New interplay between State Aid Rules and Bank Resolution in the EU: the Tercas case

Introduction

On 2 March 2021, the Court of Justice of the European Union (CJEU) issued its decision in the Tercas case (Tercas ruling) upholding the General Court’s decision and rejecting the Commission’s arguments by considering that the recapitalisation of Tercas bank by a private consortium did not constitute state aid, even though the consortium was operating as a mandatory Deposit Guarantee Scheme (DGS) and was obliged to reimburse deposits in case of liquidation, pursuant to the DGS Directive.

The significance of the CJEU’s Tercas ruling is twofold:

1. The CJEU starts developing its distinctive case law on the appropriate evidence needed for demonstrating the imputability of an aid measure taken by a private undertaking.
2. The CJEU provides Member States with an alternative when considering how to deal with ailing credit institutions; such an alternative threatens in practice the credibility of the EU bank resolution framework and puts additional pressure on the Commission and the Member States to complete the Banking Union.

Factual background

On 30 April 2012, the Bank of Italy (BoI) recommended to the Italian Ministry of Finance to place Tercas, an Italian regional bank, under special administration under Italian Law. Banca Popolare di Bari, another regional bank, agreed on a transfer deal with the administrator to inject capital into Tercas subject to its negative equity being covered by one of the two Italian DGSs, the Fondo Interbancario di Tutela dei Depositi (FITD). The FITD constitutes a mandatory consortium established under private law that may, according to its constitution, take measures to support other members of the consortium that are under special administration. Had the administrator failed to find a viable solution for Tercas and had the latter entered liquidation, Tercas would have needed to reimburse all deposits up to EUR100,000 pursuant to the DGS Directive – deposit reimbursement would come with a price tag significantly higher than covering the bank’s losses. The FITD decided to support Tercas with an aid measure up to EUR280 million, which was deemed by the Commission as state aid, illegal and incompatible with the internal market.

1. Appropriate evidence for demonstrating the imputability of an aid measure

One of the conditions that the Commission needs to verify when assessing the existence of state aid pursuant to Art. 107(1) TFEU is that the aid should be granted by a Member State or through state resources.

Pursuant to established case law, imputability can be inferred from a number of indicators, none of which may be decisive on its own. Indicatively, an aid measure has been considered as state aid when the entity in consideration could not have taken such measure without taking account of the instructions or directives of the public authorities (Stardust Marine (C-482/99)) and when the objectives pursued in the use of the funds collected through statutory and mandatory levies (as in the case of DGSs) had not been determined solely by the entity (Doux Elevage (C-677/11)).

Against this background, the Commission considered that the private nature of Tercas did “not necessarily mean” that the bank could have taken its decision without any practical involvement by the state. The prevalence of FITD’s public mandate and BoI’s control over its decision were sufficient, in the Commission’s view, to establish that the FITD’s resources were actually under public control.

The General Court, in its decision, rejected the Commission’s arguments and stated that the imputability of an aid measure to the state cannot be grounded solely on the fact that “the absence of influence and effective control of public authorities over the private entity is unlikely,” thus setting a higher burden of proof for the Commission to meet than what appeared to be required pursuant to the aforementioned jurisprudence.

Following the Commission’s appeal, the CJEU, in its recent ruling, upheld the General Court’s decision considering that in the case of private entities, such as private consortia that operate as DGSs, the characterisation of an aid measure as state aid requires a higher burden of proof than in the case of public entities. Therefore, according to the CJEU, the Commission had failed to adequately prove the influence and effective control of public authorities over the FITD.

From a critical point of view, one could argue that the CJEU in its Tercas ruling fails to acknowledge the incentive structure that the DGS Directive had imposed on the FITD. The FITD was obliged, in any event, to reimburse all covered depositors upon liquidation in order to serve the public objective of preserving financial stability. While voluntary interventions before liquidation, such as the one under consideration, fall outside the scope of this public mandate, they are, in principle, opted for as the lowest-cost solution only because the law requires the DGS to contribute during liquidation. In other words, the fact that the “voluntary intervention” cost less than full deposit reimbursement justified the form of intervention, not the intervention itself.

2. The Tercas paradigm as an alternative to the European crisis management framework

While the CJEU did stress that the assessment of aid measures by DGSs will always take place on an ad hoc basis, the Tercas ruling arguably opens up the way for DGS financing to be used on a voluntary basis outside the EU crisis management framework – be it state aid or resolution rules.

In particular, under the EU crisis management framework there are three traditional alternatives to dealing with ailing banks:

1. Bank resolution rules that require credit institutions to be resolved through the use of bail-in on shareholders and creditors and the use of collective industry-funded resolution funds outside the state aid framework. However, collective resolution financing becomes accessible only after a bail-in of at least 8% of the bank’s total liabilities and own funds (TLOF) has been implemented. Consequently, in cases where an 8% TLOF bail-in may become unenforceable due to financial stability risks – as may be the case when bailing-in retail investors and depositors – collective resolution financing also becomes inaccessible.


2. When resolution is not selected for a failing institution, normal insolvency rules apply. In the context of the latter, countries can set up administrative liquidation regimes – regimes that provide national authorities with resolution-like tools yet without the stringent bail-in requirements attached to them. In such cases, state aid may be provided in the form of liquidation aid to facilitate the liquidation process subject to the “burden-sharing” requirement pursuant to the Commission’s 2013 Banking Communication. Burden-sharing under state aid rules has no quantitative minimum requirement – as in the case of bail-in – and extends to shareholders and junior bondholders only when such a measure does not impinge upon financial stability. Relevant precedent exists in the case of the two infamous Venetian banks (Italy, June 2017).


3. Precautionary recapitalisation allows for the provision of state aid to solvent banks outside resolution in order to cover capital shortfalls that have been identified during the supervisor’s stress tests. Relevant precedent exists in the case of Monte dei Paschi di Siena (Italy, July 2017)

Against this background, the Tercas case adds a fourth option – the use of DGS funding from the recovery phase and prior to failure without the need for bail-in or burden-sharing.

Conclusion

The CJEU’s Tercas case further develops the Court’s case law as regards the imputability of an aid measure to the state provided by a DGS that is a private undertaking. It sets a higher burden of proof for private v public undertakings as regards the evidence required to prove the state’s influence or control over the private undertaking’s aid measure.

Moreover, the Tercas ruling generates the following implications for the EU crisis management framework:

• Since the burden-sharing requirement attached to state aid may not apply in the provision of support by a DGS, early interventions prior to failure become more likely. Early interventions come with considerable benefits since the sooner the intervention in a banking crisis, the lower the risk for bank-runs and fire sales and thus the lower the amount of losses that need to be covered.
• Such support measures are critical for the EU banking sector. Small and mid-sized retail banks that may find bail-in unenforceable given the structure of their balance sheet (shareholders and depositors with few debtholders in between to absorb losses) may resort to alternatives similar to the Tercas paradigm before their failure.
• The risk of abusing the Tercas ruling cannot be neglected. Supporting banks through private schemes prior to failure without bail-in or burden-sharing may – in addition to generating a systemic moral hazard – ultimately threaten financial stability.
• The pressure is now, therefore, on the Commission and the Member States to complete the Banking Union and ensure that transfer strategies in resolution can be applied instead of totally relying on bail-in, thus bringing the EU framework closer to the US-paradigm that relies on bail-in only for globally systemic banks.