Memorandum by the Department of the Environment,
Transport and the Regions (GF 13)
IMPLICATIONS OF THE EUROPEAN COMMISSION RULING
ON GAP FUNDING SCHEMES FOR URBAN REGENERATION IN ENGLAND
BACKGROUND
1. The Partnership Investment Programme
(PIP) which was in operation until 22 December 1999, was a programme
run by English Partnerships (in England only, similar schemes
applied in Scotland and Wales) offering assistance in the forms
of grants and loans to private sector developers to undertake
projects to bring derelict sites and buildings back into productive
use. It was used for projects where the costs of development were
greater than the end value of the development would be (because
of local property market failure, resulting in depressed project
values and abnormal site reclamation costs)—and where no
developer would go ahead without assistance, because he would
not make a profit.
2. PIP was based on the principle of "gap
funding", which meant that, following a full appraisal of
the developer's application for assistance, the amount awarded
would be the minimum necessary to bridge the gap between development
costs and forecast end value, and enable the developer to go ahead.
PIP could be used for projects promoted by developers on regeneration
sites throughout England (ie it was not restricted to the Assisted
Areas). PIP was used to support either speculative projects (where
the developer was building without a known end-user in mind),
or bespoke projects (developed for a known end-user).
3. The gap funding approach had been used
for regeneration projects involving partnership working with the
private sector since the late 1980s—firstly in the Urban
Development Grant regime, and then in City Grant, prior to the
creation of the Partnership Investment Programme.
4. European Commission review of PIP to
assess its compliance with the State Aid rules—in May 1995,
the European Commission declared (as part of a decision on the
Single Regeneration Budget (SRB)), that a number of measures included
in the SRB were not caught by the terms of Article 92(1) of the
Treaty—English Partnerships' regeneration activities (including
PIP) were amongst these measures, (ref Case 31/95, Single Regeneration
Budget). However, within a year, the Commission looked at PIP
again, because as the Commission said in their 22 December 1999
decision "Following the approval of the SRB, the Commission's
attention was drawn to certain cases where the beneficiaries of
EP assistance were also enterprises competing in intra-community
trade".
5. In January 1996, the Commission asked
the UK authorities to provide clarification on the actual functioning
of PIP. Discussions on the State aid compliance of PIP went on
for the next two years, with Ministers and English Partnerships
arguing that PIP was not in breach of the rules, because the grant
given was the minimum necessary to bridge the cost/value gap,
did not confer an unfair competitive advantage on the developer,
and that the developers were in any event engaged in an activity
(development of derelict land) where there was negligible (if
any) trade between European Member States. The Commission also
had concerns that the eventual recipient of the support under
PIP was the party which had initiated the proposal—rather
than the public sector making the proposal and selecting a partner
through an open competition.
6. The Commission issued an "appropriate
measures" letter in July 1998, (ref SG(98)D/061108) under
which the Commission formally declared its intention of establishing
whether State Aid was involved in the operation of PIP, to identify
any such aid, and bring it into line with the requirements of
the EC Treaty, and State Aid rules. In July 1999 the UK decided
that it would treat bespoke developments within the State aid
rules. The UK accepted that there was merit in the Commission's
argument that there was a possibility of State aid where firms
were developing for a known end user, because the value of the
end development to the particular user would be greater than the
value of that development on the open market, and the valuation
could therefore include an element of benefit to the end user.
The UK therefore offered to bring bespoke projects within the
Regional aid framework from mid-1999 (in the UK's response to
the appropriate measures letter 28 April 1999).
7. EU decision on PIP—at a meeting
of the Competition Directorate (DGIV) of the European Commission
on 22 December 1999, the Commission issued a "partially positive"
decision on the PIP. This said that the programme could be made
compatible with the Common Market, if the part of the scheme dealing
with speculative development was also brought under the relevant
State Aid rules. In essence, this would amount to running PIP
solely within the Assisted Areas and subjecting it to the Aid
Intensity ceilings which apply within these areas. As this would
involve the loss of the majority of the type of projects funded
under PIP (which occur either outside the Assisted Areas, or receive
grant above the aid ceilings), we took the decision to close the
PIP as of the decision date. DGIV have allowed transitional arrangements
for projects already in the "PIP pipeline". They said
that all projects where a formal application had been submitted
by the decision date may proceed through the appraisal process
to their logical conclusion. This decision will allow several
hundred projects to complete the appraisal process.
8. No further new applications could be
allowed after 22 December 1999. Until that date, PIP operated
under the 1995 Commission approval. After 22 December, the scheme
in its current form was not approved. Grant payments to developers
(other than for projects on the transitional list) would have
been illegal State aids, and the Commission could have required
that these be paid back (with interest) by developers.
THE CONTRIBUTION
THAT GAP
FUNDING HAS
MADE IN
REGENERATING DERELICT
AND OTHER
DIFFICULT SITES
IN AREAS
OF "MARKET
FAILURE"
1. Gap funding served our regeneration policy
objectives: bringing derelict sites and buildings into use, generating
jobs, reclaiming brownfield land and combating social exclusion.
It helped achieve these objectives in a cost effective way, by
providing the minimum assistance to persuade a developer to go
ahead, and levering in significant private sector contributions.
2. One strength of PIP was the flexibility
it gave EP to support projects through a range of mechanisms,
including joint venture, gap funding grant, loan and rental guarantee,
in partnership with the private and public sectors.
The examples given in Annex A to the memorandum
reflect that range of possibilities although all include the gap
funding approach.
PIP Outputs
In the five full years of operation since its
introduction a total of £1,100 million PIP investment has
been approved in over 1,000 projects.
By way of illustration, projects approved under
PIP in the last three years of operation are expected to give
rise to the following outputs once the projects are completed:
— 50,700 jobs created/safeguarded;
— 2,060,000 m2 of industrial/commercial
floorspace;
— 1,500 ha land reclaimed/serviced;
— £1,490 million private sector
investment.
Many projects involve other public sector investment,
particularly ERDF, and the above figures reflect outputs which
other public bodies are helping to achieve. However, the PIP appraisal
process ensures that its investment is the minimum necessary to
allow all projects to go ahead.
For the last financial year (1999-00) projects
for which PIP funding was approved attracted £200 million
of other public sector funding of which the ERDF represents £89
million. The outputs attributable to the PIP element of funding
amounted to:
— 445,000 m2 industrial/commercial
floorspace;
— £353 million private sector
investment.
(Note: these figures are included in the cumulative
totals above.)
THE CONSEQUENCES
OF THE
EUROPEAN COMMISSION
RULING FOR
URBAN REGENERATION,
AND THE
ALTERNATIVE SCHEMES
WHICH SHOULD
BE CONSIDERED
TO REPLACE
GAP FUNDING
1. These two questions are closely linked
and are answered together. Following immediately on the Commissions's
decision on PIP, the Department put proposals for the short term
to the Commission. Shortly afterwards, discussions on the longer
term future were set in train.
(i) PIP has been closed, and no new applications
for gap funding are allowed
The most immediate consequence is that the Commission
has decided that the use of gap funding for the private sector
is not compatible with the common market except in so far as it
falls under a Regional Aid framework. But it is not feasible to
run PIP solely as a Regional Aid scheme, as most projects we would
wish to target would be ineligible. We informed EP and the RDAs
on 22 December that PIP was therefore closed from that date. No
new applications for gap funding under PIP could be accepted after
22 December 1999, so unless a former PIP proposal was eligible
under the Commission's transitional arrangements (at formal application
stage by 22 December) it fell.
(ii) We need to put in place short term measures
to clarify what RDAs may do
In the short term, in order to establish clearly
for the RDAs exactly what the Commission's interpretation of the
State Aid rules will allow us to do, we have notified the Commission
of a number of new schemes—two are for aid to developers
for both bespoke and speculative schemes within Assisted Areas—these
would provide gap funding, and would be State Aid, but should
hopefully be acceptable under the Regional Aid framework. Further
new schemes have also been notified—a revised direct development
scheme, environmental and neighbourhood renewal schemes (none
of which would be State Aid). We are currently answering questions
from the Commission on the first of three notifications and the
Commission's decisions on these are awaited. They cannot however
be implemented (even if approved) until the Commission also approves
a new Assisted areas map for the UK.
(iii) Direct development and funding consequences
for the RDAs of moving to a predominantly direct development approach
In the meantime, the RDAs have only one avenue
to pursue regeneration projects of the type funded under PIP—direct
development. Under this route, the RDAs or another public authority
would have to purchase the regeneration sites, and then either
undertake some or all of the development themselves, (or with
public sector partners) or enter into a partnership with a developer
(via an open competitive bidding process). Although RDAs already
use direct development to a limited extent, it has not been the
preferred approach for physical regeneration because of its costs,
and the fact that it limits the valuable private sector input.
(iv) Consequences over the longer term
On the longer term future of partnership working
in regeneration, DGIV recognised that their decision will make
joint working with the private sector very difficult in future.
They therefore invited us to submit information
on the regeneration problems we are trying to address and offer
ideas on how these might be met within the State Aid rules. We
have now presented two papers reviewing the problems, and explaining
why the existing State Aid rules do not offer any potential alternatives
which would enable us to fund the number and range of projects
supported under PIP. We have suggested that a new framework for
regeneration within the scope of the State aid rules might provide
the answer.
(v) Possible new regeneration framework
An agreement with the Commission to issue a
new framework for the approval of aid in the regeneration field
indicating that they consider appropriate physical regeneration
projects to be compatible with the existing State aid rules in
the Treaty of Rome would be the preferred solution. If the Commission
accepts the concept of a new framework, then any subsequent scheme
would have to be within its scope and would have to be made subject
to strict conditions to prevent the possibility of abuse of the
State aid rules, by any Member State. These conditions are likely
to include restrictions such as limits on the levels of grant,
a limitation on the development costs which may be considered
eligible for the calculation of grant, and strict requirements
for clawback. It is within the Commission's power to allow a new
framework within the Treaty, if they are convinced of the need.
(vi) Public procurement exercises
One of the Commission's objections to PIP was
the fact that proposals came forward from the ultimate recipients
of the support (the developer/landowner) rather than from the
public sector. We have considered whether a full and open procurement
exercise involving a set of criteria for development in a certain
area, with bids invited from site owners in that area, might offer
a partial solution. We are raising this approach with the Commission.
THE SCALE
OF PUBLIC
FUNDING REQUIRED
TO ENABLE
ALTERNATIVE SCHEMES
TO PRODUCE
EQUIVALENT RESULTS
1. The immediate available alternative to
gap funding is direct development. This has the disadvantage of
being considerably more expensive than gap funding in the early
years. Once recipients begin to come back to the private sector
several years down the line, direct development may compare well
to gap funding in cost terms.
2. Direct development costs more than the
gap funding approach under PIP, as the public sector must acquire
the development sites up front and in some cases undertake some
or all of the development. This means that the public sector is
effectively replacing the valuable private sector contribution
in the early stages of the project. The financial consequences
of a predominantly direct development approach are currently under
consideration in the context of the Spending Review 2000.
WHAT PROVISIONS
SHOULD BE
CONTAINED IN
A NEW
REGENERATION FRAMEWORK?
1. We are asking the Commission to consider
a new regeneration framework. We are in the early stages of discussions
on this, and the Commission's deliberations are likely to be measured,
taking account of the position in other Member States. Our argument
for this framework is based on our view that physical regeneration
serves Community objectives of improving both the standard of
living and quality of life within the Member States, promoting
a high level of protection of the quality of the environment and
promoting sustainable development (as set out in Article 2 of
the Treaty of Rome). We consider that a new framework would promote
these Article 2 objectives.
2. We are deploying other arguments in support
of the new framework:
— that none of the existing frameworks
(for example for Regional aid or Environmental aid) serves regeneration
goals;
— that regeneration is a "horizontal"
issue where a framework could apply across the full range of economic
sectors (as opposed to the "sectoral" frameworks which
exist for State aid to particular industries, such as motor manufacture);
— and that all existing (and potential)
Member States could benefit from the existence of the framework
for furthering regeneration objectives.
3. If the Commission is able to accept the
idea of a new framework—and it is by no means clear that
they will—we will then move on to discuss its content with
them. We will wish to discuss conditions which make it possible
for us to support a wide range of projects across all areas of
England. The Commission will clearly wish to ensure that any new
arrangement would not leave open the possibility of abuse of the
State aid rules, and would be applicable across the whole EU.
June 2000
| 
