The Right Hon. Jack Straw MP Secretary of State for Foreign and Commonwealth Affairs Downing Street LONDON SW1A 2AL United Kingdom Commission Européenne/Europese Commissie, B-1049 Brussels – Belgium – Telephone: + 32 2 299 11 11 EUROPEAN COMMISSION Brussels, 25.I.2006 C(2006)83 final Subject: State aid NN 64/2005 – United Kingdom Digital Replacement Licences Sir, 1. PROCEDURE (1) By letter of 11 February 2005, registered on 15 February 2005, the UK authorities notified the Commission of new financial terms for the holders of Digital Replacement Licences (“DRLs”). According to the UK authorities, the measure does not constitute State aid in the meaning of Article 87(1), but was notified for reasons of legal certainty. The notification was registered under the case number N 74/2005. By letter of 11 April 2005, the Commission services sent a request for information to which the UK authorities replied by letter of 11 May 2005, registered on 17 May 2005. (2) On 29 June 2005, the UK authorities announced in a press release that the review of the financial terms of the DRLs had been concluded and that a corresponding offer had been made to the licensees. The UK authorities informed the Commission of this step by letter of 30 June 2005. By letter of 7 July 2005, the Commission informed the UK authorities that it considered the notified measure to have been put into effect within the meaning of Article 88(3) EC. Accordingly, the registration of the case was changed into NN 64/2005. 2. DETAILED DESCRIPTION OF THE MEASURE a. Background: System of DRLs and Additional Payments (3) In December 2004, Ofcom, the regulator for the UK communications industries, issued new licences to the terrestrial broadcasters Channel 3, Channel 4, Channel 5 and Public Teletext. These licences replace existing analogue broadcasting licences and contain various obligations related to the switchover from the analogue terrestrial television (“ATT”) to the digital terrestrial television (“DTT”) transmission, including a target switch-off date of 31 2 December 2012. Accordingly, the new licences are called Digital Replacement Licences (“DRLs”). The licences took effect on 28 December 2004 and will be valid for a 10-year period until 2014. (4) The scope of the DRLs encompasses both means of terrestrial transmission which currently exist, i.e. ATT and DTT.1 A crucial element of the new DRLs is the obligation requiring the broadcasters to replace the existing analogue terrestrial coverage with an equivalent digital terrestrial coverage. At the moment, it is estimated that 98.5% of UK households can receive analogue TV signals for the four main analogue broadcasters,2 while currently only 78% can receive the digital terrestrial signals.3 (5) In return for the licences, Channel 3, Channel 5 and Public Teletext have to pay a licence fee called “additional payments”.4 The additional payments have the purpose of ensuring that the State receives a fair value for providing broadcasters with a scarce resource of high economic value being the analogue frequency spectrum for broadcasting. In 2004, the total additional payments for all terrestrial transmission licences amounted to approximately £230 million. The value of the licences is established about every 6 years by Ofcom, however, with the attribution of the DRLs in December 2004, licensees were granted the right to ask for review of the financial terms of their licences. This has triggered the latest review which was completed at the end of June 2005. As a result, the additional payments for 2005 will fall to approximately £90 million.5 (6) Due to the regional structure of Channel 3 (also often referred to as “ITV”), there are in total 18 DRLs which require additional payments: 15 regional Channel 3 licences; one Channel 3 licence that is national in coverage but limited to breakfast time (GMTV); the Channel 5 licence; and the Public Teletext licence. Of these 18 DRLs, 16 licences were subject to financial reviews upon request of the licensees.6 1 Separate licences exist for cable and satellite transmission. 2 This applies to the channels BBC 1, BBC, 2, Channel 3 (ITV) and Channel 4/S4C. In contrast, Channel 5 achieves a significantly lower level of coverage of 85% through analogue terrestrial TV, see DRL Consultation of 14 September 2004, paragraph 160. 3 Concerning the actual use of ATT, figures from September 2004 provided by the UK authorities indicate that approximately 44% of households in the UK have only analogue television receiving equipment. A Commission report of 2003 gives the higher figure of 53.2% for the penetration of terrestrial TV reception compared to 15.6% for cable and 31.3% for satellite (EU Commission, 9th report on the implementation of the telecommunication regulatory package. Annex 1: market overview, SEC (2003)1342). 4 C4C and S4C, the regional divisions of Channel 4, do not operate on a commercial basis in the same way as Channel 3, Channel 5 and Public Teletext licence holders. Both organisations are publicly-owned corporations which do not operate to make a profit and are therefore not subject to the same system of additional payments. 5 Under the current licence terms, annual payments to the Treasury for all Channel 3 and Channel 5 licences combined would fall to approximately £180 million in 2005, primarily as a result of the growth of digital households, see Ofcom press release of 29/06/2005. 6 Only one regional Channel 3 licensee, Channel TV, and the Public Teletext licensee did not request a review of their financial terms following the award of the DRLs. Licensees who did not apply for a review of their financial terms then could however choose to do so at a later date. In the meantime, Public Teletext has in fact requested a review. 3 b. Review of Additional Payments and role of DSO obligations (7) The basis of the review of the additional payments is specified in a statement on the “Methodology for reviews of financial terms for Channel 3, Channel 5 and Public Teletext licences” published by Ofcom on 13 October 2004 (the “Methodology Statement”). The general objective of the review is to arrive at a fair and objectively justified determination of the market value of the licences. The market value is defined as the value that a licence would realise if it were offered on the open market through an auction. Accordingly, it is determined by taking into account all rights and obligations included within the licence. For those rights and obligations for which a market price does not exist, a discounted cash-flow approach is used. The value of the DRLs is influenced in particular (i) by the value of access to the scarce analogue spectrum for television, (ii) by the value of access to (less scarce) digital spectrum and (iii) by the public service obligations as to programming and coverage for ATT and DTT. (8) In the notification, the UK authorities stated that the review of the financial terms of the licences would lead to on overall decrease in the additional payments. It is argued that this decrease reflects a decline in the overall economic value of the licences. The reason is that DTT uses the frequency spectrum four to five times more efficiently than ATT so that more channels can be broadcast and the scarcity value of the analogue licences diminishes considerably. As a result, there will be more competition between channels to attract viewers and advertising. The DTT network, which is also known as Freeview, hosts already now more than 30 programme channels compared to only five programme channels in the ATT network.7 In fact, once ATT is switched off and terrestrial transmission will only be in digital mode (planned by the end of 2012 at the latest), the broadcasters will not pay any additional payments any more. (9) Until then, the value of the licence, and thus the licence fee, are still influenced inter alia by the continuing presence in analogue transmission and by the obligations with respect to the digital switchover (“DSO”). The DRLs contain in particular the following two DSO obligations: a) After switch-off of the ATT, the licensees will be under a duty to procure coverage of their service in digital terrestrial form equivalent to, or substantially the same as, the analogue coverage currently achieved. In total this imposes a duty on all licensees to convert to digital all 1,154 current analogue transmitters.8 b) The licences contain 31 December 2012 as a backstop date by which all licensees shall be obliged to cease broadcasting their analogue service. Moreover, licensees commit to a region by region timetable for DSO. (10) These obligations will, on the one hand, entail costs to the broadcasters concerned because the broadcasters will have to convert all currently 1,154 analogue transmitters to digital. On the other hand, the higher coverage relative to the current DTT coverage is likely to allow broadcasters to increase their revenue from advertising, sponsorship and other airtime revenues. 7 In the coming years, the number of programme channels in the DTT network may increase to between 50 and 60 due to the use of currently idle capacity and due to further advances in compression technology, see Enders Analysis: Freeview Plus, June 2005. 8 The only exception is Channel 5, see footnote 2. 4 c. Argumentation of the UK authorities Award of DRLs and review of financial terms (11) The UK authorities argue that the review of the financial terms accomplished in June 2005 is a separate exercise from the award of the DRLs in December 2004. To quote from the Ofcom consultation document of 14 September 2004, paragraph 44: “Although linked, the grant of the replacement licences and the possible review of their financial terms are separate, both chronologically and procedurally.” In paragraph 38 of the same document, Ofcom mentions, however, how the award of the DRLs and the review of the financial terms are linked: “The issue of the DRLs by Ofcom by the end of 2004 is linked with other statutory obligations of the regulator. One such obligation is to review the financial terms of DRLs after they have been issued to Channel 3, Channel 5 and Public Teletext if these broadcasters apply for a redetermination”. Moreover, Ofcom’s methodology statement for the review of the financial terms explicitly discusses the effects of the DSO-related obligations on the valuation of the DRLs.9 No aid because no economic advantage (12) In the notification, the UK authorities maintain that the measure does not constitute aid because the review of the financial terms constitutes an advantage neither to the licence holders, i.e. broadcasters, nor to any other operators in the DTT transmission supply chain. (13) The UK authorities argue that the general purpose of the system of additional payments is to ensure that the licence holders do not derive any value from holding a DRL other than the opportunity to earn a fair rate of return on capital employed. Under the system, any value attributable to the licence in excess of a fair return is extracted from the licensee (through the periodic revaluation) and paid to the Exchequer. (14) The value of the licences is determined by Ofcom in its periodic review on the basis of a methodology designed to identify, objectively, the price that each licence would be likely to realise in the open market. The value will therefore take into account the market value of all relevant rights and obligations associated with the licence, and will be based on an objective and up-to-date assessment of market conditions. No advantage can therefore arise for broadcasters resulting from the operation of the additional payments system. Any change in payments following this periodic review will do no more than reflect a change in the market value of the licence. (15) The additional payments system also ensures that no advantage can arise from any change in the rights or obligations contained within the DRLs. Any positive or negative effect associated with a change in rights or obligations will be reflected in the valuation, and lead to a corresponding effect on the additional payments due from the licensee. (16) The UK authorities conclude that the review of financial terms undertaken by Ofcom cannot give rise to aid, as no economic advantage can result from a change in those terms. Arguments for compatibility 9 See Methodology Statement of 13 October 2004, figures 2, 3 and 4 and section 5. 5 (17) In their notification, the UK authorities have not made any compatibility assessment. In particular, the notification does not invoke Article 86(2) even though it lists and explains the public service obligations contained in the DRLs. 3. ASSESSMENT OF THE MEASURE UNDER ARTICLE 87(1) OF THE EC TREATY (18) The Commission has examined first whether the present measure can be characterised as State aid within the meaning of Article 87(1). The Treaty lays down the following conditions for presence of state aid. First, there must be an intervention which confers an advantage on the recipient. Second, the intervention has to be done by the State or through State resources. Third, it must distort or threaten to distort competition. Fourth, it must be liable to affect trade between Member States. Economic advantage (19) To determine whether or not the review of the financial terms of the DRLs confers an economic advantage on the licensees concerned, it needs to be examined to what extent the change in the additional payments relieves the licensees of costs which they would normally have to bear in carrying out their activities. (20) In this respect, it should be noted that, according to the current state of Community law, the attribution of the present type of licence does not have to take place at market prices.10 It has however been the choice of the UK regulator to award DRLs against payment of a fee that is meant to reflect their market value. It can therefore be considered that the market value represents the benchmark of the ‘normal costs’ that operators have to bear when acquiring a TV licence in the UK. Ofcom’s methodology statement defines and explains in detail the criteria for establishing the market value of the DRLs which underlines the efforts of the UK regulator to determine the market value in an objective and transparent manner. The valuation methodology has also been subject to extensive public consultation.11 (21) It is also noted that the attribution process of the DRLs expressly foresaw the possibility for licence holders to ask for review of the financial terms of the licences. The reassessment of the additional payments is therefore an intrinsic element of the licensing process, aiming at bringing the fee in line with the market value of the DRLs, and not a discretionary measure aimed at relieving licensees of their normal operating costs. In fact, the additional payments have also in the past been subject to periodic review and re-determination by the regulator, to ensure that the terms remain proportionate, objectively justified and non-discriminatory. (22) The valuation methodology adopted by the UK authorities has the very purpose of calculating the market value of the DRLs by quantifying the costs and benefits of all rights and obligations related to the licences. Based on this calculation, the additional payments absorb the entire market value of the DRLs except for a reasonable return to the licensees on 10 Article 13 of Directive 2002/20/EC of the European Parliament and of the Council of 7 March 2002 on the authorisation of electronic communications networks and services (Authorisation Directive), OJ L 108, 24/04/2002, p.21 which can be applied in analogy in the present case. 11 Ofcom publication: Consultation on reviews of financial terms of Channel 3 licences, 26 January 2004; Ofcom publication: Consultation on methodology for reviews of financial terms of Channel 3 licences, 29 June 2004; Ofcom consultation: Offer to bring forward periods for reviews of financial terms for Channel 5 and Public Teletext licences, 22 July 2004; Ofcom consultation: Digital replacement licences to be offered to channels 3, 4, 5 and public teletext, 14 September 2004. 6 their use of capital. Any profit attributable to the licensed service over and above the reasonable return is recovered for the public purse. The valuation methodology thus aims at making sure that, at any time and for any licence holder, the costs and benefits of all rights and obligations are taken into account in the calculation of the additional payments and, hence, no advantage is granted to any licence holder. (23) The UK authorities have provided the Commission with a full description of the valuation methodology applied in the revision process and of the elements on which the assessment was based. After analysis, the Commission does not find any grounds for objecting to the methodology or the assessment of the UK authorities. Conclusion (24) On the basis of the information provided by the UK authorities and of the above considerations, there are no indications that the review of the additional payments provides an economic advantage to the concerned licensees. 4. DECISION (25) In the light of the foregoing, the Commission has decided that the measure under investigation does not confer an advantage and does therefore not constitute State aid within the meaning of Article 87(1) EC. If this letter contains confidential information which should not be disclosed to third parties, please inform the Commission within fifteen working days of the date of receipt. If the Commission does not receive a reasoned request by that deadline, you will be deemed to agree to the disclosure to third parties and to the publication of the full text of the letter in the authentic language on the Internet site: http://europa.eu.int/comm/secretariat_general/sgb/state_aids/ . Your request should be sent by registered letter or fax to: European Commission Directorate-General for Competition Directorate H State Aid II Building/Office J-70, 4/08 B-1049 Brussels Fax No: +32.229.51373 Yours faithfully, For the Commission Neelie Kroes Member of the Commission