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Brussels, 20th May 2008

State aid: Notice on state aid in the form of Guarantees - Frequently Asked Questions

(see also IP/08/764)

General issues

What is the purpose of the Notice on State aid under the form of Guarantees?

The main purpose of the Notice is to determine whether a guarantee constitutes state aid or not, according to Articles 87 and 88 of the EC Treaty. In this respect, the Notice sets out conditions to fulfil and ways to calculate the minimum margin to be charged for a state guarantee in order to be deemed free of aid. If the conditions for buying a comparable guarantee on the financial market are not met and a state guarantee therefore involves aid, the notice indicates how the aid element can be calculated.

Does the Notice also address the compatibility of an aid?

No, this issue is addressed in the guidelines and frameworks on particular kinds of aids (e.g. environment, research, development and innovation, risk capital, regional aid) and in the regulations exempting certain categories of aid from the obligation of prior notification to the Commission (certain measures in favour of training, employment, SME and disadvantaged regions as well as all aid measures up to €200,000).

Why update the Notice?

The revision of the Notice on State Aid in the form of Guarantees is part of the Commission's state aid reform as set out in the State Aid Action Plan (SAAP" - see IP/05/680 and MEMO/05/195), launched in 2005 with the goal of implementing the European Council's call for "less and better targeted state aid". To achieve this objective, the SAAP tends to provide Member States with a clear and predictable framework for granting state aid, taking into account the Lisbon objectives of growth and jobs. One of the essential ingredients for such a framework is transparency. Against this background, the purpose of the new Notice is to clarify the former text through clear, predictable and transparent criteria to evaluate whether a guarantee contains an aid element and, if so, to calculate the value of such an aid element. Specific and easy-to-apply rules are introduced for small and medium-sized enterprises (SMEs).

Which sectors does the Notice concern?

The notice applies to all economic sectors but contains specific provisions for SMEs (see below).

Is the Notice applicable to export credit guarantees?

No, this Notice does not apply to export credit guarantees. Such operations are within the scope of WTO and OECD rules. Should state aid issues occur in that field, they will be ascertained directly on the basis of the EC Treaty.

To which types of guarantees is the Notice applicable?
The provisions of the Notice apply to all guarantees where a transfer of risk takes place. The most usual guarantees are associated with a loan or another financial obligation contracted by a borrower from a lender. Such guarantees may be granted individually or within a scheme. However, other forms of guarantee may exist and are covered by the Notice

What is a transfer of risk?

There is no exhaustive list of what constitutes a transfer of risk. Therefore, the Commission recommends taking into account one main element: the realistic diminution of the risk borne by the lender following the granting of a guarantee by the state. Letters of comfort or political declarations can contain a transfer of risk when announcing that a company can rely upon the support of the state. The same is true for other oral commitments or side letters. Such commitments constitute a guarantee as soon as it becomes obvious that the state intervention lowers the risk to be borne by the lender.

What are the main changes?

  1. First, the market investor test is confirmed as the benchmark to determine the existence of aid. According to this test, a guarantee is free of aid when the state obtains a remuneration equivalent to the premium a market economy operator would charge for an equivalent guarantee to an equivalent company. In this case, the state would act like any private investor or creditor operating on the financial market. If, on the contrary, the guarantee is granted on more favourable conditions than those available in the market, the beneficiary company has clearly obtained an economic advantage that may constitute state aid within the meaning of the EC Treaty.
  2. For that purpose, the notice introduces a clear risk-based approach. A proper risk assessment is the key element to analyse if the price of a guarantee is effectively conform to market conditions. This evaluation goes usually with an analysis of the borrower's creditworthiness which determines the market premium of the guarantee he has to pay.

Why is the rating a key element?

The lender (usually a bank) has to know which risks he will face when granting a loan. The already well-established system of rating is considered a good method to evaluate the general financial situation of a company. While, for the purpose of state aid analysis, there is no need to resort to international rating agencies, their rating grid is mentioned in the Notice as a reference tool for comparability purposes.

The Notice remains flexible with regard to the sources for the risk assessment, as long as they are transparent and justifiable. Each company may choose the financial body best placed to assess its rating, for instance a local bank granting the loan.

Conditions applying to individual guarantees not to constitute aid

What are the general conditions for an individual guarantee not to be considered as a state aid?

An individual guarantee should respect the conditions a private lender would grant to a potential borrower (the "Market Economy Investor Principle"). According to this principle, the Notice sets out four conditions to be fulfilled:

  • the borrower is not in financial difficulty.
  • the guarantee is linked to a specific financial transaction, for a fixed maximum amount and limited in time.
  • the guarantee does not cover more than 80% of the outstanding loan or other financial obligation (see further questions below).
  • the market price for the guarantee is paid (see further question below).

Why should the guarantee not cover more than 80% of the outstanding loan? How does this rule apply?

If a financial obligation is wholly covered by a state guarantee, the lender has less incentive to properly assess, secure and minimise the risk arising from the operation. Therefore, loans can be contracted at a greater risk than the normal commercial risk and thus increase the amount of higher-risk guarantees in the state's portfolio. By taking over at least 20% of the risk of a loan the lender is induced to properly assess the creditworthiness of the borrower and to make sure that proper collateral is provided.

When the loan starts to be reimbursed, the guaranteed amount has to decrease proportionally, such that at any moment in time the guarantee does not exceed 80% of the outstanding loan or financial obligation.

Losses have to be borne by the lender and the guarantor proportionally on a pari passu basis. Accordingly, any revenues generated from securities have to be attributed to the lender and the guarantor on a proportional basis. Transactions where losses are fully attributed to the guarantor first (i.e. without immediate and proportional recourse to the lender) do not fulfil the 80% condition

Are there any exceptions to the 80% rule?

Yes, the 80% rule applies neither to guarantees covering debt securities nor to public guarantees granted to finance a company whose activity solely consists in a properly entrusted Service of General Economic Interest insofar as the guarantee is provided by the public authority who had enacted the entrustment.

Is a guarantee which covers more than 80% of the outstanding loan deemed per se an aid?

No, the Notice does not automatically regard a guarantee covering more than 80% as aid. If a Member State wants to provide such a guarantee and claims that it is not an aid, it can still notify it to the Commission and motivate the chosen structure of the guarantee. It will still be considered to be free of aid, if the Market Economy Investor Principle is fulfilled. Thus, guarantees in excess of the 80% rule merely trigger an obligation to notify the project to the Commission for evaluation, not an automatic assumption of the existence of aid.

How is the market price assessed?

The Notice proceeds in two stages: Risk-carrying by a state guarantor should be remunerated by an appropriate premium. When the premium paid for the guarantee is at least as high as the corresponding guarantee premium benchmark which can be found on the financial markets, the guarantee does not contain aid.

If no corresponding guarantee premium benchmark can be found on the financial markets, the total financial cost of the guaranteed loan, including the interest rate of the loan and the guarantee premium, has to be compared to the market price of a similar non-guaranteed loan.

Conditions applying to individual guarantees for SMEs not to constitute aid

Are there any simplifications for the valuation of individual guarantees for SMEs?

SMEs are one of the main factors of dynamism in the economy. However, they face specific difficulties of accessing stable financial resources. To facilitate their economic development and reduce administrative burden, the new Notice introduces several simplifications.

The Notice sets out "safe-harbour" premiums which, if they are paid, automatically qualify the guarantee as non-aid. Thus, if an SME disposes of a rating, for instance supplied by its bank, it can simply check whether it pays the corresponding safe harbour premium in order to evaluate if a state guarantee is in conformity with the market price. The safe-harbour grid represents an important tool for Member States and financial bodies and contributes to the Commission's effort of increasing the transparency and simplicity of its rules.

If the SME has no rating, for instance because it is a start-up, the Notice proposes a fixed premium of 3.8% deemed as market-conform.

Is it compulsory for Member States to apply the safe-harbour premiums as set out in the safe-harbour grid?

The safe-harbour grid is meant as a simplification tool; Member States may decide not to use it if they believe they can demonstrate that lower premiums are market-conform.

Conditions applying to guarantee schemes not to constitute aid

What is a guarantee scheme as opposed to an individual guarantee?

A "guarantee scheme" means any tool on the basis of which, without further implementing measures, guarantees can be provided to companies if they respect certain conditions of duration, amount, underlying transaction, type or size of undertakings (such as for instance SMEs); guarantees provided to a company and not awarded on the basis of a guarantee scheme are "individual guarantees".

What are the general conditions that a guarantee scheme has to fulfil?

To be considered as non-aid, the guarantee scheme has to fulfil the following conditions:

  • no guarantee can be provided to borrowers in financial difficulty
  • the guarantees must be linked to specific financial transactions, for a fixed maximum amount and limited in time
  • the guarantees cannot cover more than 80% of the outstanding loan
  • the terms of the scheme must be based on a realistic assessment of the risk, so that the premiums make it self-financing (see further questions below)
  • the adequacy of the level of the premium has to be reviewed at least once a year
  • the premiums cover the normal risks, the administrative costs of the scheme and a yearly remuneration of an adequate capital (see further questions below)
  • the scheme must provide for the terms under which future guarantees will be granted.

How can it be ensured that a guarantee scheme is self-financing and does not constitute state aid?

The condition to be self-financing is the key element in the valuation of guarantee schemes (and corresponds to the condition that a market premium should be paid for individual guarantees as set out above).

Risk-adjusted premiums are crucial when it comes to assessing whether a guarantee scheme can be considered as self-financing. Normally, a "one-premium" guarantee system would not appear to be in all probability self-financing, as it would always be possible for a potential beneficiary with lower than average risk to find another guarantor willing to cover his particular risk at a cheaper premium than the average premium offered by a scheme. This would leave the guarantee scheme only with the higher than average risks.

Risk differentiation, on the other hand, ensures that all projects are charged with premiums that correspond to their respective risk: a potentially higher rate of default incurred with riskier projects is remedied by higher revenues through the higher premiums charged, whereas the lower premiums charged to lower risks ensure that the scheme remains attractive also for those projects.

That is why the new Notice requires that the risk of each new guarantee has to be assessed on the basis of all the relevant factors (quality of the borrower, securities, duration of the guarantee, etc.) and that on the basis of this risk analysis, the guarantee has to be classified in one of the several established risk classes and a corresponding guarantee premium has to be charged. Thus the Commission will require the premiums to be risk-adjusted. The premiums cover the normal risks, the administrative costs of the scheme and a yearly remuneration of an adequate capital.

Why do capital costs have to be taken into account?

In general, guarantors are subject to capital requirement rules and, in accordance with these rules, obliged to constitute equity in order not to go bankrupt when variations in the yearly losses related to the guarantees occur. State guarantee schemes are in principle not subject to these rules and thus do not need to constitute these reserves. In other words, each time the losses stemming from the guarantees exceed the revenues from the guarantee premiums, the deficit is simply covered by the state budget.. To avoid this disparity and to remunerate the state for the risk it is taking, the guarantee premiums have to cover the remuneration of an adequate capital.

How do capital costs have to be taken into account when calculating the premium in a guarantee scheme?

The capital that has to be remunerated should correspond to 8% of the outstanding guarantees. For guarantees granted to undertakings whose rating is equivalent to AAA/AA- (Aaa/Aa3), the amount of capital to be remunerated can be reduced to 2% of the outstanding guarantees; for guarantees granted to undertakings whose rating is equivalent to A+/A- (A1/A3), the amount of capital to be remunerated can be reduced to 4% of the outstanding guarantees. The normal remuneration of this capital is made up of (1) a risk premium of 400 basis points and possibly increased by (2) the risk-free interest rate (for further details see point 3.4.f of the Notice). In case the capital that has to be remunerated amounts to the maximum value of 8% of the outstanding guarantee to which a risk premium of 400 basis points is applied, such requirement has a maximum impact of 8% * 4% = 0,32% per year on the guarantee premium.

Which administrative costs have to be taken into account?

Administrative costs are the costs specifically linked to the granting of the guarantee, as the specific initial risk assessment, or risk monitoring and risk management costs.

Conditions applying to guarantee schemes for SMEs not to constitute aid

What are the conditions a guarantee scheme for SMEs has to fulfil in order to be considered as a non-aid scheme?

A guarantee scheme for SMEs using the safe-harbour thresholds (see questions further above) defined for individual guarantees is also deemed self-financing and therefore does not constitute state aid.

The Commission is aware that the evaluation of the risk and premium class of each individual guarantee may constitute a costly and burdensome exercise for an SME guarantee scheme. Therefore, if a scheme only relates to guarantees for SMEs where the guarantee amount does not exceed €2.5 million per company, the Commission may accept a single yearly guarantee premium for all borrowers within the scheme.


What if a guarantee or a guarantee scheme is not considered market conform? How is the aid element calculated?

Where an individual guarantee or a guarantee scheme does not comply with the market economy investor principle, it is deemed to entail state aid. The state aid element therefore needs to be quantified in order to check whether the aid may be found compatible under a specific state aid exemption.

As a matter of principle, the state aid element will be deemed to be the difference between the benchmark of the guarantee provided individually or through a scheme (e.g. market price, safe-harbour premium when applicable, etc) and the actual price paid for that measure.

What are the links between the Reference Rate Notice and the Notice on Guarantees?

The reference rate, as outlined in the Reference Rate Notice (OJ C 14, 19.1.2008, p.6 – see IP/07/1912), is a proxy for the market rate used for granting loans. The remuneration of this grant includes the risk-free interest rate, such as the EURIBOR, and the risk premium associated with the borrower. The remuneration of a guarantee however only includes the risk premium. The risk premium associated with the Reference Rate Notice and the safe harbour premiums from the Notice on Guarantees are nevertheless closely related as they represent the same underlying risk for a given undertaking.

Does the reporting monitoring not burden the undertakings?

The reporting exercise normally relates to individual guarantees or schemes authorised as aid measures by the Commission. For guarantee schemes for which the Commission has taken a non-aid decision, the Commission may ask in its decision for reports to be presented, thereby clarifying on a case-by-case basis the frequency and the content of the reporting requirement. The reporting exercise only has to be carried out at the end of the guarantee period; it is not an annual exercise. The Member State is rather invited to form an archive file and ensure that actual data will be available (for the renewal of a scheme for instance). The reporting obligation is explained in more detail but not widened in the new Notice compared to the previous one.

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