Taking advantage of the opportunity presented by the UK’s new subsidy control regime – by James Webber (partner, Shearman & Sterling)

The Trade and Cooperation Agreement (TCA) represents a deregulation of subsidy control in Great Britain on a massive scale.  Under a new reformed regime, the UK can:

  • simplify and speed up approvals for productivity-enhancing projects, helping to attract globally mobile inward investment;
  • improve research and development collaboration, enhancing the UK’s competitiveness; and
  • enable regional fiscal policy to support regional investment and the Government’s levelling up agenda.

However, achieving this outcome requires that everyone in the system – especially public funding bodies, and BEIS – break from the old EU State aid framework. This will involve difficult cultural change.  Yet, if we merely aspire to shadow the EU State aid rules the UK would be giving up the advantages of a new regime – won at the cost of increased trade friction with the EU – and prioritising the interests of the EU over itself.   Whatever your views on the terms of that bargain, it has now been struck.  It would be wrong and unfair not to use the new freedoms to the fullest extent possible to help our country grow and become more productive.

The State aid rules operate to protect a single market Great Britain is no longer a part of.  The Government now needs to set the new direction.  BEIS should issue additional guidance within the next month explaining how to apply the principles behind the subsidy control framework in the TCA.  This can and should come ahead of the planned full consultation on the new UK regime.

This short paper explains: (1) why the TCA regime is so radically different; (2) what the UK has agreed with the EU for its new subsidy policy; (3) the guidance which BEIS should now publish – ahead of its pending consultation on the new regime – to smooth the path.  This would ameliorate any uncertainty created by the significant and sudden change in approach arising from Brexit.  Section (4) briefly discusses the intersection of the ideas in this paper and the Northern Ireland Protocol.

  1. What is new?

The TCA subsidy control regime takes great care to allow for a new approach.  It avoids EU State aid terminology. This is not a peevish change. It reflects the fact that the UK and EU have agreed an approach to subsidies that is fundamentally new, and different from the EU approach – both procedurally and substantively.  There are four key changes.

First, subsidies caught by the TCA are not prohibited[1] and there is no suspensory effect, which means that any subsidy measure has immediate effect and is not suspended pending its approval.  So there is no uncertainty associated with whether domestic measures constituting the grant of a subsidy are lawful.  Unlike under the EU regime, there no basis to enjoin such a measure pending the approval of the EU Commission.[2] 

Second, the measure must actually affect trade or investment between the UK and the EU.   There must be some reasonable likelihood of actual competitive advantage for UK traders over EU ones (or vice versa).  That’s a very large change.

Effect on trade or investment will be interpreted by an independent arbitral panel.  An arbitral panel in relation to Dominican Republic-Central America Free Trade Agreement – in one of the few cases where such issues have been considered – found that “affecting” included “the notions of influencing or making a material impression upon that which is affected”[3] and that the measure must be “likely to confer a competitive advantage on a [firm] engaged in trade between the parties.”[4]  The panel specifically dismissed the argument that affecting trade meant any instance of underenforcement of the rules relating to unfair dismissal and unpaid wages , necessarily affects trade once it is shown that the employers save costs that they would have otherwise have incurred.[5]  This is the opposite of the usual reasoning in EU law – where an “effect on trade exists as soon as a financial support from State resources strengthens the position of an undertaking compared with other undertakings in a market subject to trade”.[6]  This reasoning is the route by which the Commission and ECJ usually asserts effects on trade in State aid without having to show any evidence that such effects are plausible.  

There are many instances in which there is a strong argument a UK subsidy would not confer such a competitive advantage over the EU in trade.  The UK position on each of these points should be assertive and maximise the flexibility offered by the TCA:

  • Smaller subsidies: A subsidy needs to be large to confer a genuine competitive advantage.  Otherwise the effect would be too small or diffuse to be discernible.  Subsidies sufficient to create an effect would almost always need to be substantially larger than the de-minimis threshold of SDR325,000 (about €380,000) over three years specified in Article 3.2.4 of the TCA – which should be considered merely a safe harbour or floor – rather than the starting point for effects.
  • Domestic supply chain: a subsidy to firms higher up the domestic supply chain not engaged in trade with the EU is very unlikely to affect EU trade, since that firm is not engaged in trade between the parties.  For example in the Guatamala CAFTA-DR case  noted above the US challenged any failure to enforce labour laws as liable to distort trade and competition.  But the panel drew the line much higher. In fact, the mere fact that a firm benefitting from underenforcement of labour rules was engaged in trade or in a traded sector was insufficient to engage “affecting trade” provisions of the trade agreement;[7]
  • Non-tradeable goods or services: This may include large elements of real estate, local heat or power generation, labour, training or domestic transport services.  Again, any indirect effects would almost certainly be too small and diffuse to be caught.
  • No EU investment counterfactual: where an investment or research subsidy did not involve competition with an alternative in the EU, for example because the alternative was in the US or China etc., this is unlikely to be caught.
  • Matching subsidy: where a UK subsidy serves to neutralise the effect of an EU subsidy, no competitive advantage is granted to a UK subsidy recipient; rather, a disadvantage is mitigated. This doesn’t mean each company hasn’t received an ‘advantage’ in subsidy terms. It means that the two advantages cancel each other out thus generating no net effect on trade and investment between the EU and UK.
  • No EU competitor to affect: where a subsidy is given to a firm (or for a product or service), other than perhaps to secure a mobile investment, when it has no EU competitors against whom an advantage can be obtained (e.g. specialist manufacturers or tech companies), this is also very unlikely to be caught.

Third, domestic enforcement is to be done through the courts – not publicly through notification in advance. This is a large shift, even if the UK’s domestic regime reintroduces a degree of ex ante supervision (for example through a voluntary notification regime). An enforcement claim implies that a claimant company has suffered a significant enough harm to make litigation worthwhile.[8] This means that enforcement effort will be focused on those subsidies that are most likely to be distortive. Both sides to the litigation will appear before an impartial judge.  The outcome will depend on the quality of the argument and evidence they can each muster.   The granting authorities and beneficiaries of any subsidy do not have to consider the reaction of a political or administrative decision-maker whose interpretation of the rules and standard of evidence is effectively final for the vast majority of projects. This should lead to far fewer but higher quality decisions.

Fourth, compatibility with the TCA in the UK is measured against ‘principles’. These are assessed by the granting body itself not by an equivalent of the European Commission,[9] subject to the supervision (in the UK’s case) of the domestic courts. This means that the principles will not necessarily be implemented the same way by public authorities within the UK and between the UK and EU’s granting authorities.  This is not a problem – i.e. it is a feature not a bug.

  • The ‘principles’ the UK has agreed to apply and what they mean in practice

In the TCA, the UK has agreed to apply certain high level ‘principles’ in setting its new subsidisation policy.  These principles, set out in the table in section 3 of this paper, are sensible and loosely-drafted propositions.  They answer the basic questions that arise for the UK in considering its approach.  The central questions for the granting of subsidies should be the same as any other economic policy decision: how does this subsidy expand growth and productivity? How will it help the UK compete for investment? How does it protect the UK’s Union while doing so? Do the costs of a particular scheme outweigh the benefits for the country as a whole?  While it is also necessary to consider how any proposed subsidy ensures compliance with the UK’s international treaty obligations, this is a second order issue that can and should absorb only a small amount of resource and effort.  This hierarchy should not be controversial.  The EU State aid regime is also almost entirely inward looking and spends very little (if any) time considering the EU’s international law obligations.

The principles satisfy these objectives and are all features of good subsidy policy. There is no one way to comply with them. 

A good example of how different approaches may still satisfy the relevant principle is the principle that subsidies must be proportionate and limited to what is necessary to achieve the objective.  Any UK granting authority will need to choose for itself how to evidence this in designing a scheme.  There are a large number of options and techniques.  These include:

  • A subsidy competition. This is how subsidies for renewable energy projects are often determined. The bidder with the lowest (i.e. most proportionate) subsidy will be the winner of the competition. 
  • Impose an overage provision – which allows clawback of larger than expected development profits. This may be particularly relevant in real estate regeneration ‘gap’ projects, whereby the development profit is not expected to recoup the entire investment required.  The aid can then be tailored to exactly the amount that turned out to be necessary.
  • The authority could ask for evidence demonstrating the difference between the net present value of the project with and without the subsidy – and compare that against a counterfactual or investment hurdle rate.
  • Expert evidence that the subsidy is the minimum necessary.   

These techniques are not new and have all been used in State aid practice.  But there is a fundamental difference in how a UK granting authority can decide to use them.

It is for the granting public authority to decide for itself the approach to adopt.  There is no longer a need to consider the terms of the EU’s General Block Exemption Regulation (GBER) or the relevant Commission guidelines.  Subject to any challenge in the UK domestic courts, the UK authority just takes a view of what makes most sense in order to demonstrate that the aid is proportionate – which itself is likely overlap anyway with good economic policy-making and the National Audit Office’s “value for money” assessment.

There is no aid ceiling overlay to any test for proportionality.  For EU State aid, the minimum aid necessary is benchmarked against an aid intensity ceiling. This means that regardless of how much aid is offered or needed, the EU rules put a hard cap on the amount that can be paid in area x for project y.  This ceiling concept is hard wired into the rules and used very extensively. Some ceilings vary according to the regional aid map, which shows the aid that can be paid in each region of the EU. But they also vary with the size of the beneficiary company, the type of research that is being carried out, the type of costs the aid is used to support capital, training, other operational costs and many other factors.  

Ceilings are designed to ensure that wealthier parts of the EU are not able to outspend the poorer parts and that – very roughly – aid is pointed at the right places with modest impacts on the single market.  That’s a reasonable policy design choice within a 27 member state single market.  But it is not a good approach for the UK.  Aid ceilings are administratively burdensome. Their use triggers mostly wasted work to calculate eligible costs, gross grant equivalents, scaling down etc. and consideration of which project or beneficiary qualifies for a particular ceiling – and they are anyway only a proxy for the real question of whether the distortive effects of the subsidy outweigh the benefits.

Further, ceilings are entirely superfluous for spending centrally controlled by the Government – since the UK Government can consider the effects on the union when deciding whether to spend the money in the first place. For spending by regional, local or devolved administrations, some mechanism will be needed to avoid subsidy races damaging the union – this needs to be considered as part of the consultation on the new UK regime.  In my view, this is likely to involve adding to UK internal market legislation a set of subsidy measures that are especially damaging to the UK union – such as a subsidy to move jobs from one area to another.[10]  Subsidies of this type – or otherwise large or contentious – may then be considered ex ante by an appropriate authority such as the Office for the Internal Market. This ex ante review could be a mix of compulsory – for subsidies that are especially likely to be damaging to the union and voluntary – if beneficiaries want the certainty of prior approval – in a similar way to how the CMA merger control regime works.  

Not just aid ceilings, but all familiar distinctions used in the Commission guidance and GBER have now gone in Great Britain.  There is no difference between large and small companies.  There are no development areas, no undertakings in difficulty[11], no need to consider single investment project, or the distinction between fundamental research and development research.

All of these changes remove very large amounts of wasted effort, complexity and expense from the subsidy control system.  It is still however a sudden and large departure from prior practice – in an environment before a full UK regime has been introduced.  So guidance from Government can play a crucial role to help with immediate uncertainties and to feed into the regime proposed in its consultation.  

  • What should the new BEIS Guidance now say?

The Government issued guidance on 31 December 2021,[12] summarising the UK’s international law obligations and the definition of subsidy.  However, this does not provide meaningful guidance on how to apply the TCA principles discussed above.[13]  The danger in leaving this gap is that decision-makers default to applying the old EU rules.  The UK would then lose the benefit of the policy flexibility under the TCA.

This note sets out some guidance that BEIS could issue, which is based on building out Annex 2 to the BEIS guidance issued on 31 December.  

Draft Guidance for Applying the Principles[14]

The principles below overlap to a limited extent with the GBER and European Commission guidance and common assessment principles. Some concepts from that guidance and practice may still be useful in applying these principles but the great majority of the distinctions and concepts in the GBER and Commission guidance are no longer relevant and should be discarded. For instance, there are no aid ceilings, no eligible costs, no SME or large company distinctions, no regional aid map, no single investment project issues, no distinctions between different types of research and development spend or training, no EU standards against which environmental protection subsidies are measured, and no exclusions for or concept of undertakings in difficulty[15].

It not necessary for public authorities to comply with GBER or any other EU State aid rules – except where in cases affected by the Northern Ireland Protocol.  If this is potentially an issue for a particular project, it should be discussed with BEIS as early as possible.

The table below discusses some ways in which public authorities may approach compliance with the principles. This is illustrative and not intended to be exhaustive.

PrinciplesRoutes to satisfy the principle
The subsidy pursues a specific public policy objective to remedy an identified market failure or to address an equity rationale such as social difficulties or distributional concerns (“the objective”).Identify an objective. What is the problem public money is being spent on to alleviate?   Incorporate the objective into your grant offer letter or scheme design and rationale.
The subsidy is proportionate and limited to what is necessary to achieve the objective.Choose a method to demonstrate the aid is limited to the minimum necessary relative to the objective. Public authorities are best placed to decide what is reasonable for their scheme or measure. Options include but are not limited to:   Non-discriminatory subsidy competition; Overage or claw back provisions (for example of development profit in real estate development subsidies)Review of beneficiary internal documents comparing the gap with a plausible counterfactual Expert report or assessment of the subsidy amount required to create the desired incentive effect.  
The subsidy is designed to bring about a change of economic behaviour of the beneficiary that is conducive to achieving the objective and that would not be achieved in the absence of the subsidy being provided.For a scheme this would typically be incorporated into the exercise to define a proportionate way to achieve the scheme’s objective.   If further work were considered desirable, consider what evidential basis there is for choosing a subsidy as a way to ameliorate the identified problem?  This may include legislative impact assessments, internal or expert consultant reports, study of prior policy outcome or similar work.  It need not be exhaustive and clearly not more extensive than was the case under the EU State aid rules.   Incentive effect for an individual aid would typically require the subsidy application to be made before the project started. For larger sums, authorities may consider it appropriate to seek disclosure of beneficiary internal documents.  
The subsidy should not normally compensate for the costs the beneficiary would have funded in the absence of any subsidy.In many cases this will be verified by the prior steps or assessment of effects.  Subsidy schemes that merely provide corporate welfare for existing activities rather than generate additional activity are unlikely to constitute value for money and are likely to be distortive.   This principle could be satisfied by:   A subsidy competition.  Since this will return zero (or negative) subsidy if the activity would be carried out anyway.    Likewise, internal modelling of the NPV of an investment will show whether the subsidised investment required the subsidy. This is especially so if the public subsidy is much smaller than the investment made by the private company and if there is a mechanism for the public authority to participate in any unexpected upsides.   For public service obligations, use of competitive tendering would establish this (and indeed most of) the principles are satisfied.  
The subsidy is an appropriate policy instrument to achieve a public policy objective and that objective cannot be achieved through other less distortive means.This should be incorporated into the same reasoning used for defining an objective and the evidential basis for choosing subsidy as a policy response.
The subsidy’s positive contributions to achieving the objective outweigh any negative effects, in particular the material effect on trade or investment between the Parties.While new, this does not require substantial assessment except for the largest subsidies in the most trade sensitive sectors.  For instance, the EU anticipates complying with the TCA obligations using its existing State aid rules, yet these require no systematic or empirical assessment of effect on trade and competition.    The following are likely to generate significant adverse effects:   The aid takes place in a market in structural absolute decline provided such goods or services are traded in a material way with the EU or with other competitors in the UK;The aid causes the beneficiary to close down the same or similar activity elsewhere in the UK or in the EU; orThe aid causes, against an evidenced counterfactual, an investment project to move from elsewhere in the UK or the EU.   The following are unlikely to generate adverse effects:   Subsidy to firms not involved in direct trade with the EU; Subsidy that changes investment behaviour from outside the UK or the EU;Subsidy to firms that do not have competitors elsewhere in the UK or the EU;Subsidy that matches or neutralises the effect of subsidy in another trading partner (including the EU); Subsidy below £5m per beneficiary per year; and Subsidy granted via open non-discriminatory competition.   The following considerations may be relevant to assessing effect on trade and investment of other subsidies. It is not necessary to assess all these factors or to do so in great depth. For example, the EU State aid rules do not assess these issues systematically.   The granting authority should be aiming to roughly estimate the extent of any effects – which may then be balanced against the objective the subsidy is intended to pursue.   Subsidy scale: Proportion of variable or capital cost that a subsidy represents for the beneficiary firm. The lower the proportion covered by the subsidy, the lower the likelihood of effects on that firm’s competitiveness. Size of the market: the larger the market, the larger a subsidy needs to be in order to have a plausible effect.Market share of the beneficiary: beneficiaries with higher market share are more likely to trade across the UK or across border with the EU.Payment cadence: The longer the payments persist the greater the likelihood of effects. Extent of EU trade in the good or service produced by the beneficiary firm. The greater the extent of trade the higher the likelihood of effects. Barriers to entry: subsidies can either lower or raise barriers to entry. Giving incumbent firms protection from entry or exit is more likely to cause adverse effects on trade and investment than subsidies to new entrants to assist in overcoming barriers.   Any adverse effects must then be weighed against the positive effects of achieving the objective.  It will often be possible to remedy negative effects by altering the design of the subsidy.  This would also be consistent with good economic policy design and value for money practice.    
Where relevant, record consideration against Article 3.5 [Prohibited subsidies and subsidies subject to conditions], including consideration of whether that subsidy has or could have a material effect on trade or investment between the Parties.These types of subsidy are unusual and the provisions of Article 3.5 itself are prescriptive.   Please discuss with BEIS or your advisers if unsure how to comply with these provisions for a given measure or scheme.  
  • Interaction with the Northern Ireland Protocol

The Withdrawal Agreement (specifically Article 10 of the Northern Ireland Protocol) applies the entire EU State aid rulebook to UK subsidies which may affect trade in goods between Northern Ireland and Ireland.  The extent of what affects trade means is obviously important to a new UK regime based on the TCA.

The Commission published a paper on 18 January 2021[16] suggesting that “affect trade” in this context should be interpreted to catch any aid to company that “trades with” Northern Ireland.  For example, a bank in London that has a corporate client in Northern Ireland; or Nissan in Sunderland that sells cars in Northern Ireland etc.

This is notwithstanding the fact that companies in Great Britain are outside the single market and customs union. The Commission’s approach is antagonistic and unworkable.  While the Commission’s views are not legally determinative and no more relevant than the UK Government’s, asserting their position in such a way may cause confusion and uncertainty for UK public authorities and companies.  It’s important therefore to briefly note how the BEIS guidance should provide comfort to UK undertakings and public authorities.

First, BEIS existing guidance of 31 December 2020 correctly stated that the Protocol provisions primarily apply to aid to companies trading in goods located in Northern Ireland.

Second, BEIS again correctly, noted that “subsidies granted in Great Britain are only in scope of Article 10 where there is a clear benefit from and a genuine, direct link between the subsidy and companies in Northern Ireland.”  This view is based on a unilateral declaration made by the EU about the its interpretation of Article 10 – given as part of the settlement of the dispute about provisions of the UK’s Internal Market Bill.

The declaration goes to the EU’s international law obligations under the Withdrawal Agreement and is not itself a question of EU law. The declaration starts by saying “When applying Art. 107 TFEU to situations referred to in Art. 10(1) of the Protocol, the European Commission will have due regard to Northern Ireland’s integral place in the United Kingdom’s internal market.”

Its purpose is to modify or reinterpret the usual approach to effects under EU law for the specific circumstances of Northern Ireland. That modification was then expanded upon to say that the link to Northern Ireland must be genuine, direct and evidenced by reference to real foreseeable effects. This is a substantially higher threshold than affecting trade between Member States in the State aid case law of the ECJ.  Such a higher threshold is also logically consistent with GB firms (unlike NI firms) being outside the customs union and single market.  

The Commission’s suggestion that the declaration changes nothing and that the usual approach in EU law applies as if GB (rather than NI) were still a Member State is highly unlikely to be correct. It is also disingenuous and should not as a matter of principle be permitted to undermine the development of an independent subsidy control regime by the UK as foreseen by the TCA.

BEIS should add to the existing guidance therefore a reminder that, since the end of the transition period, the Commission’s view on the extent of Article 10 of the Northern Ireland Protocol is speculative and untested. Public authorities are encouraged not to place reliance on it.  

JAMES WEBBER


[1]              Except export subsidies which are anyway prohibited by the WTO Agreement on Subsidies and Countervailing Measures.

[2][2] It is possible that some subsidies in Great Britain have such a strong direct connection to goods trade between Northern Ireland and Ireland that it is reasonably foreseeable the subsidy would affect that trade – and would therefore be caught by the suspension obligations in the EU State aid rules via Article 10 of the Northern Ireland Protocol.  These cases should be unusual.  The Northern Ireland Protocol is discussed in section 4 below.

[3]              In the Matter of Guatemala – Issues Relating to the Obligations Under Article 16.2.1(a) of the CAFTA-DR FINAL REPORT OF THE PANEL June 14, 2017, para 164.  This case was one of the few instances in which “level playing field” provisions in a trade agreement have been considered.

[4]              Ibid.,para 190.

[5]              Ibid, para 478-79

[6] See Commission Notice to Stakeholders re Withdrawal of the United Kingdom and EU rules on State in the field of State aid, page 6 available at: https://ec.europa.eu/info/sites/info/files/notice-stakeholders-brexit-state-aid_en.pdf

[7]              In the Matter of Guatemala – Issues Relating to the Obligations Under Article 16.2.1(a) of the CAFTA-DR FINAL REPORT OF THE PANEL June 14, 2017, para 168. 

[8]              The approach of the UK courts to standing in these cases has yet to be tested, although the terms of the TCA track highly restrictive EU standing rules, it is possible that UK courts would be more generous.

[9]              Title XI 3.4.

[10] A similar concept is used in EU State aid assessment usually referred to as “manifest negative effects”

[11] Although there is a different concept of “ailing or insolvent economic actor” in Article 3.5(3) whereby aid is prohibited in the absence of a credible restructuring plan.

[12]             Available at https://www.gov.uk/government/publications/complying-with-the-uks-international-obligations-on-subsidy-control-guidance-for-public-authorities/technical-guidance-on-the-uks-international-subsidy-control-commitments-from-1-january-2021.

[13]             Step 3 in the BEIS guidance is only high level on the point.

[14]             Ie. those principles contained in Title XI Chapter 3 Article 3.4 of the TCA.

[15]             Although there is a concept of “ailing or insolvent economic actor” in Article 3.5(3) whereby aid is prohibited in the absence of a credible restructuring plan.

[16] https://ec.europa.eu/info/sites/info/files/notice-stakeholders-brexit-state-aid_en.pdf

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1 Response to Taking advantage of the opportunity presented by the UK’s new subsidy control regime – by James Webber (partner, Shearman & Sterling)

  1. stephenrmoore@btinternet.com says:

    Hi James,

    Great article. Many Thanks. Very helpful.

    Stephen

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