Catch-22

Allister Hayman, Regeneration & Renewal, 15 August 2008

But the EC wants them to claw the cash back. It's a classic state aid snag that other remote parts of the UK will recognise, says Allister Hayman.

Shetland islanders are used to isolation. When the plane is grounded by sea fog, as it often is, it's 13 hours by ferry to Aberdeen from the Shetlands. The islands, pawned to Scotland in the 15th century as a dowry from a Danish king, are the British Isles' northernmost point and seem impossibly remote from the Westminster village. The Shetlands flag is a common sight around the islands: the white cross on a blue background droops from garden poles or flutters furiously from car windows. While they're not exactly gripped by nationalism, the Shetlanders do have a strong sense of their own identity and independence.

So it is a source of intense irritation that plans for the islands' economic future are being stymied by regulations imposed from afar - not in this case by Whitehall, but by the even more distant Brussels. Last November, the European Commission ruled that £1 million of Shetland Islands Council (SIC) funding was deemed to have contravened EC rules on state aid. The council had used the money to finance a 13-year programme to improve the islands' fishing industry. The cash was used to revamp a fish processing factory, modernise fishing vessels and provide individual grants of £7,500 to 78 young people to help them enter the trade. But Brussels ruled that the recipients must repay the money - with compound interest - saying the funding contravened EU rules on fair competition (R&R, 25 January, p7).

The ruling was particularly galling for the Shetlands because the cash had come from a trust established and approved by the UK Government with the explicit purpose of fostering the Shetland's traditional industries. When oil was discovered in the North Sea in the 1970s, the Shetlands struck a special deal with Whitehall. Worried that the independently-minded Shetlands might break away from the UK and take the oil - seen in the 1970s as a panacea for all of Britain's ills - Whitehall agreed a deal with the SIC that gave the council the right to levy royalties on the oil production over and above the usual business rate. These revenues were squirreled away in a charitable trust and kept separate from council income to prevent the UK Government from cutting the subsidies it gave the islands. The oil fund was then used to pay for public works and services, welfare and economic development.

It is this oil fund that has enabled the SIC to become one of the richest local authorities in the UK and means the Shetlanders enjoy well-paved roads, a number of swimming pools and leisure centres, excellent care services for the elderly and top-ups to welfare provision, including a £226 bonus at Christmas for all pensioners. But with North Sea production having dropped 40 per cent since its peak in 1999, fears are growing that the EC state aid decision will prevent other attempts by the SIC to use the oil fund for what it was intended: to prepare the Shetlands economy for life after oil. Fishing and farming contribute three times as much to the Shetland's economy than oil, and council leader Sandy Cluness, an independent, says the implications of the EC decision could be far-reaching. "We have a number of schemes set up to foster traditional industries, such as fisheries and agriculture, but also new sectors such as renewables and communications," he says. "We fear that some of these might now be subject to complaint and it's making it very difficult to determine what we can and can't do in the future."

In January, the council asked the UK Government to intervene in the dispute. But the Department for Environment, Food and Rural Affairs (Defra) decided not to appeal against the EC decision because it said it had not received sufficient evidence, information or legal advice about the case from the Scottish Government. This was denied by Holyrood, which supported an appeal on the council's behalf, and said it had given Whitehall all the information necessary. A senior source at the EC says the commission found the UK Government's position strange. "The Scottish Government wanted to appeal so it seems very odd to me that the UK Government should say it was not given enough information," he says. "It seems more likely that they were disinclined to appeal and were passing the buck."

A Shetlands matter

This week a Defra spokesman denied that the Government was sitting on its hands and said the department "sympathised" with the fishermen. But he said the case "was a matter for the Shetlands" as it was the islands' council, not the UK Government that had launched the appeal. For his part, Cluness is stoical. He says he didn't expect the Shetlands' problems to be a high priority in Westminster, but says they may have had "a more amicable result" had the Scottish Government been able to lead the appeal. "But in any case, we're used to doing things on our own," he says.

The council is appealing the EC decision on the basis that both the UK Government and the European Union knew of the scheme since its inception in 1992 and the council had a "legitimate expectation" that it complied with EC rules. Cluness had hoped that the EC would accept the application of de minimis rules to the case (which exempt aid that is considered so small or trivial that it has a minimal impact on the market). This would mean the £7,500 grants made to the 78 first-time fishermen - which with compound interest now total around £16,000 per person - would not have to be recovered. In March, however, the EC ruled out the application of de minimus, and confirmed that the SIC funding must be recovered. But Cluness says the council doesn't want the money back. "That's the irony. If we lose the appeal, we're £1 million richer, but we don't want the money. We'll be in a position where we will have to claw it back, but in some cases the recipients have moved on, or they're not in the industry anymore, or they're dead."

Hansen Black, chief executive of the Shetland Fishermen's Association, says the EC ruling could damage the islands' fishing industry, particularly following the downturn in the whitefish industry, a consequence of overfishing and subsequent EU quotas. "Any attempt to claw back that money is going to lead to significant hardship," he says. "Most of these guys now have young families and mortgages. It'll be a major kick in the teeth and may be enough to tip some of them into bankruptcy." The Shetlands have a real problem in keeping their young people on the islands and Black says the first-time shareholders scheme was designed to give young people a helping hand into the industry. "The money was not a lot when you consider the whole cost for the fishermen's boat and gear might be over half a million pounds," he says. "If the EC thinks that's going to distort competition then it's disconnected from reality."

Zealous officials

When examining the EC decisions in more detail it is easy to assume that Brussels officials are being overzealous. The fish factory is the only facility on the islands that processes waste fish products unfit for human consumption. It is therefore a key part of the industry as a whole, as it deals with waste that other factories would otherwise have to pay to be removed. Yet the EC ruled that all payments made to the factory by the islands' council were incompatible with the common market, save those used to reclad one of the company's buildings, "the purpose of which is to seal the building and thereby reduce foul air emissions". This was deemed permissible state aid as it constituted an environmental, rather than an economic, measure. For similar reasons, in the fishing vessel modernisation scheme, grants to improve the safety, hygiene and working conditions of the main deck were deemed acceptable. But grants to replace engines, clutches and pumps were not, as they affected the power of the vessel - with a new clutch a vessel could, presumably, beat a rival to a shoal of cod. Meanwhile, the grants to new fishermen were ruled incompatible for two reasons: the vessels purchased were under 20 years old; and the scheme's requirement that the fishermen use those boats for at least five years was half the ten years required by an EU worried about overfishing and therefore keen to constrict the trading bloc's fishing fleet.

The senior EC source agrees that the decisions "can seem ridiculous", but he says that the commission is simply working under EU law. "The rulings work on precedent," he says. "Each particular case can have ramifications beyond it, so any exemptions can only be those allowed under the regulations. But yes, there is a lot of confusion out there and it can be extremely complicated."

The EC has made efforts to clarify some of its regulations. In July, the General Block Exemption Regulation (see box) increased the number of aid schemes that do not need to be submitted to the EC for formal approval. The UK Government welcomed the move, saying it simplified the process for a wide range of state aid schemes and would allow the commission to concentrate on larger, potentially more market-distorting forms of aid.

But the measures don't help the Shetlands. Douglas Irvine, head of business development at the islands' council, says the GBER is welcome, in that any loosening of the regulations is to be applauded, but it does not resolve many of the islands' state aid problems. "We cannot attract inward investment into our economy," he says. "Many of the projects we would like to do simply aren't viable on commercial terms." Irvine speaks wistfully about plans for a modern slaughtering facility that could process and package Shetland lamb to add value to the product. "But to do it on purely commercial terms is simply not possible," he says. "There needs to be a substantial subsidy, but that's been knocked on the head by state aid regulations."

Fewer aid rows

Since an EU state aid ruling forced the UK Government to abandon its Partnership Investment Programme, a gap-funding scheme for urban regeneration in England, there have been few state aid rows in England. A new regeneration framework, regional development agencies, and the regional discretionary aid scheme set up to establish grants to deprived regions clarified many of the parameters of state aid. But while exemptions exist for disadvantaged regions, they don't apply to remote islands. This is largely why Scotland, with its many outlying islands, has had a spate of state aid cases, most recently concerning subsidies the Scottish Government pays to two ferry firms that run services between the mainland and the Shetlands and Orkneys (R&R, 25 April, p9). Irvine says that many of these problems would be resolved if the EC adopted an exemption for remote island communities. "With an exemption, we could use the oil funds as intended," he says. "But as it stands, we have to work within the regulations and we're largely hindered from doing that."

There have been unpleasant consequences as a result of the state aid ruling. Last month, the council's plans to build a cinema and music venue on an old dock in Lerwick were subject to a state aid complaint. "What's happening now is that any project that has an element of controversy to it is being subject to a state aid complaint," Irvine says. "The process of anonymous complaints is being used by detractors, for political reasons, to delay or halt schemes that would be for the good of the islands as a whole." The EC source agrees that "there's something unpleasant" about anonymous complaints, and that the process can be used mischievously. "But if we have any reason to believe that there might be a question of illegal state aid we must investigate it," he says. Irvine says the state aid complaints are harming the confidence of the Shetlands community. "People see projects being proposed and then delayed or knocked back and that makes them question whether the islands have an economic future," he says. "The oil industry is winding down and this is the time when we really should be investing in our future, but we are being constrained from doing so. We're pretty resilient people, but we're genuinely concerned about the impact this is having."

The Shetland islanders are used to sea fog. But the clouds rolling in from Brussels are of a more menacing nature, and the islanders fear they're unlikely to clear any time soon.

A LOOSENING OF RED TAPE

The General Block Exemption Regulation introduced in July widens the scope of state aid schemes that do not need to be formally approved by the European Commission. Its aim is to simplify the process for a wide range of aids, allowing the EC to focus on larger forms of aid that are more likely to distort the market.

For the first time, aid will be exempted in the fields of environmental protection, risk capital, research and development, innovation, female entrepreneurship, and aid for new small enterprises. The measure also lifts the ceiling for the amount of aid that can be granted for investments in small- and medium-sized enterprises, training and employment.

As long as the aid complies with the terms of the new regulation then it need only be registered with the EC and does not require formal approval.