Denmark Guarantee Scheme

The General State Guarantee was part of a two-part package that became known as Bank Package I. First, it declared that all banks that were members of the private consortium of Danish banks known as the Private Contingency Association (PCA) were automatically covered by an unlimited guarantee on deposits and debts to unsecured creditors until September 30, 2010. Banks not already members could sign up until October 13, 2008. Once an institution joined the guarantee it was not an option to opt out, but non-compliance with the conditions could lead to exclusion.

Second, it created a state-owned Winding-up Company called Finansiel Stabilitet that would secure payment of creditor claims to distressed institutions and handle the controlled dismantling of financial institutions that no longer met solvency requirements.

The Individual State Guarantee was introduced as part of a multi-part scheme today known as Bank Package II. First, it introduced a guarantee scheme for newly issued debt (by banks and other credit institutions) to be administered by Finansiel Stabilitet. Second, it gave banks access to capital through preferred shares acquired by the government, for a total of potentially up to DKK 100 billion. The Ministry of Economic and Business Affairs administered the recapitalization scheme.

The General State Guarantee was based on an agreement from October 5, 2008, between the Danish government and a private consortium of Danish banks known as the Private Contingency Association. That agreement was then codified into law on October 10, 2008, in the Act on Financial Stability.

The Individual State Guarantee was enacted on February 4, 2009, through an Act to Amend the Act on Financial Stability.

The Danish authorities notified the European Commission (EC) on October 8, 2008, of the General Guarantee and received the EC’s approval on October 10, 2008, under a new, simplified protocol for emergency rescue measures. The Commission found the scheme to be “compatible with EU state aid rules because it [was] the most appropriate means to address the risk of a severe disturbance in the Danish economy, while keeping potential distortions of competition to a minimum through effective safeguard mechanisms” (State Aid: Commission 2008).

The Individual State Guarantee was presented to the EC on January 23, 2009, and received approval by the EC on February 3, 2009. The EC found that the measures of Bank Package II were “limited in time and scope, require[d] market oriented remuneration and contain[ed] sufficient safeguards to avoid abuses” and thus compatible with the EC Treaty (State Aid: Commission 2009).

As discussed in more detail below, the need to structure the Guarantees in such a way as to ensure EC approval significantly influenced the design of certain program features.

The total amount covered by the General State Guarantee is not readily available. However, when the General State Guarantee was enacted, the Danish government estimated the cost of scheme in terms of losses would be at least DDK 10 billion. The Private Contingency Association committed to contributing up to DKK 35 billion to cover initial losses on guaranteed debt. The Danish government committed to covering any and all losses exceeding the DKK 35 billion.

With the Individual State Guarantee, the Danish government estimated that the maximum amount issued would not exceed DKK 600 billion.

Program documents did not contain language limiting the amount of an individual institution’s participation in either scheme.

The General State Guarantee covered all Danish banks that were already members of the Private Contingency Association or that elected to join by October 13, 2008. Foreign banks registered in Denmark, including subsidiaries of foreign banks, could join the scheme fully. In addition, debt obligations of banks to foreign nationals were covered. Banks and branches participating in the General State Guarantee could not subsequently withdraw from the scheme. Failure to comply with risk restrictions or other behaviors could lead to exclusion from the Guarantee Scheme; it would not be possible for such bank or branch to re-enter.

Under the Individual State Guarantee, Danish banks, subsidiaries in Denmark of foreign banks, and Danish credit institutions which satisfied certain capital requirements in the Danish Financial Business Act were eligible to apply for a state guarantee for a specific issuance of debt granted on a case-by-case basis. The terms of the state guarantee were set out in an individual guarantee document with terms determined through negotiation between the credit institution applying for the state guarantee and the Winding-Up Company, Finansiel Stabilitet.

The General State Guarantee guaranteed all depositors and unsecured creditors against losses to the extent that those claims were not otherwise covered (cf. sections 132 and 136 of the Danish Financial Business Act). The guarantee did not include covered bonds (cf. section 16a of the Financial Business Act), nor did it cover claims based on tier 1 and 2 capital in the form of hybrid core capital and subordinate loan capital (cf. Sections 132 and 136 of the Financial Business Act).

The Individual State Guarantee covered specific existing and new unsecured debts and supplementary collateral (junior covered bonds), including commercial papers, senior unsecured bonds, supplementary securitized capital covered bonds, and new loans covering existing debt. Subordinated debt was not covered.

The non-inclusion of covered debt in the General State Guarantee came to be seen by many as an error that undermined the covered bond market. In seeking and obtaining approval from the European Commission for the inclusion of covered bonds in their own programs, Finnish and Swedish authorities specifically cited the example of Denmark, where the non-inclusion of covered debt in the General State Guarantee was seen as resulting in the drying up of that market. As noted, the Individual State Guarantee specifically included covered bonds.

The government does not appear to have established minimum maturity requirements for eligible debt under the Individual State Guarantee.

Programs documents did not contain language restricting the currencies that were eligible.

Under the General State Guarantee, the Private Contingency Association (PCA) paid an annual fee of DKK 7.5 billion for two years in addition to an initial DKK 10 billion. The PCA committed to paying another DKK 10 billion if losses surpassed DKK 25 billion; however, this condition was never triggered. Fees for individual banks were risk-adjusted and calculated by the PCA in relation to each bank’s required capital and solvency rules.

Under the Individual State Guarantee, beneficiary institutions paid a fee based on the Recommendations of the European Central Bank. These fees were risk-adjusted and based on the credit default swap (CDS) spread for the applicant credit institution. For banks with CDS data, the calculation of CDS spreads was based on “(i) the median value of 5 year CDS spreads over a sample period starting on 1 January 2007 and ending on 31 August 2008, or (ii) the median value of the 5 year CDS spreads during the same sample period for the rating category of the bank concerned, whichever is the lowest” (State Aid N31a/2009). For banks without CDS data nor representative CDS data who still had a credit rating, an equivalent CDS spread could be derived from the median value of five-year CDS spreads during the same sample period for the rating category of the bank concerned. The total price of the credit guarantee also included the add-on fee of 50 basis points. For banks without CDS/representative CDS data and without a credit rating, an equivalent CDS spread was to be derived from the median value of five-year CDS spreads during the same sample period for the lowest rating category.

After the third extension of the Individual State Guarantee, there was an increase in the guarantee fee based on the European Commission’s updated compatibility conditions for the renewal of guarantee schemes. Specifically, the guarantee fee was increased to be higher than the original pricing formula recommended by the European Central Bank in October 2008 at least by 20 basis points for banks with a rating of A+ or A, 30 basis points for banks rated A-, and 40 basis points for banks rated below A- or banks without a rating (State Aid N257/2010).

There were several other conditions relating to fees under the Individual State Guarantee: For issues of junior covered bonds the guarantee premiums would be determined on the basis of a market-based risk assessment. For both issues of unsubordinated and unsecured debt and issues of junior covered bonds, the maximum aggregate premium would not exceed 0.95 percent per annum. If the guaranteed loan was issued in a currency other than Danish kroner, the guarantee premium could be increased to reflect the increased costs involved with making payments in another currency.

For banks using both schemes, the benefits of the Individual Guarantee were free until the General Guarantee expired. As of October 1, 2010, banks that wished to be covered by the Individual Guarantee had to pay a fee for continued guarantees. By contrast, mortgage credit institutions and banks that were not members of the PCA had to pay a premium for the Individual Guarantee for its full duration.

Both guarantees shared the same additional requirement on executive compensation, dividend payment, balance sheet strengthening, reporting, and other behaviors. The Act on Financial Stability established a ban on dividend payments and share repurchases by banks as well as new stock options for management. Expiring stock option programs could not be renewed or extended. In addition, banks had to adopt a more cautious approach and strengthen their balance sheets during 2009 and 2010.

In addition, the schemes imposed other behavioral safeguards and monitoring and enforcement procedures. Banks participating in the schemes could not undertake mass marketing invoking the fact that the unsecured creditors were now insured against losses. Moreover, participating banks could not undertake a significant expansion of their activities which would not have taken place in the absence of the arrangement. The Private Contingency Association committed to reporting to the Danish Financial Supervisory Authority on any abuse by its members. The Financial Supervisory Authority committed to monitoring the banks based on a series of quantitative indicators such as growth in loans, exposure to certain sectors, concentration risk, growth in risk-adjusted loans, etc.

During the third extension of the Individual Guarantee, additional conditions were introduced including viability review requirements and an additional reporting obligation.

In 2012 the Finance Committee of the Danish Parliament decided to extend the Individual State Guarantee so that under certain conditions banks could extend or issue debt until the end of 2013 with an individual government guarantee expiring by the end of 2016.