UEFA Say Fair Play To Arsenal

Some time tomorrow in a nondescript, modern building overlooking Lake Geneva in Switzerland, football’s great and good, also known as UEFA’s Executive Committee, will meet to implement the snappily titled Club Licensing and Financial Fair Play Regulations. This vision was first given the green light in UEFA’s September 2009 meeting and they are now expected to approve their March 2010 draft proposal, which requires clubs to break-even from the start of the 2012-13 season, if they wish to qualify for European competitions like the Champions League. In the slow-moving world of football bureaucracy, it is striking how quickly UEFA has managed to translate the initial concerns of President Michel Platini, who had described clubs borrowing to buy sporting success as “financial doping”, into a practical, workable document.

UEFA’s aim is no less than “protecting the long-term viability and sustainability of European club football”. Under this financial fair play concept, clubs will have to balance their books and operate within their financial means, thereby helping restore stability to the European game. Clubs will be required to spend no more than they earn to “introduce more discipline and rationality in club finances and to decrease pressure on players’ salaries and transfer fees.” They will be forced to settle their liabilities on a timely basis, but will also be encouraged to invest for the good of the club in areas such as youth development and infrastructure (stadium, training ground).

"Only thing bust about Arsenal"

This is probably all beginning to sound very familiar to Arsenal fans, who have observed the club investing in these themes over the last few years, but wait, it gets even better. In order to ensure a level playing field, UEFA have also targeted the influence of wealthy benefactors. General Secretary Gianni Infantino baldly stated, “It will not be possible for the big sugar daddy to just write-off a cheque at the end of each season”. President Platini went further, encompassing clubs financed by mountains of debt, when he called the initiative the end to “success on credit”.

In recent seasons, many clubs have reported repeated financial losses, which have been getting worse. The wider economic situation has created difficult market conditions for clubs in Europe, negatively impacting revenue generation and creating additional challenges for clubs in respect of availability of financing. Many clubs have experienced liquidity shortfalls, for instance leading to delayed payments to players, other clubs and even the tax authorities (Portsmouth) with auditors questioning the ability of some to continue as a going concern (Liverpool, Hull City).

In February UEFA published a mighty tome entitled “The European Club Footballing Landscape”, a financial survey of more than 650 clubs all over Europe, which contained some jaw-dropping statistics. Gianni Infantino reported, “We found that 50 per cent of those clubs are making losses every year, and 20 per cent of them are making huge losses, spending 120 per cent of their revenue every year.” He said that the primary reason for the losses is wage and transfer inflation, driven by clubs relying on owner finance or debt, “Around one third of the clubs are spending 70 per cent or more of their revenues on wages. Revenues across European football grew by 10 per cent last year, but the salaries of players and coaches have gone up by around 18 per cent.”

"Gianni Infantino looking through the books"

While such over-spending “may be sustainable for a single club, it may be considered to have a negative impact on the European club football system as a whole.” As Infantino said, “The problem is that all clubs try to compete. A few of the biggest can afford it, but the vast majority cannot. They bid for players they cannot afford, then borrow or receive money from their owners, but this is not sustainable, because only a few can win.” In other words, the richest clubs drive up players’ salaries and transfer costs, forcing smaller clubs to over-stretch their budgets to compete. Intriguingly, UEFA’s draft proposal states, “clubs will therefore be assessed on an individual basis as well as in the wider context of the European club football environment.” Not sure how they are going to achieve that, but it sure sounds good.

Debt may be a four-letter word for UEFA, but apparently loss is an even worse one, as the break-even requirement is described as the “cornerstone” of the new regulations. Gianni Infantino again, “We are not speaking about debts. We are speaking about losses. Debt per se is not necessarily a bad thing. The problem with debt is the cost of the debt, for example the interest you have to pay, and this can create a loss. We are focusing on the losses.” The key principle is that a club should always aim to at least break-even excluding expenditure for the long-term benefit of the club and must not repeatedly spend more than the income it generates.

So how do England’s finest fare under the new regulations? Of the seven teams that qualified for Europe this season, four of them fail to break-even – and by a long way. As we can see in the table above, Chelsea, Manchester City, Aston Villa and Liverpool are the offenders. This should come as no great surprise, as three of those clubs are funded by rich owners, most obviously with Roman Abramovich at Chelsea and Sheikh Mansour at Manchester City, but also to a lesser extent with Randy Lerner at Aston Villa. In marked contrast, Liverpool are not, having to bear the considerable burden of loans arising from the Hicks and Gillett takeover, which resulted in £40m interest payments last year.

That leaves just three clubs making a profit (Arsenal, Manchester United and Tottenham), but even this is misleading and over-states the situation. United’s profit only arose after last summer’s £80 million sale of Cristiano Ronaldo to Real Madrid, which is hardly likely to be repeated every year. Without this once-off factor, United would have reported a hefty loss thanks to their crippling £70 million interest payments. Despite this, United’s Chief Executive David Gill has claimed that the club would not fall foul of the new regulations, “We have seen what the proposals are and we would meet the financial break even rules.” Hmm. His confidence was not shared by the club’s bond prospectus, where the risk factors included the following, “These rules are intended to discourage clubs from continually operating at a loss. There is a risk that, in conjunction with increasing player salaries and transfer fees, the financial fair play initiative could limit our ability to acquire or retain top players and, therefore, materially adversely affect the performance of our first team.”

"David Gill - trust me, I'm an accountant"

What about Spurs? Although they don’t have to make huge interest payments, they are actually in a similar position to United, as their profit was only due to significant player sales of £57 million (Dimitar Berbatov to United and Robbie Keane to Liverpool). Without this, they would also have made a loss. Indeed, in the subsequent interim accounts for the six months up to 31 December 2009, Tottenham reported a loss before tax of £8.3 million. It looks like Harry Redknapp is beginning to work his magic on another club, as the impact of all his player purchases begins to bite. Sooner or later, this strategy will feed through into higher player amortisation, as, like all clubs, Spurs have to capitalise the cost of acquiring a player and then write-off that cost over the period of the player’s contract. To place this into context, Tottenham’s amortisation costs of £38 million are higher than United’s, but their revenue is only 40 per cent of Old Trafford’s franchise.

No, the only one of these clubs that is genuinely profitable is Arsenal, even after excluding the money made from property sales. Again, this should not raise too many eyebrows, as UEFA had already advised that Arsenal was the only major English club that would meet the financial fair play criteria today.

"Away From The Numbers"

The more financially astute will already have noticed that UEFA’s break-even template is subtly different from a regular profit and loss account. As they almost said on Star Trek, “It’s a P&L, Jim, but not as we know it.” The UEFA template introduces the concept of relevant income and expenses, which looks complicated, but is essentially a variant of the good old “carrot and stick” incentive that tries to achieve two goals: (a) encourage clubs to make sensible long-term investment; (b) close any loopholes which might allow clubs to artificially meet the break-even target.

Let’s take the positive aspect first. Clubs will still be permitted to borrow for “good” projects like improving the stadium or training facilities. Any costs associated with this investment, like interest on loans to fund the construction or depreciation on the resultant fixed assets, are excluded from the break-even calculation. In other words, an excess of expenses over income may still be allowed if the excess is solely related to costs that are for the long-term benefit of the club. As Infantino explained, “We are also saying losses can be admitted, if the money is invested for long-term purposes — developing a youth academy for example or infrastructure. This of course can lead to a loss in the short-term, but in the long-term it will be beneficial for the club, help increase the revenues.”

So the costs of building the Emirates Stadium would be removed from Arsenal’s relevant expenses, as indeed would the depreciation. Eagle-eyed observers will have noticed that this guideline appears to greatly benefit Manchester United, as they can deduct £44 million of depreciation and amortisation, largely because they report £35 million amortisation of goodwill. In accounting terms, goodwill arises after the acquisition of a subsidiary and represents the difference between the purchase price and the fair value of the net assets. This is capitalised like any other asset and amortised over the estimated useful economic life. This deduction makes a huge difference to United’s profitability. Maybe this is why David Gill was so confident of United meeting UEFA’s new regulations?

"Moneyball"

On the other hand, UEFA are clearly no mugs, as they have addressed some of the more obvious ways of getting around the new regulations. Many clubs these days have an intricate inter-company structure and there were fears that a club like Liverpool could argue that the football club was profitable, as their massive interest was paid out of the club’s holding company. Clearly, that does not make sense to any reasonable man and UEFA have caught that one, “For the calculation of relevant expenses, management must include any expenses incurred in the reporting period in respect of the activities of the club that are not otherwise recorded in the audited annual financial statements of the reporting entity that forms the basis for preparation of the break-even calculation.”

Next, they have anticipated the possibility of a wealthy owner paying a ridiculous £200 million to sponsor his team by embracing the concept of “related parties” and “fair value” so beloved of tax authorities when reviewing inter-company transactions. In short, if an owner over-pays for services, this income will be adjusted down to a fair value, i.e. what the club would have received if the transactions were conducted on an “arm’s length” basis. Enough tax jargon for you? The guidelines list specific examples like sale of sponsorship rights and use of executive box, but I wonder whether this regulation might also apply to interest-free loans? After all, banks don’t usually provide loans without charging interest.

UEFA wish to exclude any income and expenses from non-football activities, which are “clearly and exclusively not related to the activities, locations or brand of the football club”. This might be a factor for Arsenal, as any profit made from future property sales at Highbury Square, Queensland Road, etc would presumably be excluded from the break-even calculation. On the other hand, this might benefit a club like Barcelona, if they can eliminate the £24 million losses they make on other sports (basketball, handball and hockey).

However, you would not expect UEFA to be too tough on their meal ticket and, sure enough, they revealed the velvet fist inside the iron glove by making a number of concessions to Europe’s top clubs. The most significant is that there will now be a phased implementation over five years. The scheme will still kick-off (if you’ll excuse the pun) in 2012, but there will be a three-year transitional period and it will not be fully operational until 2015. As David Gill said, “If clubs are not complying now, then there is time for them to get their house in order.” Or, as cynics might say, there will be time for clubs like Manchester City to accelerate their spending before the regulations take full effect.

Furthermore, in the same way that British transport classifies trains as being “on time” if they are only ten minutes late (or something like that), UEFA have stretched the definition of break-even to include an “acceptable deviation”. Losses that are not underwritten by club owners are allowed up to a total of €5 million over three seasons. To be fair, Infantino’s explanation makes sense, “You can have losses for one year, because perhaps you had one bad season and you did not qualify (for Europe). So we are looking at losses over a multi-year basis. So one year you can make a loss, but not over three years.”

Less justifiable is the acceptable deviation for billionaire owners, who will be allowed to absorb aggregate losses of €45 million over three years from 2012, so long as they are willing to cover the club’s losses by making equity contributions. To be fair, the maximum permitted loss then falls to €30 million from 2015 and will be further reduced from 2018 (to an unspecified amount). This means that in the transition (weaning-off) period, owners can pump in an average per season of €15 million up to 2014 and then €10 million up to 2017. After that, who knows? Perhaps break-even will actually mean what it says by then.

Maybe the soft landing is why the top clubs have given UEFA’s initiative their support. The European Club Association (ECA), which represents the 137 leading clubs in Europe, voted unanimously to approve the proposal at their General Assembly with their chairman, former German international Karl-Heinz Rummenigge, declaring, “these measures will shape the future of European club football into a more responsible business and ultimately a more sustainable one.” According to Platini, “The owners are asking for rules, because they can’t implement them themselves. Many of them have had it with shoveling money into clubs. They asked me to do something – Roman Abramovich asked me, the owner of Manchester City agreed – and I think it’s very moral. And it’s not just the biggest clubs – it’s all the clubs.”

"Pointing the way"

The owners might also have been stunned into action when Portsmouth went into administration. If a club from the world’s richest league could crash in this way, what about the rest? Inter’s Chief Executive, Ernesto Paolillo, admitted, “The old times are finished. Sometimes you need a shock and this is it.” At the same Soccerex Forum, Sevilla’s vice-president, Jose Maria Cruz, said that half a dozen Spanish clubs faced bankruptcy. Whether clubs are a going concern is clearly in UEFA’s thoughts and the regulations specifically require a club to “prove that it has no payables overdue towards other football clubs arising from transfer activities and towards employees and social/tax authorities.” This is evidently a major issue with the Footballing Landscape report listing €1,650 million of transfer debts, including €550 million over 12 months old. To put this more bluntly, clubs are fielding players that they have not paid for.

Although UEFA will come down hard on clubs that owe money to those in the “football family” (other clubs or players) and the unforgiving tax man, they appear more sanguine about debt in general. Platini and Infantino have both said that debts will be permitted if clubs can service the payments, so the issue is not so much the level of debt as whether the interest payments can be covered. UEFA have effectively acknowledged that debt can be an important tool for funding growth, but they want it to be manageable. However, they have expressly commented on the debt at Manchester United and Liverpool, “Just over half of the Premier League’s commercial debt has been placed into the clubs as a result of leveraged buy-outs, acting principally as a burden rather than to support investment.”

Some have argued that this UEFA initiative is one reason why the owners at Chelsea and Manchester City have wiped out their clubs’ debt by converting loans into equity, but I’m not sure that it makes much difference. Given that the loans were effectively interest-free, in terms of the break-even calculation, this is simply moving money from the left pocket to the right.

"Stuck in the middle with you"

However, it does affect one of the financial ratios used by UEFA as “warning signs”. A red flag will be raised if net debt exceeds annual turnover and the club will be asked to provide additional information, including proof that the debt level is sustainable. UEFA helpfully define net debt as “the borrowings of the club less cash” with borrowings including loans from banks and the owner. Journalists, please note that it does not include accounts payable or trade creditors.

Although they have resisted calls for a salary cap, another warning sign occurs if the wages to turnover ratio is over 70 per cent. In a slightly contradictory statement, Infantino explained the thinking on salaries, “The limit would be the break-even rule. You could spend 80 per cent on salaries, if the rest of your costs are 20 per cent. But if your other costs are higher, then the salaries will have to go down.”

Monitoring of the clubs and their adherence to the rules will be overseen by the newly-formed Club Financial Control Panel, which will be made up of financial and legal experts, who will conduct audits to ensure that the system is applied correctly. Chairing the panel will be former Belgian Prime Minister, Jean-Luc Dehaene, which is an example of how seriously UEFA is taking financial fair play. Michel Platini described Dehaene as being “very experienced in financial matters and a great football fan. He is the ideal person to take charge of the economic destiny of European football.” We shall see. If this Panel believes that the requirements have not been fulfilled, it can refer the case to the scary sounding Organs for Administration of Justice with the ultimate sanction being a ban from UEFA competitions.

"Jean-Luc Dahaene - a formidable figure"

Obviously, the introduction of such a scheme will not be without difficulties. Platini himself admitted, “It is not easy, because we have different financial systems in England, France and Germany. In England you can have debts; in France you’re not allowed to have debts; and in Germany you get relegated to the second division (if you have debts).” As always, the devil is in the detail and we can already anticipate many tedious arguments from lawyers and accountants. Nevertheless, the break-even analysis is based on accounts that have been audited and we must hope that common sense is applied during any disputes.

The other major concern is that far from making football fairer, all this initiative will achieve is to make permanent the domination of the existing big clubs: survival of the fattest, rather than the fittest, if you will. The argument goes that those clubs that have already reached the promised land of the Champions League will continue to benefit from the highly lucrative broadcasting revenues, while the challengers will no longer be able to spend big in a bid to catch up. This may be why Abramovich’s support may be considered a tad hypocritical, as he has already spent his millions to join this exclusive club.

"Back off, Europe!"

This is one of the reasons why the Premier League has reservations. Chief Executive Richard Scudamore said that he was opposed to any limits being set on the ability of owners such as Sheikh Mansour to invest money in their clubs. A spokesman went further, “The benefactor model of investment is not one the Premier League wants to see outlawed. We don’t want to discourage investment in our league, which has benefited clubs of all sizes.” There is something to this, but, for me, the financial fair play regulations are the lesser of two evils. They might make it more difficult to gatecrash the party, but they will stop clubs like Portsmouth (and Leeds in the past) gambling their future to “live the dream”. As Platini argued, being financially supported by a single backer is not sustainable, as he might run out of money (or might never had any). Of course, an Arsenal fan might also point out that their club has managed to qualify for the Champions League for many years without spending any money.

The Premier League contends that it has introduced its own financial criteria, which give them increased powers of scrutiny and intervention and will go a long way to preventing another “Portsmouth”. Clubs will have to submit annual accounts and budgetary information. Scudamore explained, “If the board believes the club is at risk of not being able to meet its obligations, then it has to step in and agree a budget for the running of that club. It has the ability to embargo any transfers or, and I think this is a first, to stop clubs renegotiating upwards any player contracts and remuneration.” Not sure about you, but his words don’t exactly inspire me with confidence.

"Ivan Gazidis - fair comment"

Will all these regulators have the bite to go with their bark? Expelling teams from European competitions works fine on paper, but would it ever happen in reality, especially when you consider that Europe’s most indebted teams are among those that attract the largest television audiences. Would UEFA really bite the hand that feeds? Indeed, one of the members of the Club Financial Control Panel admitted that there was a risk that aggrieved clubs “could fly off into the ether and form their own competition.”

Let’s end on a positive note and leave the last word to Arsenal’s Chief Executive, Ivan Gazidis, “The fundamental issue that we all face is do we have the courage and fortitude to control our spending in a fairly irrational environment. If we can manage that, there's no reason why anyone can't have a long-term stable business in football.” Can’t say fairer than that.