The death of FFP, the birth of FSR - Net Equity Rule

Introduction

The shifting sands of European football’s legal landscape has seen another major change. The UEFA Club Licensing and Financial Fair Play Regulations (FFP Regulations), introduced in 2009, have been replaced by a new set of rules, the UEFA Club Licensing and Financial Sustainability Regulations (FSR). This change heralds the departure of the controversial “Financial Fair Play” from the lexicon of football regulations.

UEFA announced last year that it intended to replace the FFP Regulations with a new set of rules in order to address the recent challenges encountered in European football and to promote and ensure the sustainability of the game. The efforts have yielded the FSR, which came into force on 1 June 2022. The long-time applicable break-even requirement as a financial metric for the stability of a club will continue to apply for the 2022/23 season, but will subsequently be abandoned. 

Instead, clubs’ financial performance from football-related activities will be evaluated against a range of new measures. One such measure is the net equity rule, which we break down in this post.

Net Equity Rule

The net equity rule, found at Article 69 of the FSR, aims to improve clubs’ balance sheets by incentivising them to maintain a positive equity position. A similar rule was contained in the FFP Regulations (the negative equity indicator), though without any serious sanctions for non-compliance. Under the “old rules”, the breach of the negative equity indicator would only trigger obligations for the club to (i) deliver future financial information to demonstrate the ability to continue as a going concern; and (ii) prepare break-even information for the reporting period T. 

The net equity rule will come into effect on 1 June 2023, though for the first two seasons of its existence non-compliance with this rule will not lead to licence refusal, but to a sanction to be determined by UEFA. The rule will limit the ability of clubs to load their balance sheets with debt in order to acquire new players, on the basis that the costs for acquisition of such players are recognised on the balance sheet as an intangible asset, which is typically amortised faster than the repayment of the loan used for the acquisition. Such an approach may consequently reduce the club's equity if the club is unable to cover the disparity on its balance sheet due to an unsatisfactory financial performance.

(A) The requirement

The net equity is measured on the 31 December preceding the deadline for submission of the club’s licence application. The requirement is met by the applicant if the net equity position (i) is positive or (ii) has improved by 10 % or more since the previous 31 December. 

(B) The fallback

Article 69.03 of the FSR provides for a fallback in case the requirements have not been met as at 31 December. The applicant can submit a new audited balance sheet by 31 March at the latest in order to demonstrate compliance with the net equity requirement.

(C) The exception

An alternative assessment date for the net equity position can be requested by the applicant if its financial year ends on 31 May, in which case it may rely on interim financial statements prepared for a six-month period ending on 30 November. In the event its financial year ends on 30 November, such annual financial statements for the reporting period ending on 30 November may be used for the calculation of the net equity position.

(D) Net equity calculation

The rules on the calculation of the net equity are found at Article 69.02 of the FSR. It is a balance sheet exercise whereby the liabilities are deducted from the assets as set out in the applicant’s annual financial statements or interim financial statements, as applicable. If the assets exceed the liabilities, then the applicant’s equity position is positive and if the liabilities exceed its assets, the applicant has a negative equity position.

(E) Adjustment

The FSR allows for calculations of the net equity to be adjusted to factor for any subordinated loans. Article 69.04 of the FSR stipulates that certain preconditions must be met for an adjustment to be made: the subordinated loans must be (i) for at least the following 12 months subordinated to all other liabilities; and (ii) non-interest bearing. The first precondition seeks to ensure that the net equity position will not deteriorate until the next testing date, in case such subordination ceases to apply. The objective of the second precondition is to avoid any leakage and to guarantee true subordination (of both the principal of the loan and any interest accruing). If these conditions are met, the subordinated loans may be added to the net equity result to improve the applicant’s net equity position.

The second precondition will need to be interpreted broadly. While it is customary in financing structures that no interest payments are made to the subordinated lenders (which could be intra-group lenders or external financiers), interest is embedded in the terms of the loan. Such interest is not paid in cash, but it is capitalised (the so-called payment-in-kind or PIK). If external financiers are providing the subordinated loan, they will have no economic rationale to do so without receiving a yield. If the subordinated loan is granted by an intra-group lender, the lack of interest on the loan may breach applicable tax legislation related to base erosion and profit shifting (see OECD BEPS Action Plan endorsed by G20 and the EU). Non-interest bearing requirement should, logically, allow for (and not exclude) subordinated loans with capitalised interest. Otherwise, the adjustment mechanism will rarely be applied in practice.

Comment

These are long-awaited changes to European football’s financial regulations and expectations are high. However, UEFA will push for patience as the (European) football world enters a transitional period and clubs adjust to the new rules. The net equity rule (being just one of several new measures*) appears to be more stringent than its predecessor in the FFP Regulations (the negative equity indicator). But it will be a couple of seasons before we can determine whether the new rules have had their intended effect – to promote the long-term viability and financial sustainability of European football. 

*Please contact the authors if you would like any advice on the new measures.

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