The adjustments in the business units, in particular the cessation of the aviation business unit and the reduction in the international real estate and the shipping segments, will automatically lead to a reduction of the ‘miscellaneous segment’.

The ‘miscellaneous segment’ includes – besides the corporate centre – the capital markets business, in which HSH manages its treasury and which serves as a supplier of products for the business units.

HSH will consistently reduce capital market business with a high risk potential and has already reduced its product catalogue significantly. Proprietary trading has already been discontinued.

Paragraphs 33 et seq. of the Impaired Assets Communication require identification of eligible assets and their organisation into categories of assets (baskets). Detailed guidance on the definitions of those categories is provided in Annex III to the Impaired Assets Communication. The variety of assets covered by the risk shield goes beyond the basket system covered by the Impaired Assets Communication. However, paragraph 35 of the Communication allows for additional flexibility in the identification of eligible assets. It allows banks to be relieved of impaired assets that are not covered by paragraph 33 without a specific justification, but only for a maximum of 10-20 % of the overall assets of a given bank. However, since [around 75] % of HSH’s balance sheet is covered by the risk shield, paragraph 35 of the Impaired Assets Communication does not provide a satisfactory solution here.

Lastly, paragraph 36 of the Impaired Assets Communication allows for wider eligibility criteria if the measure is compensated by in-depth restructuring. The greater the proportion that guaranteed assets represent in the portfolio of a bank, the more thorough the restructuring that the bank will have to undergo. In the Decision initiating the procedure the Commission expressed its doubts regarding the eligibility of assets because the initial restructuring plan submitted to it at that time was not sufficiently far-reaching to adequately compensate for the flexible application of the eligibility criteria. HSH submitted the modified restructuring plan on 11 July 2011. The modified restructuring measures comprise a balance sheet reduction of around 61 %, divestment of […] shareholdings and closure of 15 out of 21 international locations. They allow the Commission to conclude that the depth of the restructuring compensates for the flexible application of the Impaired Assets Communication as regards the eligibility of assets. Consequently, the Commission’s doubts regarding the eligibility of assets have been allayed.

In recital 45 of the Decision initiating the procedure, the Commission expressed doubts about the compatibility of the guarantee in relation to the management of assets on the basis that there was no evidence of a clear functional and organisational separation between HSH and the shielded assets as all assets would remain on HSH’s balance sheet; this applied in particular to management, staff and customers.

Germany provided additional information, explaining that HSH had set up a restructuring unit which was an internal winding-down bank with separate management. HSH had introduced segment-based reporting, including separate management for the restructuring unit, so that no conflict of interest between the core bank and the restructuring unit could arise. The Commission agrees with the comments from Germany on management of assets as summarised in recital 115 of this Decision, and accepts the changes introduced by HSH in the management of assets. Consequently, the risk shield is in line with the requirements of the Impaired Assets Communication with regard to the management of assets.

In recital 45 of the Decision initiating the procedure the Commission also raised doubts about the valuation of the shielded portfolio, because only a small portion of the portfolio had been valued by independent experts, and HSH had not provided enough information for the assessment of the REV of the entire portfolio. Prior to the implementation of the measure HSH had appointed two independent experts, Blackrock and Cambridge Place. They had valued only a small fraction of the shielded portfolio, namely the assets-backed securities (ABS) and parts of the CIP portfolio.

Valuation should follow a general methodology established at Union level. At the Commission’s request, HSH and its external expert Morgan Stanley conducted a full valuation of the portfolio in close cooperation with the Commission’s experts. The underlying assumptions applied by HSH in the valuation were in line with the severe stress scenarios applied by the Commission in other cases. A consistent methodology has therefore been applied.

The result of the valuation was that the expected losses would considerably exceed the EUR 3,2 billion first-loss tranche and exhaust the EUR 10 billion second-loss tranche […]. The valuation of the portfolio showed that the REV lies […], at around EUR [155-170] billion (around EUR [172] billion minus EUR 3,2 billion minus EUR [2,5-10] billion).

The valuation was conducted in line with the conditions set out in the Impaired Assets Communication and the Commission therefore takes the view that its doubts as expressed in recital 45 of the Decision initiating the procedure have been allayed.

In recital 42 of the Decision initiating the procedure the Commission raised doubts about the compatibility of the measure with regard to transparency and disclosure, in so far as Germany had not provided a full valuation of the assets of the shielded portfolio carried out by a recognised independent expert.

In accordance with paragraph 20 of the Impaired Assets Communication, applications for aid should be subject to full transparency and disclosure of impairments by eligible banks on the assets which will be covered by the relief measures, based on adequate valuation, certified by recognised independent experts and validated by the relevant supervisory authority. The information on the impaired assets should be provided with the degree of detail suggested in point II and Table 2 of Annex III to the Impaired Assets Communication.

Since the adoption of the Decision initiating the procedure, detailed information about the shielded portfolio and the assets has been provided to the Commission. The valuation determines the REV of the portfolio at around EUR [155-170] billion. The capital relief effect of the risk shield was calculated to be [around EUR 3,5] billion. Morgan Stanley has officially signed and validated the valuation, including the underlying assumptions and the applied methodology. The capital relief effect of the measure was confirmed by BaFin in February 2010. The capital relief effect calculated on the basis of the asset valuation differs from the Commission’s preliminary assessment in recitals 51 et seq. of the Decision initiating the procedure. The Commission accepts the result of the valuation and the calculated capital relief effect submitted by Germany. In view of the outcome of the investigation, the comments that Germany made on the capital relief effect no longer need to be addressed.

The Commission’s doubts regarding adequate transparency and ex ante disclosure have been allayed.

Section 5.3 of the Impaired Assets Communication requires incentives for banks to participate in an impaired asset relief measure to be aligned with public policy objectives, through (a) a six-month maximum enrolment window, (b) mechanisms to ensure participation by banks most in need of asset relief and (c) appropriate behavioural constraints to, among other things, limit the impact on competition.

The guarantee was specifically designed for HSH and tailored to its particular situation in the light of its systemic importance to the economy of the public-sector owners. In the context of the modified restructuring plan, HSH will be subject to a number of behavioural commitments, in particular related to the payment of coupons and dividends, corporate governance, remuneration and market presence in specific sectors such as shipping.

Based on the above, the risk shield for HSH is compatible with the requirements of the Impaired Assets Communication with regard to alignment with public policy objectives.

In recital 49 of the Decision initiating the procedure the Commission expressed doubts about the adequacy of the burden sharing. Under paragraph 24 of the Impaired Assets Communication, HSH should be requested to contribute to the loss or risk coverage in the form of first-loss clauses (typically with a minimum of 10 %). Adequate burden sharing can also be ensured by higher remuneration or ex post compensation. In addition, in recitals 51 et seq. of the Decision initiating the procedure, the Commission expressed doubts that the fee of 400 bps adequately remunerated the risk taken by the public-sector owners.

Paragraph 41 of the Impaired Assets Communication states that for any impaired asset measure an adequate remuneration must be secured for the State. An adequate remuneration for an impaired asset measure is one that would remunerate the regulatory capital impact of the measure. Thus the capital relief effect should be adequately remunerated.

As explained in recital 46, HSH has proposed to pay a guarantee fee of 400 bps for the risk shield. Thus, depending on the scenario, HSH will pay EUR [> 1,5] billion (no drawing of the guarantee), EUR [> 2,5] billion (EUR 5 billion drawing) or EUR [> 4] billion (EUR 10 billion drawing).

As [around 220] bps on the outstanding guarantee amount is an acceptable approximation for 6,25 % on the capital relief amount, the Commission is satisfied that 6,25 % per annum on the capital relief effect will always be paid to HSH Finanzfonds AöR. The capital relief remuneration can accordingly be considered to be in line with the Impaired Assets Communication.

In addition, paragraph 41 of the Impaired Assets Communication requires the transfer value for asset purchase or asset guarantee to be based on the REV of the assets.

According to the Commission’s valuation of the risk shield, the guaranteed value of around EUR [168] billion was set too high (above the REV) and the first-loss tranche too low when designing the guarantee measure. The difference between the guaranteed value and the REV is EUR [2,5-10] billion. The consequence should be a ‘correction’ of the guaranteed value and an increase in the first-loss tranche. Germany has provided evidence that it is not possible for HSH to pay back EUR [2,5-10] billion, and does not accept such a claw-back. However, even though HSH is unable to increase the first-loss tranche by EUR [2,5-10] billion in order to cover the expected losses, the difference could, pursuant to paragraph 41 of the Impaired Assets Communication, also be recovered at a later stage, for example through some combination of a claw-back mechanism and far-reaching restructuring measures.

The remuneration would result in an insufficient claw-back through the basic premium. Therefore, to achieve a full claw-back, the difference between the REV and the transfer price not covered by the basic premium of 400 bps remains to be paid to the State by HSH. Depending on the scenario, that difference ranges from EUR […] billion to EUR […] billion.

As Germany and HSH refuse to increase the payment in that respect the aid measure cannot be approved as compatible under Article 7(3) of Regulation (EC) No 659/1999.

The Commission observes that the modified restructuring plan does demonstrate that it is impossible to ask for an additional claw-back payment of between EUR […] billion and EUR […] billion without threatening HSH’s viability, because a full claw-back would consume its profits over the entire restructuring period and beyond, based on the projections in recital 91 above.

Nevertheless the Commission considers that the compatibility of the aid measure might be ensured if a remuneration system were put in place that allowed for a correction in line with the rules established by the Impaired Assets Communication and the Commission’s decision-making practice regarding claw-backs and remuneration. Paragraph 41 of the Impaired Assets Communication in fact specifies that it can be acceptable for the transfer value (guaranteed value) of the assets to exceed their REV if there is far-reaching restructuring and if conditions are introduced that allow for the recovery of the additional aid at a later stage. In sum, paragraph 41 of the Impaired Assets Communication leaves some room for accepting partial claw-backs if adequately compensated through restructuring.

In the case in hand the Commission considers that a partial additional claw-back could be obtained if a combination of measures were implemented.

First of all, the Commission considers that, to the greatest possible extent (and without undermining HSH’s return to long-term viability), the payment of any additional claw-back should be made immediately and not deferred any longer than necessary. It has therefore investigated the possibility of an upfront payment. As explained in recital 90, the Commission requested HSH to include in the financial projections a one-off lump sum payment of EUR 500 million in 2011. The financial projections in recital 91 above demonstrate that HSH is able to pay such a lump sum amount of EUR 500 million to the State. Such a payment would consume all of HSH’s expected profits and is expected to lead to a EUR [150-200] million net loss for 2011. However, that loss can be absorbed in subsequent years and will not prevent HSH from establishing a track record of consistent profits (representative of its business profitability) for all the remaining years of the restructuring period. Such a track record will be necessary to demonstrate HSH’s return to long-term viability and ultimately to improve its ability to attract investors. On that basis, the Commission considers that EUR 500 million is the largest possible upfront contribution towards an additional partial claw-back that HSH could afford.

However, in any event, the Commission does not consider that the amount clawed back up front needs to be paid back to the State in cash. Given HSH’s capital situation, which to date has been insufficient to cover losses from its investing activities or to contribute to the strengthening of its capital basis, the Commission considers that the lump sum payment of EUR 500 million could be made in shares rather than in cash. HSH’s capital position needs to be reinforced, in particular in view of the fact that it will continue to operate and focus on business lines which exhibit a strong pro-cyclicality and volatility, such as ship financing, as explained in detail below (see recitals 223 to 226).

If more than this additional premium had to be paid it would endanger HSH’s ability to achieve a common equity ratio of 10 %. For the reasons set out in recitals 223 to 226 and further explained in recitals 229 to 232 below, the Commission considers that achieving a level of capitalisation sufficient to buffer variations in the financial performance of HSH resulting from swings in the economic cycle is crucial in order not to compromise its return to viability. Such a sufficient buffer is considered to be a common equity ratio of 10 %. Thus if the additional premium were to compromise that ratio, its payment should be deferred to the extent necessary to avoid compromising HSH’s viability.

On that basis, the Commission considers that it would be possible for HSH to make further payments during future years without impeding its ability to return to viability.

Based on the above considerations, and in order to ensure the compatibility of the risk shield with the Impaired Assets Communication, the Commission requires an alternative remuneration mechanism which alters the guarantee provision agreement concluded on 2 June 2009 as follows. It should be based on the existing basic premium in the guarantee provision agreement in the amount of 400 bps p.a. on the nominal amount of the outstanding guarantee. That basic premium should remain unchanged, except that any drawings under the guarantee would no longer reduce the nominal amount of the guarantee for the purposes of calculating the premium. This avoids providing incentives to draw the guarantee. In addition, the basic premium should be supplemented by an additional premium amounting to 385 bps and a lump sum payment of EUR 500 million in ordinary shares (‘lump sum payment’ or ‘lump sum payment in shares’). In order to implement these conditions the initial guarantee contract needs to be amended as set out in recitals 201 to 208.

First, the additional premium needs to be added. The basis for the calculation of the additional premium should be similar to the basis for the calculation the basic premium, namely the nominal amount of the guarantee reduced by partial cancellations but not by drawings. However, the basis for the additional premium should depend on the extent to which HSH ultimately cancels the guarantee regardless of the timing of such cancellations. Thus, HSH’s profitability would be affected only to the extent that it makes actual use of the guarantee. Therefore, upon partial cancellation, the portion of all the paid additional premiums corresponding to the amount of guarantee cancelled should be reimbursed to HSH. In order to achieve that effect, whilst both premiums are to be calculated on the contractually agreed guarantee amount reduced by cancellations but not by drawings, the basic premium should be paid on an annual basis on the outstanding guarantee amount but the additional premium should be set aside into a reserve account. The additional premium would be paid to HSH Finanzfonds AöR only if the guarantee is drawn. On the other hand, upon partial cancellation of the guarantee, the additional premium set aside in the reserve account corresponding to the cancelled amount should be repaid to HSH.

In order to ensure that cancellations are not performed at the expense of viability, partial cancellations of the guarantee should be carried out only as long as they do not result in the ratio of HSH’s common equity falling below [8,5-9,5] % as at 31 December 2011, [9-10] % as at 31 December 2012, [9,5-10,5] % as at 31 December 2013 or [10-11] % as at 31 December 2014. Further, a partial cancellation may not take place if, despite the ratios being met at the time of the partial cancellation, this would no longer be the case in the light of conservative estimates for the following years.

The additional premium should be calculated retroactively from 31 March 2009 and on a pro rata basis for parts of financial years. The additional premium should be payable together with the basic premium as long as HSH’s common equity ratio is at least 10 % (the ‘minimum common equity ratio’).

In order to ensure that HSH’s viability will not be endangered by the payments of the additional premium, the claw-back mechanism should contain a debtor warrant (Besserungsschein). The debtor warrant should have a maturity of up to 31 December [2030-2040]. If HSH’s common equity ratio were to fall below the minimum common equity ratio because of the additional premium, the payment would be delayed and transformed into a debtor warrant. If the common equity ratio increased above the target, the debtor warrant would be repaid up to the limit of that target. That mechanism gives HSH the necessary flexibility but at the same time ensures that the claw-back will be paid at a later point in time once it is again in a situation to pay.

The deferred additional premium entitlement should be completely restored for the duration of the debtor warrant. The additional premium will be payable until 31 December [2015-2025] at the latest. In any case, the basic premium and the additional premium should be payable at the latest until the sum of partial cancellations and drawings on the guarantee reaches EUR 10 billion.

Second, HSH Finanzfonds AöR and HSH should be required to amend the initial guarantee provision agreement by adding a claim by HSH Finanzfonds AöR against HSH to a lump sum payment amounting to EUR 500 million. In order to prevent further reductions of HSH’s own capital ratio, that claim should be payable by HSH in ordinary shares by means of a capital increase. The issue price is to be calculated on the basis of the value of HSH as of the day of the resolution of the general meeting of shareholders on that capital increase, and the net value of the lump-sum payment claim. HSH should issue shares corresponding to the net amount of the claim directly to HSH Finanzfonds AöR (and thus indirectly to the public-sector owners).

The capital increase can take place either through an ordinary contribution in kind, with no right of option for minority shareholders, or through a mixed capital increase by way of contribution in kind and cash, with a right of option for all shareholders other than HSH Finanzfonds AöR regarding the cash portion. It is up to HSH Finanzfonds AöR and HSH to choose the form of the capital increase which will ensure speedier implementation and entry in the commercial register.

The Commission acknowledges that, in spite of the additional conditions imposed, in all the scenarios set out in Table 13 the remuneration mechanism will still result in only a partial claw-back of the EUR [2,5-10] billion gap between the REV and the guaranteed value (EUR […] billion in scenario 1, EUR […] billion in scenario 2 and EUR […] billion in scenario 3).

The risk shield allows for a partial claw-back and is combined with far-reaching restructuring. It consequently meets the requirements of paragraph 41 of the Impaired Assets Communication and falls within the outer limits of the range observed in the Commission’s decision-making practice. Furthermore, the HSH guarantee remuneration mechanism provides a partial claw-back in all possible scenarios. In particular, if the full amount of the guarantee were to be drawn (as in scenario 3), that partial claw-back would amount to […] % of the claw-back required. At the same time, as illustrated below at recitals 266 to 270, the restructuring of HSH will lead to a 61 % downsizing of its balance sheet. Considered in combination with the present extent of the restructuring, that partial claw-back is in line with the Commission’s decision-making practice. Therefore the Commission is of the view that the impaired asset measures can be considered compatible with the Impaired Assets Communication if the conditions described above and further detailed in Annex II are met.

On the basis of the foregoing, the Commission concludes that the comments provided by the Member State and third parties have not allayed its doubts regarding the risk shield. In the Commission’s view, the risk shield is not in line with the Impaired Assets Communication as regards the points examined in section 9.2.2 of this Decision. However, compatibility can be achieved under the conditions laid down in Annex II to the present Decision.

1. (i)

   lead to a restoration of the long-term viability of the institution;

2. (ii)

   include a sufficient contribution of the beneficiary’s own (burden sharing);

3. (iii)

   contain sufficient measures limiting the distortion of competition.

In line with its practice during the financial crisis, when assessing the restructuring requirements the Commission will not add the amount of liquidity guarantees to the amount of aid.

The Decision initiating the procedure raised doubts on the ability of HSH to restore its long-term viability. Those doubts were confirmed by an in-depth viability analysis performed after the adoption of the Decision initiating the procedure.

In the Decision initiating the procedure, three main areas were identified as major weaknesses likely to jeopardise HSH’s long-term viability which had not been properly addressed in the initial restructuring plan: (a) HSH’s dependency on wholesale funding, (b) its reliance on volatile and cyclical activities and (c) the large size of its capital market activities relative to its banking activities. Furthermore, doubts were raised as to the sustainability of the growth rates and other assumptions used in the restructuring plan.

The Restructuring Communication indicates that, in order to limit the distortions of competition and to prevent moral hazard, (a) restructuring costs and (b) the aid amount should be limited, and there should be a significant own contribution. The Restructuring Communication states further that, in order to keep the aid limited to a minimum banks should first use their own resources to finance the restructuring. The costs associated with the restructuring should not be borne only by the State but also by those who invested in the institution. These include shareholders and subordinated bondholders.

The Restructuring Communication requires that the restructuring plan contains measures limiting distortions of competition and ensuring a competitive banking sector. The Restructuring Communication indicates, in point 30, that the measures to limit the distortion of competition created by the aid should be tailor-made to address the distortions identified on the markets where the beneficiary bank operates following its return to viability after restructuring. The Commission in its assessment should take as a starting point the size, scale and scope of the activities of HSH.

In the Decision initiating the procedure, the Commission viewed the proposed measures to address distortion of competition as insufficient. However, the modified restructuring plan provides more measures to address distortion of competition.

Further, HSH has given a commitment to reduce the number of its international branches or representation offices from 21 to 6 and the number of national branches from 9 to 7. The remaining branches or representations in London and New York will also be substantially downsized and the branch in Luxembourg will remain solely as a branch of the restructuring unit.

HSH has given a further commitment to observe an acquisition ban during the restructuring period (until 31 December 2014). HSH will not expand business activities through the acquisition of other firms. Landesbank mergers remain possible, subject to the Commission’s approval. Debt-to-equity-swaps and other usual asset management measures are allowed as long as they do not lead to a circumvention of the acquisition ban. If the public-sector owners relinquish control over HSH, then the acquisition ban will apply for three years only. The Commission considers that the privatisation of HSH would have a positive effect on HSH’s viability and ensure effective competition. The continuation of the acquisition ban significantly beyond the date of sale could hinder a possible privatisation process.

In conclusion, the proposed measures to limit distortion of competition constitute a material improvement to the steps taken by HSH in the initial restructuring plan, and are viewed as appropriate and sufficient.

The Commission comes to the conclusion that the restructuring measures, including Germany’s commitments in Annexes I and III, are such as to restore the long-term viability of HSH, for an adequate contribution on HSH’s own part, and make up for the distortion of competition due to the aid measures in question. Under the conditions in regard to remuneration and burden sharing which are to be imposed by the Commission, and which are specified in Annex II, the modified restructuring plan also provides for adequate and sufficient burden sharing, and therefore may be deemed to be compatible with the internal market in accordance with Article 107(3)(b) TFEU.

Finally, the Commission considers that the aid contained in the EUR 17 billion of liquidity guarantees provided by Soffin constitutes compatible restructuring aid in so far as it was necessary to address a market failure, in the form of the collapse of the interbank market.