretation [of each case]. This is not necessarily correct or legally binding.'
The Commission has already acknowledged problems in the flow of information and is considering opening its files to complainants. It has also signalled a desire to bring state aid policy in line with existing antitrust laws enshrined in the Treaty of Rome.
Schohe supports a Council regulation which he says would increase transparency, establish a direct dialogue between the Commission and the airline (rather than the government), and enshrine the rights of third parties to challenge decisions. 'The anti-trust regulations have been around since the late 1960s and, although not an open book, spell out clearly the procedures for challenge,' he says. 'Ideally I would like an adversary procedure.'
Support for a Council regulation remains mixed among competing airlines. 'I'm less worried about procedures than the actual policy,' says KLM's van der Maaten. 'The guidelines could be enough if they were severe enough.'
Van der Maaten hopes that the Luxembourg court will set a precedent by upholding the airlines' complaint over the Air France aid and asserting that Commission's conditions were too weak. 'I hope that the court would be more useful and less political [than the Commission],' he adds.
While it may be overly cynical to view the Commission's handling of previous and existing state aid cases as a thankless task, there are signs that Brussels is moving in a predictable bureaucratic manner. It is acting both to protect its remit and bolster a decision-making process against political interference.
Private principle should get real
The Commission's first-time, last-time policy makes it clear that, while Brussels will not tolerate more than one restructuring payment from a member state, it does expect more applications to be made on a market investor basis.
The clearance of Iberia's second tranche in January 1996 demonstrated the Commission's willingness to develop the MEIP route and, as the Italian government has already attempted, shore up the inherent deficiencies of the approach.
The Commission, which appointed Cooper's & Lybrand to review the current application of the MEIP last June, concedes that the policy is a blunt instrument. The consultants' recommendations were delivered at the end of January and, while Commission officials stress that the report's conclusions may not be adopted, they do highlight the pitfalls of attempting to replicate investor practice when it is not their own cash being injected.
The report stresses that, while economic return and rigorous analysis are to be praised, they do not incorporate wider and subjective judgements which are made in the real world.
It indicates three areas of weakness in the current procedure used in the Iberia case: the assessment of the business plan; risk analysis; and techniques for risk management and post-transaction monitoring.
The business plan submitted by the Italian government for Alitalia last year has already come under fierce criticism, both from the Commission and competitors, for its lack of detail and unrealistic assumptions. 'The mistake made by Alitalia is that they didn't prepare their case very well,' notes one financier. 'The Commission was almost looking for a plausible plan to clear.'
The report highlights the need for management to identify a clear timetable for the implementation of restructuring policies coupled to targets, such as cost and productivity levels, which provide a more concrete base for discussion.
The Commission examines two types of risk: systematic risk, which represents that held by a portfolio of assets, and company specific risk. The latter is usually dealt with by incorporating a premium which, in the Iberia case, led to the unrealistically high 30 per cent rate of return required as part of the clearance.
However this creates two difficulties: lack of transparency and, according to the consultants' report, a divergence from market behaviour. It says market investors are less concerned with compensation for an overall level of risk than with identifying and containing individual risks with a range of likely outcomes.
This assessment is shared by Rigas Doganis at Cranfield, who points out the equity injections received by most European carriers between 1990 and 1994, both public and private, were not tied to particular rates of return but included loans extended by banks simply to save the airlines and thereby minimise their own losses.
The report also identifies risk management and monitoring as one of the most important areas of difference between public and private investors. Commission officials concede that they have to improve their knowledge of the day-to-day running of an airline, and as a result the transport directorate is recruiting more in-house analysts to mirror the existing efforts of external consultants.
Source: Airline Business
