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UK measures to stabilise the mortgage market and their compatibility with EU State aid rules

October 26, 2009

Introduction 

Any support measures adopted by Member States to counteract the economic downturn must comply with EU State aid rules. The EU State aid regime imposes a uniform discipline on Member States to ensure that public money is used for well-defined objectives and to minimise distortive effects State aid has on competition in the EU. Although the EU State aid regime limits Member States’ powers to deploy measures they see fit to remedy the economic crisis, the European Commission has shown flexibility in approving national remedies: UK measures to stabilise the mortgage market are a case in point.

The UK Homeowners Mortgage Support Scheme

The Homeowners Mortgage Support Scheme targets households affected by a temporary income shock and who are at risk of falling behind in their mortgage payments. The aim of the scheme is to reduce the number of home repossessions that are likely to occur as a result of the economic downturn. The scheme enables households to defer their repayments of principal and up to 70% of their interest repayments for up to two years. There is a two-year window for eligible borrowers to enter the scheme, reflecting the UK's expectations of the impact of the downturn on employment and on the rate of repossessions.

Under the scheme, the borrower switches to interest-only terms and defers a proportion of the interest payable. Borrowers still have to pay a minimum of 30% of the monthly interest that they were paying on entry for the duration of their participation in the scheme. The Government guarantees 80% of the deferred-interest payments in return for the banks’ participation in the scheme. The risk of non-repayment of the principal remains with the lender. The state only pays out on the guarantee in the event that the proceeds of repossession are insufficient once the principal of the mortgage has been repaid, to cover the guaranteed deferred interest. The guarantee runs for four years from the date the borrower leaves the scheme in order to avoid any incentive for the lenders to repossess before the guarantee expires.

Although individual consumers were the primary beneficiaries of the scheme, the Commission decided that the scheme was caught by the State aid provisions (which apply only to undertakings), because it provided a selective advantage to mortgage lenders in the UK, in that a part of the deferred interest was guaranteed to them[1].  This could allow them to recover some of the interest payments that they would otherwise have had to write off. However, the Commission approved the scheme under Article 87(2)(a) of the EC Treaty[2] as it provided aid of a social character to individuals, affected by a temporary income shock and at risk of losing their homes. Finally, the Commission found that the scheme was non-discriminatory, as it was open to any mortgage lender in the UK.

The UK Asset-Backed Securities Scheme

The Asset-Backed Securities Scheme establishes a guarantee for the domestic residential asset-backed securities market. Under the scheme, investors will benefit from the guarantee provided to securities issued by special purpose vehicles collateralised with residential mortgages. Guarantees allocated under the scheme will be limited to a total of £50 billion.

The UK Residential Mortgage Backed Securities (RMBS) market is the second largest worldwide. By guaranteeing AAA-rated RMBS issued by special purpose vehicles sponsored by a bank or building society, the UK Government wants to encourage the return of confidence in this important market for the UK economy. The institutions eligible under the scheme are UK-incorporated banks that have a substantial business in the UK (including UK subsidiaries of foreign institutions) and building societies.

The Commission concluded that the scheme involved State aid, as it enabled the issuer to sell RMBS and therefore provided the necessary liquidity to the originating banks or building societies on more favourable terms that would have been possible under the conditions prevailing in the markets. However, the Commission decided to approve the scheme under Article 87(3)(b) of the EC Treaty, which allows aid to remedy a serious disturbance in a Member State's economy[3]. The Commission found that current conditions on the financial markets justified the scheme, which aimed at facilitating banks to acquire liquidity and underpin lending to the UK “real” economy. The Commission emphasized that the whole UK economy was more dependent on residential real estate market than most other EU Member State.

In particular, the Commission found that the scheme was well targeted to remedy a serious disturbance in the UK economy, proportionate to the challenge faced and designed to minimise negative spill-over effects on competitors, other sectors and other Member States. The scheme was non-discriminatory, limited in time (six months) and scope and with a market-orientated remuneration.

Remarks

In the current economic crisis, the Commission has shown great flexibility in approving national aid schemes. For this purpose, it has used exemptions in the EC Treaty which, before the credit crunch, had lain dormant. By entering uncharted waters, and given the speed by which the Commission is nowadays approving State aid, it will sooner or later be exposed to criticism.

It is for example not clear why cross-border mortgage lending (which admittedly represents a very small market share in the EU) would not benefit under the Homeowners Mortgage Support Scheme. The wording of the Decision suggests that some form of establishment in the UK would be required for institutions to benefit from the scheme. The freedom to provide services in the EU and the fact that social aid under Article 87(2)(a) of the EC Treaty requires that it should be granted without discrimination related to the origin of the products (or services) concerned, raise some question marks over the compatibility of the scheme with the EC Treaty on this point.


[1]   Link to general case information:
http://ec.europa.eu/competition/elojade/isef/case_details.cfm?id=3_230469

[2]   Article 87(2)(a) of the EC Treaty states that “aid having a social character, granted to individual consumers, provided that such aid is granted without discrimination related to the origin of the products concerned” shall be compatible with the common market.

[3]   Link to the non-confidential version of the Commission decision: http://ec.europa.eu/community_law/state_aids/comp-2009/n232-09.pdf