When a public body seeks to provide financial assistance (such as an equity investment, grant or loan) to a private entity, it needs to consider this within the confines of the Subsidy Control Act 2022. This doesn't apply if it's giving assistance to another public body who doesn't engage in commercial activity (eg Treasury to the NHS).
Subsidy control regulation seeks to allow government entities (including local authorities) to achieve their policy objectives, while limiting the potential harmful impacts of such activities on competition, as well as fulfilling UK’s international commitments and obligations.
Subsidies can correct market failures, create employment opportunities, and rebalance localised and regional inequalities. However, failure to thoroughly consider the potential impacts of government financial assistance through a subsidy-control lens can have significant consequences. Financially, if the assistance is successfully challenged, the funding recipient may be required to ‘pay back’ the subsidy, which can lead to financial distress. Further attempts to offer financial assistance are likely to attract greater scrutiny, which can damage reputations. It could also mean that the UK breaches its international commitments, including the post-Brexit Trade and Cooperation Agreement (TCA).
Ultimately, this could worsen the market failure which the financial assistance was intended to correct, and have other unintended consequences.
The Subsidy Control Act is the primary legislation that governs UK subsidy control. The TCA also contains subsidy control provisions. The UK has also entered a number of other arrangements which require consideration of subsidies, including World Trade Organisation Agreement on Subsidies and Countervailing Measures (WTO ASCM), agreements and bilateral treaties with countries.
When the UK was part of the European Union the state aid framework required that for support to be considered a subsidy it needed to be:
Therefore, many local provisions of support didn't meet this test, as there was limited impact on trade within the EU.
However, the Subsidy Control Act includes an additional provision that support will be considered a subsidy if it impacts investment and competition between UK and any other country, and crucially competition and investment within the UK.
Support that wouldn't have been previously considered state aid, in that it doesn't impact trade with the EU, may now be considered a subsidy insofar as it affects domestic or local (UK) competition. This is likely to capture many more government support programmes, particularly support provided by local governments.
Public authorities will be required to scrutinise virtually all support above the minimum threshold: £315,000 over three years, as most will contain an element impacting competition at the local or domestic level. As such, an understanding of the services/goods being offered as well as the market in which an entity will compete is critical.
It's necessary to look at the impact of support defined as a subsidy in relation to the control-principles in the Act. There are seven principles a subsidy should meet, seeking to ensure that public authorities design them in a way that strikes the right balance between enabling benefits, while limiting the most harmful impacts, ie, minimising any negative effects on competition.
The subsidy-control compliance of a public authority's support can be assessed by looking at two key questions:
1 Can the support be considered a subsidy (ie, does it meet all the relevant tests)?
2 If the support is a subsidy, is it likely to be justifiable under the subsidy-control principles?
Answering these questions involves complex economic and financial assessments.
For support to be considered a subsidy it must meet four criteria:
The second criterion is often the most difficult to answer and requires an assessment of whether the support being provided by the public authority is in line with normal market expectations. Support wouldn't to be considered a subsidy if a commercial return expected by the public authority is in line with returns expected by private equity or debt investors in similar projects. This is the market economy operator principle (MEOP).
However, occasionally simple debt or equity financing structures may not provide the required returns and more bespoke solutions may be necessary. For instance, royalty financing, where finance is provided in exchange for a proportion of the project’s future revenues, could also be considered. However, there may be challenges with market benchmarking as such arrangements can be specific to the project circumstances.
It's worth highlighting that the subsidy control test focuses on both domestic and international trade. This means that local authorities are likely to need to consider this test when awarding support since local investments may impact trade between UK regions.
In many cases it may not be possible for the public authority to expect a sufficient commercial return, and the support will be defined as a subsidy. In this case, the support needs to be considered in the context of the Act. Should the support be awarded and subsequently challenged, either domestically or by foreign jurisdictions, it may need to be repaid by the receiving enterprise, which could have severe detrimental impacts, especially if the funds have already been spent.
Support needs to be considered against the seven subsidy control principles. The extensiveness of the required analysis will depend upon whether the support, or scheme, is a subsidy of interest (SSI) or particular interest (SSPI). These are subsidies or subsidy schemes that are more likely to cause negative effects on competition and/or investment; more detailed analysis is recommended – this is currently being consulted upon – and they must be provided to the CMA’s subsidy control unit for analysis before the subsidy is awarded. The proposed limits for these schemes are:
The application of the subsidy control principles involves undertaking a 'balancing test', which uses economic tools to answer several key questions. In the context of the Subsidy Control Act, the balancing test includes considering how the subsidy addresses a well-defined market failure or equity rationale by providing an incentive to the recipient proportionate to the problem tackled.
The test contrasts the benefits of the subsidy in correcting the problem against the negative impacts of the subsidy, particularly the distortion of competition or investment within the UK or internationally, and includes a consideration of alternative options that don't result in, or at least minimise, these impacts. Critically, public authorities also need to show that any negative effects are outweighed by the benefits the subsidy brings in addressing stated market failure or equity rationale – ie, that, on balance, the impact is positive.
While the required economic analysis will be specific to the project under consideration, there are a couple of impacts of changes introduced by the Act that are worth drawing out. First, and the most obvious, is the need to analyse the impact of the subsidy not only on competition and investment across the EU, but also within the UK. This will require identification of competitors to the recipient of the subsidy, and the impacts on these competitors of changes in the recipient’s behaviour in the market, as a result of the subsidy.
In addition, an assessment of impacts in upstream and downstream markets (eg purchasers of the recipient’s subsidised product) is also likely to be required, as will the impact on investor behaviour. The public authority may also wish to consider how to structure the subsidy to minimise competition impacts, such as running a competitive process for the subsidy, or offering the subsidy to all competitors on a non-discriminatory basis.
At first glance, it may appear that this change introduced by the Act could interfere with a number of policies and programmes, such as the levelling up agenda. One of the explicit aims of the agenda is to 'Levelling up' disadvantaged areas in the UK, which appears counter to the requirements of the Act that seek to limit the impact on competition.
However, a second change in the Act is that an 'equity rationale' (eg, local or regional disadvantage, social difficulties or distributional concerns) is explicitly recognised as a legitimate policy objective of subsidy provision. While this may be similar in concept to EU’s regional aid, that programme is subject to relatively strict EU guidance.
Within the context of the balancing test, additional negative competition impacts (ie, those within the UK) can be offset by additional positive impacts under the equity rationale. While there's currently no guidance as to how this new provision should be applied, we envisage that the identification and quantification of benefits similar to those in economic impact assessments, and economic case business cases can be used.
Equity rationale is unlikely to be applicable to affluent areas so that the relative impact of both changes in the Act can support the levelling up agenda both by supporting subsidies in disadvantaged are as and by imposing greater limitations on those in more affluent areas.
In addition to explicit changes brought by the Subsidy Control Act, there are implicit changes due to move from EU state aid regime to the subsidy control regime under the Act and the TCA. As before, market failure is the key reason for subsidy provision, and its correction is the key source of subsidies benefits.
Under EU state aid regime, both competition assessment, and market failure were considered from an EU-wide perspective – ie, a subsidy would need to demonstrate benefits of correcting market failure that was occurring across the common market. However, Brexit means that market failure could potentially be considered from a UK perspective.
For more insight and guidance, contact Schellion Horn